Are DSCR Loans Still "Worth It" with Spiking Rates?

[Robin Simon]

Hi all - figured I'd share a thread recently posted on twitter running some numbers on whether DSCR loans still make financial sense in the current climate of spiking rates. Would love any feedback or thoughts, particularly from active investors, on whether our examples are lining up with your current experience and market

If you are a residential real estate investor, you are probably aware by now of the unprecedented recent rapid rise in rates https://fred.stlouisfed.org/series/MORTGAGE30US#0

What are DSCR loans? These are private-lender loans (not subsidized by quasi-gov agencies) on investment properties. Typically about 50-75 bps higher in rate BUT offer a lot of great features that make it worth it for a lot of investors:

1) No Income Verification - you qualify based on the cash flow of the property and personal credit, DTI is NOT utilized and your personal income is neither collected or scrutinized. No W-2? No Problem

2) No Tax Returns - Tax Returns are not collected either, so for whatever reason (privacy, "flags" that other lending programs will mark, etc) that you might not want to provide, not a problem

3) No Cap - A lot of investors will qualify and take advantage of low-rate conventional or bank financing and get their start with those loans? The problem, Fannie/Freddie will max you out at 7 investment properties and have other quotas. Once maxed, you can switch to DSCR

4) Flexible Underwriting - private DSCR lenders like @easystreetcap aren't beholden to gov edicts or bank regs. We can underwrite what makes sense and qual cash flows creatively and be ahead of the curve in innovation. Short Term Rentals, Crypto Reserves, Delayed Financing & more

OK sounds great - but rates were around 4.50% for this product three months ago - now its 6.50% or more (!) Does it make sense anymore to finance an investment property with a DSCR loan in this current environment?

The answer may surprise you, but in many cases it is not only a "Yes" - but the deal will make MORE SENSE and cash flow MORE in 2022 EVEN WITH drastically higher rates? How? Let's break down the numbers

Here's a representative sample deal we may have seen in late '21 - a fully-rented Duplex in a hot market (Nashville), worth $500k and renting for a total of $2,850 per mo. ($1,425 per unit). At 75% LTV and 4.5% Rate on a 30-year fixed, investors nets $716 a month w/ a 1.20x DSCR

Solid Deal and one that most investors would love to have. Fast-forward six months and how does this deal likely look?

A few assumptions: Let's say property has appreciated to $550k as prices still work higher in top mkts. Let's increase Tax/Ins 10% in line with inflation. Rent has skyrocketed too, esp. in top sunbelt markets, 30% is reasonable and somehow conservative. https://www.redfin.com/news/redfin-rental-report-february-2022/

And now the big one. Instead of 4.500% rate, a deal like this today would probably price out at 6.250%, a MASSIVE increase of 175 bps, or almost 40%. Does this kill the deal, or at the very least massively dent the cash flows and coverage earned by the Investor?

Here are the numbers:

Not only does the massive rise in rate not reduce, monthly cash flow, it INCREASES it almost $200 a month. And coverage improves? Counter-intuitive, but True.

Bonus: Our DSCR loans also have an IO option, where interest-only payments are required for the first ten years of the 30-year term, with the rate still fully fixed. Another counter-intuitive feature: even requiring higher rate for IO, the monthly payment is SMALLER

Heres the same deal example, tweaked (rate increases from 6.25% to 6.75%, but its an IO loan):

What happened? Even with the higher rate, the monthly cash flow INCREASES again more than $200, and the DSCR looks even better (little known fact: DSCR is calculated on the IO payment for these loans)

Summary (TLDR): Counter-intuitively, a lot of investment properties are actually cash flowing BETTER even when financing with much higher-rate loans (4.5% ->6.5%+). This is due to rent inflation outpacing even big rate spikes.

Remember as well, rents lag rates because most resi leases are 12-months and need time to roll and be replaced at market, so the cash flow picture is likely to improve. 

Agree, disagree, thoughts?  Are there markets where above is accurate or not accurate?

[Allan Smith]

What on earth. You can't add 30% rent increase and inflation to one calculation and not the other. This removes all credibility. Way too sneaky to make your loans look better.