DSCR Loans - Will Their Be Issues?

[Chris Seveney]

I am seeing a lot of posts in BP regarding DSCR loans, many based on newer investors not being able to qualify for more conventional loans.

The number I see starts to give me pause as when we have a market downturn and vacancies increase and expenses continue to rise, these properties could go Cashflow negative and I question whether a lot of newer investors have the capital to stick with a negative cash flowing property.

Not trying to scare anyone or say omg it’s a tidal wave of defaults, but has that given anyone else pause ?

[Alex Bekeza]

@Chris Seveney Delinquency on these DSCR loans taken in the last few years is actually still very low. A combination of low rates and decent underwriting. Most have required at least 6 months PITI reserves and most have had to clear DSCR based on the LOWER of market or actual rent. However, the crazy part is that they were typically underwriting those on a per property basis! (no global reserve requirement which is really pretty risky if you think about it).

I once submitted 19 DSCR refis for a guy at one time and watched the underwriter qualify assets address by address with the same bank statements which really only had enough to cover a few of the properties if you were to zoom out. In the real world he had additional assets he could have shown but this opened my mind to an interesting issue out there.

That being said, I'm one of those investors who has taken out a handful of DSCR loans in the last 2 years and I've definitely been aggressive in my approach to scaling the portfolio but to your point I'm focusing in the short term on reestablishing 12 months of PITI reserves per property, staying on the affordable side of my market, and giving some priority to section 8 applicants based on where things are headed and based on where I invest right now (affordability is key).

Another thing to consider is that all of these DSCR loans (with a relatively small amount of exceptions) have been capped at 75%-80% LTV meaning at least investors have some equity should they run into issues. I'm sure we'll see some value declines in various pockets of the country which appreciated too drastically in the last few years but the lionshare of DSCR loans are clustered in the midwest and south where it seems unlikely to me that we'd see 20%-25% drops. (I'm seeing prices continuing to army crawl uphill on 2-4s Saint Louis). Another aspect of so much of that loan volume being in that part of the country is that many of the DSCRs are excellent even with todays rates (1.5 + and 2.0 + are common for me to run across).

@Chad McMahan I've been noticing that some parts of Arizona will see DSCR constraints on SFRs as rates hit the 6s and 7s (thinking of PHX metro though not Sedona) but some cool new long term IO products have prevented some purchase fall out for investors recently because some DSCR lenders will simply calculate it based on the initial IO payment.

@Scott Trench Makes a great point.  Many people underwrite their deals for the best case scenario when it's best to do almost do the opposite and make sure your numbers are satisfactory after haircutting potential revenue and inflating expected costs. 

(I can't tell you how many people have sent me BP calculator PDFs to discuss a deal with assumptions that completely exceeded the best case scenario in the real world LOL).

Regarding supply, I have 14 units in a neighborhood that is still COVERED in dumpsters from out of state investors rehabbing in South City, Saint Louis so I am feeling the impact of a ton of rental competition coming online constantly but at the same time the neighborhood is rapidly improving so there's some give and take with that. Again, just makes me focus on remaining affordable.