Will Your Next Deal Cost you Further Deals?

If you have a few investment properties, or are even just planning to purchase your first, make sure the next deal doesn't hurt you going forward. It might seem like getting another property in your portfolio is always a good thing, but it is very important to not handcuff yourself down the road.

The BiggerPockets crew talk a lot about the velocity of money, which is how quickly you can get money to flow out of one investment and into the next. The faster you can get that money to move, the faster you can add properties to your portfolio. This does not mean you should try to get your next deal as quickly as possible. You should be looking at how quickly you will be able to get your money out of the next deal. You might find a great turnkey, cashflow property tomorrow that checks all the boxes you want in an investment, but ask yourself how quickly can you get your money out? If you have limited capital, and use it all for the downpayment of one property, how long will it take before you can afford another property? This is why the BRRRR strategy is so popular (If you don't know what that is you are probably on the wrong website). If done correctly, you can buy a BRRRR project, rehab it and hopefully get most or all of your capital out in a matter of months. That is good velocity for your money! But there is another way to make sure the deals will keep coming, keep your debt service coverage ratio as high as possible.

The debt service coverage ratio (DSCR) is one of the first things banks look at when they are deciding if they want to give you more money. Banks typically like to see 1.2 to 1.4 DSCR for investments or your overall portfolio. There are a lot of ways to keep your DSCR high which will make banks more willing to lend.

Keep your interest rates as low as possible and think twice about taking equity out of properties. One of the biggest advantages about investing in real estate is the ability to finance. Good debt is leverage which creates great ROIs. Understanding that debt is where we make a lot of our money, we tend to try to borrow as much as we can at any cost, but that can hurt your ability to borrow more if you aren't maximizing the borrowed money's potential. If you net $65,000 from your investment portfolio, and your mortgage payments total $50,000, you are covering your debt 1.3 times (1.3 DSCR). Now maybe two of the properties have a bunch of equity in them and you can use a HELOC to get that money out. If you pull $200,000 of equity out of your properties at 4%, you will increase your annual debt payments by about $4,800 bringing your annual debt payments to $54,800 and you DSCR down to 1.19. That might not seem like a big difference, but to a bank that might be the cutoff point. I'm not suggesting that borrowing against your current properties to purchase more properties is a bad idea, but try to do it with as little debt and as low of an interest rate as you can. If you borrow from a hard money lenders at high interest rates and put rehabs on credit cards and a line of credit, it hurts your DSCR which will limit your borrowing power for future deals. 

The other way to get your DSCR up is simple, get more cashflow from your properties. Either increase rents or decrease expenses. Any time you can do either of those things, your portfolio looks much more profitable. If you can put in energy efficient lights, add some insulation to the attic and get rents up a bit, it can make all the difference. If your mortgage is $1,500 per month and you net $1,800 that's decent, but if you can get an extra $150 a month in savings or increased rent to bring your net to $1,950, your DSCR goes from 1.2 to 1.3. This all seems very obvious, but we get in a habit of forgetting about our investments over time. If you bought a property 4 or 5 years ago, are you sure rents are still at market prices? Have you shopped around for a cheaper alternative on insurance or a property manager that can reduce vacancies? Can you make the house more efficient with insulation, LED lights, a new furnace?

I'm pretty sure at least one of the reasons we are all investing in real estate is to make money. Maximizing returns on our current properties is key, not just because it means a higher ROI on our money, but it makes our properties look more profitable to lenders, which means they will be more willing to lend on more properties. Buying a property that doesn't cashflow might still be a great investment if you know it's going to have great appreciation, but just keep in mind that in a lenders eyes, that property is a decrease in your ability to borrow more money and that might mean not getting anymore properties.

When you are building your portfolio, it is important that your properties will make you money, but they also need to allow you to buy more properties. Don't handcuff yourself just to get another property.