Home price appreciation (HPA) is slowing in many areas of the country, while rents are continuing to rise. Certain regions that were previously hot fix and flip markets could offer strong rental opportunities.
Rents have risen by 3% in the past year, according to Zillow’s Real Estate Market Report, and rose for the ninth consecutive month this past June. One of the secrets to a successful rental is to invest in regions where home prices aren’t cooling as much as they are in most major markets. Concerned about an eventual market decline, people may be willing to consider a single-family rental (SFR) to get the space and lifestyle they desire until prices drop enough to consider buying.
Cities like Las Vegas, Dallas, and Phoenix, all with scarce housing supplies, represent good long-term opportunities for investors. A shortage of rentals, rising rent prices, and slower-than-average home appreciation create a perfect storm of profitability for buy and hold investors.
A bridge loan can be the ideal solution to convert your fix and flip investment into a revenue-generating rental property. But there are some important numbers to consider before you do.
What Is the Debt Service Coverage Ratio?
When lenders consider whether a specific property or investor is a good risk, they look at the Debt Service Coverage Ratio (DSCR) as a major factor. With some lenders, this number is more significant than your credit score, gross income, or your investment portfolio.
The DSCR represents how much money an individual property should make. To calculate the DSCR, divide the Net Operating Income (NOI) of any property by the principal and interest payments for the property’s mortgage.
Regions where rent is high in proportion to home selling prices will yield a high NOI. Similarly, areas where single-family rentals (SFR) are in demand—regardless of home prices—will result in fewer vacancies and a higher NOI, leading to a higher DSCR.
A DSCR of 1 or higher indicates that a property is turning a profit. A ratio of 1.25 or higher represents a healthy DSCR, indicating that the landlord can cover monthly expenses, any emergency expenses, and the mortgage and taxes on the property.
It’s important to understand that the DSCR is different from the capitalization (CAP) ratio on a property. The CAP rate represents NOI divided by the property’s total value. CAP rate is used more frequently to determine the risk and profit potential of multi-family units.
The DSCR shows the profit potential—and risk of loan default—if rent prices drop or if the property sits vacant for some time. On the other hand, CAP rate shows, as a percentage, how much profit a multi-family unit is likely to make, even if an expected number of units sit vacant.
Rising Rents Represent Solid Revenue Opportunities for SFRs
Areas like Los Angeles, where home prices are not rising as fast the national average but rent prices have increased, represent excellent opportunities for single-family rental investments.
Families and individuals may not be able to afford to buy a home or may not want the burden of a mortgage but still want the space and privacy afforded by a single-family rental. They are willing to pay more for an SFR as they wait for home prices to drop to an affordable level.
Other regions, including Miami and West Palm Beach, Florida; San Diego and Carlsbad, California; and the San Francisco/Oakland area also represent good opportunities to find rental properties with a high DSCR. Home prices are rising, but not as fast as the national average, while rental homes remain profitable for investors. In these regions, a buy and hold strategy makes sense because you will make more than you would with a fix and flip thanks to the benefits of ongoing revenue.
Light HPA Percentages, Low Rates Could Mean Strong SFR Investments
Along with calculating the DSCR, it’s important to look at Home Price Appreciation (HPA) percentages to gauge the long-term potential of an area. Veros Real Estate Solutions forecasts a 3.7% appreciation rate for residential homes in the top 100 U.S. markets through June 2020.
The Dallas-Fort Worth and Sugarland regions of Texas sit below that national average, with predicted HPAs between 2% and 3%. Similarly, Southern California home values appreciated just 1.2% in June 2019, year over year. And, home prices in Las Vegas may be close to peaking, with the median price up 3.3% since September 2018.
It’s important to note that while HPA can be used as a predictor of what the market will do, it may not be entirely accurate. It’s best to understand the specific market in which you plan to invest and investigate individual properties carefully to ascertain their potential profitability and appreciation value.
It is safe to say, however, that low rates for borrowers in today’s market, plus a cooling housing market and rising rent prices, can lead to a favorable DSCR for landlords.
Fix and Flip, or Buy and Hold?
Whatever investment strategy you choose, you’re bound to win with house prices continuing to rise. To make the most on single-family rentals, look for regions where rents are rising and light HPA values mean families will choose to rent rather than buy. This can also help ensure you’re not paying too much for the house, keeping your DSCR high and your rental investment profitable.
Working with a lender you can trust, who acts as your investment partner and valued advisor, can help you make the best decisions as you expand your investment portfolio.
Turn to 5arch for low rates on bridge and rental funding:
Call 833-411-0599 to Borrow Better℠ and maximize your profits.
5 Arch Funding Corp. (5arch) is a nationwide direct lender serving brokers, correspondents, and real estate investors. We help clients navigate the complexities of the market by empowering them to make more intelligent lending choices with our innovative products and powerful advisory service so they can Borrow Better.℠
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