Residential Magazine

Get in the Game

Clients who want to invest in condominiums may not know where to start

By Charles Goodwin

Condominiums offer a huge opportunity for newcomers to residential real estate and seasoned investors alike. Given where interest rates stand, is it realistic for a noncash investor to get into the condo investment game? The answer is yes.

Admittedly, navigating the intricacies of lengthy mortgage approval processes and complex homeowners association (HOA) restrictions can be a major hassle, but getting the capital needed to grow a rental property portfolio doesn’t have to be a stressful experience. Especially when guided by a financing adviser who understands the options available, the 2023 condo market — as challenging as it may be — still presents opportunities and expansive options for investor financing.

“These loans emphasize the property’s ability to cover its expenses, such as mortgage payments, taxes, insurance and HOA fees.”

In fact, an increasing number of lenders are offering products specifically designed to finance investor-owned condominiums. Debt-service-coverage ratio (DSCR) loans, in particular, are available for both individual properties and portfolios.

These types of loans allow real estate investors with rental units in multitenant buildings and townhome communities to secure reliable, timely and competitively priced capital that’s built to scale. If you’re a mortgage originator looking to get the keys in your clients’ hands faster, it’s helpful to know the ins and outs of DSCR loans.

Empowering tool

DSCR loans are an empowering tool for real estate investors. Despite having been around for a while, they can be a game changer for investors who are unfamiliar with the concept.

Unlike a traditional mortgage, DSCR loans put more emphasis on the property’s income-generating potential than on the individual borrower’s creditworthiness. While a strong credit score is certainly called for, the approval isn’t solely based on this factor.

With DSCR loans, approval is more about the property’s financial muscle. These loans emphasize the property’s ability to cover its expenses, such as mortgage payments, taxes, insurance and HOA fees. In summary, it’s more about the property than the person.

“For mortgage originators, adding a specialization in condo financing can be a business game changer.”

Why would a client opt for a DSCR loan? First, it doesn’t impact personal credit, making it ideal for investors who want to scale their real estate portfolios without affecting their personal debt-to-income ratio. Also, the underwriting process is often smoother and less paperwork-intensive than with a traditional loan.

Finally, borrowers who are capped out by mortgage debt on their personal credit report will find that DSCR loans are not a problem. Investors who want to scale their business activities need a product like this to grow their footprint.

Determining income

So, how do lenders calculate the debt-service- coverage ratio? It can vary from company to company, but DSCR lenders typically rely on a third-party appraisal that estimates the monthly rent that can be fetched by the property. This is significantly less complicated than working through the details of collecting bank statements and verifying that payments have been made.

The appraiser determines an estimate of the property’s monthly rent and uses that number as the numerator in the debt-service-coverage equation. On the denominator side, lenders consider the actual mortgage payments, taxes, insurance and HOA fees, which are gathered from public records, title companies and insurance providers.

Broadly speaking, the higher the ratio, the better. Lenders typically have a minimum threshold, usually around 1.1 to 1.25, but higher ratios are more favorable. Other lenders will allow the borrower to go below 1.1, but this comes with different loan terms that require more equity from the borrower and/or a higher interest rate.

Compared to traditional mortgages, DSCR loans generally have elevated rates, typically around 200 basis points higher. This number hinges on certain factors, e.g., whether the loan involves a primary residence or the investor is utilizing a more traditional financing source, such as a bank or credit union. The upside is the flexibility and benefits these loans provide real estate investors, including an easier process without restrictions on personal credit.

Understanding condos

Now let’s talk about condominiums. It’s important to note that DSCR lenders typically only work with warrantable condos (properties that meet Fannie Mae, Freddie Mac and other traditional financing standards). So, before diving into the process, make sure your client’s condo qualifies.

Whenever a new condo deal comes in, a lender often orders an analytics report from a third-party company, which helps to underwrite the HOA that oversees the condo complex. The report will include issues such as outstanding litigation against the HOA, whether the association maintains an adequate level of reserves, and the percentage of owner-occupied versus non-owner-occupied units. Beyond that, the appraisal process is nearly identical to that for a traditional mortgage with the same types of qualification standards.

Nonwarrantable condos, which often have a high percentage of investor-owned units or other red flags, won’t meet the criteria for many DSCR programs. Each lender has its own guidelines and there are some that will lend on nonwarrantable projects, depending on how the lender sources its capital.

To determine if a condo is warrantable, check factors such as the owner-occupancy percentage, the presence of litigation against the HOA and reserve levels. A quick call to the HOA can usually answer these questions.

Market dynamics

Even if your client thinks they’ve found the perfect condo rental unit, everything may not be as it seems. Before wasting time and money on what could potentially be a dead end, mortgage originators can help investors avoid these common pitfalls when seeking DSCR mortgages for condos.

Again, determine whether the property is warrantable. Imagine starting the process of getting a pricey appraisal, only to discover an issue that deems it nonwarrantable, such as a small condo complex where all the units are owned by the same investor or developer. To avoid this, you should call the HOA and ask questions to establish whether the project will meet the basic criteria.

Be aware of restrictions on short-term rentals. Many lenders won’t count rent from Airbnb or other rental platforms when underwriting the income for a DSCR loan. The main reason is that short-term rentals are considered a volatile asset class with a lot of regulatory risk. The total revenue earned can be drastically different depending on whether it’s a long-term or short-term rental home, especially since market conditions and regulations are subject to change.

Let’s say, for example, that your client wants to buy a condo in Palm Springs, California, and rent it out through Airbnb. A few years ago, short-term rental laws were extremely flexible. Today, however, many new short-term permits are not allowed in any of the neighborhoods within Palm Springs. Sometimes, these rules can even be retroactive. You want your client to be protected in the event of a regulatory change.

Investors often grapple with the decision of whether to buy condos or single-family rental properties. Each has their pros and cons. Condos offer fewer maintenance responsibilities, such as HOA-paid snow removal or landscaping, and they can be in higher demand due to amenities like an on-site gym or pool. Single-family rentals, meanwhile, often provide more control and potential for appreciation. It’s crucial to weigh these factors with your borrowers, look into the HOA’s leadership and financial health, and consider the market dynamics and the client’s investment goals before going all in.

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For mortgage originators, adding a specialization in condo financing can be a business game changer. Demand is booming for condo loans in the real estate investment market, and investors are increasingly looking for fresh and hassle-free ways to finance new purchases.

To thrive in the world of DSCR loans, make sure to educate yourself on the benefits and limitations of these programs. Stay plugged into the warrantability guidelines and the regulations tied to short-term rentals in the areas your clients are interested in, then leverage the advantages of DSCR loans to grow your business. ●


  • Charles Goodwin

    Charles Goodwin is senior director of sales at Kiavi, a leading provider of financing to real estate investors, where he oversees the company’s direct sales channels. He is also the co-founder and managing member of GBL Partners, a residential real estate company specializing in neighborhood revitalization through value-add opportunities. Goodwin and his wife live in San Diego.

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