Maximize Cash Flow: Unlock Rental Financing Secrets
In real estate investing, as in life, cash (flow) is king.
From purchasing investment properties to sourcing the materials, labor, and other resources you’ll need to manage and scale your real estate investment pipeline, adequate cash flow is the fuel that keeps the engine running.
How rental properties generate cash flow
Rental properties can be especially attractive (and potentially lucrative) for real estate investors because they generate cash flow and revenue in several ways, both in the near and long term. Here’s an overview of the typical cash flow cycle in a rental portfolio:
The primary source of cash flow for most rental properties is through rental income from tenants. Typical residential leases bring in monthly rental payments beginning from the move-in date to terms ranging from a few months to several years, guaranteeing a monthly income stream for each unit.
Over time, the value of the rental property may increase depending on factors like its location and variable market conditions from the time you bought the property to the time of its sale. Appreciation value generates cash flow if the property is eventually sold or refinanced.
Some rental properties can offer significant tax benefits, such as deductions for loan interest, property taxes, depreciation, and repairs. Remember, while we love a good tax break, it's always best to leave the nitty-gritty tax advice to the experts. So, before you start counting your deductions, we recommend chatting with a tax advisor who can help you navigate the ins and outs of maximizing your tax benefits as a rental property investor.
As your tenants make their rental payments, the property eventually starts to accrue equity you can leverage to purchase additional properties and use as collateral for refinancing existing or financing new real estate loans.
It's important to remember that not all rental properties will generate positive cash flow. Factors like the variable rental market, location, property condition, and financing terms can all impact the cash flow potential of a rental property.
4 Rental Financing Strategies to Help Increase Your Cash Flow
Whether you want to increase your cash flow to buy new investment properties, make repairs and upgrades to existing properties, or pay down existing debt, there are a few financing options available to help you meet your goals without tapping into your personal assets or relying on your credit profile.
Refinance your loan
Refinancing your rental property loan can immediately start to increase your cash flow. If you play your cards right, you can refinance to a lower interest rate, which will help reduce your monthly payment. You could also consider refinancing to a longer-term loan, which could lower your monthly payment but extend the loan term.
Consolidate your properties
Do you have multiple rental properties in your portfolio? The simplest way to make sure you’re making the most from all of them might be to consolidate them into one loan.
Rental portfolio loans work on economies of scale: the more properties you have, the more you can save on secondary costs when all loans are under one umbrella. Rental portfolio loans save you money and can increase your cash flow because you’re not paying out fees for five or more loans each month.
One catch with rental portfolio loans: they only work when you have five or more properties in your portfolio.
Use a cash-out refinance
A cash-out refinance is an option that allows you to refinance your existing loan for more than the current outstanding balance. The difference between the new loan amount and the existing loan balance is paid out as cash, which can be used for home renovations, paying off high-interest debts, or investing in other properties. Let's say you have a $200,000 loan on your rental property worth $300,000. With a cash-out refinance, you could refinance that loan for $250,000 and receive $50,000 in cash.
The new loan would have a higher balance and potentially a higher monthly payment, but you would receive the extra cash at closing.
Cash-out refinances may have higher interest rates and closing costs compared to traditional loan refinancing, so it's important to carefully consider the costs and benefits before proceeding.
However, if you use the cash-out refinance funds to invest in additional rental properties or improve your current rental property, the increased rental income could offset any higher loan payments and potentially increase your overall cash flow.
Using a cash-out refinance could potentially increase your rental income and cash flow.
Consider a DSCR loan to purchase a new property
A DSCR (Debt Service Coverage Ratio) loan uses the property’s value and outstanding debt ratio to determine your ability to repay the loan. The DSCR ratio compares the property's net operating income (NOI) to its debt service, which is the total amount of principal and interest payments.
The DSCR ratio is calculated by dividing the property's NOI by its total annual debt service. For example, if a property generates $100,000 in annual NOI and has $80,000 in annual debt service payments, the DSCR ratio would be 1.25 (100,000/80,000).
You’ll typically need a minimum DSCR ratio of 1.20 or higher to qualify for a DSCR loan. A higher DSCR ratio indicates that the property generates enough income to cover the debt service payments and has a lower risk of default.
DSCR loans are commonly used to help finance single-family rental properties. The loan terms and interest rates for DSCR loans often vary depending on the property’s operating cash flow.
With the right financing tools and strategy, your rental properties can become an ongoing source of income and cash flow to power your real estate portfolio.
Smart rental financing strategies can significantly enhance your cash flow and contribute to the growth of your real estate investment portfolio. By exploring options such as refinancing loans, consolidating properties, utilizing cash-out refinances, and considering DSCR loans, you can unlock the true potential of your rental investments. As a savvy real estate investor, it's essential to stay informed and adapt your approach to rental property financing to maximize your returns and achieve your long-term investment goals.