The lending environment is a mess right now. Investors and principals who jump on plans that limit the financing risk gain in many ways.
First, principals who establish an investing plan with limited debt requirements and achieve a record of success develop a plan that will attract capital as the market evolves and changes around them. In essence, the plan creates a self fulfilling success prophecy.
Second, economists and just about anyone who is following the market expects rates to climb and remain high for an extended period at some point in the future. This development is going place financing pressure on deals carrying to high of leverage and faced with these costs. Plans and groups focused on low leverage will have the opportunity to buy many properties at sharply reduced prices. Additionally, because these plans rely on low leverage debt will still make sense for these purchases providing further momentum. For the properties groups like this already own will be secure as the projects are able to support the increased leverage costs without requiring more capital.
Third, the principals with these plans will have the opportunity and ability to develop very strong financing access from local, regional and national banks and lenders as the strength of their plan creates greater business opportunity for them.
The strong liquidity position of principals in these plans will find themselves being fed high quality deals. As owners, brokers, lenders, and other industry players and groups become more aware of the few groups with these plans the deal flow for them will increase dramatically. This will allow these type business operators to capture even more great deals at terms favoring their business model.
Where should groups who would like to focus on such a plan set their metrics? This is something of an academic debate. That said the debt leverage ratio should be somewhere between 65% and under 50%. At this point in time, my personal conviction is that 50% is right. This will allow a very substantial rate change while keeping cash flow very strong. 65% is low today, but might not be so low if rates were to increase 300 to 600 basis points. The increased rate pressure could put a 65% leverage in the risk area. Additionally, principals should consider limits on Debt Service Coverage Ratio (DSCR). DSCR limits of no less than 1.5 or even 1.7 may be prudent. This then allows any given project to carry significantly more debt cost while keeping the DSCR within manageable levels during such a spike.
Blake Ratcliff, former Marine Officer & U.S. Naval Academy graduate, serial entrepreneur and rental housing expert writes prolifically for Ezines and is the Author of “The Warrior’s Guide” series of ebooks on real estate investing, real estate management, and investing.
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