Whether you are looking to build up a portfolio of long-term rentals or invest in short-term rentals, it's important to understand all your different options for financing a property, particularly when interest rates are up at the 6 or 7% level. Regardless of what the interest rates are it is important to tailor the financing of an investment property based on the long-term goal for the property as well as the short-term access to capital. In this blog post, we will share our top tips for financing investment properties in the Sonoma County area.
With median sales prices ranging from $700k in North West Santa Rosa to $1.1m in Healdsburg and as much as $1.3 million in Bodega Bay (it is only since the pandemic that prices in Bodega Bay have gone so high!) coming up with enough capital to purchase rentals here can be challenging.
That being said, the rewards of rental income are well worth it. There is a reason why over 75% of millionaires have made their wealth through real estate investing (according to research by HouseCashIn). From my own personal experience, I feel I have done pretty well with various stock market investments but it is real estate investments that consistently deliver (aside from a couple where I came out level).
So how can you secure funding and start building a rental property portfolio across Sonoma County in cities like Santa Rosa, Petaluma, and Healdsburg where I'm based? Here are my key recommendations:
First, you need a sizable down payment, ideally 20-30% of the purchase price. Given median prices in the county according to MLS data are around $800k, I know that seems unattainable. But there are creative ways to bridge the gap through retirement account loans, real estate partnerships, and more.
This equity upfront gets you the best interest rates and loan terms. It also provides a financial buffer for those unexpected repairs and maintenance costs that come with managing rentals.
Next, you need to aim for a credit score above 700 if possible. Taking the time to clean up your credit and reduce debts will pay off thousands of dollars of interest savings over the life of an investment property loan. One of the things that often catches people out is changing jobs which can really mess things up. I had a client recently who was a wealth manager and she sold her company and got some money up front so she had a good down payment but then the fact that she had changed jobs meant that the rate she got was 1.5 points worse than it should have been. If you are thinking of purchasing a property in the next 12 months, it is always worth checking in with a lender to make sure there is nothing about your personal situation that might cause a problem down the line.
What Are The Different Loan Products?
Now let's discuss the loan products themselves. While 30-year fixed-rate mortgages are common, a lot of people dismiss conventional loans for investment properties. However, I wouldn’t totally write off conventional 30-year fixed loans. You can have up to 10 conventional loans at a time on 1 to 4-unit properties including your primary and any secondary homes you have mortgages on.
The key is to find a trusted lender to explore all the different avenues open to you including interest-only loans, ARMs, bridge loans, or hard money loans from private lenders. The right product depends on your investing timeline, risk appetite, and target property type. For example, some properties might only qualify for hard money if it is a major fixer or won’t pass an appraisal because it doesn’t have a heat source for example. That being said, there are always creative ways that we can navigate particularly difficult properties. For example, it is sometimes possible for a lender to apply for and get an appraisal waiver for certain properties which can remove a headache.
Debt Service Coverage Ratio (or DSCR as they are called) are loans that qualify on the property’s income, or rather cash flow, not your own income. They are attractive because they do not count towards the 10 conventional loan limit, yet they can be 30-year fixed loans. To qualify, your income is not considered, but the potential income from the property is considered. The theory is the property can pay/cover the debt itself. I have had a client find a good balance with a DSCR product that is fixed for 30 years, but interest only for 10 years, and then amortized over the last 20, which helps with day 1 cash flows. For this type of loan, you would typically require 25% or more as a down payment.
In my experience, connecting with local mortgage brokers who specialize in financing investment properties is invaluable. We work hand in hand with a number of local lenders, who can come up with creative solutions for clients because we know where to find properties that will make good investments.
Local banks are also a great source for investment loans because they know the intricacies of the local markets and have different underwriting standards and flexibility since they often hold the notes in the portfolio. Local banks here to consider are Redwood Credit Union, Community First Credit Union, Summit State Bank, Poppy Bank, and Exchange Bank.
Make Sure The Numbers Work
Finally, you need to be realistic about the numbers. You must carefully analyze potential rents and run the numbers to forecast your cash flow, debt coverage ratio, and return on investment. I would be lying if I said it was easy to find gross yields in the 5-10% range because it’s not. A gross yield of 5% is possible but it’s getting tougher.
We have had quite a few clients recently purchasing single-family homes with an ADU which just helps to make the numbers work better. While there is no magic solution to finding properties that will work one rule of thumb is to make sure that at an absolute minimum, the rent is equal to or more than a half a percent of the purchase price. For example, for a million-dollar property, you need an absolute minimum rent of $5k per month. When you consider this scenario you can see why homes with ADUs will stand a better chance of making financial sense because for a 600 sq ft ADU, you can often get $1500 to $2500 per month which helps you on your way to your target income. For investors who have appetitive for more active involvement and choppier income, then vacation rentals are another route to go.
If you are interested in exploring the pros and cons of long-term vs short-term rentals or something in between then take a look at the video below:
As with any investment, it’s important to go into it with eyes wide open so make sure you have established a clear goal and built a business plan that takes into account every line item of income and expenses as well as the appreciation, depreciation, and the financing terms. I expect over the next 12 months there could be some good opportunities for the smart investor who knows how to identify value in different pockets of Sonoma County.
In Summary
There are so many different ways to invest in real estate, there is no silver bullet that is the right solution for everyone. Our clients span the gamut, from people buying multi-family properties to single-family homes in Santa Rosa to short-term rentals. We also have many clients who have come to us thinking that wanted a vacation rental for example, and have ended up buying four single-family homes with ADUs after we walked through the numbers and the pros and cons of each. Don't get me wrong, vacation rentals are often the best option for some investors because of some of the advantageous strategies around tax aggregation to offset W income. If you are looking at your options whether it is buying your first investment property or exchanging out of an existing investment, then get in touch.
Frequently Asked Questions:
1. What are some key tips for financing investment properties in Sonoma County?
To finance investment properties in Sonoma County, consider making a substantial down payment (20-30% of the purchase price), improving your credit score (aim for over 700), and consulting with a lender to ensure your personal situation won't affect your mortgage rates.
2. What loan products are suitable for investment properties in Sonoma County?
You can explore various loan products for investment properties, including conventional 30-year fixed loans, interest-only loans, ARMs, bridge loans, and hard money loans. The right choice depends on your investment goals and property type.
3. What is a Debt Service Coverage Ratio (DSCR) loan, and how does it work?
DSCR loans qualify based on the property's income, not your personal income. These loans don't count towards the 10 conventional loan limit and are often 30-year fixed. You typically need a 25% or higher down payment for a DSCR loan.
4. What local banks and mortgage brokers in Sonoma County can help with investment property financing?
Consider working with local banks like Redwood Credit Union, Community First Credit Union, Summit State Bank, Poppy Bank, and Exchange Bank. Local mortgage brokers specializing in financing investment properties can also provide valuable assistance.
5. How can I ensure the numbers work for my Sonoma County investment property?
Carefully analyze potential rents, calculating cash flow, debt coverage ratio, and return on investment. Aim for a minimum rent equal to at least half a percent of the property's purchase price. ADUs (Accessory Dwelling Units) and vacation rentals can help enhance your property's financial viability.