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Strategies to Maximize Real Estate Debt for Investors

Most real estate investors have big dreams when they start investing in rental properties. They envision a large portfolio of cash-flowing properties, creating passive income that allows the investor to build wealth and live a good life. 

But how do you get to this dream state? No matter how wealthy they are when they start investing, most people can’t grow their portfolios significantly by paying cash for properties and then holding them.  

That’s where debt comes in. Investors can leverage the equity in the properties they already own to purchase more investment property, allowing them to grow the scale of their real estate portfolios. Because the properties are cash flowing, investors can still profit while paying the debt service on properties—allowing them to continue to make money by borrowing money while amassing more properties and more equity. 

Lima One Capital has helped thousands of investors leverage their equity and scale their portfolios with our DSCR loans designed specifically for rental properties. These rental loans for landlords are underwritten based on a property’s value and cash flow, allowing investors to put leverage to use to maximize their real estate investments. Let’s talk about how to use debt to buy real estate. 

The Benefits of Using Debt in Real Estate & How to Leverage Debt Responsibly 

Leveraging equity in your real estate portfolio to purchase new properties is the best way to scale a real estate portfolio. However, it’s important for investors to leverage debt to buy real estate responsibly. 

This is why private lenders like Lima One Capital require a down payment on rental property and portfolio loans. This ensures that the borrower has “skin in the game” on existing properties while also protecting both the borrower and the lender against fluctuations in home price values. 

Borrowers also need to manage risk by ensuring ROI on their existing properties before doing a cash-out refinance loan. The DSCR ratio helps investors do this. DSCR compares the income of the property with the expenses of owning it—including borrowing costs, taxes, insurance, homeowners’ association fees, and more.  

While some investors try to get loans at low DSCRs of 1.0 or even below, it’s wise to leave some margin with real estate debt investing. The reason is that these ratios do not include capital expenditures that sometimes arise with homes—replacing roofs or mechanicals such as HVAC systems are good examples. Investors need to save some of their cash-flow profit to cover these expenses so that their entire portfolios continue to be profitable, even when an unexpected expense arises.

Strategies for Using Debt in Commercial Real Estate

Finding success within the world of commercial real estate requires efficient and effective strategies and by understanding key considerations & benefits of commercial real estate debt strategies, investors can make informed decisions to support long term growth.

Understanding Commercial Real Estate Debt: Key Considerations

Whether an investor is looking to build a portfolio of single-family homes or use a commercial real estate strategy of owning and managing multifamily properties, the principles of using debt to buy real estate are the same.  

With a multifamily portfolio, investors can benefit from economies of scale when it comes to managing multiple doors at one physical site. Investors also need to do the same ROI calculations for income versus expenses while saving money for CapEx needs. The main difference is that rents are more variable at a multifamily property because there are more tenants, which leads to more move-ins and move-outs, more late rent payments, and more opportunities to increase rent. 

Ultimately, most investors who use commercial real estate debt want to improve their property so that it qualifies for agency debt (backed by Freddie Mac). This is the most cost-effective source of funds for a multifamily property. However, agency funding comes with significant requirements, and so multifamily investors sometimes need short-term bridge debt to acquire a property and get it “Freddie ready.” This kind of debt allows investors to add value to a property through rehab or to stabilize it by improving tenant quality, lowering occupancy, and increasing rents. Investors using this kind of short-term debt need to make sure they continue to ensure cash flow on the property while putting enough money down to make sure they have equity even if multifamily values waver. When interest rates increased in 2022-23, some multifamily investors who over-leveraged their properties ended up in trouble because they did not fully account for downside scenarios in their underwriting.

Benefits of Private Real Estate Debt Funds in Commercial Investments

Another way that investors fund multifamily properties is through private real estate debt funds. A real estate debt fund is a private equity-backed investment vehicle that pools capital from multiple investors to provide loans for real estate projects. These funds lend money to real estate developers, property owners, and investors secured by real estate assets as collateral. 

This is another form of short-term debt. It can offer the general partner of the debt fund a cheaper cost of funds, but it also puts the onus on them to deliver the returns promised. For limited partners, this is a way to invest in real estate fractionally and receive a return, but they must ensure that they underwrite properties and general partners just as thoroughly as they would if they purchased a property themselves. 

Investors might choose to put money in a real estate debt fund for several reasons: 

1. Steady income: Real estate debt funds promise regular distributions through interest payments on loans, providing a reliable source of passive income. 

2. Diversification: Debt funds spread capital across various loans, reducing the impact of individual property performance on overall investment. 

3. Professional management: Experienced fund managers conduct due diligence, assess risks, and actively monitor the portfolio. 

4. Accessibility: Real estate debt funds often have lower entry barriers compared to direct property investments, making them more accessible to a broader range of investors. 

5. Flexibility and liquidity: Compared to direct real estate investments, debt funds often offer greater flexibility in entering and exiting positions. 

By investing in real estate debt funds, investors can gain exposure to the real estate market without the complexities of direct property ownership while potentially benefiting from steady income and diversification. Again, underwriting is key here, as investors need to know where their money is going and who is managing it to ensure successful investments. 

Using Private Lending to Leverage Debt for Real Estate Acquisitions

With this explanation of how to use leverage complete, it’s time to turn the focus to how private lending can help investors leverage debt for real estate acquisitions.

How Private Lending Helps Investors Use Debt Wisely

Real estate investors choose private lenders over banks because private lenders can move faster and require less paperwork. Private lenders also offer asset-based lending that isn’t based on an investor’s debt-to-income (DTI) ratio. This is ideal for investors who may have irregular income from selling properties or who have developed enough cash flow to quit their full-time jobs. These flexible, timely financing solutions are ideal for investors who want to leverage debt. 

Lima One Capital serves investors with asset-based rental loans that are based on DSCR, not DTI. We check a borrower’s credit and liquidity but not debt-to-income. This approach is ideal for investors looking to add to their portfolios. 

Using Private Lending While Putting Money Down to Manage Debt

Remember that when using private lending or any other debt strategy to add doors to your real estate portfolio, you need to retain equity to safeguard yourself against changing markets or static home values.  

At Lima One Capital, we offer up to 80% loan-to-value loans on rental home purchases, which means that investors need to put 20% of the purchase price down on the property. For cash-out refinances, we offer 75% loan to value, which means the investor retains 25% equity in the property. This gives them the flexibility to sell the property if needed and cover the debt while receiving some money back. These standards help investors avoid over-leveraging.

How to Calculate and Manage Real Estate Debt for Maximum ROI

Risk level is something each investor must determine for himself or herself. Standards that private lenders offer provide a good guideline, but some investors may choose to be even more conservative. For example, investors must choose how much of their profits to hold back to cover potential CapEx needs. There’s no right answer to this question—it’s something each investor must evaluate as part of an investment strategy.  

Key Debt Metrics for Real Estate Investors to Track

As discussed throughout this article, here are two key numbers investors need to track on their properties: 

• Loan to value 

• Debt service coverage ratio (DSCR) 

Conclusion: Using Debt in Real Estate Responsibly for Growth

Debt is not a bad word when it comes to real estate, but it must be used wisely. Putting enough money down to have equity in a property—or leaving enough equity in a property when doing a cash-out refinance—are vital strategies that every real estate investor must use when thinking about how to leverage debt to buy real estate. 

Lima One Capital’s rental loans are meant to help investors succeed over the long run as they scale their business with cash-flowing properties. Contact us today to discuss your real estate portfolio strategy and to get a quote on how our private lending options can help your portfolio grow.