High DTI (Debt-to-Income)? How to Still Buy Rentals (Rookie Reply)

Ashley:
On today’s rookie reply, we’re tackling three more thoughtful questions straight from the community, covering some really creative and challenging situations.

Tony:
First up, we’ll talk about a property manager exploring a unique way to earn income by tying their pay to appreciation instead of rent. Then we’ll help a rookie investor figure out how to buy their next property despite a high debt to income ratio. And finally, we’ll give some tips to a couple with kids who want to rent out a room in their home to medical students.

Ashley:
Welcome to the Real Estate Rookie podcast. I, I’m Ashley Kehr,

Tony:
And I am Tony j Robinson. And with that, let’s get into today’s first question. Alright, our first question up comes from Jeff and Jeff says, I’m a Superhost on Airbnb for my own property, and I’m considering starting to offer management to other people. But rather than taking a cut of the revenue which can make the cashflow challenging for the owner and markets with decent forecasted appreciation numbers, I’m playing around with the idea of taking a percentage of any future appreciation. Has anyone come across that business model any way to do this where I can see myself with X percent of $0 unless there’s no appreciation? Would this be an attractive option for you as a property manager as opposed to a percent of revenue? This is interesting. I’ve literally never heard anyone frame this question as a property manager to say like, Hey, I don’t need cashflow. I just want a piece of the appreciation. Have you ever heard anyone structure a management deal like this? Ash?

Ashley:
Actually, I think that I have as, I don’t think that I would do this, but I’m pretty sure that I have talked to people that instead of wanting part of the cashflow, they want part of the equity in the property and it’s a way to get them started in real estate investing. You see this in business models where someone goes and works for a company and they say, instead of taking X amount of salary, I’ll take a little bit less, but I also want some profit share or equity in the company too. So I don’t think this is uncommon. The reason that I would not do this as the property owner is because I wouldn’t want to tie myself to someone. And I think it gets more complicated if they don’t perform or don’t do a good job to actually separate from them. So first step is talking to an attorney to see what you would need to set the structure up and what would happen when you decided to part ways and to separate from each other. The thing that I would not want to happen is Tony comes on as my manager. I give him some equity, he does a horrible job. I tell him he’s done, but yet he still owns 10% of my property until the day that I sell it.

Tony:
Yeah, I couldn’t agree more. I feel the same way. As an owner, I would not give up a percentage of ownership of my property to a property manager for all the reasons you just said. I think what would be a better approach, Jeff, if the skillset of effectively managing Airbnbs, I would either just go the traditional route of offering a percentage. And if you want to be conservative of their cashflow, then I dunno, maybe structure where it’s like, Hey, I’ll only take a percentage of the revenue above X dollar amount per month. Like, Hey, you’re going to earn a thousand bucks a month. I’ll take everything above the thousand dollars, then I’ll get my 15% or whatever it is. But hey, if you don’t get at least a thousand bucks, then you don’t pay me anything. And maybe that’s a more attractive way to protect the owner’s cashflow without marrying yourself to that deal.
But I think it would be a tough sell, in my opinion, to go to someone and say, Hey, I’m going to manage your property in exchange for that. I want a percentage. Now I think it’s different. And Ash, you lemme know if you think differently here, but if Jeff came to someone and said, look, I found this amazing deal. I’m going to set the property up. I’ve already got it under contract, I just need you to buy it. I need you to fund the deal and then we’re going to partner on this thing. I think that’s a different proposal than going to someone who already has a running Airbnb and saying, Hey, can I get 10, 15, 20% of your equity? What do you think as, would that be a better approach than trying to do it as a management partner?

Ashley:
Yeah, I think that’s a great idea. You’re bringing somebody who has the capital, you’re doing all the work for them. And that’s how I got started. I brought my first deal to my partner and I said, I’ll manage it. I’ll find the tenants, I’ll manage the contractors for a little bit of repairs, and they became the money partner. So yeah, I definitely think you probably have a better opportunity with that. The one thing I will say though is even though me and Tony are kind of crapping on this idea of don’t do this, you should still ask people, you should still put it out there because just like we say with low ball offers, you never know until you ask. So I would not say don’t do this, but I think look at other ways that you could partner with somebody or become a co-host, provide value with not only this structure, maybe have different options for someone and say, Hey, you give me equity, I’ll manage your property and this is what it would look like.
And then there’s the offer too where it’s maybe a step up where the first month I’m going to make all these changes, I’m going to manage it and after the first month, if I’ve increased your revenue by X amount, you owe me a percentage. If I don’t do that, okay, we can continue on if we’re seeing a growth trend, but you don’t have to pay me anything until I hit that number or something like that. So I think you’ll have a better chance of getting those partnerships if you have different options and once you’ve kind of gotten that track record of doing it for other people, you’ll have a lot more wiggle moon of being able to say, this is how I structure the people I co-host for. This is my structure. But I think just to start building that brand and building that confidence in other people to have those different options available is a great start.

Tony:
Yeah. So Ash, we talked about maybe not taking your management fee unless a certain revenue threshold is met, but I think the other piece is the profit sharing. Maybe instead of you taking your management fee off of gross revenue, you can say, Hey, I want a percentage of the profits. And if you approach the property owners with that perspective, well now you’re almost like a partner because you’re not incentivized just to maximize the top line, but you’re also incentivized to maximize the bottom line and the actual profits that owner’s seeing. So I think maybe adding in the option of, Hey, I don’t charge my management fee off of the top line revenue, but actually charge a fee off of the actual profit that hits bank account is another creative way to approach owners in this situation.

Ashley:
Okay, we’re going to take a short break. When we come back, we’ll have another question from a rookie investor. Okay. Welcome back from our break. Today’s next question is from Daniel. Since joining this forum, less than a year ago, I had the good fortune to connect with a real estate pro who helped me buy my first investment property, a house hack owner occupied duplex with 5% down. I’ve caught the bug and want to buy another property as soon as possible, but my debt to income is already dented from my current mortgage and my six figure student loans, which I’ve been comfortably paying back. How can I get around this? Or is it more prudent to pay off these loans first? Okay, so I think probably the first thing to talk about is DTI. What is DTI? And it is your debt to income. And this is calculated by mortgage brokers, lenders, banks, when they’re seeing how much debt you have compared to your income.
So for example, if your monthly mortgage payments add up to $10,000, maybe that includes your auto payment, your student loan payments, that’s $10,000 and then your monthly income is $20,000. So that means you have a 50% debt to income. Your debt payment is 50% of your income. Okay, so with this question from Daniel is saying he wants to buy another property as soon as possible. Okay. So right here we have two options that we’re not sure what he is trying to do and is you can live in his house hack for a year and then he’d be able to move to another property to make it his primary. When he did this option, the bank would then look that he’s filling his side of the duplex with rental income and they could take a portion of that, a percentage of that rental income and count it towards his income, and that would lower his debt to income and that would free up some debt to income room for him to purchase his next primary.
If he’s going to buy the second property solely as an investment and not a primary residence, then he should look at A-D-S-C-R loan. So this is a debt service coverage ratio loan where instead of looking at your debt to income, it is looking at the income of the property and how much debt you’re putting onto the property. So what the lender will want to see is that the property is able to support itself and to pay the mortgage payment on the property. I think that is probably the best route for him to go. And then he doesn’t have to worry as much about paying completely off his student loans, especially when there’s six figures to be able to get that debt to income lower to go and purchase the next property.

Tony:
Great point, Ash. But you know what stuck out to me was he says, my DCI is already dented, but he didn’t say like I’ve been told by a mortgage broker or I’ve been told by a loan officer. So I think what I would do first, Daniel, is just go to a few lenders and give them your current financial situation and let them actually tell you if your DTI is an issue. But what I wouldn’t want you to do is just assume that because you have the student loans, because you have the mortgage from the House act that you can’t get qualified for another loan. So I think the first thing is just go talk, go shop around to as many lenders as possible to understand what the different options are. And as you bring up a good point of the DSCR, but as you talk to more lenders, and we just had Jeff Wegen on episode 5 88 of the Ricky Podcast and he talked about lending and he talked about so many different loans that Ash and I had never even heard of before.
So I think the first and maybe most important step, Daniel, is go shop talk and get the option of what makes the most sense for you. I think the second part of that question is, should I pay off my student loans? I think maybe it depends. If you do go to talk to a lot of lenders and they all say the same thing, like, Daniel, do these student loans are killing your ability to get approved, then maybe it is the prudent choice to pay those down. If you’ve got super high interest rates on the student loans, maybe it is a good idea to pay those down so you can free up more cashflow to get approved. But if the lenders are like, eh, it doesn’t really hurt that much and you’ve got a 2% interest rate, then maybe it is the better decision to go out there and use that money to buy that next deal. So I think there’s some nuance to the question, some detail maybe that we’re lacking, but I just wouldn’t make any moves until I’ve gotten no from multiple about buying that next deal.

Ashley:
Tony, did you have student loans?

Tony:
Yeah. Yeah, I still do.

Ashley:
Did you prioritize paying them off or did you invest first?

Tony:
I invested first because mine, they’re all federal loans and all of my student loan debt is a 2% interest rate. It’s crazy. So I have no pay that off left to pay that off. So I’m paying what I need to pay, and I’ve used that money to grow out there and buy all the real estate deals we’ve done. So for me, it was the right financial decision, but mathematically it made more sense for us as

Ashley:
Well. Okay. We’re going to take our last break and we’ll be back with our next question for rookie reply. Okay. Our last question today is about renting a room with kids at home. And Tony, we often hear the excuse of, oh, I can’t house hack, I have kids. So maybe Jennifer is proving us wrong. Now you actually can. So Jennifer asks, my husband and I are interested in renting out a guest bedroom and bathroom on the side of our home. We have four small children, so rules would need to be established. The guest would be in medical students. My husband was a medical student before becoming a physician and feels familiar with this guest space. What are some things we should know months, a month, contracts, damage, deposits, common spaces, et cetera. Okay. Well first of all, I think this is awesome that you’re going to be utilizing this extra bedroom and bathroom in your home to bring in additional income.

Tony:
Yeah, I think the first thing is that I like that you guys have a specific avatar of who you want in mind. There’s some commonality there, and I think if you are bringing someone into your home, and as you can probably speak to this way better than I can, but if someone’s moving into your primary residence as a tenant, you have a lot more latitude over saying yes or no to that person than you would if it was just a traditional investment property. Can you elaborate on that, Ashley? I know you’ve mentioned that in the podcast before.

Ashley:
Yeah. Some of the fair housing laws don’t apply if you’re actually occupying and living in the property, you have more say who’s going to be living in your home or even if you have a duplex who’s going to be living in the other unit next to you that you can’t if you’re just a landlord and not inhabiting the property. So that definitely is a huge advantage that you can select and not have to go off of the laws of like, okay, well this person met the screening criteria first you have to rent to them and can’t view all of the applicants and then pick who you thought was the nicest. Or in this situation, you can pick off of who you get the best vibe from or whatever. Even though you should, no matter what, do proper screening techniques, you do have more say as to who you can run to and why or why you could say no to somebody.

Tony:
And I think that takes off a lot of the pressure, right? Because you can really make sure you’re choosing someone that you feel you’re going to feel comfortable with being around you and your four children. So Ash talks about all the basics of tenant screening, so I think we should cover that too, but I think just maybe go talk to a real estate attorney and get the actual guidelines that you need to follow. When you are screening a tenant for moving into your spare bedroom, how much latitude do you actually have? Can you say no to someone just because you don’t like the way they smile? How much latitude do you have? So I think getting the ground rules are important there, but as you talk about the basics of tenant screening, what are the non-negotiables that this person should still do regardless of all of the other things they can look at, but what are just the basics of tenant screening?

Ashley:
Yeah, I actually just put out a guide too with rent Ready. It’s talking all about tenant screening and it’s actually a pretty long thing. It’s not just a one pager of how to do a tenant screening. It goes pretty in depth. You can find that at biggerpockets.com/resources and it’s the tenant screening guide. But basically you should have some kind of software that is actually going to run a background check for you, credit check for you do an income verification, or you should manually be calling to verify that they actually work where they say they’re employed. There’s a situation recently from a friend of mine that works for a property management company and they just rented to somebody and they went off of their credit screening reports just saying approved or denied and didn’t actually dig into what was on the reports. And now the dog board in is calling my friend who works at the company saying this person has been evicted to other places, which in New York you can’t deny someone based on eviction, but they have all of these felony records and stuff that didn’t show up.
And so he did a simple Google search of this person. So there’s three or four articles that come up to three or four different circumstances where this person was arrested for a gun charge, illegal possession of a weapon for gang violence, all these things that didn’t show up in the screening report. So it is very, yes, you should be using these reports 100%, but there are other things to do. Look at the person’s Facebook too. So violent things like gun possession, gang violence, those are things that you could turn someone away from because this wasn’t in a complex where there’s a ton of other people living and for the safety of others, you could deny that person. So I really like looking at the person’s social media, especially when it’s your house act too, and you can deny for any reason looking at their social media, can you see pictures of the room they’re renting now and is it kept clean? Is it kept nice? So yeah, I think use the standard screening procedures, but also do a little bit of your own. And most women are very good at exposing the truth about different things and doing the digging and investigating.

Tony:
That’s nice. Sarah, my wife, she never surprises me with her ability to sleuth on the internet. So yeah, do a little bit of that and see what you can dig up.

Ashley:
Yeah, it’s like you meet someone and then you’re like, oh, you know that person you talked to, here’s their house. Did you know they bought it?

Tony:
Well, I think the other piece of this too, Ashley, is, and I’m just thinking about myself as a parent with young kids at home, it’s like if someone were renting a room in our space, I’d also have to have some very clear ground rules around, Hey, how are you going to interact with us in our family? Do they have access to the entire house or are they like, Hey, all the other bedrooms are off limits. Make sure you’re never inside any of our rooms. The communal space, what does that look like? If you’ve got four young kids, quiet hours, if the kids go down at eight o’clock, can they be up making a bunch of racket at 10:00 PM? So I would just think through what areas of your life currently do you not want to be impacted? Do you not want to change? And just whatever that is, I don’t think there’s a right or wrong answer, but whatever that answer is for you, make sure it’s very clearly articulated to this person before they decide to say yes and sign that lease. That way you guys can make sure that there’s peace, there’s harmony when they actually do decide to move in.

Ashley:
And I think to set the expectations of what this person should expect from you too. So if you do have four young kids, if they’re loud, you’d want them to be able to run around and somp on the floor and not make that them aware of that so they know coming into it so it doesn’t become a problem. Later on with my short-term rentals, I was just a guest on figure stays with Garrett Brown, and we talked about how in my listing I put all of the bad things, here are the things people aren’t going to like about my property. And I put them in there so that it’s not an issue because it’s going to be more of a headache for me. When someone gets to the property and says, what do you mean you don’t have a grill? Or What do you mean there is this there in the shower, the faucet was put on the wrong way.
So when you want cold water, you have to turn it to the hot side. Okay, we literally put that out, we tell them right away because that was an issue a couple times. So I think getting ahead of anything that you may think may be a problem for someone else too, and setting that expectation, I would not want to tell my kids in my own home, no, you can’t run around the circle and chase each other and stuff like that because we have somebody in their room and they might be studying. We got to be quiet. So I would set that as an expectation. Hey, there’s four kids here, they’re allowed to run around, play, have a good time. One may wake up at 1:00 AM screaming or something. I would set expectations like that too.

Tony:
I think we should also just give them kudos for even thinking through this because it is a sacrifice that I think a lot of folks aren’t willing to make, especially with four young kids. So kudos to you because we always say one of your biggest expenses is your living expense, and if you can reduce that cost, you’re able to then have access to a lot more capital to go buy more deals. So kudos you guys on that. I probably couldn’t swing this in my life mostly because I feel like I would probably be fine with it, but I don’t think Sarah would be okay with us having a stranger living in our four walls. But yeah, I think I might be able to swing it. What about you, Ash? Do you feel like you’d be okay with renting out a room

Ashley:
To maybe My brother is 21, I’d say Yeah, but another thing I thought of too, right when I read this is getting an au pair. So maybe there’s something else that you need help with in the house that rather, instead of generating income, you get an au pair who helps with the kids and stays there for free. So instead you get in-home childcare. I don’t know exactly how this works, but I think it’s something similar to that. You provide a place for the person to live, you get free childcare, and then maybe that gives you the opportunity to go and do some other kind of work or something that you’d rather make money at than having to rent out the room to a medical student. I don’t know. But I’m just saying there’s other things like that too. I would say yes, Tony to a live-in chef, best you can live in my home. Alright,

Tony:
Ashley’s putting that out there right now. So if anyone wants to move to Buffalo Cook for Ashley and Darrow and the boys, she’s got an opening.

Ashley:
I need you guys to make me healthy meals, though. I really want to eat healthy all the time. I just don’t want to cook all the time.

Tony:
Yeah, I’ll take one of those here. If anyone wants to move to SoCal, all good questions for today. And whether it’s testing a creative new business model, finding ways to invest with heavy debt, or just figuring out how to open your home to a tenant while keeping your family happy. Today’s questions prove that rookies are thinking outside of the box.

Ashley:
And the best thing you can do is keep asking these kinds of questions. Run the numbers, talk to others who’ve done it, and don’t be afraid to try something unconventional if it fits your goals.

Tony:
Now, thanks again to everyone who submitted a question. And if you want your question featured in the Real Estate Rookie podcast, put in the forums. That’s where we go to find the questions for the episodes, it goes to the BP forums. Submit your questions. We just might choose it. And if you’re listening, don’t forget to subscribe. Share this episode and leave us a review so more Ricky’s can learn right alongside you. I’m Tony.

Ashley:
And I’m Ashley.

Tony:
And this has been an episode of Real Estate Ricky. We’ll see you guys next time.