Scaling from One Property to a Real Estate Portfolio

Four limits decide how fast you can add rentals after the first one: cash for the next down payment and reserves, lender caps on how many financed properties you can have, your debt-to-income ratio, or the time it takes to manage more units. For conventional loans sold to Fannie Mae, you can have up to 10 financed properties, and the cash reserves the lender requires rise as you add them. Past those limits, investors use portfolio and DSCR loans, cash-out refinances, partners, and property managers.

Limit 1: Cash for each down payment and reserves

Each conventional rental purchase needs a down payment, closing costs, and reserves, which are assets the lender requires you to still have after closing.

• Down payment: Fannie Mae's minimum is 15% for a one-unit rental and 25% for a two- to four-unit rental. Borrowing more than 80% of the property's value generally requires mortgage insurance, so include its cost in your cash-flow budget.
• Reserves on the new property: for loans run through Fannie Mae's automated system, six months of its payment, counting principal, interest, taxes, insurance (including any monthly mortgage insurance premiums), and any HOA dues.
• Reserves on your other financed properties: a percentage of what you owe on them, not counting the new property or your home. The percentage is 2% if you will have one to four financed properties, 4% for five or six, and 6% for seven to ten.

An example with assumed figures: you have a mortgage on your home and three rentals with $540,000 in loans. Buying a fourth rental for $275,000 gives you five financed properties. With 20% down, you need about:

Reserves do not have to sit in a savings account: Fannie Mae also counts stocks, bonds, mutual funds, and the vested balance of retirement accounts that the lender confirms allow withdrawals regardless of your current employment status. You do not have to withdraw retirement funds used for reserves. On a first rental, the 4% line would be $0. By the seventh financed property, the rate is 6%, so $1.2 million in loans on other rentals would mean $72,000 in reserves on that line alone. How much cash reserves investors need covers how much to hold beyond what the lender requires.

Limit 2: Fannie Mae's 10-property cap

Fannie Mae counts every one- to four-unit property where you are personally liable on the mortgage, including your home if it has a loan and the property you are buying. Its limit for a borrower buying a rental or second home is 10 financed properties, on loans run through Desktop Underwriter (DU), Fannie Mae's automated underwriting system. Three counting rules change what that cap means for you:

• A building counts once. A fourplex is one financed property, so larger buildings add units without using up the cap.
• Five-plus units and commercial property do not count. Loans on buildings of five or more units and on commercial property are left out of the count.
• Loans you do not personally owe do not count. A loan made to your LLC that you have not personally guaranteed is left out.

Fannie Mae no longer sets a minimum credit score for loans run through DU, and its old 720 minimum for borrowers with 7 to 10 financed properties is gone from the guide. Individual lenders can still require a higher score, so ask each lender for its minimum before you apply.

Limit 3: Your debt-to-income ratio

Your debt-to-income ratio (DTI) is your monthly debt payments divided by your gross monthly income. Fannie Mae allows up to 50% for DU loans, and 36% (up to 45% with strong credit and reserves) for loans a person underwrites by hand.

Rentals often add to DTI instead of reducing it, because of how lenders count rent. On a purchase, the lender takes 75% of the rent (the appraiser's market rent estimate, or a lease if the market rent supports it) and subtracts the full monthly payment. A rental at $2,400 a month with a $2,200 payment counts as $1,800 minus $2,200, so $400 a month is added to your debts even though the rent exceeds the payment by $200. Fannie Mae also requires 12 months of rental management experience before positive rental income can be used to qualify; without it, that income can only offset the property's own payment. Each thin-margin rental uses up some of your salary's borrowing room.

Limit 4: Your time

Each unit adds leasing, rent collection, repairs, and turnover work. If you add properties every year while working full time, management hours can become the limit before financing does. A property manager takes over that work for a fee. Ask each manager for its full fee schedule (monthly fee, leasing fee, renewal fee, and any markup on repairs) and include those costs in your cash flow before you buy. Scaling your property management covers when to hire a manager and how to compare them.

How to get past each limit

1. Portfolio loans. A portfolio lender, often a local bank or credit union, keeps the loan on its own books instead of selling it to Fannie Mae or Freddie Mac, so it sets its own rules on property count and income. Portfolio loans explained covers terms and where to find these lenders.
2. DSCR loans. A debt service coverage ratio (DSCR) loan qualifies the property's rent against its payment instead of your personal income. Each lender sets its own minimum ratio, down payment, and credit score. DSCR loans explained shows how the ratio is calculated.
3. Cash-out refinancing. Fannie Mae will lend up to 75% of a one-unit rental's appraised value on a cash-out refinance (70% for two to four units). The loan being paid off must be at least 12 months old, and you must have been on title at least six months. A rental worth $300,000 with a $180,000 balance can return up to $45,000 before closing costs, but the larger loan raises that property's payment and adds to the balances your next lender's reserve requirement is based on.
4. Partners. A partner can bring cash or qualify for a loan you cannot. Put contributions, decision rights, profit splits, and the exit in a written operating or partnership agreement. If a partner puts in money and leaves the work to you, ask a securities attorney whether the deal is a securities offering; the SEC requires every offer and sale of securities to be registered or to fit an exemption, such as Rule 506(b).
5. A property manager. Hire one before your hours limit you. Moving a few properties to a manager early lets you compare their work with your own records.

A realistic path from one property to ten

The stages below count financed properties, so include your home if it has a mortgage. With a mortgaged home, your sixth rental is your seventh financed property, and your tenth rental is over Fannie Mae's cap.

• Financed properties 1 and 2: conventional loans, building up 12 months of rental history on Schedule E so lenders can count your rental income. Keep the reserves for each one in place.
• Financed properties 3 to 6: reserves on the other rentals rise from 2% to 4%. When DTI blocks the next conventional loan, consider a DSCR loan; a portfolio lender sets its own income rules, which may still include a DTI limit.
• Financed properties 7 to 10 and beyond: the reserve rate is 6% and the Fannie Mae cap is near. The options from here are DSCR and portfolio loans, LLC loans you do not personally guarantee, or a five-plus unit building.

Before each purchase, stabilize the last one: a tenant in place, the first repairs done, and a few months of actual income and expenses that match your projections. As example arithmetic, 10 rentals that each clear $250 a month after all costs produce $30,000 a year. Passive income and financial independence covers how to work out how many rentals your own spending requires, and what is passive income covers how much work rental income takes compared with other sources.