Airbnb and short-term rentals have become a major source of income and wealth-building for real estate investors. The investment mortgage and business lending market was initially skeptical, but the industry has caught up. Numerous attractive financing options exist to help Airbnb investors finance their investments — mortgage, renovation, furnishing, marketing, even down payment.
The most effective solution Munoz Ghezlan Capital helps investors execute for their Airbnb acquisitions is a combination of DSCR loans and business working capital loans. In this article, we’ll explore this strategy of acquiring airbnb investment loans — the benefits, limitations, potential pitfalls, and how to decide if it’s right for you.
Key Takeaways
- DSCR loans are a type of mortgage based on the income potential of the property, rather than the personal income and employment history of the borrower. Many DSCR lenders will consider Airbnb properties, though there may be higher down payment and DSCR requirements.
- Business working capital loans are available to established business entities and can be used to fund AIrbnb setup and listing launch. Some DSCR lenders will even let a borrower use a working capital loan as the down payment and other acquisition costs.
- DSCR + working capital can be an effective way for investors to scale their portfolios with 0%-down acquisitions and have the ready capital to furnish, decorate, renovate, launch, and market their listings quickly.
- Airbnb investors using the DSCR + working capital financing strategy must beware of overleverage, regulatory considerations, disclosure requirements to the lender, and irregularity/seasonality of Airbnb NOI.
Why Speed Is Everything in Airbnb Investing
In the short-term rental (STR) market, speed-to-market directly correlates with higher returns for a variety of reasons:
- Speed of access to financing may make the difference between getting the deal vs. not getting the deal.
- Early entrants into untapped STR markets can corner the market and build a reputation on platforms like Airbnb and VRBO, enabling them to charge higher prices while competitors are starting from scratch with no reviews or testimonials.
- The faster a property can be renovated, furnished, and put on the market, the sooner it starts generating income to cover required expenses like insurance, property taxes, and debt service. Speed-to-market can also help the investor avoid missing seasonal uptrends, common in the STR market.
For these and other reasons, access to fast, reliable capital can make all the difference in securing an Airbnb investor a growing, thriving portfolio of short-term rentals.
Understanding Airbnb Investment Loans
A variety of investment loans can be used to finance the acquisition of an Airbnb. The two most effective, which Munoz Ghezlan Capital often helps investors acquire simultaneously for each project, are DSCR loans and business working capital loans.
DSCR Loans
A DSCR loan is a kind of conventional mortgage available for real estate investors.
In many ways it is similar to the traditional mortgage that conforms with Fannie Mae/Freddie Mac guidelines. There is a deed of trust and a promissory note. The loans are long-term (usually 30 years) with fixed interest rates (though ARMs are available), fully amortized.
Interest rates and origination points tend to be a little higher; down payment requirements tend to be higher as well. However, compared to hard money or private loans they are still very competitive in their cost of borrowing.
The major difference is that DSCR loans are based on the income potential of the property as an investment, not on the personal income, employment history, or debt-to-income ratio of the borrower. DSCR loans can also fund quickly compared to traditional loans — in the range of 7-14 days as opposed to 30-45 days. This makes them ideal Airbnb investment loans (with some caveats).
The metric used to calculate this income potential is the debt service coverage ratio (DSCR), a ratio obtained by dividing the net operating income (NOI) by the debt service, resulting in one number that indicates the ability of the property income to cover the debt service.
You can read more about general requirements for DSCR loan approval in this article.
Business Working Capital Loans
Business working capital loans are loans made to businesses for the purpose of financing their operations. This could be payroll, regular expenses, capital investments, or major marketing pushes.
Working capital (WC) loans tend to be shorter-term (usually 2-7 years), higher-interest loans compared to a traditional mortgage or DSCR loan.
However, they are often unsecured, meaning the borrower doesn’t have to put up any specific collateral. Unlike a DSCR loan or other mortgage, the lender can’t automatically attach the property to a foreclosure (though they can sue for seizure of assets, including the property, in the event of default).
Best of all, WC loans can range from $50,000 to $500,000 and beyond — enough to make a serious impact as Airbnb investment loans. They can also fund quickly, sometimes as fast as 24-72 hours, making them ideal for the speed required of successful Airbnbs.
WC loans are available to companies with legal business entities (corporation, LLC, etc.). Lenders often look at business credit, personal credit, years in business, and track record of revenue. You can read more about the requirements for WC loan approval in this article.
DSCR for Airbnb: How It Works and Why It Matters
Usually a DSCR loan will be used like any mortgage — to finance 70-80% of the purchase price when acquiring the loan. It can also be used as a cash-out or term-only refi loan later on. Here’s how it works for Airbnb properties:
How DSCR Lenders Underwrite Short-Term Rentals
As mentioned above, debt-service coverage ratio (DSCR) is the most important metric of approval for a DSCR loan. The lender wants to confirm that the income will be sufficient to pay the mortgage every month.
However, it’s not as simple to calculate dscr for Airbnb units. NOI is more complicated for STRs than it is for a long-term rental for a number of reasons:
- No Official Appraisal Estimate. Lenders typically base their underwriting decisions on the results of a professional, independent appraisal. However, official appraisals’ only estimate of rent potential is Form 1007, which estimates the property’s market rate as a long-term rental. As such, lenders cannot rely on the appraisal as an accurate source of NOI data for an Airbnb.
- Fluctuating and Seasonal Cash Flow. A long-term lease allows some expectation of predictable income. A short-term rental can potentially produce larger annual income overall, but the daily-rental model could produce erratic income patterns. Many short-term rental markets are seasonal, where Airbnb hosts can expect to make the majority of their annual income over a few short months or even weeks. How will the borrower cover their mortgage in the lean months?
- “New-Host” Liability. Airbnb users tend to prefer established hosts with good reputations, as well as listings with positive reviews and testimonials. A new Airbnb unit on the market may have to offer a discounted rate to build its reputation on the platform. There is also the risk that the host will do a bad job or get an unlucky booking, resulting in negative reviews that hobble or slow down its future potential.
- Unusual Expense Plan. Airbnbs have unusual expenses like cleaning fees, remote front desks, and handyman-on-call plans, as well as amenities like gifts, complimentary toiletries, WiFi and streaming services, and repair or maintenance of furniture and other personal property that normally doesn’t factor into expense calculations. Moreover, platforms like Airbnb keep a percentage of every booking, meaning the daily rental rates you observe on Airbnb aren’t an accurate representation of the income the investor will actually accrue.
Despite these discrepancies, DSCR lenders have evolved models to calculate income and expenses for Airbnbs, as well as underwriting and approval practices. They may:
- Rely on outside data sources like AirDNA, AllTheRooms, and PriceLabs to estimate the income potential for an Airbnb at the specified address, taking into account the quality of the unit, seasonality, and competition.
- Require risk-management measures like a higher down payment and higher cash reserves requirement — the cash reserves being important to cover the mortgage during slow months.
- Use proprietary models to estimate expenses unique to an Airbnb, including platform fees, cleaning expenses, amenities, etc.
DSCR Thresholds For Airbnb Properties
Airbnbs often have higher income potential as a use case for a given property compared to its use as a short-term rental. However, DSCR lenders manage their risk by requiring a higher DSCR for Airbnb use cases.
DSCR calculations reveal one of three things — a number greater than 1; exactly 1; or a number less than 1.
- Greater Than 1: The property is expected to cover its mortgage with cash flow to spare.
- 1 Exactly: The property is expected to generate just enough net income to cover the mortgage.
- Less Than 1: The property is not expected to generate enough NOI to cover the mortgage — in which case the loan application will probably be declined absent extenuating circumstances.
Predictably, DSCR lenders want to see a DSCR of at least 1. The normal approval range for a DSCR loan is between 1 and 1.2. However, for Airbnb investment loans, lenders tend to want to see a higher DSCR — often in the range of 1.2 to 1.3.
Requirements vary, but this is the range where the majority of DSCR lenders will become comfortable lending to an aspiring Airbnb host.
Property Eligibility Considerations
Of key concern to the lender is whether or not the subject property is eligible to be used as an Airbnb.
Ordinary considerations apply — is the property habitable? Safe to occupy? Compliant with applicable environmental or soils regulations?
Specific to short-term rentals, however, the property must be legally eligible under city and county ordinances to be operated as an Airbnb. DSCR lenders do not want to be involved with an Airbnb that is run “under the table,” outside the law.
Some municipalities have blanket bans on Airbnb hosting. Yes, hosts do run secret Airbnbs, but lenders don’t want their income calculations foiled by a city injunction should the host get caught.
The property’s zoning must allow for its use as a short-term rental. If the city requires a permit or license to operate a STR at that address, the lender will likely want the borrower to obtain those credentials before approving the loan.
Why Airbnb Investors Pair DSCR Loans With Working Capital
DSCR loans may be a viable solution to fund 70-80% of the purchase price, give-or-take. However, that leaves a large down payment. Moreover, the investor must shoulder the cost of furnishing and decorating the unit, securing contracts from cleaning and maintenance companies, and performing any renovations or upgrades needed.
Business working capital loans are a viable source of Airbnb investment loans for these extra expenses. Since they are unsecured, they don’t put any extra liens on the property, and they can be used for nearly any expense the investor chooses, allowing them to quickly acquire, renovate, furnish, decorate, and otherwise get the STR operational as quickly as possible.
WC loans can even be funded before acquisition, not only to meet lender seasoning requirements but to fund the fees involved in obtaining the necessary licenses and permits to operate an Airbnb — which, as discussed above, may be a crucial hurdle to obtaining the DSCR loan.
Working Capital for Airbnb Setup: What It Can Cover
Down Payment
Can you use borrowed working capital as the down payment for your DSCR loan? The answer used to be “no.” Lenders uniformly maintained strict policies against the use of borrowed funds for down payment to make sure the borrower had “skin in the game” — if borrowers had their own money tied up in the deal, they would be less likely to walk away from a struggling deal.
However, since 2008, certain lenders, including DSCR lenders, have softened on this requirement. Not all DSCR lenders will accept this arrangement, but certain lenders will (provided that the borrower meets the legal requirement to disclose the source of the funds).
Munoz Ghezlan Capital keeps track of which DSCR lenders will consider WC loans as down payment funds so we can help interested investors execute this strategy.
Furnishings And Interior Design
Furnishing and design is a major expense for Airbnb investors. If the property isn’t beautifully furnished and decorated, it will get negative reviews or not get booked at all. With funding in as little as 24-72 hours, a working capital loan can be a valuable source of quick furniture and decoration funding to help the property hit the ground running.
Renovation
Like any long-term real estate investment, a prospective Airbnb may require renovation and rehab. To get the property on the market quickly, these renovations must be completed without delay. WC loans can help Airbnb investors get the ball rolling as soon as title transfers. It can even be used to make advanced payments to contractors to secure priority scheduling.
Technology And Automation
Airbnbs tend to be more labor-intensive than long-term rentals. If the investor wants the Airbnb to be a truly “passive” investment, he/she might want to invest working capital into “virtual front desk” services and technology to outsource or automate daily operations.
Marketing And Launch Costs
At the very least, the host will need attractive professional photographs to attract guests to the listing. The host might also need a professional copywriter for the listing description, as well as assets like a logo, branded house manual, and welcome messages. The host may also need a website, social media profiles, and a paid marketing campaign, especially if they intend to market directly to the public in lieu of using a platform like Airbnb or VRBO.
Licensing and Permits
Some municipalities charge hefty fees for the permits and the license needed to operate a single-family or multifamily unit as a short-term rental.
Operating Reserves And Contingency Funds
Every Airbnb host needs operational reserves and contingency funds to cover emergency expenses. The DSCR lender will also require a contingency fund for payment of the mortgage — often a larger one due to the risk involved in Airbnb operation. The host may need to retain 12 months of mortgage payments as cash reserves.
Structuring DSCR + Working Capital Correctly
Separating Acquisition Funds From Setup Funds
The investor should maintain separate bank accounts for acquisition funds (down payment, closing costs, reserve requirements, etc.) and setup funds. Even if the investor intends to use a WC loan for acquisition funds, these funds should be kept separate.
This is even more true if the investor does not intend to use a WC loan for acquisition funds, but rather only intends to use borrowed working capital for Airbnb setup. Remember, the law strictly requires that you disclose the source of acquisition funds to the lender. If you intend to use borrowed funds for setup and other funds for acquisition, they must be kept separate.
Entity And Banking Structure
The ownership of the purchasing LLC must be transparent and disclosed, and all business bank accounts must be opened in the name of the LLC, with no commingling of personal funds or funds from other business entities.
Disclosure And Documentation Best Practices
Maintain clear paper trails of all funds that have been deposited into the business accounts to be used for acquisition and setup. Disclose everything to the DSCR lender, including the WC loan documents. The law strictly requires this, so there’s nothing to be gained and everything to lose by withholding. This is why Munoz Ghezlan Capital works hard to pair investors with DSCR lenders who won’t be resistant to the funding structure the investor has in mind.
Timing Coordination
Make sure the funds will be in place for the milestones that require them, whether it be acquisition, permitting, furnishing and decorating, renovation, marketing, or any other expenses on the calendar.
How Working Capital Impacts DSCR, Cash Flow, and Approval
Since you are required to disclose any loans you intend to use for acquisition financing, the DSCR lender will factor debt service on those loans into your DSCR calculation. DSCR loan approval is not solely based on the service on the mortgage debt you are attempting to obtain. It will be calculated on all debt used as Airbnb investment loans.
This means that the lender will add your payments on the WC loan to the payments on the prospective mortgage when calculating your DSCR for Airbnb. That’s often a substantially bigger annual debt service payment than what you would face if the DSCR loan was the only debt factored into the DSCR calculation.
On top of this, as mentioned above DSCR lenders usually have higher DSCR thresholds for Airbnb financing. All of these factors combine to form a single conclusion — you need a substantially higher NOI to pass the DSCR qualification for approval if you intend to use a working capital loan for acquisition costs.
With STRs, this is often possible. However, with the DSCR + working capital acquisition strategy for 0%-down financing, it’s not just possible — it’s mandatory.
Keep in mind that the service on that WC debt will also put substantial pressure on your cash flow. An Airbnb that might otherwise be a cash cow might barely break even with the debt on a WC loan to service.
However, WC loans are also of much shorter terms, usually somewhere between two and ten years. If you intend to hold the property long-term, you have a built-in cash flow increase on the calendar, because when the WC loan is retired you will have substantially less debt service. If the property increases in value due to market forces or renovation, you may also be able to do a cash-out refi and retire the WC debt early, recovering some cash flow.
Risks, Pitfalls, and Compliance Mistakes to Avoid
Overleveraging Early
Taking on too much debt to acquire a deal carries the risk of overleverage. This means that even a small problem could threaten the entire investment. If you want to use the DSCR + working capital strategy of Airbnb finance, the numbers must work even in the worst-case scenarios.
Furnishing Beyond ROI
Many Airbnb hosts are tempted to acquire luxury furnishing and decoration — either because they think it will pay off in lucrative bookings, or because they apply their own expensive tastes to design decisions. The risk of overfurnishing and overdecorating is especially pronounced if the investor is tempted to treat working capital for airbnb setup as “free money.”
However, some properties and markets just don’t have the revenue potential to justify such a high furnishing and decoration expense. Service on that shorter-term WC debt can be expensive. Smart Airbnb hosts furnish and decorate their units with the minimum viable effectiveness and calibrate their decoration budget to the unit with a realistic perspective on the maximum income it can generate.
Regulatory Surprises
If a host doesn’t carefully research the regulations that apply to STRs in that market, they could end up with a declined loan application, hefty fees, or prolonged periods where the unit is shut down while the host waits for permits, inspections, and licenses. Such interruptions can be especially costly if the host has added WC debt to the capital stack alongside a DSCR loan.
Unregulated STR markets can be particularly risky. Although strict regulations can be a burden, unregulated markets could be subject to surprises — new regulations that suddenly put pressure on the host while the listing is already in the field. For regions where neighboring municipalities have been trending towards regulation, hosts in unregulated markets should be very wary of overleveraging their investments.
Misaligned Debt Terms
Remember, a WC loan is almost always shorter-term than a DSCR mortgage. Airbnbs tend to have rampup periods — meaning less income early on, more income later. With the DSCR + WC strategy, it’s the opposite — more debt service early on, less debt service later. If the host can make it through that awkward early period of misalignment, the investment can be very lucrative. However, if the low early cash flow results in a debt service shortfall, the consequences can be severe.
Who This Strategy Is Best For
Ideal Candidates
- Experienced STR hosts with the skillset to launch quickly and the reputation on platforms like Airbnb to inspire confidence in prospective guests considering their new listing.
- Investors scaling quickly with excess cash flow that could be used to hedge overleverage risk.
- Markets with strong nightly rates that can absorb the DSCR hit that the extra working capital debt will incur.
Poor Candidates
- First-time investors who need the solvency of low debt service to learn the ropes (though with a good-enough deal, anything is possible).
- Unregulated STR markets where regulatory surprises could put sudden pressure on cash flow and operability.
- Thin-margin deals where a slow month could lead to negative cash flow and default.
Step-by-Step Playbook: DSCR + Working Capital Airbnb Launch
- Market Selection - preferably an in-demand area of a popular market that can command high nightly rates with reasonable frequency.
- Property Underwriting - DSCR calculation, factoring in WC debt service to arrive at an accurate DSCR for Airbnb investments.
- DSCR Lender Selection - Munoz Ghezlan Capital can help pick a DSCR lender who will accept a working capital loan in the capital stack.
- Working Capital Approval - Munoz Ghezlan Capital can also help select a WC lender who will approve a given business entity and offer terms that fit the underwriting.
- Closing Coordination - timing the funding of any necessary loans to the closing of the sale contract.
- Furnishing Sprint - furnish and decorate the unit appropriately and as quickly as possible for speed-to-market advantage.
- Listing Launch - photography, copywriting, and any marketing assets and campaigns necessary to get the first guests.
- Stabilization - establish a reputation, increase nightly rates to market, and align with seasonal trends.
Bottom Line
Stacking a DSCR loan with a business working capital loan can be an excellent way for Airbnb investors to acquire new listings and scale their portfolio. While the DSCR loan, based on the income potential of the property, can finance the majority of the acquisition, borrowed working capital for airbnb setup can finance renovation, furnishing, decoration, marketing — even, with the right DSCR lender — the down payment, closing costs, and cash reserve requirements.
Munoz Ghezlan Capital has helped dozens of investors find the right lenders for this structure of Airbnb investment loans, even helping them scale their portfolios with 0%-down acquisitions, the WC loan taking the equity position in the capital stack. We have also helped investors avoid the pitfalls inherent in this strategy, and help them determine if DSCR + working capital is right for them.
If you’re wondering whether it’s right for you, click here to schedule a free strategy call with a Munoz Ghezlan STR financing specialist. We can look at a deal you have under contract, or strategize for the next deal in your Airbnb empire.
