Key Takeaways:

• Airbnb changed the real estate investing landscape, creating opportunities for certain properties to reap much greater income than their long-term rental potential.

• QM lenders have not adapted to this change. Short-term rentals don’t fit into the box of conventional mortgage organizations like Fannie Mae and Freddie Mac.

• DSCR loans for Airbnb financing present an opportunity for STR lending, with flexible underwriting based on property income or potential income.

• DSCR lenders can finance Airbnb investors, even if they have been rejected by every conventional lender.

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It’s hard to overstate how Airbnb disrupted the real estate industry. Average people became de-facto hotel magnates right under the noses of the big players, prompting a flurry of changes in laws, housing prices, and underwriting practices.

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From an investor’s standpoint, Airbnb opened to the masses a direct-to-consumer marketplace for short-term rentals. Suddenly, with the right marketing, condos and houses had the potential to generate far more income than their potential as a long-term rental.

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But Fannie Mae has not caught up. Traditional mortgage lenders and mortgage brokers have struggled to respond to the change. The profit potential of a short-term rental simply doesn’t fit their underwriting models. The result — savvy investors struggle to get approved for a conventional mortgage on a promising short-term rental … and due to lack of financing, golden opportunities slip through their fingers.

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DSCR loans have stepped into the vacuum to fill that need. Munoz Ghezlan Capital routinely helps aspiring short-term rental (STR) investors get the Airbnb financing they need after being rejected by QM lenders. Let’s investigate the details that make DSCR mortgages and Airbnb investors a match made in heaven.

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Why Short-Term Rentals Are Different

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Short-term rentals break the traditional model for income calculation. The right property can generate far more income as an STR than its established potential as a long-term rental. Any number of factors can lead to this accelerated income. Examples include:

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• Proximity to Desirable Destinations. Being close to downtown entertainment districts, tourist attractions, universities, even airports can make a particular Airbnb unit a hot commodity.

• Luxury. High-end properties can be hard to rent out, as there are only so many high-income or HNW families and individuals who want to rent long-term instead of buy. But for the travelling business class, accustomed to a certain style, a luxury property in a good location can command handsome prices with a far more robust market of eager renters.

• Affordability. If the daily rental rate of a reasonable property is less than the average rate of a comparable hotel, even modest properties can become cash cows.

• Unique Experiences. Properties like farmhouses, treehouses, yerts, tiny homes, converted airplane hangers, and the like can have significant profit potential simply for the unique tourism experience they offer.

• Clever Branding. Even a basic house or condo can stand out and generate outsized income if the owner plays to a specific niche — for example, music- or sport-themed decor, even down to branding the unit after a specific pop or sports star that has a rabid fan base.

• Furnished Rental Market. Some renters need the convenience of a furnished unit. An Airbnb owner with thrifty furniture-shopping habits can command a significant premium for providing this convenience, even attracting long-term renters willing to pay far above the market rate.

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Despite these potential advantages, short-term rentals pose significant challenges to mortgage underwriters, including:

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• Massive Growth and Adoption. Airbnb is no longer a secret. The popularity of STR platforms like Airbnb and VRBO have led to a flood of adopters, prompting risk of market saturation. Every year, headlines break about an Airbnb bubble about to burst. It hasn’t happened, but it makes underwriters skittish.

• Seasonal and Unpredictable Income. Short-term rentals are a seasonal and unpredictable market. There could be whole months with high vacancy and minimal income … only for the high tourism season or a renowned festival, sporting event, or convention to make the owner’s year. Still the owner has to have cash on hand every month to pay the mortgage and utilities, and no one understands that better than mortgage underwriters.

• Expense Calculation. Airbnb owners have a whole different set of expenses to account for — regular cleaning, wear-and-tear repairs, amenities from Wifi to shampoo bottles to mints on the pillow, fees to platforms like Airbnb and VRBO, and management or virtual-front-desk expenses if the owner wants to turn the Airbnb into a passive expense. It certainly doesn’t fit neatly into the grid of a standard underwriting template.

• Reputational Risk. Airbnb and VRBO properties live and die by the reputation of the host and the property. A new host might have to offer the STR at a discount until they build some reputation on the property, but unhappy guests who leave negative reviews can flatline the unit’s income potential. As such, lenders want to see attentive, proactive hosts, preferably with a track record of high guest scores.

• Regulatory Hurdles. State and local governments have responded to the Airbnb boom in very different ways — sometimes with complete permissiveness, sometimes by enforcing laws already on the books, sometimes with new laws. Austin, TX, for example, has a longstanding “hotel operator” license that commands a hefty fee and takes months to get approved for. California has responded with widespread, outright bans on Airbnb properties to respond to the dearth of affordable long-term housing. Lenders are understandably hesitant to lend on a property that will take months to become legally operational, if ever.

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Form 1007 on the Appraisal and How it Undermines STR Underwriting

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Lenders of all stripes approve loans based on appraised value. In the case of rental income, the time-honored benchmark for the rental value of a property is Form 1007 on the appraisal. On this form, the appraiser gives a professional opinion of the property’s potential as a rental unit.

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But Form 1007 only takes into account the long-term-rental potential of the subject property. The appraisal industry has not adapted to the landscape created by widespread availability of STRs as a small business model. The lender is left to make a decision about the rental potential of a property intended for STR without the comfort of an appraiser’s corroborating opinion.

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What Is a DSCR Loan?

A DSCR loan is an elegant solution to the problem of fitting the square peg of an Airbnb into the round hole of traditional mortgage underwriting. It’s a type of mortgage that focuses not on the personal income and employment history of the borrower, but rather on the cash flow potential of the property. 

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DSCR Explained in Brief

“DSCR” stands for “debt service coverage ratio.” It measures whether the net operating income (NOI) of the property will be sufficient to cover the mortgage payment (or “debt service”). The equation looks like this:

DSCR = Annual Net Operating Income (NOI) ÷ Total Annual Debt Service

Or:

Total Annual Debt Service = Annual Net Operating Income (NOI) ÷ DSCR

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A DSCR number greater than 1 (say, 1.1 or 1.25) means the property has the potential to generate enough cash flow to pay the mortgage with cash left over as profit. 

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A DSCR less than 1 (say 0.7, 0.8, 0.9) means there will be a shortfall and the owner will not be able to cover the mortgage with the NOI alone. 

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A DSCR of exactly 1 means the property is expected to generate exactly cash flow to cover the mortgage (with no profit cash flow left over for the owner).

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For a more in-depth examination of DSCR calculation (including examples), check out this article on DSCR calculation.

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How DSCR Loans are Different

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Instead of requiring the borrower to submit W2s, pay stubs, tax returns, debt-to-income calculations, and proof of employment history, a DSCR lender will instead want: 

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• Trailing cash flow statements (if the property is already in use as an STR) 
• A business plan from the borrower on how they intend to realize the property’s full potential
• An appraiser’s opinion of rental value, or, in the case of a short-term rental, credible data on the property’s potential as an STR.

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DSCR Loans are Non-Conforming — What That Means for You

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DSCR loans are non-QM or non-conforming loans, meaning they don’t meet the qualifications set by agencies like Fannie Mae and Freddie Mac, making them harder to sell on the secondary market. This adds risk to the lender. As a result, DSCR loans tend to have higher interest rates (+1-2%), higher closing costs (+1-2%), and higher down payment requirements (20-30%). 

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However, this also means that the lender has much more flexibility in their underwriting process. They don’t have to fit the deal into the rigid boxes set by Fannie Mae, so they are free to approach each deal with fresh eyes. If the buyer can tell the lender a convincing story of how they plan to unlock the property’s STR profit potential, a non-QM lender will be willing to hear them out.

How Lenders Evaluate Airbnb & STR Income for a DSCR Loan

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We now understand what DSCR mortgages are — a mortgage based on property income instead of personal income — and why they are a promising source of Airbnb financing and STR lending. So how do lenders evaluate the income potential property income of an STR? Is the process different than the udnerwriting process for a long-term rental?

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3 Main Methods Used By Lenders

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A DSCR lender will use three main methods to evaluate the income potential of a short-term rental:

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12-Month Trailing Income (“T12”)

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If the property is already in use as an Airbnb, the lender will request the “T12” or “trailing 12-month income” statement. This is a summary of all income expenses for the past 12 months, broken down month-by-month. This helps the lender understand how much net operating income the property has generated in the recent past. It can also help them identify seasonality and seasonal vacancy trends.

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Note that the T12 won’t necessarily tell the lender what to expect if the buyer intends to reposition or rebrand the property to increase its popularity on the STR market.

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AirDNA or Similar Market Reports

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If the property is not currently in use as a short-term rental, the lender will rely on aggregators who compile short-term rental data. These data aggregators charge a fee for access to the data and can often provide accurate data down to the zip code or even the neighborhood, including real data collected from Airbnbs on the market. AirDNA is a popular aggregator of short-term rental data.

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A market source like AirDNA usually breaks the data down by unit type, unit size, and high-end vs. medium-end vs. low-end. This data parsing can help the lender evaluate the impact of a rebranding or repositioning plan by comparing the different tiers of STR quality. For example, if the buyer wants to reposition the property from the medium end to the high end of the market, AirDNA and other data sources, can give the lender an estimate of how big a boost is plausible in that market.

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Long-Term Market Rent (1007) Only

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Some DSCR lenders are old-school — they rely solely on Form 1007 of the appraisal, which only accounts for the appraiser’s opinion of the long-term rental potential. DSCR lenders who adhere to this model can be expected to offer lower loan balances, up to the value justified by Form 1007.

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Income Adjustments Lenders Make

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Lenders use these tools to determine the income potential of the subject property, but they also have to account for expenses. DSCR lenders will typically make the following adjustments to adjust their assumptions about the NOI:

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• Expense Load. DSCR lenders will assume expenses of 10-40% of the income potential.

• Vacancy Assumptions. The vacancy assumption for an STR will usually be higher than the assumption for long-term rentals, usually in the vicinity of 10-15%.  

• Platform Fees. Lenders will calculate the percentage of the gross income that must be paid to platforms like Airbnb and VRBO of the privilege of access to their audience.

Example Calculation

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Let’s do a sample calculation to demonstrate how the DSCR calculation can drastically alter an investor’s buying power when considering the same property as an Airbnb vs. a long-term rental. Let’s consider a 3bed/2bath house in a suburban neighborhood. 

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Long-Term Rental

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Based on Form 1007 of the appraisal, the market rent has the potential to produce an NOI of $30,000. 

The lender requires a DSCR of at least 1.1. Here’s the maximum monthly payment they would approve:

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Annual Net Operating Income (NOI) ÷ DSCR = Total Annual Debt Service 

$30,000 ÷ 1.1 = $27,273

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That’s the annual debt service. Divide that by 12, and the highest monthly payment the lender will approve would be $2,272. Depending on prevailing interest rates, that might be a loan balance of $350,000. For quality properties in desirable markets, that might not even cover half the purchase price.

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Short-Term Rental

But let’s say the data showed that the property had a potential NOI of $69,000. Let’s do the math again. 

Annual Net Operating Income (NOI) ÷ DSCR = Total Annual Debt Service 

$69,000 ÷ 1.1 = $62,727

The lender would now be justified in approving a mortgage payment of up to $5,227 per month. Depending on interest rates, that might be a maximum loan balance closer to $630,000, potentially more than enough to finance 70-80% of the full purchase price. 

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Borrowing power of $350,000 vs. $630,000 … on the same property. That’s the power of DSCR calculations on short-term rentals.

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DSCR Loan Requirements for Airbnb & STR Properties

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Like all lenders, DSCR lenders require their loans to meet certain underwriting requirements before they will approve the loan, even for STR lending. These requirements aren’t uniform like the requirements of QM loans, so the thresholds will vary from lender to lender. Here’s what to expect in general:

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• DSCR Thresholds. Most lenders require a minimum DSCR on the deal between 1.0 and 1.25. Some lenders may accept a DSCR lower than 1 if the deal has special circumstances attached.

• Down Payment & LTV Requirements. Without the safety net of Fannie Mae conformity, DSCR lenders reduce their risk by requiring higher down payments — usually 20-25% for acquisition and 25-30% for refinance — with correspondingly lower loan-to-value (LTV) limits — 75-80% for acquisitions, 70-75% for refinance.

• Credit Score Requirements. DSCR lenders do take the personal credit score of the borrower into account, but the requirements are often lower than those of QM lenders — usually in the range of 620-660, with the best terms available to borrowers with credit scores of 700 or higher. 

• Reserves Requirements. As with many commercial mortgages, DSCR mortgage require the borrower to have a minimum cash balance in their account at the time of funding, enough to cover several months of debt service even if the property doesn’t earn a dime of NOI. This reserve requirement could be anywhere from 3 months’ worth to 12 months’ worth.

• Eligible Property Types. Properties eligible for a DSCR loans for short-term rental include single-family homes, condos, townhomes, duplexes, triplexes, fourplexes, and some multifamily buildings of 5-8 units or more. For buildings with more units, you usually need to enter the arena of commercial lending.

• Disqualified Property Types. DSCR lenders will not approve a loan on an Airbnb project for a hotel, “condotel” (a condo building where the units are rented out like hotel rooms), or a home with HOA or legal restrictions against using the unit as a short-term rental.

Step-By-Step: How to Get a DSCR Loan for a Short-Term Rental

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Step 1: Evaluate Potential STR Income

If the property is already being used as an STR, you can use the past income and expenses as a predictor for future income and expenses. 

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If the property has not been used as a short-term rental, you can estimate income by looking at comparable Airbnb and VRBO listings in the area, especially listings with positive testimonials and reviews so you know they have actually been rented out successfully. You can also subscribe to a service like AirDNA to look at aggregated STR data for your market. This data can also help you determine how much you might be able to increase the income with a rehab, reposition, or rebranding.

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Make sure to factor in the platform fees charged by Airbnb and VRBO if you intend to use them, as well as a vacancy and expenses rate comparable to those used by lenders (10-15% vacancy, 10-40% operating expenses).

Try to figure out your DSCR using the equation. This will help you target the right lender.

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Step 2: Prequalify with DSCR Lenders Who Specialize in STRs

Munoz Ghezlan Capital can introduce you to many such lenders and help you pick the most fruitful ones to approach.

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Step 3: Gather Documentation

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You’ll need your ID, income statements for the property if you have them, and/or a business plan and pro-forma projection of income for any reposition you might want to attempt.

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Step 4: Appraisal & Rental Analysis

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The lender will hire the appraiser and conduct their own income analysis of the property.

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Step 5: Underwriting & DSCR Calculation

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The lender’s underwriting team will take the reports and calculate the DSCR as well as any other relevant financial benchmarks.

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Step 6: Final Conditions & Closing

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After final inspections and agreements, escrow closes and the loan is funded. You have your DSCR loan for short-term rental financing!

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DSCR Loan Rates & Terms for STRs

DSCR loan rates can vary, especially given the variations that arise from not having to conform with Fannie Mae. Here’s roughly what to expect:

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• Loan Terms. 30-year fixed interest rate fully amortized is the most common structure, same as conventional loans. 40-year fixed terms may also be available, as well as ⅚, 7/6, and 10/6 adjustable rate mortgages (ARMs).

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• Interest Rates. Based on the SOFR (Secured Overnight Financing Rate) benchmark, interest rates on DSCR loans tend to be 1 to 2 points of APR higher than those of conventional mortgages.

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• Loan-to-Value. Lenders will usually extend 75-80% of the value of the property for an acquisition, 70-75% of the value for a refinance.

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• Closing Costs. Usually 1-2% higher than conventional mortgages, falling in a range of 4-6% of the purchase price.

Pros & Cons of DSCR Loans for Airbnb Investors

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Pros

• Income-Based Calculation. As we saw in the example, by taking into account STR income potential instead of Form 1007 income potential or raw comps, you can qualify for much higher buying power on an Airbnb.

• Flexible Underwriting. Without having to fit into the Fannie Mae box, your deal will be evaluated on its merits.

• Fast Funding. DSCR loans usually accomplish much speedier approval and funding. If the paperwork is in order and the appraiser is on time, funding can happen in weeks or even days.

• Fast Refinancing. The “seasoning” requirement — how long you have to wait until you refinance the loan — is usually as little a 1-3 months, as opposed to 6-12 months for conventional lenders.

• No Personal Scrutiny. The lender won’t perform any invasive checks on your personal income, debt-to-income ratio, job history, or personal tax returns.

• No Limit on the Number of Loans. As opposed to conventional lenders, who will refuse to give you new mortgages after you have a certain number of them on your balance sheet, DSCR lenders are known to write as many loans to one person as the number of good deals that person brings them. Great for Airbnb investors who want to scale up to an empire.

• Fund Into an LLC. Whereas conventional lenders prefer to fund a personal bank account (a problem for investors who want to limit their liability by holding the property in a corporation or LLC), DSCR lenders actually prefer to fund the proceeds into the name of an LLC, protecting your corporate veil.

Cons

• Higher Cost of Borrowing. Because the lender takes on more risk, you can expect higher interest rates, higher closing costs, and higher down payments.

• Prepayment Penalties. Some DSCR loans include a “prepayment penalty” — a big fee you have to pay if you try to pay off the loan in full in less than 5 years. Airbnbs are usually long-term “buy-and-hold” plays for investors, but if you want to sell in less than 5 years, prepayment penalties can eat into your sale proceeds.

• Credit Check. While you don’t need to send in W2s, paystubs, or personal tax returns, the lender will still hard-pull your credit and make sure you meet a minimum threshold.

Bottom Line

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For investors who see dollar signs in the short-term rental industry, DSCR loans for Airbnb deals solve several key problems. They bring the STR lending industry into the present day where Airbnb is a household name, offering loans based on property income instead of your employment history and income. They don’t cap the number of loans you can take out and use a variety of tools to break out of the box created by Fannie Mae and Form 1007 of the appraisal.

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This comes at the cost of higher borrowing costs, but the margins of an excellent Airbnb or VRBO investment could more than justify these margins.

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If you’ve never tried to get a DSCR loan and need help — or if you’re a seasoned borrower and want to see what other options are out there — contact Munoz Ghezlan Capital today. We’re experts at getting Airbnb financing, and we have a large rolodex of relationship lenders eager to put down money on a dynamite short-term rental. Reach out to us now!