Commercial Real Estate Q&A #1: Should I Tap Into My Equity?

Commercial real estate investing - where are you going?

Greetings from Cedar Crest, NM!

So much going on in the market….the unemployment rate continues to go up, delinquent loans plague lenders in record numbers, and….as if we are suprised…we are now officially in a recession (drats! who saw the smoke signal?).

In all the mayhem….is opportunity.  We all know there is a lot of opportunity, but how do we take advantage of it?  I have been getting more and more emails on “how to?”  So….today we take the time to answer a question from Mike Sell of Pittsburg, PA.  I have asked Emily Cressey to give her perspective as well.  Here is Mike’s question:

Rob,

Question for ya: Me and my buddy have about $100,000 equity in our current 2 unit investment property and are exploring ways to best tap into this. My questions is what is the best way to do it? We want to purchase another 2-6 unit property in the area, with values ranging from $300,000 to $700,000 but we want to put up as little of equity as possible. Should we refinance to pull this out (our current rate is 6%, and I know the going rates aren’t much lower), should we take out a HELOC, or do a straight leverage purchase?

The name of the game is to vulture some assets in Pittsburgh. I want to understand from you the best way to do this. Since you started by acquiring a ton of assets with little to no money down, I figure you are the perfect guy to get advice from.

Mike

Emily’s take:

Hi Mike,

Rob asked me to chime in on your question about pyramiding your investment portfolio, so here is my take.

Emily Cressey Commercial Real Estate Investor and Coach

You mention that you have $100,000 in equity in a 2-unit property, but you did not disclose the approximate value of the property in today’s marketplace.

I think when you are looking at refinancing or getting a line of credit, it is important to decide how aggressively you want to leverage yourself up.

As too many investors have learned in the last 12-months, what goes up can come down.  Leverage is a 2-bladed sword.  It helps you make money faster, but it can also make you lose money faster when the tide turns.

Depending on your other assets and liquidity elsewhere, I would recommend not encumbering any of your assets more than 70-80% debt right now.  So, if the duplex was worth $200,000 and you owed $100,000 on it, you could refi and pull out maybe $50,000 or so.  I wouldn’t go much higher than that.

Whether you Refinance or get a Line of Credit is pretty much up to the rates.  Talk to some lenders and compare costs of doing it both ways.

In regards to your next acquisition, what I am hearing from lenders right now, is that they are being a lot more conservative in who they will lend to, and how much they will lend.  Here in Seattle, they are looking for DCR’s of about 1.2.  (There is a 75% LTV requirement, but DCR is really the limiting factor.  Most people have to put 40-50% down in order to meet these lending guidelines… but I am in a very expensive marketplace).

In addition to requiring larger down payments, lenders are also looking at the experience level of the buyer(s) and their other assets and liquidity.  Cash is king and lenders are feeling risk-averse.

The way Rob and I, and our other partners in Grassland Investments, LLC, have been able to acquire property no money down is through raising private money.  I have created a training program on this which was just released for sale by Mentor Financial Group (Emily Cressey’s Raising Private Money), but the basic idea is that you would work your network of contacts so that you could raise a down payment of 20-30% of the cost of your acquisition target property, and then cut your investors in for a share of the profits.  Using this approach, you greatly expand the number of properties you can acquire because you are not dependent on your own build-up of capital (say in your other buildings’ equity) in order to raise down-payment money.

Although I am not totally familiar with your situation, I hope this discussion is helpful.  Feel free to write again as you evaluate your next steps.

Emily

Rob’s Take:

Mike…a great question.

Rob Powell commercial real estate investor and coach

The economy is much worse than what 90% of the U.S. population thought it would be.  Then there is the 10% who predicted such a downturn just a few years ago (read The Next Great Bubble Boom by H.S. Dent).  The bright side to this is that you are going to see more opportunites than ever before.  The problem is…credit is tight and one must be liquid or have access to cash to take advantage of the opportunities.

One way to free up some cash is by opening up a Home Equity Line of Credit (HELOC) on your personal residence or a line of credit (LOC) on an real estate asset/business…..the other option is refinancing and pulling the equity out.

NOW…the problem is, as I said before, credit it tight.  The real question is….will you be able to open up a line of credit or refinance?  Lenders are more and more paranoid (rightly so) and require full documentation…among “other” things.  The value of the asset is a big question….is there enough value in your assets to get the needed LTV (Loan to Value ratio)?  Is your credit score high enough?, etc.

Personally…I like lines of credit.  There serve the main purpose of having cash readily available….but there are a couple bonuses to a line of credit:

1) Asset protection.  Oddly enough, in many cases, taking out a LOC on an real estate asset will disguise any equity (even if you do not use any of the credit line) to curious eyes.  In other words, LOC can be a negative to your net worth, which is a good thing when it comes to asset protection.

2) Boost to credit score:  For reasons I cannot explain, having a HELOC can boost your credit score…especially if you do not use it.  So if you open up a HELOC and just have it available, you may see an positive bump in your credit score.

Steve Maxwell”s Take:

First lets consider your question about “tapping” into $100k equity.  The first

Steve Maxwell - Commercial Real Estate Coach

question is “will” you be able to tap into this “equity”

1.  As you probably guessed lending terms have changed and of course may continue to change (thus confirm with your mortgage lender) … thus will it be worthwhile to refi?  For bank financing SOME of the new terms (Fannie Me & Freddie Mac guideline changes) for non owner financing are below.  For more information, you can check with Aaron at Geneva Financial at aaron@genevaFi.com where I learned some of the following or if you have another lender.

* Max of 4 financed properties

* Max of 10 is subject property is primary residence

* Max LTV (non owner 90% / 85% in declining markets).  However unless you have LTV at 75% or less rates & mortgage insurance premiums are higher.

* Can do unlimited number through portfolio lender with tighter rules (full doc only, 75% LTV on in-state investors, 65% out of state investors, states are limitied)

* No more stated income

* Rental income used to qualify (must have 30% equity in property verified with appraisal or automated evaluation) – thus do you have this $100k equity?

2. Before doing a refi I would carefully look at how “seasoned” the loan is (i.e. how many years have you been paying principle).  If you’ve been paying on the loan for sometime you’ll be starting over if you refi and thus may effectively be paying a higher rate.  This is a key thing to consider and suggest you review chapter 17 of “Wi$e Up – What You Don’t Know about Money WILL Hurt You” (available on www.therealwealthcompany.com site).  IF you have a seasoned loan IF possible I might prefer adding a line of credit IF possible to obtain … again see above.

Your follow-up question is “we want to put up as little of equity as possible”  - reviewing the conventional lending environment (see above for a small view into this) this means you’ll most likely use one of the following (or possibly other approaches):

A. Use bank financing … but raise investor funds to fund the down-payment.  For the size of deals you’re discussing you might want to consider friends & family … and of course make the sure the #’s work out for both them and yourselves.  This might be the most effort (in my opinion) … but possibly the most straight forward.

B. Work with Seller’s to provide seller financing.  While some more experienced investors may be willing to work with you using something like a “wrap” to keep their existing financing in place while extending financing to you … you may find it easier (and get better terms) focusing efforts towards properties owned free and clear.  In any negotiation its always “easy” to discuss the pricing … but often you can get the best deal by working the terms … such as seller financing at an attractive rate.  How CAN you structure this deal with little money down that still provides +CF?  I suggest you make this your strong intent.  If you still need some downpayment that you don’t have … you can of course still bring in investor money from friends/family.

Hope this helps….

Until next time……rob

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