Creating Leverage - Inexpensive Financing Sources?

Question

Interest rates are extremely low and I want to take advantage of this as much as possible. I'm looking to create additional leverage through inexpensive, long term financing options to then reinvest into syndicated commercial real estate deals.

For example, an apartment complex syndicated deal in Texas is expected to earn 12-17% annually. Assuming I have a $500K house that's completely paid off, $500K in a 401K, and additional $250K in a brokerage account, would it be financially wise to:

1.) Cash out refinance the home ($375K?) with a 30 year fixed at 4-5% interest rate, and reinvest the cash into the syndicated deal. Maybe an ARM?

2.) Pull a personal margin loan from the 401K or brokerage account, keeping the securities invested, and investing the cash from the loan into the syndicated deal.

3.) Any other options?

Thoughts, ideas, suggestions? I essentially want to make the spread between the 12-17% annual investment return and 4-7% interest rate of borrowed money. I understand the risks of borrowing and the successful track record of the syndicated commercial deal operators.

Bill Gulley · Answer

I think I know of more people who have lost money in syndicated multi's than made money. Jon has a very good point.

Steven Hamilton II · Answer

@Jeffrey Magenes ,

You cannot pull a margin loan from a 401k.  The most you can do is borrow 50% of the balance up to $50k.

Jeff Greenberg · Answer

@Jon Holdman & Bill Gulley  do have a point that not all syndicated deals will live up to their promise.  There is no guarantee in any Re deal, fix and flip, buy and hold, notes, et al.  The investor needs to be educated on the strategy and do their DD.

Some strategies are more passive than others and depend more on the performance of someone else.  DD is the key and then you decide whether or not to put your toe in the water.

Jon Holdman · Answer

You must consider that these syndication deals may not return anywhere near what they're promising up front.  At this point the promoters are full of great ideas and shining promises.   It is very possible that you will get exactly zero returns out of these deals.  Its even possible they will lose money.  I have two such investments, neither of which has paid out a penny in years and neither of which can be cashed out at all, let alone for the money I have invested. So, if you're going to leverage other properties or investments you best be dang sure you can make those payments even if this investment turns into a complete, 100% loss.

J. Martin · Answer

@Jeffrey Magenes , I'm 100% with you.

Assuming you understand the risks, aren't changing your asset allocations, and your goal is to get long-term fixed rate money, I think you best bet is the cash-out on the real estate. Margin loans are almost always variable rate as far as I know, and can quickly get closed out if the stock market gets whipsawed, so it's not the best for a long-term stable rate funding source, IMHO.

The 401K loan won't have the 30yr amortization you could get with the home loan, so your cash flow wouldn't be as high with the 401k loan. And you won't be able to borrower the principal for as long on average.

There are banks doing 30-yr fixed rate cash out (although at lower LTVs than purchase - maybe 65-70%). There are also options for home equity loans up to 20 yrs fixed rate and home equity lines of credit with interest-only for up to 10 years, then fixed and amortized for another 10 years. The line with interest-only gives the highest cash flow in early years, but it's variable, and I would expect significant potential changes in rates over the next 10 years.

You said "inexpensive, long-term financing options." So if you're looking for the longest amortization and maturity, most stable, and low cost, I recommend the cash-out loan on RE (this would be my preference for my personal situation too. the fixed rate helps me sleep well at night). If you're looking for something shorter-term or don't mind the variable rate, I would consider one of the other options.

You'll probably like this saying from one of my former co-workers: "If cash is king, the leverage is god!" Having said that, don't forget that leverage and hubris have been at the beginning of nearly every financial disaster story since the beginning!.. Know what level of net cash flow decline would cause you to be unable to pay your loans, be prepared for the risk, and keep reserves!! Good luck in all your investments!

Jeff Greenberg · Answer

Don't forget that the 401k loan repayment is p&i and the 17% return on the syndicated deal probably includes after sale returns.  You could be in negative cashflow while the loan is being paid off.

Andrew S. · Answer

@Jeffrey Magenes .  This sounds like a perfectly reasonable plan - on paper.  Whether it is a good idea or not will really mostly depend on

a.) your risk tolerance (you still need to be able to sleep at night... otherwise it's probably not worth it)

b.) your ability to tap into other sources of cash if some, or all of your plans go South (for example, if you lose your job, 401k loans are typically due immediately, or, you may receive a margin call if your brokerage assets take a hit, etc, etc.).  Some of these situations can lead to instant disaster, if yo don't have the ability to respond/replenish quickly.

c.) the reliability of those syndicated deals in Texas yo are speaking of.  Those may be very lucrative investments, but they too carry downside risks, I'm sure (if not, please send info - I want in too!  :-))

Leverage is a fantastic tool to build wealth, but it also has the potential to take you down to "zero", if you are not careful.

Bill Gulley · Answer

I'd say you have a plan, except, be aware that borrowing on margin can get you in trouble if the market dives. You could also have tax issues if amounts are not repaid from a call.

There are pitfalls, but yes, you can tap those equity dollars.

Good way to go, IMO. :)

Bill Jacobsen · Answer

It is just my personal opinion that securities are overpriced at this time so I would probably recommend moving money from there to real estate.

Bill

Creating Leverage - Inexpensive Financing Sources?

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