First investment property under my belt. Now what?

Question

I closed on my first commercial property last November - a 6 unit all residential. To those that have successfully expanded your portfolio, what strategies worked for you the most? I want to avoid having my loan called and/or having to pay 5% pre-payment penalty up to 5 years. I've been told cross collateralization can be risky, but what if I "untied" the properties 6 to 12 months in? What about a HELOC ? Would it trigger the loan to be called? Or should I just do it the old fashioned way and wait till I have enough equity to refinance. This would be the last resort as I don't want to pay a 5% PPP, nor do I want to wait 5 years to buy my second property. Please note that 30% was my down payment. Any suggestions or advice would be helpful.

Randall Alan · Answer

@Rodney Lorenzo

Well… just understand that by trying to incorporate your first property again, while possible, isn’t typical… which is to say you will be going against the grain of the bank’s usual process.  If they go for it, it will probably take longer, need exceptions, etc.

Next… you will need another 25-30% down on your second property, and trying to force that much appreciation is a tall order in a declining market.  In addition, banks tighten up their lending standards the more upheaval there is in the market , which is probably against you as well.

Also, banks sometimes have their own rules on timing for certain things… like how long they want to wait before they would want to reconsider your equity position.

So while what you want to do isn’t impossible… it will be difficult I’ll guessing, but your existing banker will obviously have the best (real) answers.  My best guess is you will need at least 20% of your 30% down in cash… or whatever 10% less is of what they require for your down payment.  Banks are not a fan of you having no money in the deal.  (They know that ARV’s and appraisals can go down, just like they go up so they want you committed to the loan with your own money typically.) It helps mitigate any loss they might incur should things happen to go south.

All the best!

Randy

Rodney Lorenzo · Answer

Sorry I lost you in the explanation. What I want to do is extract money from my property to acquire a second one like most investors do after a certain amount of time. The issue is the type of loan I got has a 5% PPP attached to it and all I want is to avoid having to pay 5% of the loan if I buy within 5 years (it's not a step 54321. It's 5% every year up to the 5th year).

Since the first property is used to back up the loan for the second property, I would use a 6 to 12 month period to make improvements and force appreciation. Then I would refinance and "untie" the second from the first. Doing this would reduce the risk of losing both my properties if things were to go South. Of course, if I refinance I risk having the loan called and I don't want that to happen.

"If I tried to answer your question it would seem you want to leverage your existing property to buy your next?  Most lenders would want to refi the first property because no lender wants to be in second position.  My best advice would be to go back to your current lender after 6 months of good payments and say “this is working great… now I want to do this other one as well”. This is exactly what I want to do. Leverage my first property to buy a second, if that's possible. Maybe 6 months would be too short. Shouldn't I allow more time for appreciation?

I could go back to my lender (not hard money) and ask him for his advice. 30% down payment was required because I was a new investor and it was a 6 unit building. My goal is to acquire a larger property than the one purchased before it.

Randall Alan · Answer

@Rodney Lorenzo

Your post tries to explain your problem without explaining what or why you have the problem.  Are you wanting to extract equity back out of your newly purchased property? Why are you worried your loan would be called?   What do you mean by “untie” the properties?  Like separate them with your county into individual parcels?

I think we need to understand your objective and specific issue with acquiring your next property.

If I tried to answer your question it would seem you want to leverage your existing property to buy your next?  Most lenders would want to refi the first property because no lender wants to be in second position.  My best advice would be to go back to your current lender after 6 months of good payments and say “this is working great… now I want to do this other one as well”.

As for equity, most lenders are looking for 20-25% of your own money in the deal.  We had 5 properties collateralizing a single $500,000 commercial loan.  We went back to our lender and said “hey, these 5 properties are worth $1.2 million and we want you to release 3 of the cheaper properties(still leaving about $800,000 in value securing the loan.)  They agreed to release the 3 units after we paid for appraisals proving we were over-collateralized.  But I think working with your same lender (presuming it isn’t a hard money lender) would be your best bet!  You have the relationship, they see you are good for it, etc.  you could certainly tie your same property to another loan with the same lender with less issues than a new lender.  Also, if going for a larger loan with the same vendor I would think it would be highly likely they would waive a prepayment penalty if you are going right back into another loan with them.  I see prepayment penalties as a bank saying  “you wasted our time  with this”… which if you are borrowing more from them that isn’t the case… so I think you could probably get that waived  (with the same lender).

if 30% was the required down payment I wouldn’t see any ability to extract any equity though.  If they only required 20% and you chose to put down 30 that might be different.  But keep in mind banks really look closely at debt to income levels, as well as loan to value levels.  (They love their metrics!)… but if you have good cash flow on your properties and a good income otherwise  there is probably a chance there.

all the best!

Randy