Can I use non-real estate LLC equity as personal guarantee with portfolio lenders?

Question

Hi Everyone,I'm a new member on BP and posted an introduction in the new member introduction section yesterday.I have equity in my primary residence, but have a lot more equity in a non-real estate sole proprietor LLC. Can I use the equity in my LLC as personal guarantee to fund investment properties with a portfolio lender?Can I use the equity in my primary residence as personal guarantee with the portfolio lender instead of taking HELOC?

Chris Martin · Answer

I think Dion is spot on. While commercial lenders will allow substitution of collateral, there are underwriting limits and restrictions. Your statement "I just don't have the patience of dealing with lenders per property and their underwriting departments and fees at this point" leads me to believe that you've run into issues using (or attempting to use) equity from another industry group (dental) as collateral for REI. WF may not be the ideal vendor. Perhaps a small commercial bank. If your definition of 'equity' includes future cash flows, then you have a different, non-asset related, problem. But to answer your questions... yes, you can pledge assets in other non-REI related investments to fund REI investments. This happens frequently, in my experience. It is a given that your personal residence will be pledged as part of your personal guarantee.

Dion DePaoli · Answer

@Azita S. I think you are only hearing what you want to hear and you are missing the details, which in this case will matter. Any lender who gives you money based on a cash flow business will look to cash flow and business assets as collateral for the loan. In this case, WF will likely require a UCC over your existing business and sure you can purchase real estate, so far as it is for commercial purposes for your business. (that is what it actually says on their site) Allowing a borrower, any borrower, to borrower money and then dump into assets outside of the company is not prudent lending. Typically, a lender will allow you to purchase commercial real estate where your business vests title in the name of your business, otherwise, the UCC (the type of lien they will levy on you to secure their loan) would only be worth the free cash flow. Replace the asset being capitalized with any business related asset (X-ray machine), the lender will lien over the top through the UCC, that is how they maintain a proper ratio of what was lent with some form of collateral. That will be regardless of any personal guarantee. So a dubious borrower (not saying you are one) could borrow the money and then put said capital into assets outside of the lien from the lender in hopes of creating a separation so the lender would not be able to make claim on it. (happens often) In the event of default, without said assets under the domain of the company, meaning within the reach of the lender, the loan amount may not be able to be recovered. (ergo, not prudent lending) Especially in a cash flow business where if the operator tanks, the cash flow comes to a halt. (such as medical practice) So, they have parameters which do not allow such things, so if such a thing is done it is a breach of contract. Recovering capital when it is done in this type of situation is a mess for the lender to say the least.I would guess, the offer to allow funding into the 401k or other retirement type accounts have strings attached as well. Perhaps they must be WF products and perhaps those must then also be pledged. A lender is not going to hand you a check and give you free reign on where you want to put it, that is not prudent lending practices.Does all that mean the program is completely without some type of working solution? I do not know for sure, I would have to see the actual underwriting parameters. I know from doing a couple medical practice finance deals in my past, it is hot a high chance of success. That said, do no take my word for it, get Wells Fargo to issue you a specific term sheet where they specify the use of funds and it states to acquire residential real estate with the proceeds from your loan. I do not think you are actually past the initial sales pitch on this program yet even though you asked a couple of questions. Go dig and get specific then get it in writing. I would imagine this is a little confusing since I am guessing they bounce some program features from one or more different departments. Good luck.

Azita S. · Answer

Thanks everyone. Everyone here on BP is so knowledgeable and again I'm a newbie.I financed my first two rental properties last year, and the amount of back and forth correspondence with the lender on top of running a business was exhausting.I'm just trying to find funding without having to go through the underwriting process for each property.

Andy Collins · Answer

No matter what the legalities are of your loan, the basic concept of buying a house for $30k and renting it for $600 mo is a good one, but those figures only work on paper.A house purchased for $30k will normally (95% of the time) need to be rehabbed so some extent before you can put tenants in,,also there are cost associated with advertising, vacancies, etc, which is where the $54k a year income figure came from (figuring 50% of income for expenses and repairsj, and I'm assuming you want to use a property management firm, 15 low income rentals would require a lot of management. Your concept is good, and I think you will find most of the people on this website are doing something somewhat similiar, just remember the real execution in the real world is a little different than a spreadsheet.

Account Closed · Answer

My 2cents there is a lot of LLC fraud going on everyday and yes if the lender loan any money at all they will place a UCC filing.Joe Gore

Azita S. · Answer

@Dion DePaoli My LLC is a dental practice and the lender I spoke with today said the proceeds can be used to expand the business or fund retirement account such as 401K and according to him, purchasing real estate investment property qualifies as retirement funding.

Dion DePaoli · Answer

The link you provided points to medical practice finance. The proceeds must be used for business purposes not personal.What does your LLC actually do?Search the forums for the 50% rule. I have a suspicion your plan is not viable based on the limited information provided. Sorry to say.

Azita S. · Answer

@Dion DePaoli @Albert Bui Here is what I found on the lender's websitePerformance-based lending.With financing based primarily on the income of your practiceI'm not looking to finance any of the houses with conventional real estate loans, I just don't have the patience of dealing with lenders per property and their underwriting departments and fees at this point. My goal is do to cash purchases. I need to explain myself better; I want to take out two loans HELOC and the Performance-based lending. According to my calculations and research, between the two loans, I should be able to do cash purchases on all 15 properties.Dion : "If we use the general metric of the 50% rule, you would net about $54,000 in income before debt service. Debt service would be in the ballpark of around $23,000. So you would net about $31,000 annually from all the assets" Could you please tell me how you came up with the $54000 in income?

Dion DePaoli · Answer

First off, good stuff in developing a business and trying to formulate a plan to grow further.I am not sure what a "Performance Based Loan" actually is. Sounds like some type of Accounts Receivable Financing, is what I am guessing. That said, not sure how you are building equity in your business. If equity was building somewhere, there would be tangible assets to show for such things. So the use of the term equity in your post is a little confusing to me. Perhaps your free cash flow is building and that is what you mean, but if the cash is distributed to you as the owner, then it flows out of the business into your pocket we are back to my point, you are not "building" equity. It would be better to say you are accumulating cash. (Not a bad thing)In order to finance a portfolio, a portfolio must either be owned or purchased in whole. Stepping into the shoes of a landlord is tough. Stepping into the shoes of a portfolio manager is even tougher. Obtaining financing as a new Portfolio Manager fresh off the streets, down right impossible without some serious assets in the bank to secure the loan. Equity in your primary residence will not be sufficient for that type of deal.So in the case of your plan of 15 homes at $30k, you would need $450k in capital just to acquire them. You would need $112,500 for just the down payment. Call it another $20k +/- for closing costs and due diligence, maybe a tad more. If we use the general metric of the 50% rule, you would net about $54,000 in income before debt service. Debt service would be in the ballpark of around $23,000. So you would net about $31,000 annually from all the assets. Nothing to ignore by any means but that may not include proper allocation for reserves for capital expenditures into the future of each of the assets. Again you did not really add too much more detail to your thoughts so it's tough to add accurate commentary around it. I have concerns that your idea of HELOC and what is actually available in the market are two different things. In addition, the financing in the LLC may not be what it seems either but without details there, it is tough to tell. The lender might be still in "sales mode" and you may not be aware of all the underwriting requirements need to qualify or restrictions on use. It's safe to say it's not simply a free for all, when a lender gives you money in your business.Building up a portfolio one at a time is also an option but acquiring debt on $30k assets is a barrier as the loan amounts would be in the low $22k to $25k range. A local bank would be who to speak to for such things. Not sure if that makes you actually local to the portfolio or not, which too might be a barrier. Like I said, kuddos for starting the engineering process, I wish I could add more insight but can not without more details from you.

Albert Bui · Answer

Performance based lending? If by that you mean a loan secured by revenue/cash flow or earnings of your entity then the pricing and terms may be much more adverse as compared to a HELOC or loan secured by real estate. The underwriter will have to do a financial analysis on the source of the earnings in your entity and the valuation of those earnings in the industry whether they are 2X, 3x, 4x, etc multiple of your net earnings etc. I have a friend who does this type of business hard money lending its definitely not cheap money so you'd have to be making extraordinary returns in real estate to profit from borrowing from this source if I understand correctly what you mean by Performance based loan.You can obtain loans secured by real estate either by lien or pledged equity from portfolio or business banks as well these are usually revolving lines of credit like HELOC's or adjustable rate mortgages like 5/1 ARM's etc. Pledging equity from real estate has its advantages since you dont have to come up with cash and save on cash out refinancing costs by agreeing to encumber your asset to obtain debt financing from a bank.I think the most favorable terms and pricing will be from your primary residence since HELOC money can be obtain for as low as 3.75% to 5.25% up to 90-100% LTV of your homes value. At the end of the day however its a personal decision because some people dont like to leverage up their primary while some are okay with it.