Leverage or use as Collateral?

Question

Long story short, I just had my farm ground appraised. Looking at using the equity in it to start investing in SFR to 4-plex. unofficially the appraiser told me its worth between 500-600K but would have to do what they do to make it official.

Now I owe about 170K. If I refi, I can comfortable pull 150K out of it and it will still cashflow. However, If I refi, I lose my combined interest rate of 4.2% over 15 years. (90K is at 1.5% thanks uncle sam!)

What I would like to do is use the equity in the property as collateral against loans too get me started in REI.

Example. 
Duplex is selling for 100K 
Rent Roll is 1800 per month
cost are 1400 per month
Bank will finance 70% 
I want the bank to use equity to finance the other 30%

Can I use that equity in the land as my "skin in" to get the bank to finance 100%? Or are they going to require me to refi now and put the cash in?

My goal is to do this for this first year or two to get a good track record and a few properties under my belt. Then go back and refinance the REIs on there own and not have the Farm ground attached.

Am I crazy for thinking this way? Will the banks use the collateral?

Jeff S. · Answer

With the complications you are talking about it is possible you will need to pay higher than typical rates for this lending. If your new purchase generates 10% (rent roll less 1/2 for long-term expense and capital improvements/ purchase price=10.8%) and you are doing 100% financing and your cost of money is 10%, it would make no sense to go this route for a buy and hold.

The risk is huge and the reward is next to 0.

If you flip and can make some sure profits then maybe.

Murphys law says your expenses after your purchase will exceed normal averages in which case you will be in a bind in a hurry.

Chad McDaniel · Answer

Thanks for your replies. I'm meeting with the banks next week once the appraisal is finalized. I will keep all of this in mind.

Chad

Bill Gulley · Answer

All types of arrangements might be made, depends on the bank. Hope you're talking to an ag bank familiar with your property.

You didn't say how your land was surveyed and deeded. If you have a survey of say 40 acreas you might peel off that legal for additional collateral as your down.

I'm conservative and I don't like the idea of betting the farm to get a down payment. Things happen! What happens if you have a heart attack and can't work? Do you have sufficient insurance to cover the new debt?

We just had a thread on blanket loans and this is a good example for the use of one. You can use the farm at the 30% and the new property to carry the 70%, but make dang sure you have a release for the farm at 30% no more than 40%. But I would also hedge that 40% using disposable assets if necessary to protect the farm.

I just hate to see farms lost!

The lender may just want to take the entire farm and allow you to cash out and then do a conventional transaction for the next property, while that takes your balance higher as well, it's cleaner to do.

Good luck

Joe P. · Answer

Chad,

To answer your question, I’m sure you probably could pull money out of your farm ground to make a down payment. You just need to go to the banks and ask. Your plan to refi and release your farm ground as collateral down the road might take a while. If you are buying the properties at a discount from their current value this is very possible. For example if the duplex appraises for $140k or more you could turn that around pretty quick and refi. If the properties are worth currently about $100k and you are just counting on principle pay down and appreciation to get your money back out, you may be waiting years for that to happen.

This is what I would do if I were you.

I would probably sit down and figure out accurately what my return on my farm ground was. Make a spreadsheet if you haven’t already and really nail all the costs and income down. If you are the one farming it I would figure out what the ROI is if you leased it and with you farming it. This is always good practice to know these things in any business.

I would then take the time to really learn and accurately figure out your ROI for the duplex you want to buy. There are hidden costs and TIME associated with owning rentals. I would learn learn learn before I plunked money collateral down. Know what you are getting into and make sure it fits into a bigger plan for the future.

I think this will help with your answer.

Some other thoughts I would have is this:

•Getting a loan for 4.2% and having your farm free and clear in 15 yrs is awesome. There is something to be said for having free and clear ground. There is more to life than just the best ROI.

•Farm land and commodity prices right now are at an all-time high in some realms. What would a worst case scenario look like if commodity prices fell and farming all of a sudden became not so profitable? Would you still be able to support the debt and not having sleepless nights?
 
•Are you saving money right now? Why don’t you just save and use that for the down payment?