Creative ways to fix up 1031 replacement prop prior to closing?

Question

Hey Y'all, Im purchasing in a market that is quickly getting away from the 1% rule, and the only way I"m finding to get the cash on cash return I'm looking for is by buying slightly (or more than slightly) distressed properties. But if I have to use my cash from the 1031 exchange to do some upgrading, it quickly eats into my c on c return! So. I'm thinking I could use hard money for the fix up, then possibly raising the purchase price to cover expenses, and do my normal financing, (25% down) at closing, paying off that debt at closing out of financing, as the Seller would have to normally if they had used debt for fix up.

That's if i can get the Seller to agree to let me do substantial work prior to closing. There's also the not insubstantial problem of sinking money into someone else's property and risking them defaulting (not closing) on their newly sweet units.

I know it sounds crazy risky... but it feels like it should be doable somehow or other.

Any great ideas?

That's if i can get the Seller to agree to let me do substantial work prior to closing.  There's also the not insubstantial problem of sinking money into someone else's property and risking them defaulting (not closing) on their newly sweet units.

I know it sounds crazy risky... but it feels like it should be doable somehow or other.

Any great ideas?

Dave Foster · Answer

@Alan Brown, Yah, I agree with @Joe Splitrock.  It's nothing but a bad plan waiting to blow up if you're doing work on your behalf before owning the property.  Secondly, the seller will have to fund the improvements somehow or they will be showing more profit than reality.  And now you've got not only issues of trust and follow through contractually but with real cash on the line as well.

Instead of doing your normal 25%.  Get a private short term loan (IRA lenders will do this all the time and it's not that expensive) for the full amount over your 1031.  Then do an immediate refinance at cost of acquisition.  Get the extra cash that way and do your rehab.  Still just one cost of finance plus whatever the private lending will be.  But since it's a short time it shouldn't ding you too much.

Joe Splitrock · Answer

You can't claim expenses for rehab on work done before you own a property. I guess if you got the seller to pay you for the work, then paid them more for the property. The cash from the 1031 needs to go directly into the property purchase, so I don't see how that could be used prior to closing. This sounds complicated and a little sketchy.

Why can't you just buy the property under exchange, put money into the rehab and then do a cash out refinance? As long as you don't take out more cash than the 1031 amount, it seems you would be fine. I am following to see what others have to say. There may be something creative I am not aware of.

Dave Foster · Answer

@Alan Brown, I was making an assumption that the 1031 had provided extra funds.  Say your sale was 100K (all cash) and the purchase was $250K.  You only need $50K cash for the normal down.  But if you put all 100K down you'd only have a mortgage for $150.  You could do an immediate refinance at the cost of acquisition (250K) and pull out $200K which would pay off the 150 to the private lender and give you 50 to do the improvements.  There's a lot of lenders that don't require seasoning when you are refinancing at the acquisition price.

Something like that sort of :)

Alan Brown · Answer

Hah!  @Dave Foster I was hoping you'd turn up if I put 1031 in there... couldn't seem to find you in my contacts and was planning to PM you... I'm a bit of a luddite, but would like to talk with you about some 1031's if you can pm me somehow!

Still, to follow up on your wise counsel, when you said, "immediately refinance at cost of acquisition" did you mean 'time' of acquisition?  because I'm confused: only refinancing at cost of acquisition doesn't seem like it would cover the additional amount borrowed for rehab.  I'm imagining that you are thinking a BRRRR deal, and I'd be all for that, but so far haven't found the right lender for that, and/or someone who won't make me wait 6 months or a year for "aging' before refinancing.

It's finding a portfolio lender that will do that refi for me that may be a trick... or maybe I'm misunderstanding.

Creative ways to fix up 1031 replacement prop prior to closing?

Most Popular Reply