Wife wants to "save" the family beach house. Can we do it?

Question

Hello RE geniuses,

Story below, but here's the main question: If we were to go through with it, what is the best strategy for a medium-income family to purchase an expensive short-term vacation rental?

Here are the details I think matter most:

Oceanfront property on N Oregon CoastEstimated sale price: $1.4MMEstimated operating income: $100kLiquid cash/investments: $120kCash via refi of primary residence: $185kIncome: $120k

Backstory:

We live in Portland Metro and wife's grandfather purchased an oceanfront home in the 60s in a dinky town on the N Coast of Oregon. Wife's uncle eventually purchased it and has been running it as a STR for many years as a hobby (0 marketing). The dinky town is now a more popular destination, Uncle did a massive remodel on the place and handed it over to a property manager and is doing a lot better.

Uncle was recently diagnosed w/ terminal cancer and is planning to sell the place. Everyone involved would like to "keep it in the family" if possible.

I know this is already a red flag: Emotional purchase. I'm devastated about Uncle, but he's going to do fine selling the place one way or another, so I'm not emotionally tied up in this specific property. My wife is VERY TIED UP IN THIS SPECIFIC PROPERTY. A lifetime of good memories with family and whatnot.

We have about $120k in cash and liquid investments and potentially $185k more we could access via cashout refi on our home. That leaves us with about $305k for a downpayment and other closing costs but very little cash leftover for any emergencies.

Assuming we could even get a loan, I think it would be really tight for a few years until we build our reserves back up. However, house was totally remodeled 2 years ago, so no major capex on the near horizon, and we can direct cashflow from day job back into savings. Barring a major catastrophe in the first few years, seems like it could work.

That leaves us with income, which I think is the problem.

Currently, we have only my wife's income of $120k. I am self-employed and my existing business has basically failed. I'm currently making about $25k, but it all goes straight to a solo-401k and IRA, so my tax return income = $0. Either way, nowhere near enough income (or downpayment), I think, to qualify for the total mortgage load we would have between both properties with any sort of conventional mortgage, so we would need a lender that does other types of financing and who would factor in the existing operating income of the vacation property.

Does this type of lending exist? And at reasonable rates? Where do I even begin looking for it? I've mostly worked with local credit unions for the purchases/sales we've done, but I don't think the ones I've worked with do this kind of lending.

What are our options? Am I missing any major showstoppers or opportunities?

Jonathan R McLaughlin · Answer

@Tyler Tervooren A few possibilities that interact with each other which may be especially useful if your uncle is one of the ones that want to keep it in the family:

1) local bank, ideally one you/your uncle/family has a positive relationship with which can structure a commercial loan.

2) investigate "gift of equity" since there is a close family relationship such an arrangement is more feasible and likely to pass muster.

3) Uncle loans you a chunk of the down payment and subordinates loan to the bank. Your 120K liquid is almost exactly 10% which should work with a 10% subordinated loan. Essentially by taking 120K in the form of a mortgage the Uncle unlocks the 1.2M

Greg Scott · Answer

Would your uncle consider selling it to you owner-financed?

This strategy could be good for you because your uncle can set the terms (i.e. limit the amount of down payment) and he gets a steady stream of income.  Done right, he can avoid a large capital gains tax payment next year and can stretch it out the life of the payments.  Since this isn't a bank, you can add whatever clauses you like for a refi, or acceleration of payments, or what to do if your uncle dies.

On the other hand, I agree it is dangerous to mix those kinds of emotions with business as it often results in poor results.  You'll have to decide if this really makes sense for you and your family.

Stephanie P. · Answer

I would get someone else on title right away in the event that the Uncle does pass away, there are no probate issues.  If he added you or your wife to title, you could work out a payment arrangement with any other interested family members without a lot of money out of pocket.

Stephanie P. · Answer

@Tyler Tervooren

Even if you aren't heirs, once you're on title, you could refinance in a few months and pay him and whomever else out without a massive cash outlay and in the unfortunate eventuality that he passes, you save it from going to probate.  Call an estate attorney  asap.

Jonathan R McLaughlin · Answer

@Tyler Tervooren sorry, was rushing and it led to a little bit of confusion. I goofed on 350K, I was trying to reference the 305 in available funding you mentioned in your description. 305 minus 125 or so of downpayment (equalling 10% of the purchase price) was the number I was referencing...the amount you would have in liquid assets after downpayment. Seems like 175 or so.

I would recommend, before approaching the bank, enlisting the services of a higher end, experienced VRBO manager and getting them to put on letterhead their estimate of revenue and expenses. Look for comps and AirDNA info yourself...the more external sources the better. Put together your numbers before going into the bank. If the numbers work on paper, they have a seller willing to do second position (which means they are primarily concerned with your ability to make THEIR payments) and you can show both rental history viability and good reasons revenue would increase I think you can pull it off.

Tyler Tervooren · Answer

Yes. If lenders don't include the income from the property for qualification, we would be way outside of any lender's DTI qualifications. I think I can go get a W-2 job that would fix that, but not sure that would help in the short-term.

No, I don't mean that. I still need to get better info on revenue/expenses, but I'm pretty sure it would cashflow in most reasonable downpayment scenarios. This is all TBD.

I'm not sure what this means.

Yes. Short term vacation rental will be the primary use of the home.

Jonathan R McLaughlin · Answer

@Tyler Tervooren its more likely with an existing relationship but having a second to make up the downpayment isn't too unusual. A local bank would likely be open to it assuming everyone's finances are sound. Sounds like a straightforward solution that likely benefits your uncle.

Just hypothetically, say you offered him a 5% interest rate on a 120K loan amortized over 25 years. It is a $700 a month payment and can essentially function as an annuity for any survivers/heirs Those are good terms for a second mortgage of course, but not unreasonable given the goal of keeping it in the family: and the interest paid him over time will raise his ultimate compensation.

But the biggest problem is the one you mentioned that you can't carry the debt load. If thats the case NO bank will give you the first mortgage. Do you mean it won't cash flow even with the rental income and some reasonable input of money by you? Yikes.

You mentioned 350 so with this arrangement you would have 175K to help pay the debt, assuming its not needed elsewhere. Not sure how many years that would get you. Would multiple family members sign the mortgage? Thats its own can of worms of course. Are you planning on renting out the property

Tyler Tervooren · Answer

@Stephanie P.: Good call. I don't know anything about his will or what would happen in probate, so I guess I'd better start figuring that out. Considering he's planning to sell the place and talking to us about buying, I don't think we're heirs. haha

@Jonathan R McLaughlin: Thanks for the input. Will start investigating with my bank and ask him to do the same with his. Is a subordinated loan something that would only work with a bank where one or both parties have an existing relationship? Or can I take a subordinated loan and shop for a mortgage anywhere?

Tyler Tervooren · Answer

Thanks @Greg Scott. I think he's expecting to be gone pretty soon and might not be open to that. Doesn't hurt to ask, I guess. That arrangement would certainly be ideal.

Wife wants to "save" the family beach house. Can we do it?

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