Is the financing a good deal on this property?

Question

Hello Everyone,This is my first time posting here and was hoping to get some assistance in reviewing the loan terms I've received from a local bank. Are they good? Are they pretty standard? This is my first time seeking a commercial loan for a purchase so I'm not sure what is the norm and what is excessive. The reason I have to go with a commercial loan is because this single piece of property has two homes on it and would make it difficult for a traditional loan. The plan is to separate the two properties and then flip both of them. Cost of the property is going to be about $375,000. I should be able to sell both properties for about $650,000 combined after putting in about $100,000 in renovations in both homes over a 4 month period.Thanks in advance for your advice.MikeTERMSCollateral: First Deed of Trust on said properties and Assignment of Rents 25% equity injection requiredAmount: $300,000 (approximately). (In no case shall the loan amount exceed 75% of the appraised value of the real estate securing this Loan).Interest Rate: 5.1% fixed interest rate during the Permanent Period per annum.Repayment: For a period of 60 months (the “Permanent Period”), monthly payments of principal and interest shall be based upon a 20 year amortization. The principal balance and all accrued and unpaid interested shall be due in 5 year(s) from the date of the note. Appraisal: Subject to satisfactory receipt and review of the appraisals from an appraiser acceptable to Bank not to exceed 75% loan to value. The appraisals shall be at the expense of the borrower. The cost of said review, payable by the Borrower, will be $350 for each appraisal.Origination Fees: One half of one percent (1/2%) equal to one thousand five hundred dollars ($1,500) of the loan amount payable upon acceptance of the commitment letter. There will also be a loan documentation fee of $300 due at closing.Prepayment Fee: During the Permanent Period, any portion of the Loan which is prepaid will be subject to a prepayment penalty as calculated below: During first year of loan term 5% During second year of loan term 4% During third year of loan term 3% During fourth year of loan term 2% During the fifth year of loan term 1% Please note the prepayment penalty will not be enforced if the property is sold through an arms length contract.Loan Cost: The cost of the Loan, including, but not limited to, insurance, document preparation, attorney fees and filing fees, will be borne by the BorrowerHazard Insurance: Required on all insurable collateral.

Joel Owens · Answer

Would try to get the structure changed to interest only. You want the smallest payments possible while doing value add deals and wanting to resell them.I assume since you are only holding 4 months and selling for resale you have calculated in your cap gains when selling.Also would try to get the ltv up and down payment less. If their is full unlimited recourse then you might want to try for limited recourse or have that go away all together.The loan you are getting is very small and not many lenders except local banks want that business.

Bill Exeter · Answer

There are two reinvestment requirements that must be met. The first is that the replacement property (ies) acquired must have a total purchase price equal to or greater than your net sale price. So, you would take your gross sale price and subtract your routine selling expenses (broker's commission, title/escrow fees, closing attorney fees, recording fees, exchange fees, etc.). This is the net sale price and the amount that you must reinvest. The second is that all of your cash proceeds (net exchange proceeds) from the sale of your relinquished property must be reinvested into your replacement properties. So, if the original note and the HELOC are both secured by the property and were used toward the purchase and/or rehab work, then yes, they could be paid off as part of the sale transaction. You would still have to meet the above reinvestment requirements by trading equal or up in value based upon your net sale price (note: this is before subtracting any debt payoff) and by reinvesting all of your cash.

Bill Exeter · Answer

Hi Michael, The holding period is just one of the ways to help demonstrate that your intent is to hold for investment purposes. What really matters is your intent. The question is, if you get audited, does it appear that you had the intent to hold for sale (rehab/flipping) or investment (rental). The auditors could look at all of your documentation in order to determine what your intent was. If your intent was to rehab/flip, and the auditors pick-up on that, the holding period will not matter.

Wayne Brooks · Answer

Check with the local authority that will administer the lot split. I'did one recently with no mortgage, but with a mortgage you'll need some cooperation from the bank, perhaps switching to a blanket, as the agency likely won't split with just the one standard mortgage. And of course, you have to split it before you can sell part.

Derek Carroll · Answer

Michael Weber these are pretty standard terms from a local bank. Nothing to get excited over but nothing outrageous either 5-4-3-2-1 prepayment penalty is completely normal. Very few lenders (outside of credit unions) will give you a commercial loan without a prepayment penalty. It's actually pretty good that they will let you out of it when you sell. The intent is just to discourage you from refinancing with a competitor. I agree with Joel Owens that you should try to get interest only. It's absolutely doable for a local bank to offer this. Tell them that you're doing some rehab and structure it as a construction loan and typical will be a one year interest only with extension options. Happy to answer more questions or help you with the negotiation. Just make sure to tag me with the @ symbol otherswe I'll miss it.

Greg V. · Answer

These terms are similar to what our local bank asks for but you can negotiate. My recommendation is to look into an interest only with a 1-2 year balloon which would get rid of the prepayment and get you a lower interest rate. It's a little riskier so understand the downsides. If you're going to flip then, like was mentioned earlier, you shouldn't care about paying down principal and look to minimize carrying costs. As a backup if your plan fails, I would run the numbers for the above loan at probably 6% interest and renting out the units.

Mike H. · Answer

I guess the two things that jump out are:1) re: 2 houses in one dealHow is it you're going to be able to sell these properties individually when you stated that you can't get a loan on them from a conventional lender today? Can't you simply split the purchase up into two deals so you can get two separately loans? Are the houses on separate PINs? Or are you saying you have to get them separated? If so, how easy is that and what happens if you can't2) re: Loan terms.These are with a local bank? I don't know that I've ever seen a local bank charge prepayment penalties before. I also don't know of any local bank thats going to do an interest only loan. There's a reason they're doing 20 year amortization. They want more principal paydown. If they were at 30, then maybe I'd say give it a shot. And it can never hurt to ask. But usually banks at 20 yr amort want more paydown not less.It can't hurt to ask. But I think you might have more luck going for 25yr or 30 yr amort than going interest only. I don't know that I've ever heard of a local bank that can do interest only loans these days on sfh investment properties.All in all though its not bad financing for portfolio lending (20 yr amort is typical, rate is decent and given how unique the two home thing is, I'd say you're doing good). But definitely need to get some language in there as to what happens when you sell one property. How much are they allocating towards each one? Do all the proceeds from the first sale have to go toward the loan? Might not be that big a deal if your intent is to sell both. But what happens if you only sell one? Are you ok with all of that equity being stuck in that one house? And how does that affect your prepayment penalty if you decide to refi that and pull some money back out?

Dave Foster · Answer

Michael,It is not the holding period that qualifies your property for 1031 treatment. It is your intent. There are several things you can do to demonstrate your intent. Although you are using at least part of this property in your real estate business and acting as a dealer rather than investor Why not try this on for size if the terms of financing allow:1. Document with your financial professionals that you intend to sell one of the homes, paying off the note, and to hold the other home for productive use.2. Advertise the property for rent and keep notices ads, etc.3. Rent the other property and hold it for a period of time - there is no statutory holding period but most conservative professionals recommend anything over a year.4. Treat the property appropriately in your federal and state tax reportings and5. Save your post here where you talk about selling one and keeping one :)Demonstrating intent can come from many sources and look like many different things. The best advice is be transparent and thorough in demonstrating your intent. In this scenario you will pay some tax through the treatment of the one property as inventory but you will also be able to defer a large chunk of tax as well because you are also using the other property for qualifying use. And as a bonus you are providing for a low holding cost rental.

Joel Owens · Answer

Hi Michael,Yes the goal is to use interest only and put down as little as possible. Principal pay down doesn't really matter much because you are making your equity on the turn around or creation of the higher use property and holding short term.You need to make sure no-pre pay and look for any GOTCHA's in the loan covenants the bank is not telling you about. One word can change your whole outcome in an agreement whether that is a purchase and sale, loan document, or any other agreement.

Michael Weber · Answer

In addition, this assumes I can qualify for the 1031, can the proceeds of the sale go towards the payoff of the original note and a HELOC used to perform the renovations? Then whatever is left over go toward the Exchange?