Down payment advice?

Question

Hello,

I have found the perfect investment property. It's zoned commercial with a residential permit. It's on 2 acres of land and includes 5 buildings. It has 2 residual building with 3 units each and a 32 car garage currently being rented out as a sign business. Rents are extremely under valued at this time as the current owner is renting space mostly to family. Despite the low rents it's still bringing in over 7,000 a month.

Rents can easily be raised and it's got lots of space to expand.

It's priced at just under a million and with current rents has about a 7% cap rate.

I have great income and credit and can easily get a loan for this.

Here is the problem I need advice on.

I don't currently have the full 20 percent (200,000) down payment the bank wants to see to fund me.

I plan to sell another property i have and refinance my primary home. If I can get that done quickly and Add that to my cash assets I estimate I can only come up with about 100,000 about half what I need.

I can't get any kind of lone that will show on my credit as it may stop the bank funding.

I do have an LLC but it has no credit except a bank account and a $7000 credit card.

I did ask my realtor to see if seller would consider taking an owner financed second for the remaining down payment but that seems like a long shot.

I really want this property and I'm afraid that if I don't hurry I may lose this opportunity.

Any advice or help would be appreciated.

Randall Alan · Answer

Perfect but not perfect?

I'm going to offer advice you probably don't want to hear, but hope you might take something away from what I tell you.

It would be my suggestion that this isn't the property for you.  Not because I know anything about it, but because of your situation.  The obvious, as stated in your post, is that the deal is too big for you at the moment.  You don't have the resources.  But lets just say you accomplish your mission of coming up with the 20%.  The bank also will want you to have reserves beyond the 20%.  And, by the way, you will have to be doing this with a commercial loan (as residential loans only goes to 4 units).  They often prefer more than 20% down  AND the length of the loan is usually 20-25 years, not 30 years... so be sure to make sure you have your number calculated correctly.  This has the net effect of increasing your loan payment per month as compared to a residential loan.

Then there is actually qualifying for the loan.  It's beyond the 20% down.  They look at all sorts of things... debt to income ratio is a big one... and if you just refinanced your house to try and get the funds to make this one work, guess what, you just seriously bumped up your DTI, which the bank will not like.  Presuming you borrow the other funds from some unknown (read: off the books) source, you then have that debt load to manage / pay back as well.

Just looking at the numbers, it doesn't look good either.  $800,000 at 4.5% interest at 25 years.  Your Principle and interest alone is $4,446 per month.  Taxes... I'm going to blindly guess $8,000 a year, and insurance, let's guess $3,000.  So taxes and insurance in this hypothetical example total $916/month.  So you are now $5,362/month in expenses before any maintenance reserves.  5 Buildings, I would say budget $100 / building per month.  It's a number that works pretty well for our 40 residential units.  So with that your expenses are now at $5,862/month.  You also need to allow for capital expenses (roofs, other big issues)... maybe say $100/month.  So now you are at $5,962.

SO, while your deal appears to cash-flow at $7,000 current income per month, it may be less than you were expecting.  Be sure to now include the payment on the $100,000 extra you needed to raise.  On a 30 year, 100,000 note at 4.5%, that's an additional $519.  Your expenses are now $6,481.  Do you have liability coverage for yourself in case someone slips and falls at one of the 5 properties?  For us, that is about $2,000 a year for $1,000,000 in coverage.  Your expenses are now $6,647 at your current fully rented property.

So now let's say you raise the rent to try to boost income, but then you loose one or two tenants in the process.  How long will it take to fill that unit?  Commercially, it is a lot longer than residentially.  But say it takes you 3 - 6 months to find a new commercial renter.  You are now likely below break-even on your base mortgage payments.  How long can you sustain that?  That is why banks want reserves.  Even Fannie Mae looks for like 6+ months of reserves of what your total payment expenses are when you have multiple residential properties financed... so know that your bank is going to also look for reserves.

Also, don't forget your property taxes will reset to the new sales price you paid a year after you buy it.  So whatever they were, expect them to potentially double (or more) - you can look that up on your county property appraiser's website, or call them.  But that will likely add hundreds of additional dollars per month to your expenses.  And these are just the easy things to call out on your situation.

Then there is the unexpected.  Who knows... economic down-turn, fire, whatever it is... you are just really not in a good position to purchase this property.  And we have all been there.  We own 40 units across 24 properties.  I would love to buy a large multi-family property... say 200 apartments.  I, like you, probably am not in the position to do that from a cash down or reserve perspective.  So while I applaud your tenacity and eagerness, I would urge you to take a close look at your deal, and maybe get some closer perspective from a commercial banker before you go too far down the path to refinance your house, etc.  It's just a lot more than having the down payment.

Truly wish you all the best, but also want to see you succeed at what you do!

Randy

Ask yourself this... if the AC went out on one of the units and it was an $8,000 expense to fix it, are you going to be able to replace it within a day or two like you need to do as a landlord?  And if the 32 car garage was actually air conditioned (not that I know... it probably isn't), but that expense could be $20,000?

Ramon Jenkins · Answer

Mr Alan very nice breakdown of potential expenses