WHETHER TO LEVERAGE APPT BUILDING AND TAKE A MIL OUT

[Robert Y.]

The question is whether to leverage an apartment building more.

I already posted the setup several months ago:

I'm a 63 year old doctor and a student of BP and RE investing but little practice. My investments have been acquired and managed by my buddy my accountant, who has 250 doors. I have a 20 unit multifamily near the LA City College in LA (this is rent control but considered pretty desirable and not likely to severely crash in a decline). There's about a 350,000$ rental income a year and the net net is 70-130,000$ depending on capital investments needed. Value is 4.9 M and loan is 2.0 M. This seems like a bad cash on cash return, although admittedly it looks worse because of recent appreciation. I've had the property for 3 years after 3.3 M purchase price and we've managed to turn over half the tenants for higher rents. The rest of the tenants are rocks. But it seems like I could get both better forced appreciation AND better cash flow in another market (10 per cent would be nice). I have a friend who owns 40 doors in Cleveland, but an exchange there would give him 75 or 100 more because they are worth less and he doesn't have the time or expertise to manage it. He has gotten me an introduction to someone who might be interested in co investing, managing and helping me with the exchange and loan acquisition; his family manages 4000 + doors. Does anyone have any guidance here: this is a large part of my net worth and I'm sure it's easy to mess this up. Other markets and other ideas are welcome. Thanks ahead of time for not laughing too much, I'm new here and this site seems too good to be true.

The upshot from the above: risks in doing a 1031 into another market were too high, this was the consensus of my advisors. So I forgot about that idea.

However my next brilliant idea was leveraging this thing more. Chase cooperated and is offering me:

Loan Amount:	$3,100,000
Loan Term:	30 Years
5 Year Fixed Rate (as of today):	4.20%
Amortization:	30 Years
Monthly Payment	$15,160
Margin:	2.25% over 6 Mth. LIBOR
Prepayment Penalty	5/4/3/2/1
Life Cap:	9.50%
Life Floor:	2.50%

The original loan according to the loan agent:

The programs are very similar however your rate is currently lower at 3.83%. This loan was originated in 2014 so we are 3 years into the loan leaving only 2 years left on your fixed rate. Once this rate matures your new rate will be 6 mth. LIBOR plus 2.50%.

My understanding in speaking to Gary was that the main motivation for refinancing the property was to take advantage of the equity in the property and pull cash out. Your current loan amount is only $1.928 million so your cash out will be north of $1.1 million.

The prepayment penalty is a percentage of the current loan balance declining annually. For example if you prepay your loan in year 1 the penalty would be 5% of the $3.1 million balance. In year 2 the penalty would decline to 4% of the current outstanding balance and so and so on.

Here is a summary of your current terms:

Universal Bank Terms
Loan Amount:	$1,928,010
Loan Term:	30 Years
5 Year Fixed Rate (as of today):	3.83%
Amortization:	30 Years
Monthly Payment	$9,539
Margin:	2.50% over 6 Mth. LIBOR
Prepayment Penalty	4/3/2/1
Life Cap:	9.50%
Life Floor:	3.83%

SO this thing will still cash flow at 25 per cent of net operating income. The loan agent says the bank wouldn’t consider if it didn’t.

THE BIG QUESTION: ALTHOUGH I HAVE SOME PLANS TO INVEST THIS $$ MAYBE IT’S BETTER TO NOT STRIP THE EQUITY OUT OF THE PROPERTY. I’m not a super experienced investor. My accountant has a plan to buy 2-3 million apartment buildings for cash with 4 partners in precisely his area where he has the expertise and put the lipstick on them and flip them in a few months each. He says if we hit a crash he can always manage them and so there’s little risk. And I am considering Jeff Brown’s mortgage bonds.

So there may not be a concrete answer. I don’t need this money for lifestyle but I am 63 years old. No one knows if and when this crazy real estate in LA will crash. It does seem diversification out of this market through this loan is a reasonable idea. California is essentially a non-recourse state because it requires a 3 years judicial foreclosure to accomplish recourse.

[Joseph Gozlan]

@Robert Y. I'm not sure why everyone are so afraid of taxes. 

If you can sell for 4.9M with a cost base of 3.3M it's a 1.6M capital gain. at 20% you'd pay 330K taxes. 

Even after taxes and paying off the loan you still have $2.5M left in your hand. Leveraged that could get you a $10M property with 150-250 units complex in a hot state like Texas and will cashflow better than your current situation. 

Now this is without taking into account capex that was invested over the last few years and advance tax strategies to reduce costs from sale that an experienced real estate CPA can apply. 

So I'd only go the 1031 exchange route if I knew I'll have the emotional strength not to make poor decisions when the clock is winding down and just accept that I'll pay the taxes and still be able to get a good investment property. 

Just my .02

[Eric G.]

At 63 you are probably close to retirement (or maybe semi retirement). You are admittedly nervous about the prospect of taking on more leverage or moving into new markets. And you've stated that additional income wouldn't change your lifestyle. So if you decide to do nothing and stand pat that would be a reasonable choice.

If you are going to cash out refi, I'd recommend staying away from out of state properties. Especially if you are targeting 10% return. That would probably put you in some pretty bad markets. But even in decent markets, I would think that if the dreaded Recession hits, those peripheral markets are going to get hit the hardest. If you invest in a strong market like Southern California, it will still dip in a downturn, but the long term demand will help it recover much faster than a locale in the Midwest, for example.

[Andrew Johnson]

Robert Y. This is coming from the perspective of a 38 year old but complicating your life at 63 doesn't sound like fun. It sounds like you're getting a good return and you're insulated with equity against market "hiccups". You have owned for 3 years so you're far from the losing the benefit of deprecation.

I'm guessing you're also getting a significant tax write-off with the mortgage interest. That's going to increase when the rate bumps. So it's not as though you need more mortgage interest (through more debt) for the tax advantages. At least I don't think so but I haven't run the numbers.

You mentioned you were a doctor, is leveraging yourself more going to get that incremental return going to make a lifestyle difference for you?

[Robert Y.]

Thanks for early weekend replies.

The sale idea was well taken, but cost basis on this property is 650 K because of past 1031 trades, so taxes would be somewhat higher. 

It's a psychological jump to see your life as limited and horizons as shorter term. I'm trying to do the smart thing here in view of the absolutes (my mortality insurance tables) and the intangibles (the market). 

[Joseph Gozlan]

@Robert Y. the 650K cost basis changes the picture dramatically. 

I guess it will come down to cashflow. I wouldn't leverage any property beyond it's cashflow point. 

2006 was just 11 years ago but too many people seem to forget the euphoria that was going on in the market back then and the poor decisions people were making. Watch your numbers and assumptions and make sure to cover the fundamentals. 

If after the new mortgage you will leave you with no net cashflow (after opex, debt service, taxes and reserves) I wouldn't do it. 

[Ben Leybovich]

You are 63. The cycle is already in a bubble. Not the kind of bubble that is about to burst; that'll take time. But a bubble. You are allowed to be bullish, but on't play games! Especially at 63...

[Tim Ryan]

Robert, you need to parlay this into a 200 + unit and lots of cashflow. You'll need the right partner to make this happen. We are purchasing a NNN leased Medical Building out of state. I need to show you the numbers. If you can get something similar, you will be set for long retirement!
Let's do lunch.

[Robert Y.]

Reality bath. I guess that was what I needed. Thanks Ben. I can just hear your voice after listening to podcasts. 

The related issue is whether I should pay the 19,000 $ prepayment penalty in order to lock in the (slightly higher but stable) interest rate for 5 years (current loan starts to escalate in 2 years). Even if I don't take $$ out. 

The fed can't raise interest rates without the wheels falling off the economy, But when was the last time they acted rationally? 

[Vitaly Lunev]

@Robert Y. Regardless, of which course you take in terms of the cash out. If you are worried about rising interest rates, why not get a long-term fully amortizing loan like a multifamily FHA one (it is fully non-recourse and the all in rate including MIP will be only a few basis points higher in the high 3's or low 4's). It does have some restrictions like semi-annual profit distributions and longer closing time, however, since you already own the property and do not need the cash for your lifestyle they do not seem like major issues. The only other thing is that it typically has a 10% prepayment penalty with a one percent step down per year but again if you want to hold the deal long term (they go up to 35 years) should not be a major issue.

[Jeff T.]

@Robert Y.  I would consider thinking about your goals and that will help you determine what you want. You said you don't need the money for lifestyle, so why are you looking at generating more cashflow?  I'm just asking.  My thought is that you have a solid investment, but you are concerned about a crash.  It seems like that equity position gives you a nice cushion in case of a crash or recession.  There are jobs and barriers to entry in LA (no land, expensive to build) and availability of high paying jobs that help keep a bottom on prices that you don't necessarily have in places like Cleveland.  I didn't think that through when I went to Florida when I thought things were too expensive in CA before the last crash. CA prices have recovered and then some while FL is still making its way back.

These are just my thoughts, but I do think examining your goals will help you decide what is the prudent path for you.  Take a look at David Schumachers book Buy and Hold if you get a chance.

I was looking for more property until a couple years ago I looked at my goals more closely and since I have just been paying off property to generate more income.  Of course  I don't have 250 doors like your friend, but you have to do what's important for you, whatever it might be.

Good Luck!