Craziest idea ever… somebody tell me I’m stupid.

Rental Property Investor · SE Michigan · Member since 2014 · 4k+ posts · 6k+ votes

4y

Being able to do a cash-out refi of $80K on one of your ten properties implies that your $1M purchase is now worth about $2M. If that is the case, you should be able to do what you are proposing, assuming there are no restrictive covenants in your loan.

1 Reply

Ezra Henderson

OP

Wadsworth, OH · Member since 2021 · 110 posts · 91 votes

4y

Yes, the numbers were theoretical but the gist is the same and the properties market value is more then the purchase price. And no, there are no restrictive covenants in the loan. Well maybe it is something I should consider then

0 Reply

Osvaldo Pena

Rental Property Investor · Charlotte, NC · Member since 2017 · 7 posts · 9 votes

4y

Maybe I'm just confused. But if you bought the LLC with 100% owner financing @ 3% over 15yrs, I have to assume the seller is holding the titles to the properties which means the loan the seller made is secured by the properties until you've paid off your debt???

7 Reply

Ezra Henderson

OP

Wadsworth, OH · Member since 2021 · 110 posts · 91 votes

4y

No haha, he is not holding the titles till I pay off the debt, I can see why you’d think that though. The contract is pretty unique, but I have a very good relationship with the guy and he trusts me

1 Reply

Aaron Bress

Realtor · Salt Lake City, UT · Member since 2021 · 25 posts · 49 votes

4y

That's a lot of properties under one umbrella of a single LLC. One thing that could be considered if one property goes down in a lawsuit, the other 9 could be at risk. Any way you could separate those properties into multiple LLCs like maybe 3 or so under one LLC. Then, maybe talk to a lawyer about putting those multiple LLCs into an LLP. Nice way to hedge your risk.

2 Reply

Ezra Henderson

OP

Wadsworth, OH · Member since 2021 · 110 posts · 91 votes

4y

Thanks for the advice! I actually had just emailed my CPA about that, haha. Never heard of a LLP, but I'll look into that

0 Reply

Nate Sanow

Investor & Agent · Tulsa, OK · Member since 2016 · 1k+ posts · 1k+ votes

4y

Dude. What a great deal. I’m jelly. But also, why refi !? 3% if amortized correctly - I’m not sure if that deal will come along ever again. Just saying.

Unless you can get a ton of cash out. And buy more real estate that performs as good or better.

1 Reply

Mike Dymski

Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes

4y

We need the mortgage lenders to chime in on how they would look at the unrecorded debt. May be totally fine. DTI will be part of the equation. Having enough cash flow and reserves will be as well - for you, not for the lender. Your seller may come back at some point to formalize things...maybe for taxes...and you may not be able to...which is a given. It unsecured debt; so, seems doable.

0 Reply

Austin F.

Investor · MI · Member since 2015 · 227 posts · 478 votes

4y

Don't re-fi, but take out a LOC secured against the properties. Buy more, use the cash flow to rapidly pay down the LOC repeat. Very good idea. But be careful you will be super leveraged and can lose it all with bad choices.

6 Reply

Ezra Henderson

OP

Wadsworth, OH · Member since 2021 · 110 posts · 91 votes

4y

That's an interesting idea @Austin Fogt. How much time would I have to pay off the LOC?

0 Reply

Salvatore Lentini

Rental Property Investor · Doylestown, PA · Member since 2008 · 1k+ posts · 1k+ votes

4y

@Ezra Henderson - I would tap the equity in those properties. View the LLC loan as just a 3% 15 year loan. Right now those 10 properties are sitting there with 100% of their equity in your name. If you do a cash out refi you can use that money to accelerate your portfolio and your cashflow. What you need to be sure of though is that the properties you buy cash flow really well. $200/month is too skinny. You don't want to get into a situation where the properties you buy dip into the red each month because then you will have a have a hard time paying those new loans and your private lender for the LLC.

1 Reply

Bill F.

Investor · Boston, MA · Member since 2015 · 1k+ posts · 3k+ votes

4y

@Ezra Henderson

Not stupid idea at all, but one that kinda applies a residential mindset to a commercial idea, which doesn't always work.

LLCs get commercial loans and deal with commercial banks. The LLC will have to show historical financials and when it does that the bank will see the payments to the previous owner. They will then ask for the loan docs you signed with him and if the verbiage doesn't work for them, they could close the door because the loan you have with the owner could not allow for any debt to be senior to it and banks generally don't lend when they aren't in first position.

If they like what they see with the existing loan docs, then it will come down to Debt Service Coverage Ratio of the business to determine what LTV you can go to on the loan. DSCR is how much the bank wants left over after paying all operational expenses.

In your example, lets say your million dollars worth of properties met the 1% rule and throw off $120K/yr. Running a 40% expense ratio you have $72k in gross profit. Banks DSCRs sit between 1.2-1.5 and means you can make between $48-60k of debt payments per year. For the sake of argument lets say that apply that DSCR to your all your debt payments. You pay ~$84k/yr on the seller debt, so you've blown way past your DSCR and the bank won't do the loan, at least in this case. Most of this stems from the fact that you went 100% LTV on the seller note so the ying to the yang of putting no money down is that you get little cash flow in the first few years.

Now what about buying more properties to increase the cash flow? This gets into a chicken or the egg situation since in your example you want to pull the cash out and use it to buy properties, but the bank won't let you do that since you don't have enough existing cash flow to cover loan payment but without the loan you can't buy anything.

Short answer is you can't pull the money out and go on a RE shopping spree. Long answer, if you find a property you want to buy, you could also pledge cash flow from your existing 10 units to the loan to help make the DSCR on that asset meet the bank's needs.

5 Reply

Ezra Henderson

OP

Wadsworth, OH · Member since 2021 · 110 posts · 91 votes

4y

Awesome, thank you @Salvatore Lentini and @Bill F. I really appreciate both your advice

0 Reply

JD MartinBusiness Member

Moderator

Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes

4y

What I understand or assume from your post, so please correct anything misstated:

1. The LLC I assume has no assets other than the 10 paid-for rental properties.

2. You bought the LLC from the owner with 100% owner financing for $X amount, to be repaid over 15 years @ 3% simple interest.

3. The original LLC's recourse is against the LLC, i.e. if you don't make payments S/he can take back ownership of the LLC and its assets. Recourse against you personally as well?

4. The properties are all in the name of the LLC.

5. By purchasing the LLC you purchased all shares in the LLC, i.e. you are the only officer and have 100% control of the LLC's operations.

Assuming all of the above, there's virtually nothing stopping you from doing what you suggest other than the ability to get loans as mentioned above, i.e. you can't pretend the repayment of the LLC note doesn't exist and that the income to repay the note isn't generated by the properties. Beyond that, as long as someone will give you a loan against a property, you can do exactly as you said, which makes me ask:

Did you drug or induce the original owner into temporary insanity? They have surely lost their mind to make such a deal with you; I wouldn't make that deal with my own brother. You can literally secure first-position notes against each property and strip the LLC of virtually all of its value, and not make the payments, and the only viable recourse for the original owner would be taking back the LLC and, if you agreed, suing you personally for the loss of value. The original owner's only realistic protection before selling to you was either withholding shares in the LLC and constructing disposition of assets in such a way that they would have to sign off, or securing a first position lien against each property. From what I read here, S/he did neither.

You could literally fleece this person out of all of the value of this LLC. If you were crooked enough and so inclined, or a dumb investor who stripped the equity and spent it on losing propositions.

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1 Reply

Dennis Maynard

Real Estate Broker · Los Angeles, CA · Member since 2018 · 300 posts · 146 votes

4y

Quote from @Ezra Henderson:

Hey BP, I think I might have just had the craziest idea ever, and I need somebody to smack some sense into me and tell me it isn’t possible. But if it is possible, then it would be amazing.

So not too long ago I purchased a LLC from an investor, and in that LLC are 10 rental properties. I didn't purchase the properties individually, I purchased the Business/LLC as a whole. I got a sweet deal from the guy, and did 100% owner financing. All the properties in the LLC were payed off and owned in full. I now pay the previous owner of the LLC a set amount each month, for 15 years at a 3% interest rate. The properties were not held as collateral on the loan, and there was no lien placed on them.

Now my question is: what's stopping me from refinancing these properties, pulling out 75% equity and using that money as down payments on more properties that cash flow? And then using the cash flow from the new properties to pay off my loan on the original LLC? I know it would mean I have two loans, but I would definitely make way for money this way.

For example, to keep things easy let's say I bought the LLC for $1,000,000 dollars, and I pay the previous owner $7,000 monthly.

So on each of the 10 properties, I give $700 of the monthly income to pay off my debt.

So say I took one of those properties, and did a cash out refinance and pulled $80,000 out, and spent it on down payments on 4 new properties, each of which cash flowed $200 each month after all expenses. That would mean that 1 property turned into 5 properties, cash flowing $1,000 between them all! I would then use that money to pay of the $700 I owe from the original loan.

And then say I did that on all 10 of the properties! So I turned 10 properties into 50 properties, am now making more cash flow, and am having debt pay down and appreciation on 50 properties rather then 10.

I know it’s too good to be true LOL. Somebody tell me what’s wrong with this idea.

Thanks!!

Why not borrow against the properties and pay off the LLC? Then you have deductible expenses.

1 Reply

Ezra Henderson

OP

Wadsworth, OH · Member since 2021 · 110 posts · 91 votes

4y

@JD Martin LOL, no I did not drug him or anything like that, I know there is definitely a level of risk involved for him, but we have been friends for many years, and he trusts me completely. And there’s no way I would ever do that to him, haha. Thanks for the points you made!

1 Reply

Michael Deering

Rental Property Investor · Lehigh Valley, PA · Member since 2017 · 200 posts · 191 votes

4y

If you hold title on these properties and you can pull cash out for cash flow their is nothing stopping you from working with a bank or broker to make it happen

Talk to your Lawyer

The trick is- if pulling an additional 40 units into that LLC and you breach your contract; does the former owner take back the LLC with now 50 properties.

Talk to your CPA

The obvious course of action here is to purchase the new properties under a new entity but then you are comingling funds. One LLC can make a loan to another (I've done it).

Last tip- when consulting your lawyer and CPA don't ask "if" you can do it. Ask them "how" you can do it.

It's a good plan- Good luck!!

0 Reply

James Hamling

Real Estate Broker · Minneapolis, MN · Member since 2011 · 5k+ posts · 6k+ votes

4y

@Ezra Henderson while there is a lot here to throw out a virtual high-5, I get a sense there may be a fair bit of tunnel vision happening on this deal as there are some other factors I don't see mentioned at all, that can have HUGE impacts, that would be Operation Expenses, both realized and deferred.

You bought a LLC that happens to own real estate, this is a very different world then many comprehend in REI as your in Commercial realm, not residential, so best to reframe things and think of it more like you bought a business who owns 10 restaurants. Think on what a finance company would want to see if strolled in and wanted to get a loan against those locations. They will ask how long you have owned them, how performance has been historically before and during your ownership, AND your business plan for them, will you be raising revenues, how, what will do with the $, what costs of operation is there etc etc. Commercial lending is much more about lending on the business vs the structure, so that's where a focus needs to be reviewed as to determine.

@Bill F. hit the nail on the head, so I will focus on the items not covered which is what is the operational standing of things, is this thing a maintenance bomb waiting to blow? Many can just take this info and assume it's a great deal BUT if most items are 10yrs beyond life-span, well I am betting the seller is laughing all the way to the bank on it. AND before you go on a spending spree pressing your leverage as maximally as possible, consider what you NEED for reserves, and go 20% additional. I personally operate 3 separate reserve accounts, a primary anticipated, an over-run reserve, and what I call "WTF Reserves" which is backup for my backup, lol.

Look, I get where many will say I am under-leveraging with all the reserves but here is some important math that I am betting the other veterans can backup; 1 screw-up/ loss can easily wipe out the profits of 5-10 "good" deals, so i focus on loss mitigation because time lost from a loss is massive, and if the cost is just missing out on 1/2 added deals, well I am in good ROI area. Rule #1 is never loose $, Rule #2 is to make $, rule #3 is NEVER forget rule #1. Be careful chasing the green-eyed-monster, get a bit to caught up in it is when things turn around to take a big bite outta ya.

3 Reply

JD MartinBusiness Member

Moderator

Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes

4y

Quote from @James Hamling:

@Ezra Henderson while there is a lot here to throw out a virtual high-5, I get a sense there may be a fair bit of tunnel vision happening on this deal as there are some other factors I don't see mentioned at all, that can have HUGE impacts, that would be Operation Expenses, both realized and deferred.

You bought a LLC that happens to own real estate, this is a very different world then many comprehend in REI as your in Commercial realm, not residential, so best to reframe things and think of it more like you bought a business who owns 10 restaurants. Think on what a finance company would want to see if strolled in and wanted to get a loan against those locations. They will ask how long you have owned them, how performance has been historically before and during your ownership, AND your business plan for them, will you be raising revenues, how, what will do with the $, what costs of operation is there etc etc. Commercial lending is much more about lending on the business vs the structure, so that's where a focus needs to be reviewed as to determine.

@Bill F. hit the nail on the head, so I will focus on the items not covered which is what is the operational standing of things, is this thing a maintenance bomb waiting to blow? Many can just take this info and assume it's a great deal BUT if most items are 10yrs beyond life-span, well I am betting the seller is laughing all the way to the bank on it. AND before you go on a spending spree pressing your leverage as maximally as possible, consider what you NEED for reserves, and go 20% additional. I personally operate 3 separate reserve accounts, a primary anticipated, an over-run reserve, and what I call "WTF Reserves" which is backup for my backup, lol.

Look, I get where many will say I am under-leveraging with all the reserves but here is some important math that I am betting the other veterans can backup; 1 screw-up/ loss can easily wipe out the profits of 5-10 "good" deals, so i focus on loss mitigation because time lost from a loss is massive, and if the cost is just missing out on 1/2 added deals, well I am in good ROI area. Rule #1 is never loose $, Rule #2 is to make $, rule #3 is NEVER forget rule #1. Be careful chasing the green-eyed-monster, get a bit to caught up in it is when things turn around to take a big bite outta ya.

I am just baffled that any experienced investor would leave their investment exposed this way. Unless there's something missing in the contract documents, even if the houses are relative dumps if the OP can get any kind of financing on them he could strip virtually all of the equity out of the LLC (assuming it doesn't own anything but the houses), quit making payments and default, and leave the original owner in control of an LLC that now has virtually no value. The analogy of restaurants is a good one but more often than not the restaurants only have leases with real property owners, such that the value of that LLC is in the value of the operations of the business. I've known people who sold private businesses to others with 100% owner financing, but in cases where they owned real property free & clear they retained title to the properties and only sold the operations with a lease in place, or sold an option to purchase the property separate from the business sale.

I agree, though - just because he *can* cash these properties out doesn't mean that he should, unless he plans on fleeing the country with the proceeds.

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Skyline Properties

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2 Reply

Joe S.Pro Member

Investor · San Antonio · Member since 2020 · 3k+ posts · 3k+ votes

4y

Quote from @JD Martin:

Quote from @James Hamling:

@Ezra Henderson while there is a lot here to throw out a virtual high-5, I get a sense there may be a fair bit of tunnel vision happening on this deal as there are some other factors I don't see mentioned at all, that can have HUGE impacts, that would be Operation Expenses, both realized and deferred.

You bought a LLC that happens to own real estate, this is a very different world then many comprehend in REI as your in Commercial realm, not residential, so best to reframe things and think of it more like you bought a business who owns 10 restaurants. Think on what a finance company would want to see if strolled in and wanted to get a loan against those locations. They will ask how long you have owned them, how performance has been historically before and during your ownership, AND your business plan for them, will you be raising revenues, how, what will do with the $, what costs of operation is there etc etc. Commercial lending is much more about lending on the business vs the structure, so that's where a focus needs to be reviewed as to determine.

@Bill F. hit the nail on the head, so I will focus on the items not covered which is what is the operational standing of things, is this thing a maintenance bomb waiting to blow? Many can just take this info and assume it's a great deal BUT if most items are 10yrs beyond life-span, well I am betting the seller is laughing all the way to the bank on it. AND before you go on a spending spree pressing your leverage as maximally as possible, consider what you NEED for reserves, and go 20% additional. I personally operate 3 separate reserve accounts, a primary anticipated, an over-run reserve, and what I call "WTF Reserves" which is backup for my backup, lol.

Look, I get where many will say I am under-leveraging with all the reserves but here is some important math that I am betting the other veterans can backup; 1 screw-up/ loss can easily wipe out the profits of 5-10 "good" deals, so i focus on loss mitigation because time lost from a loss is massive, and if the cost is just missing out on 1/2 added deals, well I am in good ROI area. Rule #1 is never loose $, Rule #2 is to make $, rule #3 is NEVER forget rule #1. Be careful chasing the green-eyed-monster, get a bit to caught up in it is when things turn around to take a big bite outta ya.

I am just baffled that any experienced investor would leave their investment exposed this way. Unless there's something missing in the contract documents, even if the houses are relative dumps if the OP can get any kind of financing on them he could strip virtually all of the equity out of the LLC (assuming it doesn't own anything but the houses), quit making payments and default, and leave the original owner in control of an LLC that now has virtually no value. The analogy of restaurants is a good one but more often than not the restaurants only have leases with real property owners, such that the value of that LLC is in the value of the operations of the business. I've known people who sold private businesses to others with 100% owner financing, but in cases where they owned real property free & clear they retained title to the properties and only sold the operations with a lease in place, or sold an option to purchase the property separate from the business sale.

I agree, though - just because he *can* cash these properties out doesn't mean that he should, unless he plans on fleeing the country with the proceeds.

Yup the seller was very trusting. It doesn’t sound like the OP intends to rip the guy off, but due to the nature of life events can happen and hopefully the OP has enough Reserves to withstand any surprises.

1 Reply

James Hamling

Real Estate Broker · Minneapolis, MN · Member since 2011 · 5k+ posts · 6k+ votes

4y

Quote from @JD Martin:

Quote from @James Hamling:

@Ezra Henderson while there is a lot here to throw out a virtual high-5, I get a sense there may be a fair bit of tunnel vision happening on this deal as there are some other factors I don't see mentioned at all, that can have HUGE impacts, that would be Operation Expenses, both realized and deferred.

You bought a LLC that happens to own real estate, this is a very different world then many comprehend in REI as your in Commercial realm, not residential, so best to reframe things and think of it more like you bought a business who owns 10 restaurants. Think on what a finance company would want to see if strolled in and wanted to get a loan against those locations. They will ask how long you have owned them, how performance has been historically before and during your ownership, AND your business plan for them, will you be raising revenues, how, what will do with the $, what costs of operation is there etc etc. Commercial lending is much more about lending on the business vs the structure, so that's where a focus needs to be reviewed as to determine.

@Bill F. hit the nail on the head, so I will focus on the items not covered which is what is the operational standing of things, is this thing a maintenance bomb waiting to blow? Many can just take this info and assume it's a great deal BUT if most items are 10yrs beyond life-span, well I am betting the seller is laughing all the way to the bank on it. AND before you go on a spending spree pressing your leverage as maximally as possible, consider what you NEED for reserves, and go 20% additional. I personally operate 3 separate reserve accounts, a primary anticipated, an over-run reserve, and what I call "WTF Reserves" which is backup for my backup, lol.

Look, I get where many will say I am under-leveraging with all the reserves but here is some important math that I am betting the other veterans can backup; 1 screw-up/ loss can easily wipe out the profits of 5-10 "good" deals, so i focus on loss mitigation because time lost from a loss is massive, and if the cost is just missing out on 1/2 added deals, well I am in good ROI area. Rule #1 is never loose $, Rule #2 is to make $, rule #3 is NEVER forget rule #1. Be careful chasing the green-eyed-monster, get a bit to caught up in it is when things turn around to take a big bite outta ya.

I am just baffled that any experienced investor would leave their investment exposed this way. Unless there's something missing in the contract documents, even if the houses are relative dumps if the OP can get any kind of financing on them he could strip virtually all of the equity out of the LLC (assuming it doesn't own anything but the houses), quit making payments and default, and leave the original owner in control of an LLC that now has virtually no value. The analogy of restaurants is a good one but more often than not the restaurants only have leases with real property owners, such that the value of that LLC is in the value of the operations of the business. I've known people who sold private businesses to others with 100% owner financing, but in cases where they owned real property free & clear they retained title to the properties and only sold the operations with a lease in place, or sold an option to purchase the property separate from the business sale.

I agree, though - just because he *can* cash these properties out doesn't mean that he should, unless he plans on fleeing the country with the proceeds.

With a monthly payment as OP stated, there has got to be some securitization feature, something. I find it impossible to believe a person with enough capability to acquire 10 properties, facilitate in any fashion for tenancy in those properties, I just find it impossible to believe that person then is going to ignore all basic sense of having a default clause and securitize for performance.

The most plausible is that buyer/OP is not with full comprehension of the contract entered, all the fine print probably somewhere around page 14 mid page where it reads "buyer owes seller his enduring human soul" or something to that affect, lol. My hunch is he offloaded a maintenance bomb onto a novice buyer who got all stary-eyed with the front facing components, playing the "well hey, I am just a really nice guy" card, waiting for buyer to repair and replace everything. AND/OR got a price that the properties stood 0% chance of appraising at, hence the structure. Heck, I'd happily sell one of my aged properties on seller finance for 2X/3X factor, I'd even be a "nice guy" and take just 2% on the ridiculous price, lol.

4 Reply

Ezra Henderson

OP

Wadsworth, OH · Member since 2021 · 110 posts · 91 votes

4y

Lol you guys. It’s more complicated then I described, but we worked it out with two CPA’s and a promise it’s all kosher. Like I said, I have a really good relationship with the seller. But all the properties have been fully inspected and are in great condition! I know it seems to good to be true though, haha

0 Reply

Ezra Henderson

OP

Wadsworth, OH · Member since 2021 · 110 posts · 91 votes

4y

I do really appreciate all of your advice!

0 Reply

JD MartinBusiness Member

Moderator

Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes

4y

Quote from @Ezra Henderson:

Lol you guys. It’s more complicated then I described, but we worked it out with two CPA’s and a promise it’s all kosher. Like I said, I have a really good relationship with the seller. But all the properties have been fully inspected and are in great condition! I know it seems to good to be true though, haha

Well then what I would say is build some reserves and get some ground underneath you before venturing into something that could wreck both your business and your relationship. It sounds like fell into a fantastic opportunity here. Remember the old saying: pigs get fat, hogs get slaughtered.

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1 Reply

Wyatt Powers

Investor · Sioux Falls, SD · Member since 2022 · 16 posts · 8 votes

4y

I'd look at getting a portfolio line of credit on the equity of the 10 properties in the portfolio and I wouldn't get such skinny deals. Take the equity and buy multifamily with large amounts of cash flow or a big value add deal that could add a good chunk of cash flow and equity play. Be careful overleveraging yourself, if **** hits the fan you could lose everything.

0 Reply

Craziest idea ever… somebody tell me I’m stupid.

Craziest idea ever… somebody tell me I’m stupid.

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