What is the best way to purchase investment property from family?

[Gabe M.]

Hello Bigger Pockets community my name is Gabe Musella and this is my first time posting.

Currently, I am in the process of purchasing my second property, which is my grandfathers 2-family house, and am at a crossroads about the best way to go about financing this.

About me: 

I am A 28-year-old amateur real estate investor in Bergen County, New Jersey, and by profession, I am a credit analyst on a commercial lending team. I can say my skillset from my job has definitely helped in my RE investing journey. A few months ago I closed on my first property, an off-market, two-family where I am now "house hacking". I am living in one of the units and collecting rent for the other. I got a standard mortgage on that house and a pretty decent rate as I closed in November, and I utilized a first time homebuyer program. I was able to put less than 20% down with lender paid PMI (I put 15% down as I felt anything less would put myself over leveraged, and it was a good balance to retain some liquidity).

Some Background about the deal:

My grandfather lives in a two family house in North Jersey, that he has owned and been a landlord for 40 years, which has been free and clear of a mortgage. Long story short, my grandfather will be moving in with one of my two aunts.

The aunt he is moving in with will be putting an extension on her house in order to accommodate my grandfather. My grandfather has three daughters total. I believe upon sale, part of the funds will be used to partially pay for the extension on my aunts house.

I am writing in this today because I I am trying to figure out the best way to go about financing this property. Because this a a transaction within the family, and the house is free and clear, I am aware there are different ways this can work and I am aware of some of the options.

Another aspect of this is my younger brother may or may not be buying the property with me (he would be a first time homebuyer). And I realize that can change certain things about the deal.

One factor that remains constant throughout this process is the gift of equity. My Grandfather, Mom, and Aunts have agreed, to gift me (and potentially my brother) equity to be used as part of the down payment. The sales price that we are leaning towards for this property as of right now is around $450,000-$500,000. Which may change depending on the amount of taxes my grandfather have to pay to on sale and the inspection being done. I know doing an inspection before an offer has been accepted is not traditional, but in our case we know we want this property to stay in the family and we wanted a more detailed look of what work needs to done to further our negotiations about the price. For instance, my family is willing to work with me on the sales price if there is a serious issue that arises from the inspection.

One of my mentors who is also a local RE broker and owner of an agency ran a CMA report on the property. He thinks that if he were to list this property it would go for $600k, based on similar recent sales in the area.

So to Sum:

• I currently own a two family house which I am househacking. The LTV is around 80%. (Could be more.. The rental unit was vacant when I moved in and I am currently receiving about $300 more in rent that was on the appraisals projection… I have also done some minor- non cosmetic updates).
• In terms of my financial position I do have enough liquidity, credit, and income to qualify for a mortgage.
• My grandfathers property is a two family house (up and down) on an oversized lot, with a two car detached garage, and a huge driveway.
• My family will be utilizing a gift of equity to me (and potentially my brother) for the down payment when we buy the property.
• The price my grandfather is looking to net Is between $450k and $500k.
• Based on a CMA report I had done, the estimate on the house is between $580-600k.
• My Aunt is putting an extension on her house to accommodate my grandfather living with her and her family. Which everyone in my family is on board with. And as mentioned earlier part of the funds from the sale shall be used for that extension.
• Another aspect is my grandfather is planning on staying in the house until the extension and renovation on my aunts house is complete. They have a timeline of this being done by the fall. But knowing the current state of the market, seeing backlogs for most contractors, and supply shortages, I feel like realistically he will be in his house another year.
• We have a greed that if my grandfather is occupying the property that he will pay the appropriate rent. I did consider the option of shaving some dollars off the purchase price but I realize that the rental income is more important to cover the mortgage.
• The rental unit upstairs is currently occupied. The tenant isn’t the best in my opinion as he has been late in paying rent and my grandfather pays for his utilities and cable/Internet. My grandfather is a very passive landlord, I don’t even think he has a lease agreement in place. Aside from that the tenant is a good guy who does a lot around the property for my grandfather, He renovated the upstairs bathroom for my grandfather out of his own pocket.
• Once I am the landlord, I will most likely keep the rent the same which is about $1700, except will require the tenants to pay for their own Internet and utilities (not really a big priority currently as I am focused on buying the property first)

The financing scenarios:

What I am really reaching out to the BiggerPockets community is for some suggestion on the best way to finance this deal. Here are some scenarios I have thought of:

• Bank financing. I do like the bank that I am financing my current house through, as it is the bank that I work at, which is a Community Bank and lender I work with is very helpful and informative. He was the one who initially suggested the gift of equity idea. I know currently as of May 2022 rates are very high and they make the numbers on the deal extremely tight. The only silver lining is that I can one day refinance into a lower rate most likely.
• We have explored seller financing considering my grandfather is free and clear. I’m assuming if we did that there would be some type of balloon payment involved. I have not yet worked out a solid scenario with this route. I also think if I were to go this way I would have to put more actual cash down, as my family needs the cash in order to finance some of the construction costs for my aunts extension, Rather than a gift of equity in a bank financed scenario.
• I am aware as well depending on the occupancy of the property changes how the banks look at the deal. I am not opposed to moving out of my current house and renting the unit I currently occupy. And moving into my grandfathers house with him for a few months if I buy his property. I know this would allow me to most likely get a better rate from my bank and most likely a different loan type all together.
• If I buy my grandfathers house and do not occupy it I know that will most likely be an investment property type of mortgage or a second home type of mortgage which changes rates as well.
• Lastly if my brother goes in on this property with me he could be the occupant on my grandfather’s property, I will remain in my property and be a non-occupant co-borrower with with my brother. I know that That this would have to be the case. As my brother’s income is not Sufficient enough for him to qualify for any type of special first time homebuyer program.
• Refinancing my property is not in a deck of cards. As I have an extremely low rate currently which I would like to maintain. I also do not think I have enough equity in my home to do that as of yet.
• Another scenario I someone brought up to me is potentially utilizing a home equity line of credit. I am not sure how exactly this would fit, if I were to go this route though.

I know it seems like the above is a lot of information so I’d be happy to clarify anything or answer any questions in any gray areas.

This property is an opportunity I would like to pursue and given the climate of the housing market in rates I know deals like this are hard to come bye which is why I do not want pass it up. Preferably I don’t want to have to cough up a huge chunk of my liquidity as down payment, and I am not necessarily afraid of a high rate, as long as the numbers work.

If anyone has any advice on the smartest way to go about this please let me know, as I am in a bit of a cross roads on the direction to go. I’m not opposed to any type of suggestion or creative financing.