How To Invest With A Partner On A 203k Loan?

[Adam Wayne]

Hey there,

I'm new to real estate investing, but I've been around it in various capacities throughout my life. I have many years of experience in residential construction and I am currently working for a medium-sized builder in my area. This is important because I am a capable and connected individual when it comes to all areas of residential construction.

Last night I discovered a 3000sqft property that looks like it would be the ideal situation for me to house hack. Somebody bought it in 2020 on a rehab loan and unfortunately whoever that individual was passed away during the process. The bank is now trying to shortsell the property. It is currently taken down to the studs and has some electrical and plumbing rough-in done. I am estimating that the remaining work will cost about $100/sqft, or $300,000 in total.

The property itself is listed for $300k, and with my income I currently only qualify for a loan around $400k. Since the building is unlivable in it's current state, I would need to secure a 203k rehab loan, but at my estimation, I am about $200k short (600k estimated completion total - 400k preapproval amount), which means the only way I could make this deal work is with some creative financing. As competent as I am on the construction side of things, I am fairly incompetent or inexperienced in the financing game.

I have a couple of family members who may be interested in helping me invest in this property, but also my best friend from childhood is also interested. He is pretty wealthy and also has a passion for residential construction, so I think that we would make a great team. As it is now, I am a single guy who would be looking to live in the house, house-hacking the rooms and possibly making the basement a separate duplex, and my friend would be on the other end helping with the financial side of things. He is a married guy with children who already owns a house, so all of the project managing and landlording would be performed by me.

My question to you guys is, how could we possibly make a deal like this work? Would he need to come up with 200k (if that's possible) or would both of our names have to be on the lease? What would a fair split be as far as ownership of the property? Would it make more sense to treat this as a loan from him or a joint venture? I understand that because I don't have much in the bank right now, my end of things will be handling all of the heavy lifting and he will probably expect to be around 50% of the deal or so just for handling the financing. He's my best friend and a very fair and level-headed guy, so I don't expect any complications with a partnership from him, I just don't know what would be a reasonable expectation on how we can secure the property and how we are to divide up the appreciation or money.

Thank you all so much for any insight or advice that you can give me!!

[Julee Felsman]

@William Sing Thanks for tagging me in!

@Adam Wayne A few thoughts come to mind when it comes to the mortgage side of things:

FHA's rehab loan is the 203k. Fannie Mae and Freddie Mac also offer rehab loans: HomeStyle for Fannie and CHOICERenovation for Freddie. All three allow "non-occupying coborrowers" (NOCB), which is to say, folks who'll cosign, but not move into the property.

If you want to do the work yourself, however, FHA is your best bet. It's much more friendly to "self-help" renovation loans where you act as your own general contractor. You'll need to sell the underwriter on your ability to do the work in a timely manner (6 months or less), while keeping up your day job ('cause you gotta have income to pay the mortgage, right?). If you go the self-help route, you'll be required to finance the cost to have a contractor do the renovations, but you'll only be able to use the loan to pay for materials (you can't pay yourself for labor). The logic: if you can't (injury?) or don't complete the work in a timely manner, they want to have funds escrowed to pay a GC to step in. Any money you save by not having a GC involved will be paid down on the loan after the work is complete.

Rates on reno loans are higher, so you'll probably want to refi when you finish up, so your final, long-term loan will be smaller and reflect your hard work. But you need to qualify for the bigger payment on the bigger loan. 

Very importantly, FHA will allow you to put 3.5% down on the aggregate of the purchase price and all hard and soft renovation costs (the actual materials plus the loan-related costs plus a "contingency" reserve which is usually an extra 10% on top of the estimated costs to do the work) for a one-unit or two-unit finished property. BUT if you have a NOCB who is not family AND/OR your finished product is a two-unit property, your down payment requirement increases to 25%. Notably a house with an ADU is still considered single-family.

With a NOCB, Fannie and Freddie will require 5% down on a single family (with or with out an ADU) or 15% down on a two-unit finished property. Terms won't change if your cosigner is family or not.

I would add a caution about the size of your loan relative to FHA loan limits, which vary a lot by county, but it looks like you're in Seattle. IF that's where the property is too, you're cool. But if not (or for anybody looking at this post later), here's where you can look up the FHA loan limit for any county in the US: https://entp.hud.gov/idapp/htm...

Hope this helps!