Is this legal?

[Yan P.]

For one of my projects I have been looking for a 3-4 flat to purchase, live in one unit, and rent out the others. My goal is to not have a portion of my cashflow robbed each month by mortgage or rent for my personal residence.

I will get the best value for my money by buying a gut rehab. My question is about financing. I have excellent credit as well as enough cash for a HML lender to feel nice and safe, and be approved for long term financing. I was thinking I could put down the money for a trusted friend or family member to purchase the property, do the rehab, then could purchase from them for the price it exactly cash flows at. Do you guys see any legal issues here? Will I be able to put any of the loan in my pocket if there is room left?

[Jon Holdman]

I don't get why you want someone else to buy. You're making this too complicated. Assuming you truly can swing the permanent loan, and that you have cash, borrow money from a HML to buy the property. Fix it up, get it rented, then refi. You will need to have enough income to cover the new mortgage WITHOUT considering the rental income. You'll need good credit, 720+, 750+ would be better. You'll need to have some cash in the bank, at least six months PITI for the new loan. You will need to have good equity after the fix up. That is, you'll probably be limited to 70%, maybe 75% of the value as determined by a new appraisal. Be sure there are good, recent comps available. If there are no fourplex sales in the area an appraiser is going to have a hard time and will come up with a low value. Assume the appraiser will come up with a low value anyway. Assume you will need to hold it on the hard money loan for at least six months, maybe a year. Be sure your HML is aware you're going to move in and that they're OK with this. Some forbid you living in the property.

If you have someone else buy the property with the HML, you're going to need more cash. You're going to need whatever the HML requires as far as a down payment and contribution to the rehab. Then, when you go to purchase it, you'll have to qualify for a purchase loan. That's going to require a minimum of 25% of the purchase price. And the appraisal is likely to be more stringent for a purchase than for a refi.

You will be doing good to avoid having to kick in cash when you refi. Getting cash out will be very difficult. I have no idea what terms HMLs are offering in your area, so let me make a guess and run through a scenario. Lets say you've found a fourplex that will be worth $200K fixed up, or $50K per unit. Lets say it rents for $800 a unit. Lets ignore the fact you're going to be in one unit for a moment. If it was fixed up and you bought it outright for $200K, is it a deal. I'll assume you can get a 6% loan (might be able to do a little better) for 30 years and that you put 25% down plus closing costs (estimate about $5000).

Price: $200,000
Down: $50,000
Closing: $5,000
Loan: $150,000
Payment: $899.33
Gross scheduled rents: $3200
Expenses: $1600 (50% rule, read in Rental Property forum)
NOI: $1600
Cash flow: $700.67/month, $8,408.09/year
Cash on cash return: 15%

Yeah, that's an OK deal, IMHO

So, you goal would be to get into the $150K loan without having so much cash out of pocket. Lets say you find a place that's not falling down, but that needs work. Pretty easy to spend $10K a unit just doing cosmetic renovations along with some minor repairs. Nothing major, no roofs, wall movements, replumbing, rewiring, new heat, anything like that. So, that's $40K in renovations. Your max refi amount, based on the $200K value is $150K. Say you purchase for $100K. Say your HML is charging you four points, 15%, allows a max LTV of 65% of ARV and requires you to pay 10% of purchase and 10% of rehab. You have to put in $14,000 and the HML will loan $130K. After points, you get $124,800. With your $14K you have $138,800. But you need about $144,000 for purchase, rehab and closing costs. So you have to kick in another $5,200 bringing your total to $19,200. Say you refi in six months. Interest for the six months is $9750. You will collect some rent during those six months, presumably. You refi into a new loan, with a maximum of $150K. But you only owe the HML $130K. With the costs of the refi, your new loan will be something like $135K. That enough to cover the costs of the refi and pay off the HML. Now you could perhaps push that up to $150K after a year, but you'll pay another $9750 in interest to the HML. You end up with a $135K loan and $28,950 invested. Your payment is $809.39. That gives you $790.61 a month or $9,487.28 a year in cash flow for a 33% cash on cash return. A very good deal.

Now, lets see what you living in one unit does. Your expenses are perhaps slightly less. Your not going to wreck your own place or have to be evicted. But lots of other expenses stay unchanged (insurance, taxes, overall maintenance). So, we'll call expenses $1400 instead of $1600. But your gross rent drops from $3200 to $2400. So, NOI is $1000 a month instead of $1600 and cash flow is now about $100 a month is you buy outright or $200 a month if you can do this hard money/refi deal with my numbers.

If you have some actual numbers, post those.