Using a pre-paid lease to fund constrction?

Question

Wondering if anyone can offer some insight on this? Ever seen something like this?

I own a self storage facility and am looking for a way to expand again as demand is high.  I am looking to do this creatively as my current mortgage has a prepayment penalty for the next 18 months that I would like to avoid paying.

So here's the plan:

I have a customer who is willing to provide me with the 100K I need to put up my new building.  We have agreed that 10% is a fair return and I will pay him back in full 18-24 months (when i can refi without penalty).  Obviously he would prefer something more 'secure' than a second mortgage in case default were to occur (which we both acknowledge is highly unlikely).  To address this I have proposed that we structure this "loan" such that his payment to me is considered pre-payment for a 25 year lease.  Essentially he gives me 100K and earns interest in the form of free rent until the time at which i "buy-back" the lease for 100K.  This way his lease would survive a foreclosure and he would retain his rights as lessee for 25 years to offset the 100k (250,000K in rent value).  Or, he could always try to sell his lease to the foreclsoing bank so that they could better market it for resale.  I'm Hoping folks have some insight on this concept.  feel free to poke holes.

Thanks,

Mike

Don Konipol · Answer

Bill Gulley can give you the REAL deal on just about 
ANY proposed real estate transaction!  I am continually amazed by the breadth and depth of his knowledge.  You are a great resource Bill!

Bill Gulley · Answer

Trades of any asset, loan amounts to a lender for another asset, a leasehold interest must have appraised values. Market value is not established by rents received by the subject property or from one property. While your suggestion is obviously the value to you and the lender, it is not a market proven value which is required by other institutional lenders. Lenders can't lend based on what an agreement may dictate.

You need to pay the loan payments and he needs to pay the rents, it can arranged to wash out if you like.

Then if your rents are alread assigned any future assignments would be taking a back seat to the primary lender.

Yes, a sale-lease back would need consent of the bank, not impossible, but there is the due on sale issue.

How is the land described legally, do you have several legally described lots or is everything under on legal description?

It really sounds like your investor is after an impossible position in reality if you have no other assets. If he is not willing to step up to protect his interests in various situations with a second, he isn't a real lender, he's just looking for benefits without risks.

Another option is to admit him as a partner, making a contribution buying in and have a repurchase agreement for you to buy him out over time. You could just set aside a storage unit for the company and he could use it, how he treats that for taxes is his matter.  A favorable lease agreement could be set aside for a longer term after he is bought out. Admitting members has a much less impact on any due on sale clause, I doubt it would be an issue and can be done without any public records filings other than at the Sec. of State if required.

I also wonder about his motivations, if he is interested in acquiring the property and business? When a "lender" wants a bullet proof lien that idea can be planted in the back of thier mind.

Michael Wagner, use the @ mention feature to bring me back to the topic, I'm in and out. :)

Michael Wagner · Answer

Thanks Bill,

I really appreciate your input.  The tax hit is certainly an important consideration that I neglected.  Have to rethink that for sure.

I could surely "pay him interest" and then "take it back as rent" but beyond that, my issue with your suggestion to keep it simple is that the 'lender' is looking for security beyond a simple second mortgage despite CLTV being only about 50% of PRE-expansion value. His rationale in requiring more security is that the value of a storage facility is so heavily based on income and banks are known to run them into the ground during and after foreclosure so his second position would become vulnerable--not that either of us actually anticipate a foreclosure.  The rents and leases are already pledged as collateral to the first position mortgage holder. With that, do you have any suggestions on how else to securitize his 'loan"?

Am i right to say that a Sale and lease back would not protect me from pre-payment penalty to current first mortgage holder?

This property is within an LLC.

"Lender's" rent credit will only be $833 per month or 10K per year which equates to only 6% of gross rents at facility.  Would you agree that this makes the concerns with refinance less of an issue as it would be quite easy to prove value of rented space based on price per sq footage received throughout the other 95% of the facility?

So thankful for your willingness to talk this through with me!

Mike

Bill Gulley · Answer

Thanks Don, you're pretty sharp yourself! :)

Bill Gulley · Answer

Do you have an LLC?

Accepting prepaid rents for 25 years will give you a heck of a tax hit in the year it is received.

It would be easier to pay interest and pay that amount back as rents. Doing so makes taxes easier, solutions in any bankruptcy, estate settlement, divorce or other events that plague our financial lives.

Since you have a business together with RE, you can ledge rents from other leases with a UCC filing placing a lien on current and future leases.

Attempting to contract with a lease and credits to a loan payment will be a difficult assessment to your refinancing lender, they need to establish the value of the credits as fair market rents and determine payments made, the appraisal will likely cost more and if the appraiser doesn't see the value as you do, you could have refi problems.

I suggest you go conservative, sounds like you investor simply wants to feel better, if he's not feeling good with the RE + the business income, (you could throw in a schedule of rents for a term in addition) you could consider a sale and lease-back of the business. Either way, see your tax adviser and attorney. Good luck  :)

Using a pre-paid lease to fund constrction?

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