Puzzle to solve: How do we buy a new house without selling our current one?

Question

esteemed listmates

I have some friends who have a real estate problem - but don't know it.

SITUATION:

They have a great 3 bedroom house in San Rafael, with About $600-700k equity. Bought for around 900, worth at least 1.4 now. Its in an awesome hood and they should never sell it, ever, unless they absolutely have to.

But, They are outgrowing it. They make together, about 400k a year I would say.

They want to sell their house and buy a bigger one. I am saying- DONT SELL.

They are saying: BUT we cannot come up with a down payment for the new one unless we sell the old one.

POTENTIAL OPPORTUNITY:

They have a rich RE investor stepmom willing to buy the house they need, in cash (through a 1031) and do some sort of seller carry deal. 1.8mil 4 bd house that would be suitable for them. Terms TBD.

QUERY: How do they

-come up w downpayment for the new house without selling old house (I suggested heloc);

-Structure the seller carry in such a way that they would be able to buy and keep the new house without too much worry of not being able to pay later?

Henry Clark · Answer

They need to sell.

1.  $500,000 primary residence capital gain non taxation  if they lived there for 2 out of 5 years.

2. Let’s say their mother bought the original house for them, same as your mentioning for the new house. They don’t get the market increase. They just paid rent.

3. Let’s say the mother buys the new house and seller finances to them. You’re an attorney. What are all of the life situations that make this a bad deal? The closest I would get to this is for her to make a low interest loan for the downpayment.

4.  Unless they want to be landlords they shouldn’t.

5.  Is the new neighborhood just as good as this neighborhood?

6.  Little late in the game.  Refi the first house to get payments down.  Cash out their 401k.  Make sure their $400k salary jobs are secure.   See how their Debt to income ratio works.

7.  Determine the rental rate and the net Cashflow would be in the current house.  Make sure it make sense to hold as a rental.

On top of all that Understand what doing this in California means if anything from a rental and taxation standpoint.

Dylan Vargas · Answer

@Richard E. Welcome! Are they able to build an addition to the current house they occupy?

Henry Clark · Answer

If they rent offices, have them look at doing a medical plaza.  Then move in as a key tenant.

Henry Clark · Answer

Correct.  Trust attorney

Henry Clark · Answer

If the stepmother is in REI.  She will understand selling and re deploying into 4 properties of $1.2mm each.

She can set up contracts, property management, financing for less than 25% down.  Or doing Multi family.  They possibly keep the current house, but only get into 2 more houses by refinancing.  Or they could sell to the stepmom to get the capital gain exemption.  Set some money aside and buy back later from her.  But this is a sticky tax/legal concern.  If your an attorney you should set them up with an LLC, set them up with a trust accountant- not a standard attorney, set them up with incremental term life insurance policies to cover death risk for about 20 years.  As they pay down debt, kids go to college, kids graduate from college etc. they drop a policy.   Don’t do one big policy because if they want to lower they may not be eligible to new medical conditions.   Also read my post.  What happens if you die.  Guide them through the checklist.  Develop a checklist for all of your business or REI clients.

Richard Evanns · Answer

-True, they have to live with the contract;

-Also yes, they don't "want" to be REI's, they are therapists and not of the REI mind, BUT they want to build wealth, as we all do, and I am trying to help them do that.

-I understand what you are saying re numbers (not really "understand" per se because clearly you are a numbers whiz and I am terrible at them) of this 'investment' being not as good as others- and you are correct, these people are not into "REI" per se; they just want to build wealth and keep house 1 and live in house 2, as opposed to just sell a great house to be in a new house.

-Another thought: Maybe they can house hack house #2, maybe get one with a guest house or additional unit they can rent/airbnb to supplement income/offset mortgage.

-But then, this is also something they have to be motivated to do. they have a 2yo and a 6 mo old so.

-REI stepmother is a great resource and I thought of this too and i like this idea. REI stepmom wants to help so we should give her the opportunity to do so.

-I am an atty but also an agent and investor, and I am just launching my company, and my goal is really to help people like this build wealth- and one thing i learned if nothing else- best wealth building tip is, (unless there is a real compelling reason to do so like you can and WILL redeploy the money better) never sell your house!

Single fam house in A+ neighborhood at 3.5% rate-- i say, never sell.

Susie Wyshak · Answer

I have a lender (based in Berkeley) I work with for my many clients who want to buy before selling. She has a interesting solution. Message me if they are looking to talk to someone.

Henry Clark · Answer

Approach from their viewpoint and an REI viewpoint.

Contracts are contracts, but thanksgiving is thanksgiving.  They have to live with them.

Why would they want to be REI?  Forget whether it is a good deal.  What REI approaches have they checked on?  Syndications, BRRRR, fix/flip, cash flow or appreciation models, how many deal analysis have they done, how do they plan to scale, how many podcasts have they watched, posts have they made, books read, renter contracts, insurance, property manager, team. etc.

If they are making $400,000 per year, unfortunately there is no compelling reason for them to do REI.  They have to want it.  If they owe $200k on a house worth $1.4mm and make $400k per year, there is nothing compelling.

To your concerns, layout the deal, and ask a mortgage or home loan person about the scenarios and Debt to equity and income streams.  You can tell ahead of time if they will have any issues.

Consider House 1 as an investment:

A.  What is the cash flow return?  What rent can you get? What costs to maintain, including CAPEX?  On top of that include foregoing the Capital Gain exemption, say they plan to hold past the 5 year limit.  Let's work this backwards, what return do you need on a $1.4mm property to make it a good deal?  Let's say 15% return net.  I was going to say 10%, but you have to make up passing on the Cap Gain exemption.  Thus $210,000 per year net.  Can you achieve that?

B.  Let's say you are looking for an Appreciation return.  They bought for $900k appreciated to $1.4mm or a 55% increase.  You would need it to appreciate to $1.4 x 1.55= $2.17m value to achieve the same return.  When will it ever get to $2.17m, at some point but when.  In the meantime, you tied up $1.4mm less $200k loan or $1.2mm in cash.

Forget the 1st house, they actually want to do REI:

REI is about Leveraging.  If you assume that market will appreciate that much, then with $1.2mm assuming commercial loan at 25%; let's say you do 4 houses with $300,000 down; at 25% down that would be 4 houses valued at $4.8m total.  At a 1.55 appreciation that is $7.44m on an initial investment of $1.2mm, net of the original debt of $3.6m.  Thats $3.8m assuming net cash flow offsets carrying cost. Which you are assuming if you keep the original house by itself and rent.  If you just do House one you earn $2.17m less $1.4m or $1.3mm.  If you invest in 4 houses, you earn $3.8m before transaction costs and taxes for both transaction examples.

Walk the REI stepmother thru and ask her what she would recommend they do.

Puzzle to solve: How do we buy a new house without selling our current one?

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