All Forum Posts by: Evan C.

Is it possible or worthwhile to put a few properties into a trust (of some kind...) for the purpose of making it easier to borrow against equity? This question came up in discussion between an investor and a property manager in which the investor was complaining about the difficulty of running out of funds and finding it difficult to get a line of equity against investment rental homes. Whereupon the property manager suggested that placing the properties (three SFHs) in a trust would allow the investor to set up a line of credit against the trust. True? False? Partially true?

Maybe someone can educate me on the actual uses and mechanics of using a substitution of collateral clause (aka substitution of security) in a loan when you are the borrower. I understand this is almost only used between an individual buyer and an individual seller who is seller financing the property, not banks. But I don't think I fully understand the law surrounding this and the actual ways it should be used.

As I understand it, this is what you could do with such a clause if you are buying a property and the seller is financing it to you:

As an example using easy numbers, you could buy a property through seller financing for a price of $100,000. You put 10% down and you borrow $90,000 from the seller and make those payments (at 5% amortized over 30 years). You then might renovate the property, so it's worth, let's say, $150,000 after 12 months.

At the end of the first year you have title to a property worth $150,000 which is serving as collateral on promissory note where you owe about $88,600. Your equity is $61,400 (you also paid something to renovate but I'm not sure we need to care too much about that for this example). If you sold after one year, you would net $46,400 (assuming closing costs/commissions are $15,000).  This is where the substitution clause comes in, as I understand it. Instead of paying off the old loan and netting the rest, you talk to the first seller who you've been paying for a year and get permission to substitute collateral. 

Instead of simply paying off the old seller, you identify a new seller financed property and you negotiate 10% down again. But in this case, all the proceeds of the sale of the first property go to you, and you are able to bring the entire proceeds of the sale as a down payment on the second property. So you have $150,000 as a down payment. Which is 10% of 1.5 million. So you buy a property, which is $1.5 million (or somewhat less maybe). You pay $150,000 down and borrow $1.35 million from the second seller in a first position lien. The note from the first seller is only $88,600 so you have more than enough equity remaining to place it in second position which leaves $61,400 in equity on the new property or about 4%.

The first seller continues to receive payments and has sufficient collateral to cover the note. 

The second seller gets payments on a new note worth $1.35 million.

You the buyer received the taxable income event from the sale of the first property. You get a new property worth $1.5 million and you go about fixing that up and raising its value for the next move.

Is this accurate? Not accurate? I understand there are some other factors I glossed over like gaining the approval of the first seller to switch collateral and the lien in second position, gaining approval of the second seller to put a second position lien below the big loan, and scheduling the sale of the first property to coincide with the purchase of the second property. Those would be tricky too, and the properties have to cash flow, but is this basically accurate?

Hi Matthew, reading through your post my main impression is that you have some good problems, so to speak. You have three properties (presumably in addition to living somewhere yourself). Cash flowing $1000/month on your 4 bed is great. You have two others that are not as productive but I can't tell from your post whether this is about the property itself or something about the management, as you and Bjorn discuss. You seem to be self managing and your question is about whether to sell. I can't tell you whether to sell based on this, but I can walk through how I would think about it.

The 4 bed: I understand the frustration of wanting to access that capital but my instinct is not to sell a strong performer. Maybe that's just my inclination, I know others could make an argument for trading up through a 1031 exchange. That is an option, it could turn out well, but here for me personally a bird in the hand is worth two in the bush. This is a strongly cash flowing property, though I imagine it takes a good deal of management time and energy. A 1031 exchange entails costs and time limits that will create additional work for you that may not fit with also working your main job. I would probably hold this and review whether there were ways to make management smoother and easier.

The 2nd property: You live in Raleigh and this is in Greensboro. It is up to you but here I would consider a property manager. They are invaluable when issues beyond collecting rent crop up and they know exactly what the law does and does not permit. If you want to continue self-managing it will take some effort but you need to be clear and predictable with the tenant and never deviate from the lease. Whatever the lease says about rent due dates and late fees, follow it. When she's late, give her notice, even if she pays before anything happens. Beyond that, I don't know where the property is or what it's like so it's hard to say if there are other issues, but clearly getting a tenant paying must be first.

The 3rd property: This is not renting over the last couple of (winter) months. Obviously dropping your asking rent is one option. Without knowing your financial position in the property or its condition it's hard to know what to recommend. You allude to the condition of the house being old, so perhaps there are reasonable ways to improve that condition and present a better product. Here again I would recommend a PM. A PM can advise you on market rents, increase showings, and help with deciding what improvements to make. I have three homes in northern Winston-Salem, in areas that are neither fancy nor difficult, just in that wide suburban sprawl where it's neighborhoods but everyone's on septic. They are 2 and 3 bedrooms and two of them rent for $1300-$1400 while the other, my original, rents for about $1050. 

Again, for me as a newer investor I intend to hold and that's my recommendation, all else being equal. That's because with three properties you have started to build momentum, meaning cash flow and appreciation as well as management experience, and I would be reluctant to start anew by selling and trying to buy better properties unless I had unimpeachable reasons to think the property was going to be a net cost. Down the road when you have more, perhaps it's reasonable to prune the least performing property and shoot for something better.  As far as accessing capital, two of my properties are on mortgages just above 6%. When/if those rates drop, I'll look into refinancing to access the capital. But until then I just have to wait and perhaps you do too. Unless I can find a line of credit on a rental property or someone willing to lend generously, which I have not so far. 

Also, there is a Triad Real Estate Association (www.TriadREIA.org). I've never been able to attend meetings because I'm not even in the U.S. currently, but you might be able to make it out there. 

I use www.travelingmailbox.com. So far they've been great.

Crisis averted! Lease was posted to an old cloud storage site which I had thought was closed, but we got it. Really appreciate the guidance here, we came close to using it.

Yea fair, frankly I guess I was just hoping that my first direct communication with the tenant wasn't going to be "Hi, I'm your owner, I lost your lease, could you email that to me?" True though, so I may just have to suck that up and move on. New PM uses all new homebuilt software, not what the old PM used, so that is probably a contributing factor that screwed up in the transition.

Good guidance @Nathan Strahan, thanks. We'll see what we can do!

So it looks like I'm missing a lease. I rented out two properties together under an old PM company. They leased up a few months apart. Then, a few months later, old PM company got bought out by new PM company. New PM isn't performing well so I went to review all my records and prepare to transition to a different PM. Then I discover that I don't seem to have the lease from one property. Nowhere can I find where the old PM sent it to me, though I know the renewal date, the tenant, and the rent. Also, new PM doesn't seem to have it in their records. I want to move to a (hopefully) better run PM company, but I really need all the leases to do this. We have a couple of weeks until I have to notify the new PM that I'm not renewing the property management agreement. Would you work with the new PM to find the lease or is there a solution to transition without it?

@John @John Sandoval I think the reply above should help but message me directly if you have questions. I think I've also posted about them a couple of other times in these forums.

@Wendell Butler the first was in 2020, ~$78k w/ ~$28k improvements, then rented for a year then refinanced. The second two were bought as a package in 2022 from an investor selling his portfolio (found through a common realtor). Each was $40k, one 2 bed and one 3 bed. Needed substantial work. Put about $105k into the two of them (financed with hard money, Fund That Flip). Refinanced well but hit the beginning of higher interest rates. All are on the northern rim of Winston-Salem. Far enough to need septic. Not easy/cheap renos for sure but all are now rented and cash flowing modestly after refinance.