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Cash vs land/cash when looking for financing?

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  • Cash vs land/cash when looking for financing?

    We are doing a cash-out refi on our home currently to help get started on building a facility. Should we buy the land we're interested in and have the land/cash (as collateral/capital/down payment...not sure of the appropriate term!), or just keep all the cash available, while searching for construction financing?

  • #2

    Depends on the numbers and your objectives (do you plan to make another investment or move homes)? Change the numbers as you see fit.

    Example A, Refi House:
    Storage Build all in, $500,000
    Home/land is $600,000
    Existing Home loan balance is $150,000
    Okay going below PMI to 20% value, thus cash out refi is $600,000 - $150,000= $450,000; 20% of $600,000 is $120,000; thus cash out is $450,000 -$120,000= $330,000 cash out.
    Interest rate is 3%. Deductible or not?
    Appraisal $2,000

    Storage build is $500,000 less cash out $330,000= $170,000 loan for Storage.
    Interest rate- 4.5% deductible, non-SBA.
    Appraisal- $2,500

    Problem 1- You probably didn't recognize, but now you have two loans with two different banks. You now have collateral with two different banks and since banks don't like taking a 2nd position on a loan, you can't use one of the collateral with one of the banks. Point- try to do both financings through the same bank. They will cross collateralize these two loans then.

    Problem 2- Going SBA, you will research whether a Home loan versus an SBA loan both interest rates and term lengths are comparable. Point- Both may be close. If a traditional commercial loan the collateral and interest rate will be higher and the loan term will be shorter than a Home or SBA loan. Find out if SBA will allow collateral against a home, or if you have to bring cash.

    Problem 3- if you go SBA loan, then the $330,000 you cashed out and applied against this property, will not be usable on your next project unless you use the SBA. Point- SBA has restrictions on what they will invest in. Your Collateral might be tied up and not usable.

    Example B, Second mortgage or HELOC:
    1st rule of Real Estate investing is to put as little cash into the investment as possible. Leverage Debt. Keep cash (grow to dislike Cash) or collateral back for emergencies, poor planning or new investments.

    Everything same as above, except take out a second mortgage or HELOC, for the least amount of money as possible. This will depend on your funding source:
    1. SBA 10% collateral- you need either $500,000 x 10%= $50,000 cash or collateral. Point- don't put your home up for SBA collateral, it will get tied up.
    2. Conventional commercial loan 25%; $500,000 x 25%= $125,000 cash or collateral.
    3. Conventional commercial loan 40%; $500,0000 x 40%= $200,000 cash or collateral.
    Action- take out a second mortgage or HELOC with your existing Home loan bank for the minimal equity position of $50,000/$125,000/$200,000. Point- this leaves any remaining collateral in your home/land accessible with a second refi.

    Loan steps:

    1. Take out a construction loan first with a local bank, even if going to SBA. Ask for interest only until you hit 65% occupancy or 18 months from opening. Do your numbers. 65% should get you to Cash breakeven. Principal and Interest payments also covered. Even at 35 to 40% occupancy you should be able to cover Principal and interest.
    2. Convert the construction loan over to a term loan. With SBA or bank.
    3. In your term loan, most banks won't go past 5 years. Make sure there is a rider that only allows for X% points of rate increase. Like 1% point up to 2% points for every 5 year adjustment.
    4. Loan payoff. You should have structured your Storage deal to pay off in 8 to 12 years. If you financed for 20/25 years, then you will have excess cash coming in. You can spend it, or save/apply it against the loan. Point- see 5 below.
    5. What if interest rates increase? They will. I am hesitant to invest above 7%. Will not invest above 9%. If I was doing flips, which we stay in our "lane", I could go 15% APR for 6 months. Point- Don't get caught where your numbers don't work. Try to pay down quick. You can always do a refi, if you need cash for your next deal, or use your first storage equity as collateral for your second. If your paying down ahead, then by year 4 to 8 you should be in a good equity position, even it rates skyrocket.
    6. Make sure you are in a good financial and personal position, so the Commercial Banks will refi you at the end of the 5 year term.

    "Start small and Make Your Big Mistakes Early."


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