Can I refinance an investment property if it is already in an LLC?

What I am doing is raising capital through private investors to pay for a 4 unit or less multi-family investment property. The reason I am raising the funds soley through investors is because I cannot carry the size of the loan on my own. Besides the point...

What I am trying to find out is what the process is, how difficult, and how much would it be to purchase a property for cash using investors money in the name of an LLC then 13 months from now refinance with a bank for a 30 year note.

The reasons I would be doing this is because if I do not receive funds through an LLC I am now opening myself up to a taxable event, which I cannot afford right off the bat. Secondly, I would be refinancing because the private investors note would balloon in 5 years.

What would the current interest rates be in relation to conventional/investment property rates. (I believe since the peroperty will be in an LLC that it is now considered commercial even though it is less than 5 units)?

Also, is it tough to refinance as an LLC?

If you have any insight on this I would appreciate any help thank you.

Brendan

Edited: 06/26/2010 at 10:37AM

Jon Holdman

Real Estate Investor · Denver, Colorado

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Icon_minipost Nov 23 '09, 11:22 AM

Hi Brendan and welcome to BiggerPockets.

I'm not clear on exactly what you're doing. Some thoughts below, but you really MUST find a good CPA and get some advice from someone who knows your personal situation. Depending on exactly what you're doing, you may need assistance from a lawyer, too.

If you are the one and only member of the LLC and you are getting investors to loan your LLC the money, then the taxes are exactly the same as if you borrowed the money directly. The investors make your LLC a loan. In 13 months (really, just over a year, I think) your LLC refinances the loan and pays off the investors. Refinancing a loan in an LLC will be a pain. You're likely to have to personally guarantee it, and personally qualify for the loan. You'll be getting a commercial loan, which is going to be at a higher rate and a shorter term than getting a conventional real estate loan. A balloon payment or at least a rate reset in five years or less is very likely. I strongly recommend you find a lender who will do this NOW and be sure you understand their requirements, LTVs, rates, and terms. Keep in mind that any lender you find right now may give this business up before a year passes.

If you have investors who are willing to finance you with a five year balloon and a rate under 10% you should make your deal work with them and plan to refinance shortly before the five year deadline. You might get a slightly better rate, but after you add in the refi costs, it won't be dramatically better.

I think you're looking at a rate of at least 7% for a commercial real estate loan to an LLC. A year from now, who knows. I would put the odds on the rate being higher at 99%. I would also assume you'll only get a 70% or lower LTV.

You say you "cannot carry the size of the loan". Hopefully that simply means your DTI won't pass scrutiny by a lender. Read in the Rental Property forum about true rental property expenses and make sure the deal supports itself. Commercial lenders look at the debt service coverage ratio or DSCR or something similar. That's the NOI divided by the debt payment. Lenders have various criteria, but its likely to need to be at least 1.2 or maybe higher. The lender will want to see actual number for the last year or maybe several. An ESTIMATE you can use for evaluating the deal is that the NOI will be 50% of the gross scheduled rent. Lenders commonly use 75% of the gross schedule rent minus the taxes and insurance. Their number might be slightly higher, but not much. Bottom line is you don't have a deal unless the rent is at least 2.5 times the expected payment.

If your investors are putting money into your LLC, i.e., buying units in your LLC, be sure you understand the securities law involved. You're "selling securities" at that point and subject to both federal and state securities laws.

Edited: 06/26/2010 at 10:37AM by Jon Holdman

Jon Holdman, Flying Phoenix LLC

Peter Giardini

Real Estate Investor · Baltimore, Maryland

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Icon_minipost Nov 23 '09, 02:32 PM

Jon... fabulous post!

Edited: 06/26/2010 at 10:37AM

Brendan O'Sullivan

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Icon_minipost Nov 23 '09, 10:03 PM

Originally posted by Jon Holdman

Hi Brendan and welcome to BiggerPockets.

I'm not clear on exactly what you're doing. Some thoughts below, but you really MUST find a good CPA and get some advice from someone who knows your personal situation. Depending on exactly what you're doing, you may need assistance from a lawyer, too.

If you are the one and only member of the LLC and you are getting investors to loan your LLC the money, then the taxes are exactly the same as if you borrowed the money directly. The investors make your LLC a loan. In 13 months (really, just over a year, I think) your LLC refinances the loan and pays off the investors. Refinancing a loan in an LLC will be a pain. You're likely to have to personally guarantee it, and personally qualify for the loan. You'll be getting a commercial loan, which is going to be at a higher rate and a shorter term than getting a conventional real estate loan. A balloon payment or at least a rate reset in five years or less is very likely. I strongly recommend you find a lender who will do this NOW and be sure you understand their requirements, LTVs, rates, and terms. Keep in mind that any lender you find right now may give this business up before a year passes.

If you have investors who are willing to finance you with a five year balloon and a rate under 10% you should make your deal work with them and plan to refinance shortly before the five year deadline. You might get a slightly better rate, but after you add in the refi costs, it won't be dramatically better.

I think you're looking at a rate of at least 7% for a commercial real estate loan to an LLC. A year from now, who knows. I would put the odds on the rate being higher at 99%. I would also assume you'll only get a 70% or lower LTV.

You say you "cannot carry the size of the loan". Hopefully that simply means your DTI won't pass scrutiny by a lender. Read in the Rental Property forum about true rental property expenses and make sure the deal supports itself. Commercial lenders look at the debt service coverage ratio or DSCR or something similar. That's the NOI divided by the debt payment. Lenders have various criteria, but its likely to need to be at least 1.2 or maybe higher. The lender will want to see actual number for the last year or maybe several. An ESTIMATE you can use for evaluating the deal is that the NOI will be 50% of the gross scheduled rent. Lenders commonly use 75% of the gross schedule rent minus the taxes and insurance. Their number might be slightly higher, but not much. Bottom line is you don't have a deal unless the rent is at least 2.5 times the expected payment.

If your investors are putting money into your LLC, i.e., buying units in your LLC, be sure you understand the securities law involved. You're "selling securities" at that point and subject to both federal and state securities laws.

Jon, Thank you.

I would be going in the LLC with a partner, maybe smarter to go an LP route?? 6% to private investors in hopes to get an interest rate similar and less than the rate to private investors with a longer term, but that obviously could not be the case because of fluctuation of rates all the time.

So, I guess how do I get around being taxed on the contribution from investors if it is not going into a "company" and directly to myself? Would a limited partership give me more options?

Are the lending rules as stringent with an LP rather than going through an LLC?

Thanks.

Brendan O

Edited: 06/26/2010 at 10:38AM

Jon Holdman

Real Estate Investor · Denver, Colorado

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Icon_minipost Nov 24 '09, 12:02 AM

You really, really must get a good CPA to walk you through this. If you have one, fire him or her and find another one. I'm neither a lawyer or a CPA and you MUST have both for a deal like this.

The exact form of entity doesn't matter. The details vary and taxes are handled differently for different arrangements, but that affects the income produced by the company, not the money coming in.

I'm still not sure what you're trying to do. You say there's a partner involved and there are private investors involved. Please explain the role of each. I'm going to assume you and your partner going to create a company. The company will buy a property and the private investors will loan the company money for the property. But if that's not what you mean, please say what you do mean.

When someone loans you money, its not taxable. If someone invest money into your company, by buying shares in a corporation or member units in a LLC, that's not taxable either. If someone loans YOU money, that's not taxable. If someone gives you money, that's not taxable, either, though it may have consequences on their estate. So, I'm not sure why you are concerned about taxes, which is why I say you should fire your CPA if you have one.

Assuming the above arrangement, and that your investors are willing to lend you money at 6%, I'd keep that money as long as possible. You might get that rate personally if you have good credit, good income, and can get a conforming residential loan. Any other sort of loan right now is going to be at a higher rate. I'd be surprised if you can get anyone to loan you money at that rate, but certainly naive people with money do exist, and if you've found one who's willing to loan you money more power to you.

This is simple to set up. You and your partner form the LLC. In many states, that's 15 minutes and some chunk of change on the Secretary of State's web site. Then get an IRS EIN for your new LLC. Open a bank account. Put in enough cash to get the deal rolling. Make the offer. Line up the investor as a lender. Get all the paperwork to a title company. Close the deal. The LLC ends up with a deed from the seller. The LLC gives the lender (the investor) a deed of trust (or mortgage, if that's what your state does) and a promissory note. The seller gets the money. The only taxes owed are owed by the seller.

If there are multiple investors, the best approach is for them to form their own LLC. They would put their money into that LLC, and then that LLC would loan your LLC the money. That LLC is not your problem, and you're not involved in its setup.

Do spend some time on the operating agreement for your LLC. You and your partner need to work out ever little detail while you're friends so the decisions about what to do when things get rocky are in writing. Consider all the possibilities like the LLC needing more money, one of you needing money, one of you dying, getting sued and losing or getting divorced. Then, take your notes or draft operating agreement to a lawyer who deals with this sort of thing and get their input.

If you are thinking you will get investors to put money directly into your LLC, that is, buy units of the LLC, you MUST get a lawyer. If you, your partner, and these investors are all members of the company, you must have rock solid documentation and operating agreements. It would be best to do proper Regulation D securities filings. If there are just three or four of you and you all know each other intimately, then maybe you can just do a solid operating agreement with an attorney. This is NOT a DIY project. If even one of the investors is someone you just know casually, then you really MUST do those Regulation D filings. Plan on $20K or so to do those filings and all the legal work. The loan is much simpler and cheaper. This only makes sense if you're talking about raising a million bucks or more.

If you're going out to get investments from strangers, then you need to do an IPO - initial public offering. Plan on a million bucks to do that. The Reg D filing will set you up to raise money from people you know, but not strangers.

If I've misunderstood what you mean, and I probably have, straighten me out and I'll try to give better advice.

The best advice remains, though, get a good CPA and a good lawyer.

Edited: 06/26/2010 at 10:38AM by Jon Holdman

Jon Holdman, Flying Phoenix LLC

Vikram C.

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Icon_minipost Nov 24 '09, 01:42 AM

Jon's posts are great. If your investors and you are all investing in the LLC at startup time, then you will most likely get a safe harbor as co-incorporators and not need to worry about the securities laws aspect of things. But if you and your partner set up the LLC initially, and then sell membership interests to the investors, then you need to worry about creating a prospectus, etc. which is expensive, as Jon said. It will probably cost you around $10,000 or so. But if the investors are accredited, then you should be able to get away with it for a much lower cost.

BTW, for a four-plex, I would not really do a separate LLC for each investor. If they are just lenders, then do the loan and deed of trust as Jon said. If they are going to be members of the LLC, do the operating agreement through a lawyer as Jon said and make sure they are founders of the LLC at the time of setup and don't come in later.

If there are multiple investors investing in a 4-plex, they may wish to form one LLC of their own that does the lending. In my opinion, the more complex you make this, the less likely it is to be worth doing it.

The ideal advisor for this transaction would be a securities and corporate lawyer who does RE deals. Those guys are very familiar with the tax and securities aspects of things.

Edited: 06/26/2010 at 10:38AM

Jimmy H.

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Icon_minipost Aug 19 '10, 05:09 AM

It is difficult to finance in an LLC because you have to get commercial financing (higher rates etc.) and likely must have a personal guarantee anyways.

So is thought then, if your investing in commercial assets, use an LLC.

If your buying less than 4 1-4 family properties then keep them in your own name.

I believe that is the general rule?