How do you expand your portfolio?

Question

I closed on my first commercial property last November - a 6 unit all residential. To those that have successfully expanded your portfolio, what strategies worked for you the most? I want to avoid having my loan called and/or having to pay 5% pre-payment penalty up to 5 years. I've been told cross collateralization can be risky, but what if I "untied" the properties 6 to 12 months in? What about a HELOC ? Would it trigger the loan to be called? Or should I just do it the old fashioned way and wait till I have enough equity to refinance. This would be the last resort as I don't want to pay a 5% PPP, nor do I want to wait 5 years to buy my second property. Please note that 30% was my down payment. Any suggestions or advice would be helpful.

Henry Clark · Answer

Think of the lender as being one of your team.  Not just as money.   They want you to be successful so they can loan you more.

To scale:

1.   What is their Federal lending limit?

2.  Don’t chase interest percentage points.  Stick with the same lender.

3.   By staying with the same lender you can cross collateralize your equity position in your existing properties into your future properties.

4. Who are you? Can I trust you? Build that relationship with that lender.
5. Set up LLC in case you need outside money. They can easily invest in your LLC.
6. Look for value add deals and not just straight cash flow deals.
7. Do cost segregation to get tax reduction Cashflow early.

8.  Geographical. Stay in the same general location.  Build a team. Plumbers, electricians, carpenters,  property managers, etc

9. If you use a property manager use them to also look for properties.
11. Insurance. Talk thru with your provider scaling.
12. Develop an operational plan to scale. You do all the work. Hire a property manager. You hire a team.

Ben Firstenberg · Answer

Sounds like you got the idea, just a couple of clarifications.

The words may not actually be "second lien will be an instance of default". It might be more fancy "legal" terms than that. You'll probably know it when you see it. "Subordinate" is another word they often use for "second lien".

The other risk with tying properties is you may not be able to "untie" them as easily as you think. Commercial lenders on fixed rate product generally don't allow any changes to the collateral or other terms unless you refinance with a whole new loan, which would incur the prepay penalty. If untying them is important to you, make sure to negotiate prepay terms or "releases" upfront.

Loan term is not when you pay off the loan in its entirety. It's the initial term of the loan, in this case 5 years. What you're thinking of is "amortization term".

The strategy you're talking about does sound like a good one though! Force some appreciate, then when the time is right, do a cash out refinance and use those extra loan proceeds to purchase the next property. Some lenders will even allow "future funding" meaning you can borrow additional money for improvements/repairs/renovations. The risk there is that it's generally floating rate debt which is very risky. Many borrowers who used floating rate debt 1-2 years ago are in hot water now.

Taylor L. · Answer

Partnering & working with investors is key to my strategy.  We're always limited when we're working alone with our own resources. When we can work with others and divvy up the profits, we can all go further together.

Ben Firstenberg · Answer

I can answer a few of these questions.

About the HELOC: you can find this in your loan documents. Look for anything that references a second lien. Commercial lenders typically don't allow them, but sometimes they do. If it says something like "second lien will be an instance of default" then it for sure will trigger the loan to be called.

5% prepay is pretty tough. I'm really not sure if that's the standard for smaller commercial properties or if your lender took advantage of you. Typically it's the greater of yield maintenance (the interest they would have received) or 1% of the loan amount. So that prepay penalty would diminish over time. My experience is mostly with larger, commercial properties so maybe 5% is the norm.

From your description, it seems like you're a little bit stuck here. You can't really refi or pay off the loan without incurring that prepay so unless your loan docs allow a second lien, your best move is probably to stand pat, save cash and be ready to expand when the loan term expires.

In the future: you can negotiate with the lender and request 1) second liens, 2) "releases" so that if it's a portfolio you can sell off a couple of the properties to free up some cash and 3) lower prepay penalties. You can also pay upfront for better prepay privileges. The price for this is typically an additional 5-25 bps on your interest rate, depending on what privileges you ask for and how your lender calculates them.

How do you expand your portfolio?

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