Convert my home to a rental and sell equity

[Alexander Wehrmann]

Hi BP Community

I am moving and would like to keep my current house and convert it to a rental; however, I need to pull some equity out of the house for the down payment on my new house. The home is worth $1.3mm today, and I have $700k remaining mortgage and $600k equity in the house. I'd like to keep $100k equity for myself and sell the other $500k to equity investor(s) so I can keep the excellent mortgage (fixed at 3.25%) and take advantage of the cash flow and build more equity. Finding a cash flowing property in San Diego is not easy, so this is a fairly rare opportunity, and I can self-manage it.

Because I am closing soon on my new house, I don't have as much time as I'd like to meet equity investors the traditional way (meet ups, networking, etc.) and am looking for something fairly quickly. Are there any crowdsourcing or other online opportunity that folks have found effective for something like this? Most of the sites I've found seem to be more targeted towards investors, and not the person bringing the deal opportunity. Or any other tips for a first time fundraiser looking to meet equity investors with this specific criteria?

Thanks!

Alex

[AJ Wong]

Hi Alex..sounds like a good idea, but unlikely to be executable within a quick timeframe. I would suggest exploring a cash out fixed rate HELOC or fixed second. You can access nearly 95% CLTV (on a primary - depending on income) and on investment properties up to 85% (full income verification) or use the proposed rental income (DSCR) usually up to 70-75% max. They are efficient and many lenders have a cap on maximum cash in hand of $250-500k but others have no limitation. Check in with @Joseph Chiofalo he's working on several high balance cash out transactions for clients and they can close very quickly. Usually the lender on your new purchase mortgage will allow cash out proceeds as eligible down payment contribution (provided the DTI work). Hope this helps. Good luck!

[Joseph Chiofalo]

Hi Alexander, 

On a full documentation loan, lenders will allow up to a 95% combined loan to value on a primary residence assuming income is strong enough to support your debt to income ratio and reserve requirements are met. 

How quick would you need the funding on the primary?

[Alexander Wehrmann]

Thanks both... I expect the cash flow to be barely negative/breakeven initially, and then sustainably positive by year 3, and then slowing climbing positive from there. If I put more debt on the house it will eat away at my cash flow, so I'd rather find an equity investor looking for appreciation. I know "appreciation" can be a four-letter-word in the BP community sometimes, but in a place like San Diego with SFH cap rates in the 2.5% range, it's just how it is.

[Dan H.]

I suspect there are better options available to you. What price do you think you can get for $500k of equity? Note if they paid $500k for $1.3m and only got $500k on asset, they are coming in at 0% LTV. Their return from appreciation would have no benefit of leverage.

Let's say you discount it 50%, $250k for $500k value it starts great (100% return, but rate or return after would be 2 times the appreciation while at 80% LTV the return be 5 times the appreciation.

Using 5% annual at 5 years 

$250k for $500k equity: 155% return

500k at 80% LTV: 138%

Using 5% annual for 10 years

$250k for $500k equity: 225%

$500k at 80% LTV: 314%

The numbers show the issue. At more than 5 years, selling the equity at 50% of value starts to not look very good.

good luck

[Alexander Wehrmann]

I'm not sure I follow your math... There is $600k total equity in the house, so I'd sell $500k and keep $100k for myself. So the investor(s) would own 5/6 of the house, and I would own the remaining 1/6. They would receive 5/6 of the cash flow, pay for 5/6 of any repairs and expenses, and receive 5/6 of the proceeds from a sale.

The IRR works out to be in the mid-10% range, which is attractive by most standards, especially for a low-risk property in San Diego in a nice neighborhood. I'm an LP in some other RE investments and they pay out a 6-7% preferred return, so a fair equity split seems like it would be attractive to the right investor. I'm just not sure how to get connected with the right type of entity looking for appreciation. Most of the crowdfunding sites I've seen appear to be focused on cash flow, and less on appreciation. Thanks for reading.

[Don Konipol]

Quote from @Alexander Wehrmann:
I'm not sure I follow your math... There is $600k total equity in the house, so I'd sell $500k and keep $100k for myself. So the investor(s) would own 5/6 of the house, and I would own the remaining 1/6. They would receive 5/6 of the cash flow, pay for 5/6 of any repairs and expenses, and receive 5/6 of the proceeds from a sale.

The IRR works out to be in the mid-10% range, which is attractive by most standards, especially for a low-risk property in San Diego in a nice neighborhood. I'm an LP in some other RE investments and they pay out a 6-7% preferred return, so a fair equity split seems like it would be attractive to the right investor. I'm just not sure how to get connected with the right type of entity looking for appreciation. Most of the crowdfunding sites I've seen appear to be focused on cash flow, and less on appreciation. Thanks for reading.

Any transfer of ownership in any way will kick in the so called due on sale clause, so you and the investors will have that risk to deal with.  The 3.25 % interest is the main attraction of the deal, as you are essentially selling a house worth $1.3 million for the full $1.3 million value.  
The risk to you is that by selling partial ownership you may be selling a security under the Federal definition and therefore depending on the method used to find investors could be violating Federal or state securities regulations.  The deal is so small that no government agency will ever take notice or pursue an enforcement action. But the risk is that should the deal go south (check out what happened to real estate values in 2008-2012) the investors may sue you for selling an unregistered security without an exemption from registration and since you did not utilize a Reg D offering you would have no statutory defense. 

In my opinion better to sell the property whole than to structure what could be considered a security/investment offering.