innovative/creative or illegal?

Question

Theoretically let’s say someone or some entity is interested in an 18 unit for 500k. Three questions…

They have a decent credit score, about 40k cash in the bank but not the 25% (125k) for a down payment. However, they fully own 12 units that cash flow about 40k a year worth about 250k-275k. In place is a very reputable property management company that would be willing to take on the 18 unit in question.

• 1) How would refinancing the equity in the 12 units to acquire the 18 work? Would they essentially be taking out a mortgage against their 12 units for 75% of their value (187k-206k) to obtain the 25% down and then a second mortgage to repay the remainder of the 500k?
• 2) Also, let’s say the deal goes through… For commercial loans they do a 5 or 7 or 10 year balloon, 30 year amortization. Banks “like to see” 6 months’ worth of reserves to cover rent (where the undermentioned 40k comes in.) All of a sudden a month after the 18 unit is secured, suppose a deal for 12 units becomes available for 10% down with a 2 year land contract. Is there something stopping the borrower legally from tapping a portion of the reserves cash and putting 10% down to take on the land contract for the 12 immediately after mortgaging the 18?
• 3) If that is somehow illegal, is it illegal to enter into a land contract after taking on a commercial mortgage period or is it just illegal to use the portion of funds that was to cover the reserve?

Paul M. · Answer

Thanks for the reply JD!

Re #2/3 So basically the borrower would look for the at the mortgage agreement for that requirement? Fair enough.

They're not gamblers no. From an equity build approach, seems taking on the 18 by itself is almost more of a gamble, no? Sure, it cashflows and has a 15% cap. but still, even with the added income from their first 12 units, there's no way they're paying off the mortgage(s) when they balloon in 5 years (after expenses & taxes all 40 units would bring in about 70k annually.) They might just barely pay it off with a 7 year if they're lucky enough to have a low vacancy and not have any roofs to replace or boilers/furnaces go out, ect. A 10 year should be doable but who knows, that's a long time ya know?

To me, the way the commercial mortgages are set up, it almost encourages the type of strategy I'm positing here. If the loan is set up amortize for the 30 year on 500k then the refi, debt service is only going to be approx 2k monthly. That frees up considerable cash to put towards the land contract. Sure the additional 12 units under consideration have a price tag of 285k but they would bring in an extra 30k of revenue yearly. With 52 units cashflowing (100k after expenses/taxes) paying off the land contract in 2-3 years should be realistic, I'd think. A 5 year balloon is still unlikely however a payoff between 6 and 7 years in this much more likely in this scenario.

Am I not seeing something here?

JD Martin · Answer

1. Yes, a mortgage on the first batch to "cash out" on those units, and a mortgage on the second batch to cover the difference.

2. Not unless it's required in your contract or can trigger a pay demand.

3. See above. These are bank requirements rather than legal issues. As long as the bank won't enforce a pay demand contained within your mortgage notes, you're good. Whether the bank will do that is really a question of the bank. I have known banks enforcing insurance requirements, while others will just buy the insurance on your behalf and charge you for it. So whether they will enact other provisions of the note is really up to them. Are you a gambler? :)