A recorded second from our money partner cost five months at the refinance
Structure was clean on paper. I did the documents, my operating partner did the buying and the renovation, and a third party put in 85k for the rehab. To protect him we recorded a second position mortgage in his favor at closing, at a fixed return, with the operating agreement pointing at it. Everyone signed something they understood. That was the mistake and it took me five months to see it.
The refinance was going to be a DSCR style investor loan on the improved value. Our lender's program did not permit subordinate financing on the subject property. Not a negotiation, a program covenant, and it was in the term sheet in language I read as boilerplate the first time. Our money partner had to be paid off in full at the refinance or released. He didn't want to be paid off. His whole return depended on staying in past the refinance date, because that's how we'd priced his fixed return.
So we spent five months on options. Asked for a subordination and got a flat no, because the program didn't have a mechanism for it, not because the lender disliked us. Asked two other lenders and got the same answer once we described the second. Looked at moving the partner's security to a different asset we own, and the lender's counsel wanted comfort we couldn't produce cheaply. Ended up paying him off out of refinance proceeds and rewriting his participation as an unsecured share of the entity, which he agreed to only after we increased his return.
What it cost, roughly:
- four months of extra hard money carry and one extension fee, about 7,400
- legal work redrafting the partner arrangement, 3,100
- an appraisal that expired and had to be redone, 650
- the increased return we gave him to accept unsecured position, present value somewhere near 3,000
Call it 14k. Add the rate at close being worse than the rate we modeled in the spring and we left about 26k in a deal that was supposed to return everything.
What I'd do differently. Before we structure the money partner, I get the refinance program's requirements in writing and read the subordinate financing language first, not the rate sheet. Recording practice and lien priority mechanics also differ by state, so whatever I write next gets checked by counsel in the state where the property sits. And I stop assuming a security interest is the only way to protect somebody. It's the strongest one at the front end and the most expensive one at the exit.