$71k of rehab, then I learned my exit kills the 3.5% loan

Took over a 1958 ranch at $214k balance, 3.5%, 24 years left, PITI $1,498. Seller wanted $8k and out. House was rough, not unlivable. My plan was standard for me: put $45k in, rent it at $2,200, refinance in a year to pull the rehab money back out and keep going.

Scope crept to $71k because the panel was a 1960s fuse box and the sewer lateral had a belly under the driveway. That part I own, that's my job.

The part I did not think through is that a refinance pays off the existing loan. Obvious when written down. I had been telling myself "refi" as an exit for months without noticing that my exit destroys the only asset in the deal. Every quote I got was 7.25% to 7.6%, which turns $1,498 into roughly $2,050 at the same balance and more if I pull cash. So the choice was leave $71k of my money buried in a house at a payment that works, or refinance and hand back the rate that made the deal.

I left the money in. Return on the total basis is about 5.9% cash on cash, which is not what I do this for. Cost me a year of working capital and one deal I couldn't fund.

What I'd change: fund rehab on a sub-to with money that has an exit that doesn't touch the first lien, and decide that before the deed moves, not after the drywall.

5 replies

2samantha_ruizAU4APRO6

@halyard it's narrower than that. The low rate is worth something as long as your exit doesn't require paying it off, and there are exits that don't.

@harrow the structural error was treating rehab capital and acquisition capital as one pool. On a sub-to the first lien is the whole prize, so the money that goes into the house has to be able to leave the house without touching that lien. Two ways I've done it. A private second behind the existing loan, interest only, with the lender knowing exactly what sits in front of them and that the first is in someone else's name. That is a real disclosure conversation and the paperwork needs a lawyer, because a lender in second behind a loan the borrower isn't on is not a standard product. Or you exit by selling on terms instead of refinancing, so the buyer's down payment returns your rehab money and the underlying loan keeps running underneath.

Run your numbers on the second option. $71k in, house probably worth $305k after that work. A wrap at $310k with 10% down gives you $31k back at closing and monthly spread on top, and the 3.5% stays alive. You'd still be $40k in, but the payment doesn't move and you're not choosing between your capital and your rate.

What this depends on: installment sale and wrap rules vary by state, and some states regulate them hard enough that you need local counsel before you write the note.

1aaron_fitz10 Get yoursPRO6

I've been going back and forth on whether sub-to fits me and this thread is the clearest argument I've read for keeping heavy rehab out of it. If the loan is the asset, why would I want a house that needs $71k attached to it?

1aliyah_bAU2APRO6

@harrow what did the $8k to the seller actually buy, given the house needed that much work? Trying to understand how equity gets priced when the property is beat up.

2stephen_ok9CO2CPRO6

@keystone's second-position idea is the one I'd want to be on the other side of, and I'd price it painfully. My risk isn't the house, it's that the borrower I'm lending to isn't the borrower on the loan in front of me, so if that loan goes bad my remedies get complicated fast. I'd want proof of payment history, the reserve account, and my name on the insurance before I quoted anything. @harrow leaving the money in at 5.9% was probably the right call given the alternative, it just tells you the deal was mispriced at the start by about $70k.

$71k of rehab, then I learned my exit kills the 3.5% loan

5 replies