Time is running short until escrow closes on the apartment building we’re selling. After the sale, I will need to buy a replacement property. Our apartment building currently has two loans on it: the primary bank loan, and a second loan through a different family partnership. Upon close of escrow, the primary bank loan will be paid off, but instead of paying off the second loan, I will be taking that loan with me to a new building. Because the mortgage payment amount is already fixed, I need to find a building that earns enough cash flow to cover that payment. The purchase price for buildings with that amount of cash flow is fairly high, so I will be pushing the limit of my cash reserves, and maybe even beyond that a little. I’ve decided to set up an emergency plan for cash before I go out and buy a new property.
My Cash Situation
After we sell our current building, I will have a decent chunk of cash to use as a down payment for the new property. With that, plus the loan that I’m bringing over, I’m hoping to buy a new property without borrowing any additional money. If I didn’t have to pay taxes on the proceeds of the apartment building sale, I’d be in great shape. Unfortunately, the sale didn’t qualify as a 1031 exchange, so I’m going to lose a sizeable chunk of the proceeds to capital gains taxes and depreciation recapture. That’s going to crunch my cash significantly.
I’m looking to get a replacement property that will earn enough in cash flow to be able to make the loan payments on the loan I’m bringing over. That essentially means that I have to spend at least a certain amount to get a building that generates enough cash to cover the loan payments, expenses, and leave a little cash flow in reserve to cover capital expenditures that might arise. If I spend too much to get a building with better cash flow, I won’t be able to afford the purchase price of the building. If I spend too little, I will be stuck with a building that doesn’t generate enough cash flow to cover the mortgage. I have to hit that sweet spot in between.
Emergency Plan for Cash
I’m not so worried about having cash in time to close on a new property. The gross proceeds from the apartment building sale will be more than enough. But in the month or two following the building sale, I will need to make estimated tax payments to cover the anticipated capital gains. Also, I will have a new property tax bill on a very expensive (to me, at least) property. That’s where I might run into a cash flow problem.
Fortunately, I have a lot of equity in my house, since I’ve been aggressively paying down my mortgage. So my plan is to apply for a home equity line of credit (HELOC) that I can use to cover the cash difference. I know I will be able to pay it back fairly quickly, since I’ve already been paying extra on my mortgage. Additionally, if all goes according to plan, the new building will be generating some extra cash flow that I can use to pay it down, too.
If I were to wait to apply for a HELOC until after I bought my replacement property, I could get myself into a bit of a jam. A lot of banks make borrowing very difficult if you have rental properties. Some banks won’t give you any credit for any of the rental income unless you have experience managing rental property. Some banks won’t give you credit for the rental income unless your tenant has been in place for more than a year. Even if they do count your rental income, often they will apply a very high presumed vacancy rate, ranging from 10 to 30%, even if you can prove that your actual vacancy rate is far less.
To make matters worse, some banks will not count your rental property income, and they will count the mortgage obligation against you when calculating your debt to income ratio. That’s doubly unfair, but there’s not much you can do about it, other than trying to find an alternative lender who will use different criteria than the major banks.
In any event, it seems clear to me that I need to apply for this HELOC and have it fund before I buy my replacement property. One more thing to put on the to-do list in a hurry.
It Helps to Have Your Financial Info Prepared
I will say that it’s nice living in these modern times, when scanners and email and electronic storage make it so easy to keep all of your financial information at your fingertips. In years past, you would have to dig out your old tax returns and photocopy them, along with pay stubs, W-2s, and other information requested by the bank. Now, whenever I complete my tax returns, I print a pdf and save it in my email or on a cloud storage. The same goes for W-2s, property tax bills, insurance policies, 1099s, and K-1s.
It Also Helps to Have a Good Loan Officer
I have a favorite loan officer at Bank of America. I know Bank of America is reviled by a lot of people, but I really have had very good experiences there, on the whole. Especially in the past few years. This loan officer helped me do my refinance in 2014, and he and I got it done, start-to-finish, in three weeks. THREE WEEKS! That’s by far the fastest loan that I’ve ever gotten. His strategy is to tell the borrower up front what documentation the loan department will be seeking, and to have the borrower send the information directly to him in advance. He reviews it for completeness and uploads it to the loan department right away. Because I have my documents stored electronically, I can get him all of the documents within a day or two of applying for the loan. By the time the loan department gets the file, he’s uploaded all of my documents, so the file is complete and ready for underwriting.
Most other loan officers I’ve dealt with have told me about half of the information that they think the bank will need. I’ve dug out those documents, and then I have to wait for the loan department to request them before I could send them in. Then the loan department puts away my file for a week before looking at it again. A week later, they decide they need some other documents that my loan officer didn’t mention. I have to go find those documents, send them in, and another week passes. Even if you have all of your documents ready, just the back-and-forth process ends up eating up a lot of time. It can be very aggravating, particularly when you know that they know in advance which documents they’re going to need.
Anyway, so when I decided that a HELOC would be a good idea, I went in to see my favorite loan officer. He explained the rates and we walked through the application pretty swiftly. He gave me the usual list of documents that they would need, and said it might be 4-6 weeks. I was a little nervous that it might take too long, because I wanted to get the HELOC in place before I closed on a new property, but I figured I’d wait and see what happened.
I got back to my office at work and sent them all to him within a matter of hours. A couple of days later, the loan processing center called me and walked me through the loan terms on the phone, recording the call to cover their butts in case anything were to go wrong. A couple of business days after that, I got another call from the loan center, saying that they couldn’t read the scanned pay stub I sent in, because it came out a little blurry. The loan rep said that was the last piece of information they needed before sending it to underwriting. I re-scanned and emailed it within a few minutes.
Less than 24 hours later, I received a call from my loan officer saying that underwriting had completed their review and my loan was approved. It only took one week from the time I applied to get approved! All that’s left is scheduling the signing, and that should happen in just a few days.
Now I’ve covered my temporary cash problem, and it’s time to move forward with choosing a new investment property.
If you ever find yourself running close to the limit of your available cash, what tends to be your emergency plan?