Entrust Learning Center > 7. Case Studies > Gaining High Yields from Rehabs

Gaining High Yields from Rehabs

Lori knew the real estate market and decided that she could achieve very high yields from rehabilitating properties, or "rehabbing".

 Lori also knew that her gain would be substantially higher if she used her IRA to execute the transaction rather than using personal funds, since she would be required to pay taxes on the transaction if personal funds were used. So, she decided to locate a "fixer-upper" that would earn higher returns after rehabilitation and use her IRA to purchase it.
She had budgeted $100,000 from her IRA, but she needed an additional $200,000 to complete the $300,000 purchase and to have the $50,000 required for the rehab work on the house. Lori liked the idea of using other peoples’ money, so she decided to try borrowing from a bank rather than partnering with herself or others.

Using an IRA to Borrow Money

IRAs may borrow funds but may not be used as collateral for loans for personal use. Debt financing a property in an IRA is for the benefit of the IRA and is therefore not prohibited. The most difficult issue is finding a lender. Most institutional lenders do not lend to plans because such loans are not salable in the secondary market. Community Banks and other portfolio lenders, such as mortgage companies and hard money lenders are much more likely to lend to plans.
Here is what Lori learned about obtaining a loan for her plan:

The loan-to-value ratio is important for any lender.
• The loan to the plan must not permit recourse to Lori as an individual.
• Lori could not guarantee a loan, but a third party who is not related to her may.
• Lori could use other or additional collateral for the loan

Banks prefer an 80% loan-to-value (LTV) ratio on single-family dwellings. The higher the LTV, the more appealing the transaction may be to a lender.

Commercial properties are treated differently. Such properties are often evaluated on the basis of cash flow, occupancy rates, return on capital, and other factors. The personal ability to repay the loan becomes less of a factor when commercial property, such as four-unit residential buildings, strip centers, multi-unit apartment buildings, and other commercial buildings, is concerned.

Getting the Non-Recourse Loan

Lori had a good relationship with her local independent bank and so chose to apply there. Because plans are trusts and the IRS Code does not allow Lori to guarantee the loan, she needed an non-recourse loan. The community banker was sophisticated enough to understand that this loan would be a portfolio loan. The analysis of suitability of the loan in the bank’s portfolio is similar to the analysis required for a commercial real estate loan. The bank decided to make the loan to Lori’s plan. Lori had of obtained an agreement from a private mortgage company as a back up plan, but was happy to use the services of the bank as the mortgage company loan would have been at a higher interest rate with more points to pay.

Keywords|Tags

Refine your search using these keywords