2/16/14: Ask The Guys – Loan, LLCs and What To Do About a Big Fannie

If you want great answers, you have to ask great questions.

In this edition of Ask The Guys, we take on several great questions from our amazing audience!

Broadcasting from the beach in beautiful Belize because we can:

  • Your unbelizeable host, Robert Helms
  • His rummy co-host, Russell Gray
  • The Godfather of white sand real estate, Bob Helms

You’d think with that tee-up that this whole episode is about Belize.  But it’s not.  We just happened to be in Belize when we did the show.  Not sure how we got there.  Rum may have been involved.  But when we realized it was time to do the show, there we were in Belize, so sometimes you just do what you gotta do.   You have no idea the sacrifices we make to bring you The Real Estate Guys™ Radio Show.

There are few things we like better than answering your questions.  Mostly because we don’t have to think of a topic for an episode. 😉   But also, because we always get great questions.  We wish we had time to answer them all.  Since we can’t, we pick out those we think are most relevant to the audience.

How do we know what the audience likes?  By reading all the questions that come in.  So add your views to the discussion by sending your question to us on our Ask The Guys page.

Remember!  We’re not lawyers, CPAs, or investment advisors.  In fact, we’re not even that bright.  So before you run off and put real money at risk because “The Real Estate Guys said so”, remember we’re only sharing ideas and personal opinions.  Always check with your own qualifed advisors before taking action on anything you hear on the radio, find on the internet or read on the bathroom wall.

With that said, let’s get into it…

Should I dump a great loan so I can put the property in an LLC?

We get this one a LOT.  And like nearly every question we get, the answer is…it depends.

In this listener’s case, he has a below market interest rate on a loan he got when he was the owner-occupant.  Great!  But the bank may call the loan if he moves it into an LLC.

Stop right there.  Why would the bank do that?

Well, in the real world, as long as you’re making the payments on time, they probably won’t.  At least, we’ve never seen it happen.  But they have the right to because nearly every loan contains a “due on sale or transfer” clause which “accelerates” the loan in the event of any change of ownership.

But even if you make the payments on time, if you have a below market interest rate, is the lender motivated to get the money back from you so they can loan it to someone else at today’s higher rate?  Maybe.  It’s a risk you take.

Now if you call up the lender and ask ahead of time, our experience is they almost always say “no”.  So you can try to sneak it by and hope no one notices, which happens all the time, but you run the risk of losing that lush loan.

Or, you can go ahead and transfer the property into the LLC and get a new loan.  Which begs the question, “Is it worth it?”

First, the loan will undoubtedly cost more.  Not only will you pay today’s higher market rates, now that it’s a rental property, you’ll pay the additional risk premium (higher interest) for it not being owner-occupied.  Plus, you can’t get government subsidized loans like Fannie, Freddie or FHA if you are using an entity like an LLC.  So you’ll pay even more.

Add to that the time, expense and hassle of forming an LLC and transferring the property, plus the ongoing expense of maintaining the entity, and it really starts to add up.

So if it’s a somewhat expensive hassle, why consider it?

It’s all about asset protection…and perhaps about privacy.  Let’s deal with each individually.

First, asset protection.  An entity like an LLC creates a firewall which isolates the liability created by the property.  In order to get to assets not owned by the LLC (like everything else you own), the plaintiff (the person suing you) will need to “pierce the corporate veil” and prove in a court that you’re personally liable for whatever damage they suffered.

BUT…before it ever comes to your other assets, they will need to get past your insurance policies.  In most cases when you or your entity is sued, your insurance policies will defend you.  And because the lawyers really don’t want to go to court, they’ll just work together to get the insurance company to settle.  Sometimes, they’ll ask you to kick something in too, which is no fun.  But it’s less expensive than going to trial.

At least that’s our experience.

So, when you look at all the added expenses of giving up the great loan, it might be a better use of money to beef up your insurance policies.

Of course, if there’s millions of dollars of net worth exposed to the liability of the property, then the added expense might be worth it.

This is why we say, “it depends”.  Check with you own professional advisors and they’ll help you make the right choice for you.

How do you build a great local team when investing out of the area?

This is another great question and is less complicated to answer.

First, look for referrals from other successful investors in the area.  Just being referred by someone is an edge because now the service provider is risking both your business and his current client’s (the referrer) if they do a poor job.  That alone is worth something.

Next, find the real estate agent who controls most of the kind of inventory you’re looking for.  That is, what name seems to show up the most on the For Sale listings?  This is obviously a person who’s very active in the market.  And with the internet, it’s easy to find them and check our their on-line reputation before you ever meet face to face.

Property managers can be a great starting point in a new market.  Someone who primarily or exclusively does property management often has less of a sales agenda than nearly anyone else on your real estate team.  Why?  Because while the agent and lender will handle your transaction and get paid all at once then are off to the next deal, the property manager is looking into a long term relationship where they’ll make their money over time…like you do.

Local market real estate expos and investment clubs can be a great place to meet fellow investors and service providers who are active in working with local investors.  You may have to fly into a town a few times to network and have meetings, but once the team is built, you can operate fairly easily from afar.

What’s the optimal amount to put down on a property?

We LOVE this question. In fact, we cover this topic extensively in our out-of-print book Equity Happens (we’re working on an update) and our Real Equity Home Study Course.

The short answer is:  Use as much leverage as you can comfortably debt service when allowing for unexpected expenses and inability to raise rents substantially.

Obviously, prevailing interest rates, local competition, the strength of the local job market, macro-economic factors that affect cost of living (interest rates, oil prices, healthcare costs, etc), all affect the durability of the rental income and must be carefully considered when pushing the leverage ratio higher.

But rather than just dump money into paying down a loan when mortgage rates are still dirt cheap, think about taking the extra cash and buying income producing investments that outperform the cost of the mortgage.  For more ideas on this topic, check out Using Oil to Lubricate Your Investment Portfolio and Real Asset Investing.

How can I keep investing if I can’t get any more Fannie Mae loans?

Another great question that comes up a lot.

First, even though post 2008, it seems like the only loans available are government backed, that’s starting to change.  So when you Fannie (portfolio) has gotten too big, you have the option of switching to private (non-government) money.  This could be owner-carry back, hard-money lenders, mortgage pools or any number of independent funds that have stepped into the pick up the pieces after the mortgage meltdown wiped out most the mortgage banks.

You can also go commercial by moving into apartment buildings (5 residential units or more), commercial, industrial, retail or office properties.  For the average rental home owner, the natural progression is apartments.  But you could look at mobile home parks, self-storage, or even parking lots.

Assuming you want to stay in the residential 1-4 space and collect more Fannie loans, you could take on credit partners.  These are people who have virgin credit scores when it comes to Fannie / Freddie, and you partner.

Whew!  If you read all the way to here, you’re a hard core information junkie.  Great!  So are we.  So you keep reading and listening, and we’ll keep reading and talking.  Then let us know what you think on our Feedback page.  And if you love the show, please give us some love on our iTunes page.  Each positive review not only inspires to keep working, it improves the show’s ranking, which is helpful for attracting sponsors to support the effort and VIP guests to interview on the show.

Thanks!  Now, please enjoy the latest edition of Ask The Guys, where believe it or not, there are additional questions discussed that didn’t make it into this mega-blog.  But we’re getting callouses on our finger tips from typing, so enjoy the podcast!

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