Refinancing FHA Loans for Investment Property

Today I refinanced my triplex in Boyle Heights. I bought it with an FHA-backed loan, which is meant only for primary residences between 1-4 units. It’s quite difficult to use an FHA loan in most good areas of L.A. nowadays, as FHA loans have stricter closing requirements than traditional loans. However, I bought this Boyle Heights triplex in December, 2014 when it was a different world out there.

One interesting point about this refinance is that I actually refinanced out of primary residency and still saved money. When I bought the apartment building, mortgage insurance was higher and so were interest rates.  So now I’m saving $264/month and I can legally move wherever I want. I recommend it to you investors who still have your FHA loans.



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Real Estate Loans

Once in a while, I like to touch on the basics. But if this is obvious stuff, skip to the next post. Here are the questions I’ll be answering:

  1. What is a real estate loan?
  2. What loan programs are available today?
  3. How do I qualify?
  4. What are the hidden costs and benefits of a loan?

1. What is a real estate loan?

A real estate loan allows you to buy a property whose purchase price (or, value) is a lot more than you have in cash. Banks and mortgage companies will lend you large sums of money so that they earn loan origination fees, plus fees for selling your mortgage to a third party, who then collects interest on your loan.

2. What loan programs are available today (as of 4/21/2016)?

For a single family home as your primary residence, you can put anywhere between 3.5% to 25% cash down, or more. If you put down less than 10% of the purchase price, you will likely have to pay hefty mortgage insurance up to 1.75% of the total loan up front, plus 1% annually. These loans are usually 30-year fixed loan (your interest rate doesn’t change for the life of the loan) and government regulated.

For a duplex the same rules apply, except you’ll pay mortgage insurance if you put down less than 20%.

For 3-4 units as your primary residence, the same rules apply, except you’ll pay mortgage insurance if you put down less than 25%.

If any of the above are investment properties only and not primary residences, you have to put down 25% minimum.

For any residential income properties with 5 or more units, you must likely put down around 50% in order to qualify for a loan, based on today’s market. For five or more units you must get a “commercial loan” which is based on the gross annual rental income, and therefore varies by how much your property currently cash flows. These loans are usually amortized over 30 years, but the interest rate is fixed for a shorter time period (usually around 7 years).

3. For 1-4 units, you qualify partially based on the rent, but mostly based on your average annual income over the past two years (the rent counts toward your income). Banks use a standard formula to determine if your annual income is enough to secure the loan, despite these loans usually being non-recourse.

By contrast, for 5 or more units, your personal income is not a factor because the loan is based on gross annual rent from the subject property. This makes these properties better for investors who can’t show regular income on their tax returns.

4. The hidden cost of your loan is obvious: all the interest and mortgage insurance you pay during the life of your loan adds up.

The hidden benefit of your loan is twofold: if your rental income is covering your mortgage and expenses, that 75% LTV (loan to value) that the bank gave you is turning into money in your pocket over the course of the loan. In other words, if your interest rate is less than the your annual return on your loan, you are making money off the loan.

Make sense? If not, feel free to ask any questions you may have at:

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Cash vs. Loan on Income Property

Many clients who read this blog shop for investment properties with the understanding that they will need a loan. The idea of a loan is pretty simple (for a brush up read here), but what you may not know is the actual implications on the real estate transaction, and why on earth there is so much power granted to cash buyers.

The main issues lie in

(1) time,
(2) hassle, and
(3) the value of going through only one escrow.

Off the bat, a cash transaction requires no more than a 21-day escrow, whereas a loan requires between 30-45 days or more. No deal is done until escrow is closed, so those extra weeks cause not only expediency problems, but psychological ones, as well. That’s 2-3 extra weeks that everyone has to worry about closing the deal.

The hassle is real but manageable. Here are the extra steps for closing a loan deal from the Seller’s point of view:

a) pre-approval process to determine the buyer’s ability to close
b) initial appraisal of property by bank
c) loan and appraisal contingency periods
d) fixing physical issues that the bank finds objectionable (this could be anything from exposed studs to unstrapped water heaters to chipped paint — yes, chipped paint)
e) re-inspection by appraiser to confirm those fixes are completed
f) field review by second appraiser to confirm value (this is a new one)

For example, yesterday and today I went to two different properties my clients have in escrow and personally fixed two last-minute physical issues that the Sellers weren’t willing to fix and for which my Buyers couldn’t get a handyman in time. That wouldn’t happen with a cash deal.

There are only two reasons why a loan is more likely to fall out of escrow than a cash deal. The first is that the Buyer may not qualify for the loan. The second is that the property does not qualify for the loan if those physical issues above cannot be fixed. If a deal falls out of escrow, the property may lose value because (a) its market momentum slows, (b) it’s tinged with the question of “what’s wrong with it,” or (c) the backup buyer finds another deal in the meantime.

So what is the real consequence of needing a loan? If there are enough buyers interested in the property, one or two of them are likely to be cash and they have an advantage if your offers come in around $10,000 of each other. That’s why, as a buyer using a loan, you have to be slightly more creative than cash buyers in the types of properties you buy, the terms you elect on your deal, and our approach with the listing agent.

All that said, 83% of my closed deals have used one kind of loan or another. Don’t count yourself out; just know what you’re up against.

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1031 Exchange Strategy

I’ve had some very active buyers and sellers lately and it feels like everyone is in a 1031 exchange. This is a very important tax strategy in real estate, and it’s important that you know how to operate with precision when trying to execute a 1031. First I’ll explain what it is, and if you don’t need a refresher, go ahead and skip to the Strategy.

What is a 1031 Exchange?

Simply put, a 1031 Exchange is when you sell an income property, buy a new income property to replace it, and skip paying taxes on your sale.

What are the rules?

  1. They have to be income properties – essentially that means that neither property can be your primary residence. I’ve heard of some people doing some tricks like putting title in an LLC and paying themselves rent, but I’m not a lawyer and that is certainly not advice.
  2. You have to name 3 options for your replacement properties (or “uplegs”) within 45 days of your sale property (or “downleg”) closing escrow.
  3. You have to complete the purchase of your upleg(s) within 180 days of the sale of your downleg.
  4. Both the equity (cash down) in your upleg(s) and the total value (purchase price) has to be equal or greater than that of your downleg(s).
  5. All has to be accomplished within the same taxable year and to the same person(s) on title.
  6. You have to own the property for one year before selling.

These are the most common and basic rules. There are more if you strive to be more creative.

The Strategy

By skipping capital gains tax, you could save hundreds of thousands of dollars. But why sell in the first place if you’re just going to buy something else?

I’ve written about this before, but the fastest way to substantially grow your wealth through real estate is by buying and selling again and again. I’ve been a party to this and I think my clients in question would admit that I masterminded this growth for them. (And yes, when writing a blog your humility sometimes falls by the wayside.) Staying ahead of gentrifying neighborhoods, good deals and unnoticed potential is key to unlocking a property’s value that you can cash in one year later (1031 Rule #6).

Why sell that unlocked value rather than hoard it? Once you have unlocked a property’s value, you have maxed it out. And unless you have unlimited capital, you can’t simply buy more and more properties; you have to use that unlocked value to unlock even more value, and so on.

That’s the abstract. Here’s an example:

Property A, a fourplex, is selling for $780,000 in an up-and-coming neighborhood.

After closing the deal with 25% down, you fix up a vacant unit and rent it for $700/month more than the seller predicted. Another tenant moves out, and you do the same. Not only did you raise two rents in the property, but those rents are so high that you proved what the other units can get. You may or may not have the cash to renovate the other units, but who cares. You’ve implied the value in the property that no one saw before; you’ve unlocked it. Now your property is worth $1,050,000 (if  your agent knows how to present that unlocked value as current value).

You spent $50,000 to fix it up, and $220,000 on the down payment. After a year, the mortgage pay down is near negligible. But you doubled your equity to $540,000 on a $1.05M value. The bank not only won’t value your property like a buyer will, but it also won’t let you cash out enough to do it again. So you sell to a smart, more fluid, and less hands-on buyer and do it twice more with the newest gentrifying neighborhood / great deal / unnoticed potential.

If that sounded tricky, buying Properties B and C is where things can get sticky.

Because you only have 45 days to name your next properties, being sharp and aggressive during this process is absolutely essential. You make strong bids, drive by dozens of properties, and always see the forest rather than the trees.

When I have a client in a 1031 exchange, that client usually gets my ideas in their inbox first because (a) the 1031 time sensitivity and (b) they reward me with selling their property, as well as their responsiveness and aggressiveness in getting the next amazing deal.

Do you want to make one of these deals happen? I’ll tell you how you can unlock the value in your property to get top price, and guide you towards doing it again.


IMPORTANT DISCLAIMER: I am a licensed real estate agent, not a CPA nor a tax attorney, and nowhere on this website am I offering you tax advice.


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The Fed and What .25% Means

I couldn’t explain this more clearly and succinctly than one of my go-to loan brokers, Justin Brown of NuHome Financial:

First, what is the Fed?

The Federal Reserve Board (the Fed) controls the Fed Funds Rate and the Discount Rate. These are overnight loans from bank to bank or from the Fed to member banks. The Fed adjusts the rate to influence the economy. For example, if things are going well, a rate increase may slow inflation. If the economy is struggling, a rate drop could be the boost it needs.


Two important things to note:

– The Fed can influence, but does not directly set, consumer rates.

– The Fed’s rates are short term and often do not impact longer term rates, such as mortgage loans.


Why the fuss?

Increases in the Fed Funds rate can cause banks to raise their “prime” rates, which are often used to calculate costs of revolving credit or home equity lines of credit (HELOCs).


What about mortgages?

Mortgage loans are a different animal, so to speak. The “agencies” (Fannie Mae and Freddie Mac) pool mortgages together and sell them as mortgage bonds. The amount investors pay for these bonds directly influences mortgage rates.


Bottom Line:

When the Fed moves, it generally provides lots of warning, and markets have already had a chance to react. Markets are constantly responding to other factors as well, from the stock market to global events to consumer spending. In the end, no one can say for certain what the reaction to Fed moves will be.

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Beware of False Financials

I follow a number of Realtors on Instagram, Twitter, blogs, etc because sometimes oversharers enjoy friendly competition. However, most of these Realtors who dabble in multifamily properties couldn’t understand a financial model if it were spelled out on subway tiles.  One particular Instagrammer recently pointed to 3165 Cazador St., a “turnkey” duplex, claiming it earns $2,000 “monthly profit after expenses” on a $850,000 asking price with 25% down and a typical interest rate.  That would mean an 11% return on investment.  That’s damn good for not doing any renovations. The problem is, that’s also totally untrue.

The reality is, if we’re assuming her rental projections on the vacant units are accurate ($3200 and $2500) and the property needs zero work (this is never the case for multifamily deals), we’re only making 4-5% on our investment with about $800 monthly cash flow.  That’s actually still good for a Los Angeles investment property, but there are a lot of barriers to reaching that profit.

Here is what this agent is missing in describing a $2,000 monthly profit: property tax, insurance, water/sewer, trash, gardener, replacement reserves, pest control, and possibly exterior electric bill.  That’s not including a management fee and repairing deferred maintenance. While many agents have great aesthetic taste, know the owner’s family, or have sold millions in single family homes, understanding the financials of a multifamily real estate investment is key to understanding a good deal.  And not all properties are the same, so these financial models can’t be carbon copied from one deal to the next.

Moses Kagan, the broker at Adaptive Realty, has brought his finance background to the over forty properties he’s renovated in the last five years, and knows firsthand what max rents are in neighborhoods from East Hollywood to Highland Park because of the properties Adaptive manages.  The agents at Adaptive Realty, half of whom are Princeton graduates, fully understand the financial details of real estate beyond the picture that the flashy agent paints.  One of the first things we do with new clients is to go over spreadsheets for three properties in their target market to help them understand what the numbers really are.

Part of me wants to educate all Los Angeles real estate agents on the expenses involved in multifamily investment properties because then perhaps asking prices will come down on bad deals.  Until then, however, I hope you find a smart agent who tells you the truth about your investment property, or else you may find your expected returns quickly chopped in half upon taking ownership.

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