Mortgaging Real Estate in Your Self Directed Retirement Plan – Part 2 - How Commercial Loans are Structured

However, most commercial loans are written for shorter “TERMS”. They will most commonly be written as 2, 3 or 5 year balloons or as Adjustable Rate Mortgages (ARM’s).  Commercial loans, in theory, are based on a 2.5 to 3% profit to the lender. This is 2.5 to 3% above what they are paying out to their depositors. In other words, your lender wants to lend to you on a shorter term basis to adjust for fluctuations in the market, most especially on those on the up side.

Third, always make sure you check for temporary prepayment penalties on any commercial loan. Lenders use prepayment penalties as a “protection” to against early loan payoff. These penalties are meant to discourage “flippers” who should be using other outlets for borrowing.

Does putting a non recourse commercial loan on an IRA owned property make sense? This can be the “million dollar question” and the answer is, yes and no.

The answer is YES, especially if it is the only way for you to buy this property. The answer is YES if your IRA doesn’t have sufficient cash to purchase the property on its own. That was simple.

And the answer could be NO.

Do you remember our example for the “Debt Service Coverage” ratio? 

Let’s review our example from Part I.

“A six flat is being sold for $300,000, has a net operating income of $1908.00/ month. The lender uses a DSCR of 1.20 for a multi-family building. The net operating income (NOI) of $1908/month is divided by 1.20 which leaves you with a figure of $1590. This is the maximum Principal and Interest - P&I - that can be applied and still meet expenses and “the cushion”.

·         Using a 25 year amortization

·         Interest rate of 7%

·         The maximum mortgage (PV) is $224,950.00

Again, the numbers, in the above scenario, are “doing all the talking”. This property would require the IRA to use $75,050 (25%) as a down payment.”

In Part I the $300,000 six flat had net operating income of $1908.00 per month and a monthly P&I payment of $1590.

• Cost: $300,000.00
• Net Operating Income: $1908.00
• Monthly Principle and Interest: $1590.

This leaves you with a positive monthly cash flow of $318.00 per month or $3816.00 per year.

• Positive Monthly Cash Flow - $318.00
• Positive Yearly Cash Flow - $3,816.00

Since the IRA put $75,050.00 into the property with the down payment, and receives cash flow of $3816.00/year, the IRA is getting a 5.08% return on its money. Just divide $3816.00 / $75,000 = 5.08%.

• IRA ROI (Return on Investment) - 5.08% ($3816.00 / $75,000.00 = 5.08%)

Why the mediocre to poor return? The interest rate or “cost to borrow money was 7%. Paying more for money than the rate of return is rarely prudent investing.

• Interest Rate – 7%
• IRA ROI – 5.08%

Yes, you can attempt to reduce expenses, but let’s just look at this without manipulating the expenses. When does this make sense?

Here is when your answer will be YES.

Is your IRA purchasing the property for cash flow only or are you speculating on appreciation? If the 6 flat appreciates 6% a year and you sell in five years the yield and return on the IRA investment jumps to almost 10.76%.

• Six flat appreciation – 6% annually x 5 years = 10.76%

(Yield and return on money invested)

This part of the equation is explained for your benefit only. You should know that your lender will never factor appreciation into the loan and will always assume a 0% rate of appreciation.

You now see how the power of leverage can provide you with additional investment opportunities. These are opportunities that you might not be able to take advantage of if you have to fund every purchase on an “all cash” basis.

Please make sure to consult your accountant or financial advisor for further analysis.

So, are you ready to become a lender? Maybe, but that is a discussion for another day. In the meantime, if you work the numbers and calculations in advance and you will be able to estimate the maximum mortgage the lender will extend to your IRA.

Who knows, some day you may even become interested in becoming “the wizard behind the curtain”. 

Steve Miszkowicz is the President & Managing Member of Chicago Trust Administration Services LLC

www.chicagotrustadministration.com

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