Do you want to purchase commercial real estate, but don't have the money for a down payment? Are you cash poor but have equity in a property? Can you use that equity to purchase commercial real estate? The answer is, YES! You're about to discover how to unleash your HELOC power to purchase commercial real estate! Specifically, you'll learn, (1) How to use your property's equity using your Home Equity Line of Credit to buy commercial property; (2) Four questions to ask when considering HELOC to ensure the numbers make sense, and (3) When it is a bad idea to use your property's equity to purchase commercial property.
Calculating Property Equity
First you need to figure out how much equity you have in your home. To calculate this simply subtract the amount owing from the property value.
Example Property: If you have a single-family home that is worth $500,000 and you owe $100,000 on the mortgage, the property has $400,000 in equity. Remember, what the property is worth minus what you owe equals your equity.
Calculating Your HELOC
If you were to purchase a house for $100,000, and you went to the bank for a loan, the bank would require you to put down 25%, which is $25,000. The bank is giving you a loan for $75,000. This is what is called a loan-to-value of 75%.
The same concept applies to a HELOC. In our example property there is $400,000 in equity. How do we get that out so you can start using it? Here are the steps to calculating your HELOC :
- Your property is worth $500,000
- The bank is going to give you a loan for 75% of it, just like buying a new home, which is $375,000.
- You must subtract what is owing on the mortgage, which is $100,000.
- The remainder is $275,000.
This $275,000 is your HELOC; the cash that you can use and the source of your down payments. The lender is not going to give you the entire $400,000 in equity to make sure they are protected and that there is still equity remaining, just in case something goes wrong. When you close on this HELOC, you will be given a check book in which you can start writing checks against the $275,000.
HELOC Payments: If you use the entire $275,000 on a property and the bank is charging you 5% interest over a 30-year amortization, the HELOC payments are $1,476 a month.
How to Unleash Your HELOC Power to Purchase a Commercial Property
A 16-unit apartment building with a purchase price of a million dollars. You're going to put down 25%, which is $250,000.
Mortgage: My loan is going to be $750,000. My mortgage is at 5% interest rate, amortized over 25 years. This means my payments are $4,384 per month. I need a yearly figure, so I multiply by 12 which equals $52,608 per year.
Income: Each of the 16 units brings in $800 a month. To get a yearly figure we multiply that number by 12 months, which is $153,600 per year. I'm going to subtract 5% from this number to accommodate future vacancy. This equals $145,920 per year in income.
Expenses: I'm going to use a rule of thumb that we use in our company, which is 40% of the effective gross income as expenses. Multiplying 40% into $145,920 equals $58,368 per year in expenses.
Net Operating Income: Income minus expenses equals the NOI. $145,920 minus the $58,368 equals an NOI of $87,552.
Calculating Cashflow: The NOI minus my mortgage equals my cash flow, which is $34,944 per year. If I divide that by 12 it equals $2,912 per month in cashflow.
4 Questions to Ask When Considering HELOC
This leads us to the four most important questions that you need to ask yourself if you're going to use your HELOC to purchase commercial property.
- Does the deal cover the HELOC cost?
- Is there a cash flow left over after covering the cost?
- What's the exit strategy if I only have one property with equity?
- What are the next steps?
1. Does the deal cover the HELOC cost?
The answer to that question in my example deal is yes. With a cash flow of $2,912 per month and a HELOC cost of $1,476 I have plenty left over.
2. Is There Cash Flow Left Over?
If I subtract my HELOC cost of $1,476 from my cash flow of $2,912, I have a cash flow of $1,400 remaining. After paying the mortgage on the property and the HELOC there is cash flow remaining. This is very important.
3. What is the Exit Strategy?
If you only have one property with equity, and you want to build a commercial empire, what do you do? It’s simple. I'm a proponent for building up your NOI. Remember, as you increase your NOI, you increase your property value allowing you to do a cash-out refi and pull out cash. If you only have one property with equity, the goal here is to increase the NOI by increasing the rents over time. It may take several years to increase the property value to a level where you can do a cash-out refi to pay off what's left over in a HELOC.
4. What Are the Next Steps?
Again, your goal is to increase the NOI, increase the property value, do a cash-out refi on the property, then pay off your HELOC. Then you can repeat the process. You can get a larger HELOC on your single-family home, and then do this over again with a larger property.
2 Reasons Not to Use Your HELOC to Purchase a Commercial Property
1. Not Enough Cash Flow
Do not use HELOC when there is not enough cash flow from your deal to pay the HELOC payments. The example property had a cash flow of $2,912 per month, and the HELOC costs $1,476 to use, leaving an additional $1,400 left over. However, I don't advise you to do a deal where the cash flow does not cover the HELOC payments.
2. You Don't Know What You're Doing
It is a bad idea to use your HELOC when you don't know what you're doing. Save your HELOC because the equity in a property may be your kid's college fund or your retirement. Don't blow it. What you need to do instead is get expert help or get a coach. Get educated or call us.
I suggest you watch two of my videos which will put you in a good position to make sound business decisions if you do, in fact, get a HELOC and use it to buy commercial property.
This is an important video. Learning these terms will help you make great business decisions moving forward with commercial deals.
In this video I go through how to find and evaluate it, what key terms you're going to use, and what they mean to you.