This is part two of a two-part series.
Because this is an active deal, with both an existing tenant and partners, I can’t reveal certain deal terms. However, I will do my best to share what I've learned.
If you missed part 1, please click below ...
In 2012, as the market struggled to improve, interest rates continued to fall. They were in the mid 4% range at this time.
I was keenly aware of this, especially since we were paying 6.5% interest on a seller-financed contract for a little office property that housed a janitorial firm.
I’d run the numbers on the property and realized we had a great opportunity.
Based upon the rent the tenant was currently paying and stabilizing cap rates, our property was now worth substantially more than we paid for it.
I’d read about refinancing a property and pulling cash out to purchase another property. This seemed like a perfect opportunity to make that happen.
I took the idea to my investing partner, Kevin. “What do you think?”
“It sounds like a great idea. Let’s do it.”
Look and Ye Shall Not Find
We searched for a bit, but couldn’t find a property that we liked enough to put under contract.
Kevin and I were both antsy about interest rates climbing. No one had a crystal ball back then and we couldn’t foresee that unbelievably low interest rates were going to be on the horizon for some time.
Kevin said, “We should refinance now and pull the cash. That way we’ve got it sitting in the bank and ready to go when we need it.”
“I don’t know,” I said. “I think we’ll be tempted to take it out. I don’t want to add debt just to get cash.”
When we started investing together, Kevin and I had discussed using leverage to get into deals and then paying it down aggressively. We both saw many investors lose their properties after the market crashed because they were over-leveraged. We wanted to avoid that mistake.
After a while, I saw the logic in Kevin’s argument. Interest rates couldn’t remain low forever and we weren’t finding anything on the market. We looped the other partners into our discussion and they agreed that we would refinance, pull the cash and put it into the bank. Therefore, when a property popped up on the market, we would be ready to strike.
Ups and Downs in the Process
Kevin called “Bob,” the previous owner of the property (not his real name) and asked if he would be interested in an early pay-off of the loan and, if so, would he discount the note. Bob agreed to both and we were set-up to begin the process.
We couldn’t believe our good fortune.
Our banker started the refinance paperwork and a Broker’s Opinion of Value (BOV) was ordered.
When it returned several weeks later, we were where we expected to be. The property had jumped over $90,000 in value in a little over a year and a half. This was due largely to our putting a solid tenant in place. Please note this was $125,000 higher than the previous BOV.
We believed the new deal terms from the bank were outstanding. We would lower our interest rate by two points and we wanted to jump on this deal.
The bank reviewed our paperwork and pointed out a deficiency. We needed the tenant, National Maintenance Contractors, to extend their lease to meet our lender’s underwriting needs.
We approached our tenant and asked them to renew their lease early. They still had over a year to go before they would be forced to decide on renewing. They waited a couple weeks to respond and when they did they had a laundry list of wants.
The building would be improved by their requests, but it would eat into our cash flow for some time.
We negotiated for a bit, but it was clear we would meet their demands
Take the Money and Run
The refinance went off without a hitch and we put roughly $62,000 in the bank. If we were to buy a property with 25% down, we could have purchased another property worth $248,000. It’s exactly what we had planned for.
Unfortunately, life sometimes gets in the way. When people see that amount of money sitting idly by, they will find a use for it.
Kevin wanted his share for some outstanding bills.
Another partner had an investment he wanted to use his share in.
During this refinance process, I had finalized my divorce. As part of those proceedings, my ex received half of the ownership stakes in the properties I’d invested in. Therefore, she had a say in what occurred with her share of the money and she wanted it.
Unfortunately, I had added some personal debt during the split so I agreed to take the money as well. Getting debt-free really seemed appealing to me.
When all was said and done, though, they only thing we accomplished as a group was to re-leverage the property and agree to provide a bunch of work for the tenant.
Our dream of a refinance / cash-out / new purchase had backfired.
Winning Through Intimidation
As I’ve written elsewhere on this blog, one of the most important elements of any negotiation is this:
Whoever wants it less, wins
Unfortunately, we were the ones who lost in the negotiation. The gift of time is it allows us to go back and review what we did wrong. We put ourselves over the barrel unnecessarily. We wanted the refinance and needed our tenant to extend. They didn’t care if they renewed at that moment.
In this case, we should have taken a step back and reassessed where we stood.
Elsewhere on this site, I’ve reviewed Winning Through Intimidation, the book by Robert Ringer. It is clear we failed to heed those lessons.
We didn’t need to refinance. We wanted it and created the excitement in our minds. Yes, our interest rate was slightly high compared to the current terms. However, the numbers on the project were still doing great.
We should have waited until the actual renewal was necessary. Then we would have been on (at least) equal footing with our tenant.
Timing Isn’t Everything
Continuing on the discussion above, our rush to grab a lower interest rate cost us not only with the deal points that we gave the tenant but the actual interest rate we achieved.
After we signed the deal, interest rates continued even lower. A full point lower. Then they remained there for years.
We signed at 4.5% interest and a few years later we were securing new loans for as low as 3.49%. Due to our fear that low interest rates wouldn’t hang around, we actually missed out on a better rate.
In reality, we still ended up far better than the 6.5% interest rate that was initially attached to the deal. However, if we waited until the renewal period, we may have gotten a slightly better deal.
The lesson here is that you can always kick yourself for not getting the “perfect” deal.
I love that quote. You can continually pick apart your deals and find ways that you could have done them better.
We might have messed up with the money we pulled from the refinance, but the timing of it was fine. It wasn’t perfect, but how many things are?
Don’t Leave Money Lying Around
Hopefully, you can see where we made our mistake. We refinanced with no specific purpose in mind for the money we pulled out. This was radically different than the refinance we did in part three of The Little Property That Could. On that project, we had a goal in mind, pulled cash out and bought a new asset that we already had under contract.
In this scenario, we refinanced, pulled cash out with the hope of finding something to buy. Then everyone’s mind went to work on how their portion of that cash could be better used than sitting in a savings account. It was guaranteed to fail.
If we didn’t have a plan for the extra cash, we shouldn’t have refinanced at all or refinanced only for the existing loan balance.
Have you ever pulled cash out in refinance
and then regretted it?
I'd love to hear from you.