Will Investment Property Cash Flow Enough for a Non-Recourse IRA loan?
Due to the simple fact that IRA loans cannot be tied to an individual directly, the bank granting the loan will scrutinize the property to make sure that they won't lose money by giving a loan on the property. This is basically the way that commercial lending works. The individual isn't scrutinized but the property is scrutinized to see if it makes sense. Will the rents more than pay for the debt obligation against the property? For single family homes, the bank will want to see a positive cash flow of 20-25%. For properties consisting of 2+ units, the bank will want to see at least a 25% cash flow.
To determine what the positive cash flow on a potential property would be, there are several factors to take into consideration. You need to find out the Net Operating Income first. In order to do that you need to figure out what would be the Gross Annual Income for the property. If there is no data available on the rents, you may contact a local property management company or a few of them and ask for estimates. As an example we will say that there is $200,000 in the IRA and a $400,000 property is desired to be bought with the down payment coming from the IRA and a non-recourse loan being giving on the the remaining balance. Lets assume that the property rents for $2,800 a month or $33,600 a year. Then you need to figure out the costs such as vacancies, taxes, insurance, maintenance and management fees. North American Savings Bank likes to use a vacancy factor of 7%. Vacancy $2,352; taxes $5,000; insurance $1,500; maintenance $700; management 6% or $2,016. So you take the GAI of $33,600 and subtract all of the expenses just mentioned - (2,352 - 5,000 - 1,500 - 700 - 2,016). All of the expenses add up to $11,568.
So we take our GAI of $33,600 and subtract our expenses of $11,568 and we get a NOI of $22,032 for this property. Lets say that the down payment coming from the IRA would be $150,000 so that there is still 20% of the loan balance remaining in the IRA as a reserve account for any unexpected repairs, vacancies, etc. This leaves us with a loan balance of $250,000 on the $400,000 purchase. Using a 7% interest rate amortized over 25 years that would be $1,767 per month or $21,203 a year. Now what the bank is looking for is something called the DSCR or Debt Service Coverage Ratio. This can be found by dividing the Net Operating Income by the yearly principal and interest. When $33,600 is divided by $21,203 it equals 1.58. What this number means is that the NOI exceeds the annual debt payment by 58%. If these numbers were real life numbers, the bank would swallow this deal with no questions asked, assuming other guideline requirements were met. Banks such as North American Savings Bank are looking for a 1.25 DSCR or 25% cash flow on these non-recourse IRA loans. So our example here is about twice as profitable as the minimum required. This positive cash flow can then be deposited back into the IRA account where it can grow tax free or tax deferred. Once your IRA account is built back up you can buy your next investment property and leverage your money through an IRA non-recourse loan. Concepts fromt this blog post were derived from Leverage Your IRA by Matthew M. Allen.
Will Investment Property Cash Flow Enough for a Non-Recourse IRA loan?
Fresno and Clovis Real Estate Prices
