Dividend recaps in RE?
Dividend recaps are mentioned often in PE and have been profitable for some investors even if the company ended up in bankruptcy. Wondering why it is not mentioned as often in real estate investments.
Here's a simple example: * Buy a house that you will rent out using an LLC for $100k with 20% down * At the next mortgage term (5 years), assume the house value has grown from $100k to $120k * Renew mortgage at existing debt amount left + $20k which you pay yourself as a dividend
You now own a house where you have your initial investment back, and any future gains through cash flows and appreciation are pure profits. If the house defaults on the debt, you already have your money back and the lenders can't come after your other assets due to the LLC structure. I feel like there is something preventing this from being done as it pushes all the risk on the lenders. Would like to hear other people's opinions
Happens all the time in real estate, typically once you've unlocked some value but aren't ready or able to sell just yet. It's often referred to as a cash-out refinancing.
Don’t have hands on experience so thanks for sharing. So as long as it meet their debt service coverage ratio they are fine with it and theres usually no claw back provisions for the dividend in the event of default?
That's right. Lenders underwrite the refinancing as an entirely new loan, although they do take the cash-out aspect into consideration as the implication is the borrower has little or no cash left in the deal. You generally see a cash-out refinancing take place when value has been added to the property (e.g. after completion of a renovation, lease-up, repositioning, development, etc.), which justifies the upsize in a lender's eyes.
This is pretty common with new developments. Building costs $50 to build and is worth $80 upon stabilization. Original Construction loan was $40, and the developer gets a loan from a LifeCo at $55 after the building is up and running. Everything from that point on is gravy.
It’s kind of funny that in PE it’s called a dividend recap. Of course they have this confusing term for “I’m taking all of my equity out of the deal and transferring more risk to the lender”. RE Lenders usually refer to it as a “cash-out” which is way more straightforward in my mind.
Cash out refinancing is a very common strategy as others have mentioned. Your example with a house and LLC is generally impossible as no logical bank with give a loan to a shell LLC to buy a house. You have to sign personally and will have the debt attached to your personal assets.
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