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May 30, 2013


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Good for him for achieving so much at such a young age already. If the profit after selling the house is $100K then borrowing from the 401k appears to be a pretty good short term solution, and is probably what I would do in his position :D If he requires more capital, he can consider converting his taxable investment account into a margin account if he hasn't done so already, and borrow the remaining cash he needs on margin if he's willing to risk using a bit of leverage :)

The taxable investments would go first, then the Roth, since there is no penalty. You could get $18k more out of the rental, which might not be a bad idea, anyway, to leverage that money better since interest rates are going nowhere but up. That's $88k right there. You can only get $32.5k out of your 401(k). So that's $120k. You're still $20k short.

But if you haven't built a house before, I suggest to take a deep breath and a step back and make sure you can find an EXPERIENCED, HIGHLY RECOMMENDED builder who will do a fixed-cost contract. And I think you should REALLY look into the benefits of having the bank hold the loan--they have a LOT more power than you if something doesn't go right.

Also, because this is an investment home, I have some very serious suggestions for cutting the cost of the home and raising your profit. You should look for a very simple foot print--a rectangle or an L-shaped house, with a very simple roof. Fortunately, these are extremely popular now as "new old houses." They have a classic farmhouse look. Make sure the builder uses advanced house framing and other cost-saving measures. Constructing the house with all the windows, doors, and major rooms at multiples of 16" to save framing materials and labor can save a pretty penny, too. And examine the high-end of IKEA cabinetry for some cost saving but high quality kitchen options--some of IKEA's products are junk, but the cabinets are really an incredible bargain and are more usable than framed cabinets like Kraftmaid and just as sturdy.

I agree with above, you should take a bank loan specifically for this investment rather than gutting your personal and retirement accounts. This purchase is business, not a personal bet at a casino. You should start running your business finances accordingly. Plus, if the bank refuses to give you a loan, that gives you a heads up that the deal might not be as good as your buddy led you to sure to independently look into the actual costs of building and the likely actual sell price before investing more $.

If you purchased the land for cents on the dollar, why not just sell the land as is? This avoids the problem of taking out a loan or pulling money from your 401(k).

If you're determined to not take a loan, then I'd sell the now good lot and enjoy the quick profit.

Otherwise, I'd use the taxable account and borrow the rest. Money is cheap and you could put half down if your partner also has $35K avail.

I "don't borrow money", but in my business where I also have to put out very short term large amounts of money my business does use short term loans. You have the money in the 401k/Roth if something happens where you end up needing it, but that should be a worst case type scenario.

What is your risk profile? Check your gut feeling and go with it.

I am a commercial real estate attorney with 25 years of experience. My advice to you is, similar to Jenny @ Frugal Guru Guide above, to slow down, think long and hard about what you are about to do, and get it right.

It sounds like this is the first time you are involved with building a home to sell as an investment. There is a lot involved. This first time out needs to be an education for you as much as an investment for you.

You need to build a team of experts to watch your back. You should have a good lawyer involved to help you along (examples: set up a partnership agreement with your friend, set up an LLC to limit your liability, draft and review the contracts & perform the closing..)

To answer your question-- I suggest you get a construction loan -- do not utilize your own funds. Why? The benefits of a loan will be enormous as you watch carefully how the bank analyzes your proposed investment. And at todays historically low rates-- your education will cost less than ever.

See how they run the numbers and evaluate the investment. Will they require a Phase 1 environmental report? Look carefully at the appraisal that they will surely obtain. Try to build a relationship with the loan officer-- this can be an important relationship considering that you seem to want to increase your activity in real estate investing.

The main point here is that having a bank putting up the money will force you to have another set of experienced eyes evaluate the investment, require prudent due diligence be performed, utilize solid contractual documentation with the contractor and subs, and confirm that all laws, permits ansd regulations are being followed.

Make this first investment a success and you will increase your chances of this not being your last.

Appreciate the feedback. We have already setup an LLC and have been running other projects through it for a couple of years. My partner has built (13) homes to date and has 2 more currently in different stages of completion, so there is a level of experience associated with our plan. I consider myself very calculated and do not fly by the seat of my pants. I’m not extremely risk averse and do not have any issue pushing the chips out if it is the right move.

One question, in terms of construction loans, what is needed on the front end to obtain one? Some type of business plan? Given my profile above, how big of a loan would I be able to obtain? Given the current interest rates, what type of rate is usually applicable in these cases?

I am not opposed to going this route, my preference is to leave my accounts alone.

1. I do not agree with the loans from a 401-k are bad theory. If it's for a new boat, then yes, it's bad. If it's for an investment that makes a return then I see no problem with it.

2. I do not understand the reason for the statement that you don't want to get a bank loan. Unless there is a reason that would make it difficult for you to get one, that seems to be just a basic business cost calculation. You may even be able to get a builder to carry the building costs for you. They will charge you for it and probably at a rate higher than if you get the construction loan yourself but it can be done that way too. Either way, I would not jump through 17 different hoops to try to round up enough cash and tap yourself out when you could get a bank to give you short term financing. The financing from the bank gives you more options not less. If things go poorly and you need to put in some more money then you can go to your cash. If you tap out your cash resources and need more cash where are you going to get it? It is going to be a lot harder to get a bank to give you financing when things are not going well with your project. Take the bank financing and feel comfortable that you have a nice cash cushion if you need it.

3. One thing I notice is you said both you and your partner prefer to use cash and not loans but in your follow-up comment you said you are not opposed to financing and would prefer to leave your accounts alone? So which is it? I am just guessing here and I may be totally wrong but given your partner has more experience and has other ventures with capital outlay is it your partner who doesn't want to take on more debt for this project and has been pushing in that direction? If that is true, you have to decide if you truly want to extract that much cash or if it is your partner pushing you in this direction?

Since this is an LLC partnership I am guessing you would have to get the loan in the LLC with each of you personally backing part or all of it. That makes things a bit more complicated, but I think you should definitely do what you are comfortable with regardless of what your partner may want or need to do.

Apex - you hit it on the head with your 3rd point.

You say you don't want to take out a loan to do the construction. But how are you going to get cash to do the construction? You'll either have to sell something or take out a loan against something. I assume you don't want to sell your rental. You shouldn't cash out your 401k/IRA retirement. You could sell off your investments. You couldx take loans from your 401k. You could refi that house and do a cash out refi. Or, you could simply take out a home construction loan and do the thing you don't want to do. If you want to sell off your investments then that is fine but it only gives you 40k before any taxes due. You need 70k. One way or the other you need to borrow against something.

Why not just borrow against the new construction?

The more I look at it, the more and more the financing route makes sense. If I liquidate my investment accounts I'm going to have a tax hit from selling any investments that may outweigh the interest on any loan that is secured.

It appears that the most logical move is to leave everything alone and see what type of financing I qualify for.

I agree - I'm also a real estate attorney and investor. I would urge you to get a construction loan, either from a bank or a "hard money lender" and fight to avoid signing a personal guaranty. If you must sign a guaranty, ask for a limited guaranty with standard bad boy carve outs. Use a cheap but good lawyer (small firm or solo) as this is a small deal. Hard money lenders I represent currently charge about 1-3 pts and 11-13% on a loan like this - assuming you can avoid a personal guaranty, this is a better option for your than a 401k loan, but more expensive than a bank loan.


Why exactly is a hard money loan with points and 11-13% interest better than a 401-k loan at 5% to yourself?

I know it's for a short time window and hard money is a viable place to go for money when you have to have it and there are not better options, but that type of a loan would definitely be near the bottom of my list.

I know attorney's often advise to never give a personal guarantee or to put personal assets especially your house on the line for business investments. I have been advised as such by multiple attorney's I have known. Frankly I ignore them. That is CYA advice which I understand is a good thing to give, but it's mostly just not practical. In a perfect world that would be great but if you have an unestablished business with no proven repeatable cash flow and no significant assets for the bank to tap there is little chance of getting a loan without putting some personal collateral on the line.

Personally I just find that banks are overly paranoid especially now about anything that doesn't fit into their neat little formulas. I understand the real risks of the situation far better than they do and if a personal guarantee on a deal with very manageable risks waters the money tree then I am happy to do that.

The only reservation I would have in this case about the personal guarantee is the fact that it's a partnership and the two of you are going to sink or swim together. You are not in full control of managing the risks.

That's why I avoid partnerships like the plague. I have been approached by multiple people, friends even, to do partnerships, even similar to the one proposed here. Turned them all down. If both of us brought something unique to the table then I might consider it I but I have not encountered such an opportunity yet myself. Otherwise they just result in me getting 1/2 of a pot that is twice as big. I know they have new math now but I am pretty sure that even with new math that doesn't make my pot any bigger, but it does make my headaches bigger. :)

If I read this correctly, you consider tapping your taxable and retirement accounts to fund 50% of your investment in construction, and it's your first home construction.......but you have a partner who has already built 13 homes? If your partner is successful, why does he need you? Is he over extended on his other projects?

There is too much here that could bite you real hard. What you have going for you is your youth + a decent salary and the discipline to save. Bottom line -- you'll probably recover from whatever could go wrong. But yes, it could go very, very wrong.

Thanks Catherine.

No, he's definitely not over-extended. We formed an LLC to purchase the rental home we have and I wanted to get more involved with this side of the world. He doesn't need me, this is more of an opportunity to potentially get things rolling in our partnership. I know APEX is opposed, but I think there is some value associated with working together.


I am not entirely opposed, just cautiously suspicious at all times. :)

It sounds like you are getting benefit out of the partnership by leveraging your partner's experience that may be difficult for you to acquire on your own. Those are the instances I was talking about when I said if we each brought something unique.

You do still need to be careful about how it is managed but with 2 years under your belt in the partnership you probably have a pretty good sense for how it is going. It does sound like there is a bit of a push here from your partner to do things in a certain way that may not be what you wanted so I would just attempt to keep things from your end moving in a direction you are comfortable with and not let your partner encourage you into a path you would have preferred not to take.

" I understand the real risks of the situation far better than they do and if a personal guarantee on a deal with very manageable risks waters the money tree then I am happy to do that. . . if you have an unestablished business with no proven repeatable cash flow and no significant assets for the bank to tap there is little chance of getting a loan without putting some personal collateral on the line."

This. Plus, it's a credibility thing with the bankers I use. If I like the deal I'm willing to stand behind it (and as a practical matter would liquidate personal investments to avoid the inconvenience and cost of a foreclosure anyways).



The credibility point is a very good one. Someone has to take the risk of holding the bag on a deal gone bad. Bankers can't stay in business taking that risk. That's why so many got bailed out 4 years ago, they ended up holding the bag on far too many deals gone bad. If you won't sign a personal guarantee when your LLC has no collateral you are telling your banker you want him to hold that bag. That's how he loses his job. He isn't going to willingly hold your bag. Period.

I have strong confidence in the deals I do. Of course sometimes things don't always turn out exactly as planned but I understand the downsides and am prepared for them. As you say, I am not going to let a deal go into foreclosure and incur that cost, burden, and future ramifications. That's an even more costly mistake. I am going to liquidate assets or use other backup reserves to make the deal whole anyway. So given that why would I worry about giving a personal guarantee? The bank doesn't actually need it to force me to pay them off because I intend to do that with personal assets if necessary anyway. Exactly as you are describing.

Thanks Apex. You got it right. He's been down this road many times before and I'm trying to get things going as well. Leveraging his experience is exactly what I'm trying to do, but do so in a way that works for me (which is why I'm asking these questions). I appreciate the feedback.


I have personally guaranteed deals to save money and understand why you'd do it on your own deals, but I would almost never agree to a personal guaranty in a partnership with someone who is being squirly to begin with (or at least that's how it sounds in this post). Plus, personally I am 100% opposed to messing with a 401K because it is one of very few asset protection tools that is judgment proof and bankruptcy proof (until you get a loan from it). My personally investing philosophy is to view my 401k as my safe money and to leave it safe. There are many people who successfully use a solo 401k or self-directed IRA to fund real estate deals and get huge untaxed gains, so reasonable minds differ.

Also, as a follow up comment as to why I disfavor signing a personal guaranty, especially if you have some assets. At least 60% of our developer and investor clients went bankrupt and lost everything between 2008-2011 - people who did almost everything right and now have nothing left to show for it. I understand the need to take big risks early on, but once you have something to lose, why offer it as collateral? Even the best and brightest got caught in the great recession and lost everything and are starting over (in their 40s or 50s). They have judgments that will be in collections for the rest of their lives. I think at some point you have to start being really defensive.

If you can't comfortably pay cash for the house construction, sell the land at a nice profit and move on. Consider holding it for a year first = long term capital gains tax treatment and perhaps a higher market value for the property. The tax rate savings alone would make part of the "lost" potential house profits.

Remember: Pigs get fat - hogs get slaughtered.


I agree with most of what you said. The personal guarantee is more important when you have little else to offer.

I agree with you about the personal guarantee in a partnership. That would give me great pause. If I did it I would only guarantee my half. I would expect the partner to find a way to bring their own money or guarantee their half.

I also agree with you about not putting up all your assets once you have built a sizable portfolio over the years. If your clients unnecessarily put a considerably large asset base at risk with a personal guarantee that could have been secured by a smaller set of specific collateral assets then that was an unwise decision.

I think your last sentence is the kicker. At some point when you have been successful and have something to protect you have to start being defensive. It sounds like 60% of your clients didn't do that.

Why not do a 75/25 split rather than 50/50? If this is your first go at it, maybe work your way in. Then when you have some more liquid assets you can go 50/50.

I'd like to know how to get a job paying that kind of money at that age. I'm 28 and making much less.

If your credit is good and things line up then borrow. Rates are low -- there is no better time. Why mess with tapping your retirement accounts. This is what leverage is for. Be diligent (and I think you are) and pay it off when you sell the house. Good luck to you.

@ Tommy Z, there are actually quite a few jobs out there paying that much at that age. Engineering in the oil industry is one of them and that's actually on the low end.

I would get a 3rd partner that would put up the cash for the construction and then split the profits 3 ways. Less profit, but a huge reduction in risk.

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