Financing Mortgage through Investment in Municipal Bonds? Smart or Scam? Help!

[dfree86]

Hi Guys,

I'm a total real estate newbie but am working with a family member on financing a new property. The essentials are: he owns a lucrative, but small residential/commerical building in NYC and wants to use it to finance another property he aims to buy.

One mortgage broker has offered the following scenario through his firm:

1) Take a $2.5m commercial mortgage on the owned building. The payments on this mortgage will be "interest-only" and thus low for the first 10 years or so of the loan, meaning paying only interest and no principal. After 10 years we would restructure to either continuing paying only interest or try to lock in a better rate. This is essentially kicking the mortgage-principal-can down the road 10-20 years, when the newly purchased property appreciates and can be sold to help payoff the principal here.

2) Invest that $2.5m in municipal bonds portfolio

3) Have his firm actively manage the bond portfolio to produce a 4.2% return (above the normal 2%-ish muni bonds often return). He claims that because his firm is massive ($90 billion capital managed), they have access to best bonds and rates. Using "smartest guys in the business", he can guarantee minimum 4.2% return to cover the payments (below).

4) Use that 4.2% return from Muni bonds to pay a $3m mortgage (at 2.75% interest) on the newly purchased property, and still have a little leftover to pocket each month.

In this way, the first property pays for the second.

To me this sounds like a too-good-to-be-true situation, but I know nothing about Muni bonds or paying interest-only.

Does it sound like smart or waaaaaay to risky?

thanks!

[dandarc]

I fail to understand why the bonds are necessary at all.  Two multi-million dollar investment properties can't produce enough cash-flow to pay for a mortgage on one of them?

[dfree86]

I fail to understand why the bonds are necessary at all.  Two multi-million dollar investment properties can't produce enough cash-flow to pay for a mortgage on one of them?

Mortgages on both. 2.5m on the original, 3m on the new.

[dandarc]

I fail to understand why the bonds are necessary at all.  Two multi-million dollar investment properties can't produce enough cash-flow to pay for a mortgage on one of them?

Mortgages on both. 2.5m on the original, 3m on the new.

Why not just get the mortgage on the new one?

[dfree86]

I fail to understand why the bonds are necessary at all.  Two multi-million dollar investment properties can't produce enough cash-flow to pay for a mortgage on one of them?

Mortgages on both. 2.5m on the original, 3m on the new.

Why not just get the mortgage on the new one?

Can't qualify for the full $3m on the new one. So Muni bonds a means to an end.

[dandarc]

How does having $2.5 million more debt outstanding help qualify for a loan?

[frugaliknowit]

Smokin' rope:

3) Have his firm actively manage the bond portfolio to produce a 4.2% return (above the normal 2%-ish muni bonds often return). He claims that because his firm is massive ($90 billion capital managed), they have access to best bonds and rates. Using "smartest guys in the business", he can guarantee minimum 4.2% return to cover the payments (below).

Tell ya what:  I'm gonna borrow money at 2.75% and produce a 4.2% via yield and trading because I can predict what munis are goin to do...

Just get a freagin mortgage if you like the deal...!

[dandarc]

Just get a freagin mortgage if you like the deal...!

Apparently they can't borrow $3 million, but they can borrow $5.5 million . . .

[Reynolds531]

Did he at least scratch "Madoff Securities" off his business card before he handed it to you?

[NextTime]

So he owns outright, a $2.5 million, lucrative, income generating property and can't secure a $3 million dollar loan?

[Proud Foot]

Hi Guys,

I'm a total real estate newbie but am working with a family member on financing a new property. The essentials are: he owns a lucrative, but small residential/commerical building in NYC and wants to use it to finance another property he aims to buy.

One mortgage broker has offered the following scenario through his firm:

1) Take a $2.5m commercial mortgage on the owned building. The payments on this mortgage will be "interest-only" and thus low for the first 10 years or so of the loan, meaning paying only interest and no principal. After 10 years we would restructure to either continuing paying only interest or try to lock in a better rate. This is essentially kicking the mortgage-principal-can down the road 10-20 years, when the newly purchased property appreciates and can be sold to help payoff the principal here.

2) Invest that $2.5m in municipal bonds portfolio

3) Have his firm actively manage the bond portfolio to produce a 4.2% return (above the normal 2%-ish muni bonds often return). He claims that because his firm is massive ($90 billion capital managed), they have access to best bonds and rates. Using "smartest guys in the business", he can guarantee minimum 4.2% return to cover the payments (below).

4) Use that 4.2% return from Muni bonds to pay a $3m mortgage (at 2.75% interest) on the newly purchased property, and still have a little leftover to pocket each month.

In this way, the first property pays for the second.

To me this sounds like a too-good-to-be-true situation, but I know nothing about Muni bonds or paying interest-only.

Does it sound like smart or waaaaaay to risky?

thanks!

Seems to me like the mortgage broker is seeing $$$.

1. $$$ for closing the initial mortgage
2, 3. $$$ for managing the bond portfolio
4. $$$ for closing the $3m mortgage

I don't see a point in getting the first mortgage and investing it in muni bonds other than to make money for the broker.

[Coleman50000]

You are definitely adding a sizable amount of risk to the deal because you can't get bonds that yield that much without dipping into municipalities that are lower credit quality.  I'm very familiar with munis and I'm not sure if I would do this.  I know the best guys in the business and they're not guaranteeing 4.2% right now.  They are all lowering expectations and praying for rates to just rise so they can get over it and start making real money again.  It may work, but you should definitely consider what could go wrong.

Some of the risks (not all-inclusive and this is not financial advice):
1. Default risk - you can potentially buy lower-credit munis to get a great yield, but a lot can happen in 10 years.  Think Detroit & Puerto Rico.
2. Rate risk - If rates rise up to 3-7% in 10 years, your muni bond portfolio could be worth less (look up bond duration and price relationship) unless properly structured to mature when you need the money.  At the same time you may have to refinance the mortgage in a time with much higher rates with bonds that are worth less than you expected.
3. Management risk - Are they going to do a good job managing the portfolio?  If you're stuck using them for ten years do they have an incentive to do well?  What if they lose money or even just make less than your mortgage payments?  This is totally possible given market conditions in munis right now.
4. Fraud risk - You never know.  Do your due diligence.
5. Fees - Not a risk, but a certainty.  Figure out what these are.  Is the 4.2% net of their fees on the muni management?

Hopefully this helps!