As of today, we reduced out real estate holdings significantly. We now only have one more rental unit, instead of the 6 we still owned last month. Rather than being landlords, we are now acting as the bank, as we provided the buyer of our real estate with a mortgage. So we went from landlord to lender.
Mortgage House Cash – Free image on Pixabay – Pixabay
Why?
Why did we sell most of our real estate holdings and turned lenders? There are quite a few reasons to be honest. It was also a process that took many months to culminate. In no particular order:
- We moved to our money pit, which is located about an hour drive from our previous property that now houses 5 tenants. This appeared to be somewhat unpractical. Real estate, when not completely outsourced, is not really that passive at times. Being close to your tentants can be very handy, being an hour away, not so much;
- I’m becoming even more lazy. This, in combination with the above noted, makes it that I would like to have more passive investments. And, as I was way more active with the real estate, Mrs CF was okey with the move away from real estate to give me more “peace of mind”. A loving and understanding spouse is really helpful here too;
- Changing taxes. Albeit not all changes are final, there is a good chance that wealth, and in particular real estate, will be more heavily taxed. A diversification from 80% real estate in our portfolio, to something less, was not a bad idea;
- Changing legislation. Again, the proposed changes are not yet finalized. But the risks associated with the change were enough to consider this risk too in the switch from landlord to lender;
- Locking in the profit made by real estate price increases, now that the market is cooling off and even declining in places; and,
- Diversification of the investment portfolio. As we had paid off all our rental properties (which made sense at that time), we had 80% of wealth in real estate. This was a bit high for our liking and diversifying was something we wanted to do for some time. But leveraging (and reinvesting these new funds elsewhere) in combination with above noted points was not an option.
The Deal
What deal did we make? The deal obviously comprised of the sales price, the mortgage arrangements and interest rates. But before we got to that point, we also arranged how the tenants were to be treated. We wanted to make sure that they would be treated well and that they did not suffer from any sale to another buyer. Or at least as little as possible. Being ethical as landlords is strange, I know.
After some negotiations we made the deal to finance the entire sale price, so 100% of the purchase price of about €700k. The buyer is a smart guy, and is also very interested in becoming FIRE. He is an entrepreneur, and quite succesful too. Furthermore, he also has good (work) ethics and we already knew him for a few years (and his other tenants). This made us decided to allow him to initially finance 100% of the purchase price, albeit with a staggered interest rate. This as we knew he would not be able to get financing via regular channels, but clearly had the means to pay for the mortgage.
The first half million is financed at comparable market rates the banks and large lenders use. The next €100.000 has 1% interest added, the next €100.000 another 1%. This is to incentivize the quick repayment of the first 30-ish percent of the sales price. We want to get the loan-to-value to about 70% within the next 2-3 years.
The returned funds will be used for our money pit and to invest in other assets. We obviously want to reduce the risk and exposure to just one party too. Fortunately, we know the collateral for this mortgage is good, as we took good care of the property in the past years.
Win-Win
Although we did not get the highest selling price possible for this property with 5 rental units. The financial arrangements, the way the tenants will be treated and the fact that all parties feel they won, makes this a very good deal.
Housing Loan Property – Free photo on Pixabay – Pixabay
The consequences
This sale and change from landlord to lender obviously has financial consequences. The main one is the locking in of the increased value of the property in the form of a mortgage. This is not a bad thing in times of dwindling housing prices. It also makes your wealth look better on paper 😉
Furthermore, we will earn slightly less from the monthly interest payments that we did from the rental income. Albeit not as much as one would think due to the relatively high interest rates used. That being said, we will also spend a whole lot less time on this and there are no more financial risks associated with maintenance and tenants.
Due to the fair sales price, we will unfortunately pay a bit more taxes as the entire mortgage loan will now be added to our wealth in Box 3. For a property, this is still limited to the WOZ (government assessed value). Which in this case is still significantly lower than the sales price. On the plus side, we can also lower our cash reserve and invest more as we have a smaller financial risk associated with (emergency) maintenance and potentially problematic tenants.
The (Financial) Future
As we start with a loan-to-value ratio of 100%, it is prudent to reduce this risk quickly in the coming years and divest in other assets. We will also use some of this money to address our own refinancing risk of our money pit. This as we have a 10 year fixed term for 60% of the total mortgage amount (interest rate is just 1.3%). The other 20% is a 20 year fixed term at 1.7%. The remaining 20% is an interest only family mortgage at 1.5%. The 10 year fixed term obviously carries the greatest refinancing risk and we want to address this one first. Albeit it is rather counterintuitive to pay off a 1.3% mortgage faster…
Depending on how much of the mortgage is being repaid, and how fast (there are penalty clauses on quick/large repayments), our monthly cash-flow will be reduced in the coming years. We will therefore look for other (cashflow) investments, even perhaps in real estate but then likely commercial/recreational instead of residential. Simply due to fewer regulations and restrictions.
Whatever we will do, it will be less hands-on than our previous real estate investments.
Thoughts, ideas?
Could you repay a big junk of the 10 year mortgage in 10 years (without penalty)? If so, you might want to consider putting the money in government bonds maturing shortly before the 10 years are over instead of overpaying the mortgage. Interest is currently above 2%, so should be about 1% risk free return after subtracting what you pay for the mortgage and same effect on your refinancing risk. (Perhaps even put part of the money in stocks?? Glide path?)
Am I missing something?
Bonds are a good idea, but the assumed ROI for a tax purposes might cause this to be less interesting than keeping it in cash. That being said, we will look at some option similar to this.
As to you question on repayment, because current market rates as much higher than what we pay, we can pretty much pay off as much as we like without penalties.
Why not accumulate the money to be used to pay off the 1.3% mortgage at the refinancing moment in a cash deposit, which pay way more than 1.3% these days, wealth tax deducted.
That is one of the considerations indeed. But we might split it up in multiple pieces, subject to how fast money is returned. Putting some into a pension plan is also an option to defer taxes and limit income taxes (albeit I have none this year so far).
What a big change! Can’t wait to read about the new financial direction – no doubt will be a great one!
It will be a lot more passive for sure 😉