Inner Circle Deal Analysis of the Month: A Pre-hab Flip in a Health Savings Account
This months’ deal evaluation comes from Mike Nees, a member from Columbus, Ohio, who wholesales and owns rental properties. He’s been in real estate since the 90’s, but is a relative newbie to investing in self-directed accounts, He’s one of the half-dozen real-life investors presenting at the 2017 Tax-Free Investing Summit in Columbus on August 12-13, too. www.CentralOhioREIA.com for more info on that.
The property: A “double” (2 family) in a border zone area in the city of Columbus. One unit was occupied by a long-term tenant at $350/month, which was at least $150/month below market. The other unit was vacant and rough. Here are some “before” pictures of the outside and the vacant unit:
How did you find it?: This was actually the 3rd property this particular seller sold me. Originally, she responded to a piece of direct mail I sent. Now, whenever she gets sick of one of her rentals, she just calls me for an offer.
What did you pay? There aren’t very many fixed-up comps in this area, so I figured that based on a trashflow analysis, it was worth $33,000 to a landlord when fixed up and operating. Based on that, and on the condition, I offered $8,500.
How did you finance it? That’s where things get interesting.
I actually bought this property in my self-directed Health Savings Account, which I opened in 2014 with the maximum contribution of $3,325. Obviously, this isn’t enough money to buy any property, so I knew that I’d have to borrow money for the purchase and rehab in order to build that account.
The issue is that when a lender makes a loan to a self-directed plan, whether it’s an IRA, 401K, H.S.A., or whatever, that loan has to be non-recourse, which means that the property itself is the only thing that the lender can take if the loan defaults. I can’t personally guarantee a loan if the property is owned by my H.S.A., so the lender can’t come after my income or my other assets. All he can do is take the house back.
Luckily, I knew a guy that I met at the OREIA convention who was looking to make small loans from his IRA. I called him and explained the situation. He ended up loaning my H.S.A. $13,350, which was enough to buy the house and, along with the money I already had in there, do the ‘pre-hab’.
The terms of the loan were: 10% simple interest, 1 year, no payments, and I agreed as part of the financing to pay the costs of wiring money and so on from his IRA. It basically cost me $1,425 in interest and fees to borrow the money.
What did you do next? I thought I could get a lot more for this house by cleaning it out and listing it on MLS than I could by just wholesaling it as-is, so I hired some guys to do the work (you can’t personally do work on properties owned by your H.S.A.). As you can see, it was literally just a cleanout:
When it was done, I had an agent list it for $27,000. It sold fairly quickly.
When the dust settled, my H.S.A. got a check for $26,700 from the sale. I had also collected $1,050 in rent during the 3 months I owned it. After purchase, rehab, finance, and fees to the H.S.A. custodian, I ended up with $11,311 extra dollars in my Health Savings Account, so now I have 2 years’ worth of deductibles in that account.
Because I borrowed all the money to do this deal, I will have to pay about 20% tax on the profit. Still, it put about 3x the money into the account in about 3 months than I could contribute in 1 year, and the profits I generate from the profits will be tax-free.
What’s your future goal with your H.S.A.? Since it can only be used for qualified medical expenses, I’m not looking to put millions into it the way I am my IRA. I’m in the middle of another deal in it, and when that one’s done I should have enough cash to start making private loans or maybe buy a rental. I just want to have 4-5 years’ worth of out of pocket expenses in the account.
Any advice for Inner Circle members? I basically learned how to do deals in IRAs and HSAs from a 2-day seminar COREE put on in 2015. I knew that they COULD be done, but it took going to that event and meeting people who had DONE it to get me off my butt. Since then, I’ve been all about building retirement and health care funds tax-free. I’m going back again this August, and I’ve gone from being a complete novice to a presenter in that 2 years. I’d suggest that if they can make it, they do that. www.CentralOhioREIA.com
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