I had a good meeting with my broker this week. We have another meeting for tomorrow. We are pressing on two deals a little. I won’t say much about those in this post, but I’ll jump into another topic.
Did you know there is no such thing as a “cash out refinance” in Japan? For the most part, that is true. And that was a surprise to me.
This blog is new, and I assume (for now) I am mostly writing to and for myself. But for anyone out there that can hear me (“Can you hear me now?”), I’m happy to walk through my understanding of a cash-out refinance, and why it matters to real estate investors (in Japan, or any market).
As quickly as I can:
Let’s say an investor buys a property for 10,000,000 JPY. Let’s pretend he can get a 80% loan to value (LTV), so he puts 20% down (2,000,000 JPY), and uses a loan (8,000,000) for the remainder of the purchase price. After he takes ownership, he “forces appreciation” (via improvements to the property, higher rent, new sources of income, etc) and he improves the NOI on the building. After the building is stabilized at the higher rents, he works with a bank to refinance the building. As part of the refinance, based on the higher income the building is professionally appraised for 12,000,000 JPY – a 2,000,000 improvement in the value of the property. Based on that appraisal, the bank offers him a new loan, again at 80 LTV, for 9,600,000 (80% of the new value of 12,000,000). As the refi is complete, he pays off the original loan of ~8,000,000 JPY (a little less than that, as he has paid down the principle some) using that 9,600,000 JPY, and he has… 1,600,000 JPY left over in cash, and still owns the building (still at 20% ownership).
That is a broad simplification (we didn’t talk about the principle paydown, or prepay penalties, or appraisal fees, or loan origination fees, or the cap ex he used to make improvements), but the general idea is:
— He used 2,000,000 down to buy a building
— He improves the operation of that building, raises the NOI, and does a cash-out refi
— He pulls 1,600,000 out of the building, but still owns it, at the same % he did when he bought it
This cash-out refi is one of the “Rs” (R #3) in the idea behind the “BRRRR” investment strategy (made famous by Brandon Turner).
He still owns the building, and he has 1,600,000 of his original money to go buy a new building (plus all the cashflow from the first building). He doesn’t quite get all his money out (nor his cap ex contributions), but he gets a bunch of cash out, and he can go out and do it all again. Yehaw.
Sounds good, but…
In Japan, they don’t like cash-out refi’s. Why, “because rules.” That is what I hear, anyway. My team and I know a lot about loans for foreigners to buy investment property in Japan, and we made a call or two, and it turns out that Tokyo Star may sometimes offer a cash-out refi (but the terms are really not great). I was surprised by all this, and it made me reconsider my investment strategy.
If you can’t use a refinance to pull cash out, what are your choices? Well, you can keep the building – but your money is tied up. If your NOI is up, and you don’t increase the size of the loan, your cashflow should be higher as well – which is a good thing. Maybe that cash stacking up each month is good enough. You still own the asset, it’s improved, it’s printing money, and since you’ve made those improvements, you probably have lower cap ex in the coming years. Not a bad position.
Your other option – we’ll call this the “Japanese Flip” – is to just sell it. In this case, using the numbers we modeled out above, the building appraises at 12,000,000 JPY, the original loan is for ~8,000,000, so as you sell, you have 4,000,000 left after loan pay back (instead of 1,600,000). You no longer own the building. And you have to pay 25% corporate tax on the gain (4,000,000 excess cash – 2,000,000 original down payment = 2,000,000 gain, at 25% tax = 500,000 in taxes), so you end up with 3,500,000 after taxes. That gives you a lot of cash to go play with, but you’re staring over.
“Another disincentive to sell, as noted above, is the difficulty of finding your next investment.”
— From William Poorvu’s The Real Estate Game
An astute student might imagine the buyer in the scenario where you did the “Japanese Flip:” As you sell for 12,000,000 JPY, there is a buyer. And the bank gets the appraisal (based on the actual income from the building) for 12,000,000 JPY and offers the new buyer a loan for 9,600,000 JPY (80% LTV). The new buyer takes that loan, plus a 2,400,000 (20%) down payment, and buys the building from you. The astute student then asks:
“If the bank will loan 9,600,000 JPY to a new buyer for your building, why won’t they just let you cash-out refi for that same amount?”
Good question. The answer, “because rules.” My broker thinks this may eventually change, as Japan absorbs more influence from markets where cash-out refi is normal (it is normal). I bet that if you have very good relationships with lenders, they might bend the rules for you and let you have a cash-out refi right now, like today – but that is just an assumption.
Okay, so… if I want to grow, if I don’t want all my money tied up in a building where I have successfully created additional value, if I want to implement the investment strategies used in the US and other markets, do I have to sell?
Maybe I do, but check this out:
Can you sell the building to yourself?
If you are buying real estate in Japan via an entity like a godokaisha, can you just sell yourself the building? I had already been asking questions about seller financing in Japan (which is another great topic), and using godokaisha to set up seller-financed loans… but what about using corporate entities to get your cash out and also retain the building?
About this time I was listening to an old episode of Rod Khleif’s (Lifetime Cashflow Through Real Estate) podcast, and I heard this line from a US-based owner of multifamily investment property:
“The exit plan for me, is to put it into a non-recourse, Fannie Mae note and cash flow it… flip it to myself, one LLC to another.”
— Nathan Tabor, episode #167 of Lifetime Cashflow Through Real Estate
Ah ha.
So, I am already out on a limb thinking cash-out refis exist in Japan (they mostly don’t). Am I insane to think I can “flip to myself,” from one godokaisha to another? I don’t see why not. The building would carry the higher debt on the new bigger loan, just like a refi would. But I’d get the cash out, and could retain the building (and all the good work I’d put into it). I have a feeling you’re have to switch banks (for the same reason you can’t get the refi), “because rules.”
Presumably “flipping to yourself” is a very nice transaction; because the building is yours, you’re quite familiar with it, you don’t have to do any due diligence.
I haven’t research this yet. I was thinking about my investment plans and I remembered that quote. Last night, I relistened to that episode to track down that comment so I could quote directly for this post. I’ll ask my agent about it tomorrow, and maybe ask the lenders we talk to as we work on this first deal.
As an aside, we checked the “pre approval” from a lender for my investment property loan we got two months ago, this was the fourth time we asked to clarify and confirm the terms, and… the banker suddenly came back with worse terms; a lower LTV (70% vs 78%). The rates are going up in October, so, money is getting tighter for me personally and in Japan in general. I still think it’s a relatively good loan (because every other loan is worse).
That is okay. We can do it.
That’s all for now.