Increasing leverage with cross collateralizing

Discussion in 'Commercial Property' started by RickProp, 26th Feb, 2017.

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  1. RickProp

    RickProp Well-Known Member

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    I have been reading some old threads from the infamous Dazz on SS. It would be great to have him contribute here again! For those budding CIP investors, I advise you to have a read as well.

    Dazz did a lot of cross collateralizing during his earlier years, using his PPOR and other RIPs. His thoughts were to buy your PPOR cash and then use that title as collateral for CIP lending. The one advantage I see with this is that the full CIP loan, say 100% is tax deductable, but does it also increase leverage as another advantage?

    I have never been a fan of cross collateralizing as I think it limits you down the line with the lender, most mortgage brokers here seem to agree.

    Here are a few scenarios: Assume you have $1m in cash, ignore stamp and transaction costs

    Scenario 1 - Buy PPOR at $1m cash, use this as collateral for a CIP i.e. give bank the title. Could you use the full $1m and leverage up to a $3.333m CIP with 100% mortgage? (i.e. use the $1m PPOR as security for what would have been the 30% deposit) or would they limit you to 80% of the PPOR's value as security for the effective 30% CIP deposit, numbers working out to the same as the below then?

    Scenario 2 - Buy PPOR at $1m - 20% deposit and 80% LTV. Use $800k left to buy CIP worth $2.66m (70% LTV).

    Scenario 3 - Buy PPOR at $1m cash, refinance this with 80% mortgage and then use $800k refinanced to buy CIP worth $2.66m (70% LTV). This should allow the full interest to be deductible.

    What are the advantages/disadvantages of the above? Is it possible to increase leverage using cross collateralizing as in scenario 1?
     
  2. Blacky

    Blacky Well-Known Member

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    I think there are better ways to do things than cross-x

    In your scenarios the bank will view the position as;
    CIP $3.33m (@70%LVR) + $1mil res property (@80%LVR) = Security val $4.33mil. Loan limit $3.133mil). You would still need to find $200k+costs.
    The bank won't give you $1mil against a $1mil property.

    Scenario 3 is closer to the mark. However, you could structure things a lot better by talking to a lawyer (e.g. @Terry_w) who would probably have you set up a pty ltd atf a trust, plus maybe another company (bucket company). You would then buy your PPOR for cash, take out an 80%refinance. Lend that money to the bucket company - which in turn lends it to the trust - which purchases the CIP.

    Thus provided some level of asset protection, amongst other things.

    however, Im not an accountant, lawyer, broker or banker. So I really don't know....

    Black
     
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  3. Terry_w

    Terry_w Broker, Lawyer, Tax advisor, Debt Recycle advisor Business Member

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    Cross collateralising securities doesn't allow you to borrow more or to leverage more. The same can be achieved without crossing.

    Commercial property is more risky because of tenant litigation so it might be worthwhile considering a different ownership structure to the main residence - but this is a thread for another day.

    Scenario 1 is directly putting your main residence on the line if things go wrong. The lender could take possession of this before the commercial property if it is used as security by mortgaging it.

    Scenario 2 is no good from a tax point of view as you would be paying large amounts of non-deductible interest on the main residence loan.

    Scenario 3 is the preferrred method. Except you would pay cash, borrow against the main residence with lender A at up to 80% and use this as deposit for the commercial property. You would then borrow the rest of the commercial property loan with Lender B.

    If things go wrong you keep up payments on the main residence and sacrifice the commercial property by not paying the loan or paying it in part. At the same time put the commercial on the market and try to sell and put the main residence on the market and aim to sell before the lender takes possession of the commercial.
     
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  4. Peter_Tersteeg

    Peter_Tersteeg Finance broker and strategist Business Member

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    There's nothing in the examples given where crossing would achieve more than property structuring would. It doesn't change the value of the properties, nor the amount you can leverage against them. 80% of two individual property valuations is exactly the same as 80% of the sum of the two property valuations.

    Did you get as far as Dazz's post where he admitted he made a mistake in crossing everything? He subsequently contacted several brokers on Somersoft to try to unravel his portfolio.
     
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  5. RickProp

    RickProp Well-Known Member

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    Thanks for the feedback everyone.

    Yes I have tried to keep structures out of the discussion but totally agree. Bucket trust/company is likely a good option to act like the bank and on-lend to the trust owing the property. Both with corporate trustees. This is for the asset protection side. I guess the main point is ensuring the interest is tax deductible if you are sitting with the cash.

    I presumed as much but I thought if there was a small chance of increasing overall LTV it was worth exploring. It is always good to protect the PPOR and give ourselves more options and time should things turn bad. Since they will likely want personal guarantees for the CIP mortgage, they will still come after the PPOR, there is just more time I presume and a lot more legal process for them.

    I guess the only way to protect the $800k being lent to the bucket trust/company and then onto the property owing trust will be to gift the money to the bucket trust/company. This then renders the interest non-tax deductible. You then have secured the $800k but given up the interest deductibility? (there is also a 5 year clawback from memory for gifts).

    I am slowly making my way through his thousands of posts over many years....he was a busy lad! I have seen him releasing titles from the x-coll setup when he could not get finance with CBA for a large purchase so started using brokers etc. I guess his overall LTV was less than 65% after getting 106% finance for new purchases so overall the bank was happy but eventually got cold feet. Also much easier to get resi finance pre-GFC....those were the days....
     
  6. JacM

    JacM VIC Buyer's Agent - Melbourne, Geelong, Ballarat Business Member

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    Another problem if you get too deep into a crossed portfolio is the work required by a broker to unravel it. It might be tough to find someone prepared to due it, due to the risk of doing a lot of work towards uncrossing the loans, only for the client to change their mind part-way through. I would imagine a broker would accordingly charge a fee up front to embark on a large uncrossing exercise.
     
  7. Terry_w

    Terry_w Broker, Lawyer, Tax advisor, Debt Recycle advisor Business Member

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    If you had $1mil cash there would be no deductibility issues if you gifted it to Trust A, borrowed it back at 0% pa to buy the main residence, gave the trustee of trust A a mortgage over the property to secure its loan. And then use the main residence as security for another loan to get the deposit for Trust B to purchase the commercial property.

    But the problem here is that the lender would not lend if the loan to trust A is disclosed.

    Another way, probably which you were thinking of, is to borrow 20% from trust A, but get the remainder from a bank to buy the main residence. So it is 100% mortgaged. Trust A still has $800k and you have a $800k loan.

    You could further borrow $800k from the trust A at 0% and pay down your loan to $1 and redraw (= borrow) $800k to lend to Trust B to buy the commercial property. Not so strong because this is a debt to you personally, but you have a mortgage to the bank and trust so would have no equity.

    But you would 1
     
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  8. RickProp

    RickProp Well-Known Member

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    Thanks @Terry_w, you seem to know your structuring.

    I take it the mortgage to Trust A is not registered against main residence title, it remains unemcumbered and can be used as x-coll security for the CIP to be purchased in Trust B? I guess this puts the main residence more at risk as the CIP lender has the title?

    In terms of getting the finance, would it be easier/harder and cheaper/more expensive to get finance for the x-coll strategy or the separate mortgage of PPOR?

    It seems it is a balancing act between trying to safeguard the $1m from an asset security perspective, trying to ensure the $800k is tax deductible and obtaining finance as easily as possible at the best rates.

    As the saying goes, if it were easy, everybody would be doing it....
     
  9. Terry_w

    Terry_w Broker, Lawyer, Tax advisor, Debt Recycle advisor Business Member

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    Hi Rick

    Depends on the situation;

    The trustee would want to register the mortgage on title for added protection. But the owner of the property would want to borrow against the property so a way to do this is to just borrow 20% from the trust at the start and 80% from the bank. Tell the bank about the second mortgage and settle with both mortgages regsitered.

    Then borrow further sum from the trust and completely pay out the loan (or almost) redraw this to lend to the trust B which purchases the commercial property. Have the terms of the loan agreement with trust A so that further advances are secured by the same mortgage.
     
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  10. RickProp

    RickProp Well-Known Member

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    Sounds good Terry, there are separate loans on both CIP and PPOR, PPOR mortgage is tax deductible and $1m is trust A secured by 20% loan on PPOR and 80% loan to Trust B, if my understanding is correct.
     
  11. RickProp

    RickProp Well-Known Member

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    Big advantage for not x-coll is that mortgage on PPOR is at a far lower rate than for a CIP. I.e. If taking out a mortgage on a fully paid off PPOR and then using those funds to buy a CIP you are paying a far lower rate on the PPOR mortgage than if one had to give the CIP lender the title to the PPOR as collateral as far as I understand. Difference is late 3s/early 4s for PPOR compared to 5-6s on CIP lending. Balance of CIP mortgage will still be at that level but deposit will be at the lower rates indirectly from PPOR. The PPOR mortgage is still tax deductible if drawing out funds to earn taxable income on CIP.

    Also if the CIP does get into trouble, it is much harder and takes longer for the bank to take your PPOR as not x-coll. There is some breathing room to sell PPOR/another property etc
     
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  12. Omnidragon

    Omnidragon Well-Known Member

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    I think cross is a terrible idea. My family did that across multiple sites in 2000s and I've made them unwind it. Sometimes you have to to get the deal over the line.

    But lots of issues. Let's say someone sued you on one property for whatever reason, they could allege your other property was only secured because of this one. And then your whole portfolio is subject to a court case.

    And maybe you own nothing in the end after the judgment.
     
  13. Terry_w

    Terry_w Broker, Lawyer, Tax advisor, Debt Recycle advisor Business Member

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    This doesn't make sense,
     
  14. Omnidragon

    Omnidragon Well-Known Member

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    It may not but nothing stops someone lodging a case on that basis. Have seen that many times. The legal system is a game for people with cash to burn.

    Perhaps think of it this way. Every time you do something you should think about what it exposes you to, lawsuits included. And crossing will always increase that risk.
     
  15. Blacky

    Blacky Well-Known Member

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    Personally I have never seen an instance where cross-collateralisation was requried to get a deal accorss the line. It comes down to LVR, It doesnt matter where the security is sourced from.

    Ive never heard of anyone being sued for an individual property. A entity gets sued, not a property. Your liability in a court case is your total assets.

    The only exception I would apply to this is if you have provided security against a property. The lender has easier access to take control of the property, however, in Australia we dont have 'non recourse' loans - and most banks I have seen have an "all moneys" clause in the contract. Therefore you are liable for the full debt, regardless of which property secures the loan.

    Blacky
     
  16. Omnidragon

    Omnidragon Well-Known Member

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    1. I've seen cross being required and/or least asked. I have been asked before.
    2. Property doesn't get sued. Individual get sued in relation to property A. Property A was security for property B, so there is a claim for property B. Seen this happen a few times.

    Different people have different experiences, but point is every time you do something, you should think of the absolute worst outcome. Of course it's easy to sit there and say I've never heard of that/that's extreme it'll never happen. When you get to a certain scale, risk management becomes important. It's the unknown unknowns which can get you and that's what expensive accountants, bankers, lawyers are paid to try safeguard.
     
    Last edited: 26th Mar, 2017
  17. Terry_w

    Terry_w Broker, Lawyer, Tax advisor, Debt Recycle advisor Business Member

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    I think you are misunderstanding something.

    Crossing in this instance only has relevance to the security holder - the mortgagee.

    If someone else sues they would have to get a judgement and then could apply to take proceedings to sell any property you own to satisfy the judgement.
     
  18. Blacky

    Blacky Well-Known Member

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    Crossing is not required. Security is required. You could set up two seperate loans (uncrossed) and have exactally the same funding amount. Of coarse the banks ask or display a 'need' to be crossed - it protects their interests.

    I fully agree with your final point. Risk management is a fundamental requirement. At the very begining and at the very basic - remaining uncrossed is a good start.

    Blacky
     
  19. Omnidragon

    Omnidragon Well-Known Member

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    Yes I understand that. I'm a trained lawyer too. Anyway don't want to go into the details (equity law, account of profits, constructive trust etc), except to say I've seen it/variations of it.
     
  20. Perthguy

    Perthguy Well-Known Member

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    Earlier on I did a deal with a mate where the bank made cross collateralising a condition of one loan. Bit of an unusual situation where we were refinancing from low doc to full doc loans.

    I was ok but my mate didn't quite qualify for servicing so the bank wanted another property of his as extra security via cross collateralising with a new property purchase. His broker explained all the risks and he opted to do it. Then he got the loans uncrossed at the first opportunity. I thought it was risky but it worked out. Not sure if I would have done it though.