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Equity Stripping: Recycling Your Cash to Maximize Capital

by Arthur Garcia on February 6, 2013 · 53 comments

  
Equity

A few months ago I was speaking to a co-worker about the advantages of owning rental real estate.  What started off as a few causal questions turned into an hour-long discussion.  He had considered investing in real estate for some time, but was hesitant to pull the trigger.  So I went over the various metrics he should consider when purchasing a property as well as the basics of cash flow, obtaining financing, etc.

However, there was one issue he couldn’t seem to wrap his mind around – how to continue acquiring property after all of his investment capital was depleted.  I tried to explain the concept of equity stripping, the means by which you pull cash out of your investment’s equity to fund the purchase of a follow-up investment.  It wasn’t until I shared the following example that “the lights turned on”.

Since sharing this information seemed to be so helpful to my co-worker, I thought I would pass it along fellow BP-ers.  Here is how I used the same 35K to acquire three rental properties over a period of two years:

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Locust Avenue (single-family): The purchase price for the property was $75K. The property was acquired as a distressed sale (short sale); as such, we were able to negotiate with the bank and agreed upon the initial purchase price of $85K.  However, after wrapping up formal inspections, we argued for a $10K price reduction due to the amount of rehab required.

Note:  A detailed inspection report was forwarded to the asset manager along with multiple contractor
bids to complete the work required.  All contractors were encouraged to quote the going “retail” price point for the work needed.  Two months and two asset managers later, the price reduction was granted.  At the time of closing, the market value of the property was worth around $98-103K.  Upon closing we had roughly $18-23K in equity.

My total acquisition price (out-of-pocket costs) was $23K (down payment, closing costs and $3K in repairs).  The mortgage payment was set at $545 and the property was rented for $1125.  I carried the property for a period of 8 months, during which the property appreciated to $113K.  I refinanced the property at its current market value and pulled out $19K from the property (cash-out refinance).  This increased my mortgage from a debt amount of $60K to $84K; my mortgage payment (compound) increased from $545 to $673, lowering my monthly cash flow by $128.

With the $19K I now had available plus the remaining $12K in our acquisitions fund, I was able to purchase the next rental property.

aubrunAuburn Court (duplex): The purchase price for this property was $110K.  This rental was also acquired as a short sale.  The market was flooded with REOs so the comparable sales used to determine the price allowed us to obtain a significant discount.  The property would have likely sold for $130-140K in a conventional sale.  With this information in hand, I agreed to purchase the property with the intention of refinancing it in a few months.

My total acquisition price was $32K (out-of-pocket costs). Both units were rented for a combined monthly income of $1,735.  Both tenants were content to stay in the property and no additional rehab work was needed (atypical).  The mortgage payment was $733. I held this property for a period of 12 months, then refinanced and pulled out $24K.  The new mortgage payment was $887.

We waited several months until we had $28K of cash back in our acquisitions fund (separate from our cash reserves).  We acquired the additional $4K from 7 months of cash flow generated from our two rentals.

Shortly thereafter, we purchased our next property.

frontJeffery Street (single-family): We acquired this property as an REO.  It was a great deal from the start – we won the highest-and-best bid by offering $3,500 over asking. Our purchase price was $65,500.  At the time of closing the property was worth $85-90K.  We invested $7K into the rehab and acquired a private loan for $45K (interest-only).  Our total acquisition cost was $27K.  We’ve held this property for 9 months, during which time the property has appreciated to over $95K.  Our monthly payment is $585 (compound) and we are renting the property for $1,100 a month.   After calling all the local banks in market, I finally met one who was willing to extend me a home equity line of credit (HELOC) at 75% of the market value.  I am still in the process of refinancing this property; however, we just received the appraisal back a few days ago and the bank will be using today’s market price of $97,500 to determine the value of the home.

If all goes according to plan, I will be able to secure a line of credit in the amount of $72K.  This will provide me with $24K of working capital to continue funding future investments.  The new mortgage will be about the same or slightly less than my previous mortgage.

I share these three examples to demonstrate how to recycle your capital, or strip equity, while still maintaining control of your investments without speculating too heavily.

Here are a few additional side notes to consider:

  • Add value: If your market doesn’t have much in the way of “undervalued” property, try to think outside the box: purchase a 2/1 and enclose a formal dining room or den. Convert an attached garage (permitted) to increase the property’s square footage.
  • Network within your community:  Call community banks, credit unions and hard money lenders to see where you can find additional ways to access working capital: home equity lines of credit (HELOC), portfolio loans, private notes, hard money products, etc.
  • Be strategic:  Make sure each property you acquire has multiple exit strategies – rental, cash-out refinancing, flip, wholesale, etc.

Readers, I shared a few ways I keep my capital in play – what are a few of your strategies?
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{ 53 comments… read them below or add one }

Brandon Turner February 6, 2013 at 1:33 pm

I love this article, Arthur! I’m always encouraged to see how other people finance deals, because I learn something new each time. Thanks!

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Arthur Garcia February 7, 2013 at 10:04 am

Hi Brandon,

Thanks for the kind words. I wasn’t sure if I should post this info, due to the personal nature of the financials, but I figured it would a few folks connect the dots. It is always tough to tell what is going to connect with the viewers.

Best,

AG

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Glenn Espinosa February 6, 2013 at 2:19 pm

Woah! This article is awesome! Thanks for breaking it down and using hard numbers to paint the real picture for the new guys.

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Arthur Garcia February 7, 2013 at 10:07 am

Hi Glenn,

I’m glad you enjoyed the article. Every time I talk to new investors or folks that want to get started, they always think they have to “save” the capital to fund their next deal. However, as you’ve seen from this article, you achieve your goal much quicker if you make strategic moves along the way.

Take care!
AG

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Jim Pratt February 6, 2013 at 2:54 pm

Arthur, I’ve mention this on an earlier post but I will repeat it again. A while back I did a HELOC on one my rentals for $50,000. Bought an REO for $50,000 and $10,000 from my cash reserves for fix-up. After renting for a couple of months I refinance and got ALL my money back. Did this for the next three properties, in short, bought four properties (large four bedrooms, two bathrooms) with NO MONEY out of my pocket all cash flowing positive:) When you can pay all cash the deals are soooo much better. The only reason I stop was you’re only allowed ten loans.

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Chris February 6, 2013 at 6:10 pm

Great article Arthur. Equity stripping has other benefits as well. It may reduce your lawsuit risk. Lawyers may pass on a lawsuit if they check title and see there is no equity in the property. I am a big fan of at least getting a HELOC if you have additional equity. Even if you don’t use the funds, any nosy lawyer checking title will assume the funds have been stripped out. Also, you will have a really easy cash reserve for emergencies.

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Arthur Garcia February 7, 2013 at 10:14 am

Hey Chris,

You bring up some great points regarding asset protection. I too like having a mortgages or HELOCs on all my properties. I feel having 100% equity is too tempting for a potential lawsuit.

Take it easy and thanks for posting.

AG

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Arthur Garcia February 7, 2013 at 10:11 am

Jim,

Thanks for taking the time to post.

It sounds like you found the secret to buying with no-money down ;) I completely agree, buying in cash, is the ultimate way to get the best deals. The problem I’ve had in my market is that investors have decided to go “all in” so our distressed properties are creeping up. I also like to have some cushion (available credit) in each of our HELOCs to act as cash reserves.

Thanks again for sharing your experience!

AG

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Chris February 6, 2013 at 6:12 pm

Opps, didn’t mean to leave my comment as a reply to Jim. Sorry Jim.

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Charles February 7, 2013 at 9:46 am

I don’t feel this is very useful, to any but the newbiest newbie. Why? The magic trick in the middle…

Sure, it’s great to cash out refi, but we are talking an incredibly difficult loan to get right now. A useful post would be how to actually get a cash out refi, in a market where banks HATE them.

Otherwise we are finding the pot of gold by assuming the leprechaun.

And as an ex lawyer, heloc stripping will do you no good against an even vaguely competent lawyer (much like much of the shielding advice on this site…. ). What works is good insurance. Period.

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Arthur Garcia February 9, 2013 at 9:51 am

Hi Charles,

I’m sorry you didn’t find this article particular helpful to your situation. It is always difficult writing for such a broad audience, you never know what content is going to resonate with the readers.

I think you’re assumption that banks HATE cash out refi’s is wrong. Is it challenging, yes, however, over the past few years, we’ve built our entire rental portfolio on this model, so it does work – even the magic trick in the middle.

Here are few tips to help you:

lenders – create a list of local community banks/ credit unions in your market and hard money lenders. When I first started doing this, it took me about 40 different phone calls to get to the right people. I made appointments with local bank branch managers and explained what I was trying to do and they usually pointed me in the right direction. Some where more helpful than other, but overall these local banks are flushed with cash and are looking for investments to put their capital into.

Partnerships – this is another great way to continue doing refis. The will require a few additional steps, but what I have done in the past and still do, is put our “credit partner” on title, in addition to myself. We let the property season for the length of time the bank will allow, this is typically 6 months and then the credit partner pulls either a HELOC or a fannie mae loan in their name. To make these kinds of deals, I usually cut the partner in on the equity of the property and a percentage of the monthly cash flow.

Commercial – this kind of goes with my first point, but once you have 10 financed properties, you’ll need to move them into a portfolio loan or a commercial product. Many community banks have a separate division that works in this sector. Typically these loans are 5 – 7 years fixed ARMs and will require you to have more than one property attached to each loan. This means you’ll have to roll up 10 properties into one loan. Doing this of course, frees you up to get 10 more fannie mae loans, rinse and repeat.

I’m not claiming the above scenario is easy and I should have been clearer in my article, but this strategy does work. It takes planning and some leg work, but it does allow you keep acquiring property after you reach your 10 loan limit.

I hope that helps.

AG

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Joe R February 7, 2013 at 10:07 am

Great article Arthur! My question is how to get around a 4 mortgage limit (5 with primary). We have 3 rentals (2 rentals with mortgages, 1 owned rental, and our primary with mortgage) If I refi-cash out on the owned rental, I will have 4 mortgages incl. primary. Several banks I spoke with have a 4 unit overlay rule creating a wall for future financing. Are you using hard money lenders or just saving enough to buy outright? Thanks!

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Arthur Garcia February 7, 2013 at 11:03 am

Hey Joe,

Currently you are allowed to get 10 mortgages, not 5. My advice would be to put together a list of lenders in your market, 10-20 (seriously) a call them all. Each lending institution typically has a few “over lays” these are additional guidelines or under-writing regulations that are not part of Fannie mae’s guidelines. I’ve found direct lenders typically have less overlays and they tend to have more control over the transaction. The key is find out who these lenders are and which ones are more “investor friendly”.

Another way to do this is to finance ten properties, then hunt around for banks willing to do HELOCs. Also, I’ve found buying a property in cash, then getting a bank to apply a mortgage or a line of credit is much easier than trying to get financing at the same time as the acquisition.

Another way to do this is to bring on an equity partner. For example, buy a property in cash, find a partner who is willing to take out a HELOC. Put the partner on title (in addition to yourself) and have them qualify for the loan/HELOC. You’ll have to sacrifice some cash flow and partial upside equity potential, but you’ll be able to continue funding deals, so it may be worth it.

Also, I typically do a combination regarding my acquisitions: Hard-money (there’s a lender in my market that only requires 25% down), private investors and lastly, savings and credit lines.

I hope that helps.

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Dawn A. February 7, 2013 at 12:36 pm

I have tried calling around to several lenders (about 5) and didn’t find anyone willing to do a cash-out refinance when you already have 4 investment properties. I found 1 willing to do it, but ONLY when I have held onto a property at least a year. So yes, this article makes it sound EASY, but finding a bank to do this is actually DIFFICULT and so the article should be up front about this — the 8 or 9 months quoted can’t be true.

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Dawn A. February 7, 2013 at 12:36 pm

I should say, 4 mortgages. 3 were investment properties and 1 was my own home.

Arthur Garcia February 9, 2013 at 10:14 am

Hi Dawn,

Thanks for sharing our thoughts. I’m sorry I didn’t do a good enough job of explaining the process. As I’ve mentioned before, it is tough to decide how many personal details to include in these articles. The BP audience is so broad that I never quite know who I am writing for.

With regards to your situation, I would like to share four ways we over came the obstacles you mentioned:

Getting around 4 loans – One way around this is to simply take on a credit/equity partner. I’ve written about this before, but the basic idea is you find a partner (family or someone you are willing to work with) setup a JV agreement which will allow them a portion of equity and cash flow in return for use of their credit. I prefer doing this in conjunction with HELOCs, as you can simply purchase the property and add your “partner” to title later. Another way around this is to make sure your significant other, if applicable, isn’t on the debt service for any of your existing properties. Ideally, you’ll want to take out 10 loans in your name and have them take out 10 loans in their name. Just doing that, based on the lenders you’ve already spoken with, will allow you to do 8 cash-out refis under 1 year.

List of Lenders – I’ve said this already, but I would create a list of lenders willing to lend in your market and call all of them and figure out their different lending overlays. I did this and found one lender who had no additional underwritting overlays and would let me reif within 30-60 days of purchase. In case you think I’m being dishonest the lender is (Denver mortgage co). They lend in CO and CA. (disclaimer – I am not affiliated with them, I only share the information to show proof of concept). I would also be sure to include local credit unions and community banks. I’ve found them to be extremely helpful in understanding the process.

Portfolio – once you speak to your local banks, make sure you ask about their portfolio options. This loan product is different than the typical home mortgage loan, as these local banks keep and service the loan in-house. The rates and terms aren’t as good as fannie mae, but they are much better than hard money.

Commercial – lastly, once you speak to the smaller banks, ask about their commercial loan products. You might be able to wrap all 4 of your financed properties up into one commercial loan. This will allow you to continue purchasing more rental properties and continue executing cash-out refis. Again, commercial loans are not as good as residential loans, they are usually for a period of 5-7 years and have an ARM attached to them.

I’m not advocating that this process would be easy, but it does require leg work and effort. However, even if you have to wait 12 months to do a cash out refi, you can still execute this strategy, it may take you longer, but it is still possible.

Thanks for sharing your thoughts. I hope my response demonstrates the validity of my post. I would hate readers to think me dishonest.

Best,

AG

Arthur Garcia February 14, 2013 at 12:14 pm

Dawn,

Did any of my previous suggestions/response help you? If not, please feel free to PM me here on BP and I’d be happy to share with you my thoughts.

Best,

AG

David Swaim February 7, 2013 at 12:09 pm

I’m curious how you are getting financing at appraised value less than 1 year from purchase. It is my understanding that (at least with the larger lending institutions) that you need at least 1 yr seasoning on an investment purchase before they will finance off of appraised value as opposed to purchase price.

It also would seem advisable to increase cash reserves as you diminish cash flow so you aren’t building the proverbial “house of cards”.

I can see how, used wisely, this method would accelerate acquisition and eventual payoff.

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Chris February 7, 2013 at 12:31 pm

David, I find a number of larger institutions will loan at appraised value after 6 months. One that will do it sooner and nationwide is Penfed.org. I was quoted 70% of appraised value, 2 pts and 3.625% for a 10 year loan. You don’t have to wait 6-12 months but because it is a popular program, I was warned it could take longer than 30 days to close. As a disclaimer I have used Penfed as a customer and do not have any affiliation with them otherwise.

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Dawn A. February 7, 2013 at 12:42 pm

You have to disclose that you can only join PenFed if you are military, belong to certain organizations, or contribute to certain organizations.

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Chris February 7, 2013 at 12:50 pm

Dawn, when I set up my account with Pen Fed, they informed me of a free, “association” I could join that would allow me to bank with them. In other words, it’s really easy to join.

Arthur Garcia February 9, 2013 at 9:57 am

Hey Chris,

Thanks for sharing this information. I’ll have to look into this lender, I’ve never heard of them. Thanks for the note!

AG

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Arthur Garcia February 9, 2013 at 9:57 am

Hi David,

The lending institutions that require you to wait 1 year is due to a underwritting overlay. This is not part of the fannie mae guidelines. I would encourage you to create a master list of all the lending institutions willing to lend in your market, try to come up with a list of 20-30 lenders. Each institution has their own set of rules and regulations for cash out refis some are more liberal than others. I apologize if I’m being a bit generic,but that is exactly what I did. It took me about 30 + phone calls and meetings before I figured out how to continue building my portfolio through recycling my capital.

Thanks for commenting.

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David Swaim February 7, 2013 at 12:48 pm

Thanks, Chris.

What larger institutions have you found that will loan at appraised value after only 6 months?

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Chris February 7, 2013 at 1:03 pm

David, it’s been a few months, so I’ll see if I can find it in my notes. I believe US Bank was one of them.

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Arthur Garcia February 9, 2013 at 10:19 am

Hey David,

The best strategy here is to create a master list of lenders willing to lend in your market. I know this is tedious and almost no one is willing to do it, but making a list of 25-30 lenders is extremely helpful. Doing this will get you a better idea of what lenders are looking for in terms of credit, job stability, under-writting overlays, etc.

Oh one more note – make sure you start building rapport with local banks. They have been a huge asset to me.

Just my two cents.

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JohnGalt February 7, 2013 at 4:43 pm

Good article, you show the nuts and bolts of how to make leverage work for you. I believe that any limit on loans is a HUD/Fannie thing, or some internal policy of banks, not a hard “rule.” Here’s why: Last week I had 12 mortgages in my or my company’s names, and seven equity LOCs. This week I just got three more LOCs–have ten total now–all on properties Iowned less than a year, all for at least twice what I paid for them including rehab. One I’ve owned for six months, the other for only two months. All are rented and cash-flowing well. I prefer LOCs, actually, as I don’t really like to have much cash on hand, makes me anxious.

Full disclosure, I own dozens of properties, many bought with seller financing or Subject To, and I’ve been in the business eight years, My advice? To get more than 4 (5, 10, ??) mortgage/loans, ignore the big banks and find a solid local bank or, better, a credit union that does commercial loans. They have money to lend well-qualified borrowers, and apparently the flexibility to make lots of loans, since they don’t sell their loans but hold them in house, Some have hungry principals who seek big spreads on cash they can buy for .1% from depositers, and are even advertising now for landlords to come borrow their money.

Bring your financials, and talk to the commercial dept. Yes, you’ll need to co-sign, and yes, your scores are important…but my last two cash out refis were at 5.5%, my new LOCs are at 6%. OK, I have good credit (mid-high 700s), which admittedly isn’t everyone’s situation, but it’s something to strive for. Plus real estate needs to be your main, or at least significant business, they want to deal with someone serious, who has a track record. But even if you’re fairly new, it’s worth looking into.

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Arthur Garcia February 9, 2013 at 10:23 am

John,

Thanks for sharing this information. I know a lot of people had a hard time believing such a strategy was viable and your business model clearly shows this is definitely doable.

I too have found building strategic relationships with local banks and credit unions is the key to building strong portfolio. I think the key here is, you have to do the work – talking to branch manager, finding possible investors to carry paper, setup strategic partnerships, etc. It isn’t easy, but the pay-off can be well worth it.

Thanks again for chiming in!

Best,

AG

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Joe R February 8, 2013 at 10:01 am

My goal is to try and leverage for sure. However, I am not a huge fan of LOC’s because of the floating rates which could throw cash flow into a tailspin. For the banks I spoke with (Chase, BofA) Lines of Credit can be a way to get around a 4-5 property overlay limit. The issue was not so much how many lines/mortgages you have on the properties, the issue was how many properties you have – up to 4 rentals and then the bank’s overlay limit kicks in. Yes, Fannie has a limit of 10, and Freddie 5 (or 10 depending on who you talk to and if the guidelines changed that week), and I agree that finding a lender who does not have the 4 property limit overlay is the trick. Don’t Commercial loans typically carry shorter terms, higher fees and higher interest rates? This is a good discussion and look forward to more feedback. Thanks!

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Arthur Garcia February 9, 2013 at 10:32 am

Hey Joe,

The long story short here is once you reach your ceiling (10 loans), you have to get creative. I’ve outlined a few strategies in other comments on the post, so review those if you have a second. Regarding your question on commercial loans, here is what I did:

Chain multiple properties on one loan – once you reach your max, you have to move multiple properties on to a single commercial loan. The terms for these are much different than residential. The loan is based off of the cash-flow the assets produce, not the comparable sales. The duration is usually something like 30 yr fixed, due in 5 or 7 years. The interest rates are based on the market so in 5 years, I’m going to have to refi or sell a few of the properties off to continue growing.

My advice would be to talk to the commercial division at a few of your local community banks. Just asking questions and picking the broker’s brain can be extremely helpful.

I hope that helps!

AG

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Frank February 8, 2013 at 11:36 am

Chicken LIttles have been crying about coming hyper-inflation for years, but as an economist, I realize the wealthy who control things either won’t let that happen or won’t tolerate high inflation/interest for long. A la the Philips Curve, inflation is a tax on the rich, unemployment is a “tax” on the poor–who’s got more clout?–so I don’t lose sleep over skyrocketing rates. My first mortgage was an LOC back in 2004. It was 6% or so then, is now 3.99%. I think my most recent ones are at prime plus 1.50 points or so. None of my lines or notes have interest over 6% currently,] Of course, they can go up (unlikely to go lower now), but I don’t carry a balance long term, I treat them like my own internal private lender, borrow when needed, repay from cash flow, try to keep at or near zero.

Can’t speak for other markets/banks, but the recent refis I’ve done with a credit union, I got 5 years fixed (before the rate can change), 25 year am, and 25 year balloon/renewal. I can live with that.

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Arthur Garcia February 14, 2013 at 12:12 pm

Frank,

This is an excellent point. I have been mostly working with hard money and I have a few ARMs. I haven’t had any ARMs change rates yet, so I guess we’ll see how that goes.

However, I agree with you. I don’t think inflation is going to get out of hand. Much like you, I try to keep my exposure somewhat low by keeping cash reserves and maintaining a strong equity positions.

thanks again for sharing your experiences.

AG

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Travis Padgett February 8, 2013 at 5:25 pm

Would like to hear any ideas on how to keep going after you reach the ten mortgage limit if you are a buy and hold investor.Im thinking at that point you would just have to start flipping properties to pay off some of those ten mortgages you have.Anybody else have any other exit strategies for that.Jim i would like to know what you have been doing since you hit that ten mortgage wall.

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Chris February 8, 2013 at 6:19 pm

Travis, a way to get past that 10 mortgage limit is to work with local credit unions that keep their mortgages in house (portfolio loans). If the credit union is not worried about selling the mortgage on the secondary market, they are more likely to look past that 10th mortgage. It also helps if you have other assets or are willing bring other assets to the bank. Establishing a relationship helps too.

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Travis Padgett February 9, 2013 at 8:39 am

Thanks man i will give it a shot i havent tried that yet the bigger banks havent been cooperative or helpful to me at all i have tons of equity in everything i own and excellent credit but still am having a hard time getting them to help at all.I have been taking all my cash flow from my rentals and paying down principal i wanted to own everything i have free and clear but it has left me cash poor so doing more deals has come to a stop for me.This has given me alot to think about.Do you have a minimum amount that you will cash flow on a property?My goal was to own ten properties and have them all paid off in ten years and have all ten bringing in about 800 amonth each minus all the bs stuff of course taxes vacancy etc etc what are your thoughts on this and how and why would you do it differently would like some feedback on my plan thanks

I am figuring that the lawsuits being mentioned above would be coming from a tenant who might possibly get hurt on your property or can they come from somewhere else?

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Arthur Garcia February 14, 2013 at 12:08 pm

Tavis,

Did any of my previous suggestions help address your question? If not, shoot me a PM here on BP and I’ll try to help you.

Best,

AG

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Bob February 13, 2013 at 9:53 am

Excellent article! This has been our buy-and-hold plan, though we have yet to fully realize it.

We have bought 3 distressed properties with cash over the last 6 months. These have been auctions or homes with severe issues that banks wouldn’t touch – which gave us a large advantage in our market as we had cash in hand.

After buying these properties with cash, the choice we faced was to pull out our equity right away or wait 6 months. Pulling out our equity right away would only allow us to retrieve 75% of the purchase price, and this wouldn’t replace any of the cash we used to pay for the rehab. Instead, waiting 6 months with our lender would allow us to do a cash-out refinance, where the property would be reappraised and we would (in a best case scenario) be able to get all of our original equity (plus repair costs) back out. We opted to wait the 6 months so we could retain as much of our original working balance as possible for future deals. The first becomes available to refinance next month.
Our lender will charge one point on the entire balance of the loan when we do this (which is in addition to the higher interest rate on investment properties that we will now have to pay).

But then we hit a bump. We just discovered the same limitation as Dawn (see above comments). Our bank only allows cash-out refinances when you have fewer than four mortgaged properties. This is a serious problem for us, as I was planning to get all the way to 10 properties using this trick. Now my growth appears to be stunted once I refinance these properties. Unfortunately 3 rentals + 1 primary residence = 4 mortgaged properties.

I have called *EVERY* local bank inside and just outside of my area in WI (and most multiple times as the residential and commercial departments aren’t always fully aware of one another). Most banks either have a lack of fixed rate mortgages for investors (only balloons or ARMs), outrageous interest rates, or both.

Can anyone help me out here? Does anyone know of a lender (either national or local in Wisconsin) that will allow cash-out refi’s up to 10 properties?
I have never used HELOCs before. Should I consider them as an alternative to a fixed rate mortgage on each additional property after number 4?

Thanks,

Bob

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Arthur Garcia February 13, 2013 at 6:15 pm

Hi Bob,

Thanks for taking time to share your situation.

I have a few suggestions/ ideas:

We: You mentioned WE in your comment above. Do you have a significant other investing with you or is this a business partner? Regardless, you may want to have each partner take on the debt loan separate from each other. For example if you wife is on all the loans, you should take her off the debt when you refinance. This will free her up to purchase more property and keep her DTI lower and allow her to refi with the lenders you spoke with. If you are working with a partner, you can still do the same thing, both partners stay on title and one takes on the debt loan. Of course, vamp this all through a lawyer and draft up a JV partnership agreement or something that details each of your roles.

Commercial Loans: The terms aren’t as good as residential loans, since they aren’t sold to government sponsored companies (fannie mae, etc). You’ll likely have to put multiple properties under one commercial loan. As you have found out, the financing is typically for a period 5-7 years and has a balloon attached to it. You’ll likely have to refinance at the end of the term or exchange out all together.

HELOCs – These are a great way to continue to purchase property and get your initial capital back. The community bank I work with allow one person to have 4 HELOCs (this is independent of fannie mae financed properties). If you take out 4 HELOCs and your Partner takes out 4 HELOCS, you can finance 8 additional properties.

Private money – This not the easiest process, but I’ve had a fair amount of success offering a fixed rate return for a fixed period of time. I’ve given 10% interest only for 7 years to my past investors. This has worked out well so far. My investors get a solid return, secured by a trust deed and I get to keep putting my capital to work.

The reality is the optimal loan product is a 30 year fixed, IMO. Once you reach the 10 loan limit, you’ll have to consider taking on partners or look at different loan products – HELOCs, Porfolio Loans, commercial loans, private money, Hard Money, etc. The above suggestions are a few ways I’ve gotten around the 10 loan limit. I hope they give you a few ideas on how you might be able to “tweak” a few of the strategies to fit your business model.

Thanks again for replying.

AG

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Bob February 14, 2013 at 11:10 am

Arthur,

Thank you very much for the detailed and helpful response.

The “We” in my story are my wife and I. We currently are equal members in the same single member LLC, and we file our taxes jointly.

Based on your suggestion, I spoke with my prospective mortgage broker about splitting the mortgages between us. We *may* be able to qualify for separate loans provided we use only our personal income to qualify. Including our rental income may get dicey though. My mortgage broker informed me that his underwriters would not consider our rental income separately if they appear on the same schedule E on our tax return – which ours will. In fact, I got the impression that attempting to go beyond 4 properties with this lender would be a risk that may or may not turn out depending on the underwriters’ mysterious criteria. It all depends on whether or not they will consider us separately. I’ll run all this past my attorney and accountant to make sure I’m not missing something. I may be making too much of this too.

So as cloudy as my crystal ball is, here is what I intend to do as of now:
Step 1) I’ll keep shopping around for lenders that will allow cash out refinances beyond 4 properties in surrounding cities and regions. Maybe there are still out there, but I just haven’t found them. If I get lucky and find one, I will proceed to step 4. If I cannot find an alternate lender, I’ll move on to step 2.
Step 2) I’ll put the first properties’ mortgages in my name only, and title them as the company. If I do not find an alternate lender when the next “cash purchased” property comes along, I’ll proceed cautiously and attempt to qualify for a cash out refinance in my wife’s name.
Step 3) If the underwriters approve the loan, we will celebrate by doing cartwheels through the lawn (weather permitting). If they do not approve the loan, I will visualize myself reaching my hand directly through the mouthpiece on my cell phone and slapping my mortgage broker about the face repeatedly. When I feel that imaginary justice has been served, I will use a HELOC on that property as a backup plan.
Step 4) When we get to property #11, I will refer back to this post for further guidance.

Thanks again for you time and insight,

Bob

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Arthur Garcia February 14, 2013 at 12:04 pm

Hi Bob,

I’m glad to hear my reply was at least somewhat helpful to you. Just to add to your conversation with your lenders, my wife and I do file jointly. However, we do not have hold our properties in an LLC, only land trusts with a lot of umbrella insurance. Our lenders have been able to use the cash flow toward my qualifying income – so the debt doesn’t count against our DIT.

Your plan sound great! I think your plan is very sound. I think you should consider HELOCs though. I know they are not as great as conventional loans, but you can always amortize the payments if you want to accelerate debt pay-down. I may have mentioned this, but my local bank allows 4 HELOC per customer. Between you and your wife, you’ll be able to get 8 additional properties financed. You can also pay interest only if you want increase your cash flow.

Please add me on BP. I would love to hear about your progress.

Best,

AG

Ryan February 14, 2013 at 9:59 pm

Hi I am fairly new to this and was wondering about the end game. Are you looking to liquidate the property at a later date. If so how long do you plan on holding and how much profit do you estimate making? And once you pay off the HELOC, do you still have to deal with mortgages? I understand the idea of taking equity out… but whats your end game?

I know I sound like most newbie but if you could point me to some literature it would be much appreciate… no pun intended.

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Bob February 14, 2013 at 11:21 pm

Hi Ryan,

I hope Arthur will forgive me for responding for him.

Arthur has his all of his goals listed in his profile:
http://www.biggerpockets.com/users/ArthurG

It looks like his end game is to sell off some of his properties to pay off the remaining debt on the others 10 to 15 years down the road. Either that, or it is to make enough money to become a self-made super hero and fight crime. (I’m pretty sure it is the first one, though.)

Bob

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Ryan February 15, 2013 at 12:41 am

HAHA… Personal shots… I love it. Thank for the info Bob

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Arthur Garcia February 15, 2013 at 9:58 am

Bob,

You’re correct, however super hero is a very close second. ;)

AG

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Arthur Garcia February 15, 2013 at 9:57 am

Hi @Ryan,

Thanks for taking time to type in a comment.

You’re asking some great questions, unfortunately, there are quite a bit of details involved in the response. Here’s the long story short regarding my business plan and a quick answer on HELOCs.

Acquisitions: I since the bubble popped, I’ve been aggressively buying up as many properties as I can figure out how to buy. Ideally, I’d like to get to 30 properties. I’ve used various combinations of partnerships, hard money, private investor note, portfolio loans, fannie mae products, etc. My typical deal is to purchase a SFH between 45K-80K (most of my purchases have been closer to 80K these days, as my market has already started recovering).

Replacement costs: The replacement cost to rebuild these same properties is roughly 150-180K. This is important because when the bubble first popped, no one wanted new construction and why would they. They could by an REO or short sale in the same area for 1/3 of the price. However, as the REO/short sale inventory has dried up over the past three years, prices have started to rise. Eventually, the prices will revert back to replacement costs and new construction will be hovering around 200K+

Stabilizing the properties: As I’ve demonstrated above in my post, my goal is to capture as much of my initial capital back out of each deal. Ideally, I’d like to hold all my properties with as little of my initial investment as possible while still cash flowing $150-$200 a month min.

Exit: I plan to stop acquiring when either I can no longer get at least 1% Rent to value ratio or if I can’t get any more capital to invest. I will exit once I see the 80K properties selling around 120-140K, maybe sooner, maybe longer, depending on the market. At that point, I will sell off half of the portfolio and pay off the other half, at least the ones with the bad financing – hard money loans, ARMs, etc. I’ll hold a few properties as notes and hold the remaining, properties as rentals.

Question about HELOCs: My bank only lends if the HELOC is in first position. This usually means, it is the only debt on the property, so once I pay off the HELOC, I’ll own the house F & C.

I hope that helps ya!

AG

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Melissa February 15, 2013 at 10:19 am

Arthur all I can say is you truly inspire me I wish I had someone like you on my team :). This article was truly encouraging I need to step my game up.

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Fran February 22, 2013 at 12:15 pm

Hi Arthur, I enjoyed your article.

I only have one rental thus far, as it used to be my primary residence, I do not wish to do a refinance since I doubt that I’d do better than my current rate. I am interested acquiring additional properties, and this HELOC sounds promising in that I could (1) keep my current rate on the bulk and (2) only pay interest when I put the money to use.

Could you speak some more about the appraisal process? Over the 7 years that I lived there, I did a lot of high quality work to my place that would not be evident in a “drive-by” appraisal. My property is in a very popular area with young professionals. The area has almost all older homes that are in various states of update.

Zillow, for example, draws their comps from a wider area that includes nearby undesireable areas. As a result, all recent sales are about 40-70k above their “zestimate.” Were I to sell it, I would easily be at the high end of any comporables in the area considering that my place has a great location with granite countertops, cherry cabinets, stainless appliances, central air, etc.

Essentially, any lazy appraisal would undervalue my home. Based on recent comporable sales of updated homes, I have about 55-60% equity. If someone simply pulled the low “comps” based on square footage, regardless of quality… they may think that my house was in need of 30k worth of updating, and they may conclude that I have 65-70% equity.

Any tips to ensure that an appraisor will come to the home? I would hate to pay for an appraisal only to be low-balled and denied the HELOC or only given a 10k line of credit.

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Stephine Anfield February 24, 2013 at 8:50 pm

Wow!!! This article is fantastic and so was the pod cast with Joshua and Brandon.

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Joshua Dorkin February 24, 2013 at 8:54 pm

Thanks Stephine!

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Rob February 25, 2013 at 12:03 pm

Great Article Arthur, I was looking for an article related to this and you did a nice job explaining. Do you find that its harder and harder to do these with the bank as you acquire more properties? If so, at what number did it start getting difficult?

On a side note – is it possible to do a partial cash out? Example – your have 40k in equity but only put down 20k and only want the 20k back?

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Honolulu Aunty February 27, 2013 at 3:56 pm

Aloha and mahalo for a great article. I was recently introduced to the ROE – return on equity formula and that has changed our plans for buy and hold forever.

We are getting a bit closer to owning 10 investment properties. These have been acquired through conventional mortgages, HELOCs, and all cash (if they were cheap enough). I am interested in joint venture partnerships with people who have access to credit. I have also been interested in portfolio loans – the ones you speak of with 10 properties rolled into one loan.

However, if one has a portfolio loan of 10 properties, what happens if we decide to sell one or two or more of the properties within the portfolio?

Mahalo in advance, and mahalo for a great blog site!!

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Arthur Garcia February 9, 2013 at 10:15 am

Thanks again for sharing :)

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Arthur Garcia February 9, 2013 at 10:15 am

Chris,

Thanks again for sharing. I can’t wait to look into this :)

AG

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