When 50% equity of $700K only gets 0.4% COC.. what to do?

Question

Please help point
out where my math and concepts are incorrect:

Primary residence
considered for converting to rental.  <5 miles from beach in
Southern CA.  Great schools.  <4 comp properties for rent in 4
mile radius.  New neighbors had to pay rent for 3 months before they
even arrived because demand is so high. Currently have 50% equity in
home = $700K

Monthly expenses of
$4900. (can detail if needed)  Rent range of $5400-$5700… use
$5400. Assuming 23/24 months rented… Cash flow avg of $240/month…
$2900 a year vs $700K equity. COC of 0.41%.

Given $5400 rent,
can only take out $40K of equity (@ 5.5%) to still make extra payment
of $240.  That raises COC to 0.43%.

The appreciation is
solid and I have no doubt the house would rent for multiple years to
same tenant.  Newer construction, so used 5% CapEx in COC, but that's
probably high.

Pencils out like a
huge opportunity cost to keep and rent vs. selling and using the
$650K proceeds elsewhere.

Ricardo Hidalgo · Answer

I would sell that property or take out a hello to move it into something else. I think you could find better options with 10% plus in appreciation and 8-12% COC return. Some of our short term rentals that are price 700k are producing 65-80k gross on average a year.

Nathan Gesner · Answer

Joe is a math guy, so listen to him.

I think you'd be much better off capitalizing on the strong sales market and deploying the equity in another state with reasonable Landlord laws and better cashflow opportunities.

Joe Villeneuve · Answer

I can't follow any of the math after, "...Cash flow avg of $240/month...".

1 - If this is your primary residence, so you have already bought it, correct?  Question:  What cash are you putting in then to calculate your CoCR?  CoCR has nothing to do with equity, and is only applied to the first year of ownership, so I don't see how CoCR even is an issue.

2 - How does the rent "take out" equity?...and, adding extra monthly payments (cash) only increases your cost...and wouldn't increase your CoCR...which again, doesn't apply here since this isn't the first year of ownership.

3 - Not even toughing how CAPEX impacts CoCR.

4 - You need a new pencil...and a new calculator.  There is no way converting $650k in equity to cash for DP's (that would be over $3M in new Property Values), and the cash flow that would follow these new properties, wouldn't be lightyears ahead of $2900/yr in CF from this property.  Your "huge opportunity" comes from selling the property, and using that equity for much better numbers.

Bottom line is, I don't think you know what CoCR means/is, and your calculator needs to be replaced...fast.

Joe Villeneuve · Answer

Deals are not found, they are made.  Deals have two parts to them:

1 - Minimal cost to the REI...that means least amount of cash out of pocket.  The only cost to the REI is the cash they put up.

2 - The strategy used so that someone or something else pays for everything else.

All of this means you have to understand market analysis, and you have to understand that if a deal doesn't have positive CF from the beginning it isn't a deal at all...and you should move on.  The role of CF is to recover your cost ASAP.

My rule is twofold.  When both of these events occur, I sell because it's at that moment when my deal is at its maximum potential, and I start losing money from that point forward:

1 - Accumulated CF equals my DP.  This means I have a free property (see above),2 - When the appreciated equity (not paydown from mortgage payments) equals the paid for equity (DP).

REFI isn't the same thing as selling.  You don't access all of your equity, and by increasing your mortgage payment through the new mortgage (REFI), your CF on the original property will go down.

James H. · Answer

@Joe Villeneuve

lots of gold there. 
losing value of your invested dollar with appreciation. 5x dropping
to 3x.  Thank you for the example, that helped a ton. Not to monopolize your time, but just a bit more to extend this..

So try to keep your
down payments low to preserve the dollars power in groups of 20% down. 
That then requires finding great deals/markets where your rent power
is strong enough to create positive cash flow.  (Hence, you make money when
you buy).

If the end goal is
to maximize the power of my individual dollars by keeping equity low
I can accomplish that by either HELOC/ReFi/Sale correct?

How do you
accomplish that?  When you reach the point that equity has increased,
but rent has not gone up enough for you to still cashflow after
pulling equity out and covering the new/extra payment…. Then what? 
Do you sit and accept your 35% equity until its advantageous to sell?

Doing so might mean
you are constantly changing investing locations or changing portfolio
type

James H. · Answer

@Joe Villeneuve

I appreciate how
your posts cut straight to the chase.

So I got to the same
conclusion as you… better to sell it.  Can you help clean up my
vocabulary, concepts and math for the future? Sounds like that’s a
big ask based on your first feedback. :-)

Maybe its not CoCR,
but my thought was, “Is keeping the house a good use of my money?”
 CoCR seemed a decent way to assess that vs selling.

1) I started with
equity as my cash in.  (If I sold my house, that equity would be
“cash out” to spend elsewhere so I figured it was a fair use) 
Cash flow of $2900 a year for my $700K equity/cash that’s staying
put = 0.41%

2) The 0.41% is
awful, and people only try to keep 20-25% equity in a property.  So I
figured out “How much equity can I pull out, at 5.5%, and break
even on the property?”  Answer is about $40K.  (Not that I would,
just seeing how much I could theoretically pull out) If I pull out
$40K I’m down to $660K equity, still cashflowing $2900…. 0.44%
CoCR

3) I thought
CapEx/Repair Reserve was fair to keep in the analysis of cash flow,
for CoCR, because its money I’m not really cashflowing/expecting to
keep every year so its a cost of not selling.

Bigger picture, how can anyone currently make money REI in
Southern CA?  I made that a new post:

https://www.biggerpockets.com/...

When 50% equity of $700K only gets 0.4% COC.. what to do?

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