How do I Use This Equity?

Question

Hello forums,

I have two rental properties that we paid retail for with conventional financing. There is probably about 20,000 in equity in each property. Now that I have found this forum, I am learning how to locate better deals, and I would very much like to purchase another property. I do not have a lot of cash to put down on something, but I want to know if using my equity is a wise idea. 
I have read in the forums that equity not being leveraged is a waste, but are also those that believe in buying and paying off one property at a time. The properties I own are out of state and run by a property manager right now.
I am trying to make this decision as the entire real estate and economic market is being turned upside-down, so any advice would be greatly appreciated.

What would you do:
1. Hold everything and not make any moves until the dust settles, or at least wait until the end of the year to get a good deal as everyone is closing their books?
2. Use the equity to purchase another property now?
3. Sell both properties (SFHs) and buy a larger investment with a better return? (i.e. a 4-unit or 6-unit apartment complex)?
4. Something entirely different.

Looking forward to hearing from you!

-Dan

Jeff Fairchild · Answer

By the way, I just read a book which suggested of using a strategy of using equity that you have in property A to make a note that you could use as down payment for property B.  Then you could always have all of your properties highly leveraged.

Another strategy involved paying off just 1 house completely and then using that equity to purchase another house with cash.  Then using that new house to purchase another house with cash, etc.

Aaron Catt · Answer

I'm not a fan of selling any property, unless of course the gains outweigh the costs.

I don't think that your LLC will benefit you financially EXCEPT, it puts a barrier between your personal assets and your investments in most cases.  However, an LLC is penetrable if you make a personal guarantee, which you will most likely have to do since your LLC has limited assets and credit history if any.

LLC's are more for when your tenant breaks a leg and wants to go after your assets.  Check with an attorney on your local laws though.

As for 'equity', it's kind of hard to say if you can even get a loan against it unless it comes from a local bank who understands your market conditions and thinks that there is good reason to 'lend' you money.

Be careful with equity though.  Most of the news people are reading today about our financial and housing mess is due to the improper use of equity.  Don't forget that if you leverage yourself on your property #1 and #2, that your debt service will increase accordingly and that a vacancy in either or both just might sink your ship.

Personally, I would continue to locate deals, look for good financing and 'force' your rents at your current properties.  I know how difficult it is to let a good deal go and stand on the sidelines with little investment capital.  But, if you use your sweat and dress up your rentals, you may be able to force your rents a $100 to $200 per month.  From an annual standpoint that's almost $4800 per year.

With regard to multiple family homes, be careful.  They are, in the case of a duplex, twice as much work....and in the case of a fourplex, four times as much work.  Generally you will see lower rents on multi-family units and higher turnover.  Turnover will kill you financially and it will eat up a ton of your time.  This isn't to say that a duplex or triplex is a bad choice, they just have different characteristics than a single family home.

As for the 1031 Exchange, you should learn it inside and out, and don't get confused, you aren't avoiding gains, you're deferring them. :)

Account Closed · Answer

Hello guys, and thanks for the fast replies. I paid $48K for one and $52K for the second one. We put 20% down on both and now we are calculating comps at $75K in the area, which I am making $70K to be conservative. (It is a military town and hasn't been affected much by the recent real estate market issues - properties are holding their values.) The units bring in $475 and $550 monthly.
These were our first two investments, and they were not "deals" by any means, but we have owned them for a couple of years now and we are learning as we go.
I don't even know if refinancing is an option, and if it is, would they be home equity loans, or would they be set up differently because I want to use the money to buy property? 
We own our own home and have outstanding credit. We have also recently started an LLC, which we use for a small business, but would it be beneficial to try and do this through the business, since the other two properties were secured under our personal name?
I really appreciate the feedback, and I am reading the archives to catch up!

Account Closed · Answer

Once again, I appreciate the replies. My plan was to purchase another property that I located, a duplex, for $50K. One of the units is renting for $800.00 and the other is vacant. I figured there had to be a way to use the equity I had, either through the cash-out refi you mentioned, or by selling them outright. Because they are in a military town, I could have buyers for both without advertising, and our realtor in that area is a friend of the family.
Maybe I will just hold these and find another way to finance #3. Thanks for the class!

Account Closed · Answer

Quick question, if I sell both properties, how long would I have to reinvest in order to avoid paying the capital gains?

Jon Holdman · Answer

Difficult, if not impossible to get any sort of second mortgage on investment property.  You would want to do a cash-out refi.  Max LTV on a cash out mortgage is 70%, maybe 80% if you find the first company.  80% of $70K would be $54K.  After costs of 2-3K, you'd get about $51K.  Pay off your existing mortgage for about $40K and you get about $10-11K.

Then you have a property with a $50K loan that brings in $475 or $550.  That's going to be costing you out of pocket.

Could you sell these?  At $70K, you'd net about $65K after closing costs.  After paying off your loan, that's $25K, pretax.  If you've owned them over a year, long term cap gains is only 15%.

Bottom line is that its difficult and expensive to extract this tiny bit of equity.

Jon Holdman · Answer

Yeah, need more info.  In particular, what are they worth.  $20K equity in a $200K property isn't really any equity because if you sell closing costs will eat up almost the entire amount.

Its unlikely you'll be able to borrow this equity.  If they're worth $200K or move, you're already at 90%+.  Nobody will give you cash for that last bit.  Even if they're only worth $100K, you're at 80%, and refinancing would net you very little after costs.  Below $50K its more difficult to get a loan.

Hassan Omar · Answer

What were the terms of the deal? How much did you pay, and how much does or will each unit bring in monthly? How much did you put down?

I know this seems like a lot of info, but can't comment without understanding what you did