Use equity (and how) vs payoff to increase cash flow

23 Replies

If I’m looking to buy and hold SFR for cash flow, how do you recommend proceeding? Purchased SFR foreclosure in 2009 with $194K VA loan having 15 year fixed at 4.5 % APR. Current balance is $75K with estimated home value of $250K. We’re only 5 years away from payoff, and an $1,165 projected cash flow (not counting rent increases). Current rent is $1,800 per month, with negative $200 cash flow (if you don’t count equity as income). The thought of one property cash flowing over $1,165 is appealing, but the risk of lawsuit on a paid property makes me want to get a HELOC or refi and cash out. My credit score is usually at or near 850. Even if I don’t cash out, I’d like to buy property #2. Tapping equity in property number one would make financing number #2 a lot easier. Am I better off waiting a year and using my saved cash for a down payment, or tapping equity? After all, tapping the equity would delay the cash flow results I’m looking at seeing in 5 years. If I tap equity, what’s the best way (refi, HELOC, other) if my goal is to buy a second property?
@Douglas Pollock You can have cash flow now by selling house and buying 2. If you wouldn't reach in your pocket and pay cash for what you could sell it for, then why do you still own it? Improve your position by trading out and up. Your equity is not doing anything for you except looking good on your PFS. It's negative cash flow with tons of equity. Move the equity into some other properties that give you more benifits. I look at my stuff every month and ask myself, "If I traded or sold this one, could I get a new one with more or better benifits?" Investments aren't like our spouses. We can trade em for sumpin better. We trade cars every so many years to get a better benifit. Safer, less maintenance, enjoyment, better financing, tax benefits, are some reasons we trade cars. And they are going down in value and cost us to trade. Why is it so hard to understand that trading equity in Real Estate can be very beneficial and easily doable?
@Jason Dillard Thank you Jason. I appreciate your wIllingness to work with a newbie. I agree, the equity looks good on paper, but it’s a couch potato when it comes to earning. Selling is an option, but since I prefer buy hold over flip, I’d like to compare selling to equity tapping. Selling does have a transactional cost, so that’s one reason I hold, and in this case the low vacancy rate. Tenants seem to stay for years at a time, the PM is doing well, and I’ve already replaced the roof as well and both HVAC so future maintenance is likely to be lower. My wife and I discussed selling to fund deals, but neither of us are ready to let number one go. What method would you use to tap the equity? I only know of three options: cashout refi, equity LOC, HELOC. I’ve never done a refi or LOC/HELOC. If I understand HELOCs, I might be able to tap into it repeatedly for successive purchases. Ie. using the proceeds of a cashout refi on the next deal to payoff the HELOC and tapping again for subsequent purchases. (Buy a pig, rehab, refi cashout, pay HELOC, tap HELOC to buy next home. Ultimately though, I want to reduce my involvement, so less doors with higher cash flows means less headaches. I’ll be a high equity investor because I want to sleep well at night.
@Douglas Pollock Refi only "taps" some of your equity. Trade up and all is moved forward. That's YOUR equity. It's just like cash sitting in the bank to an exchangor. Spend it all and your returns go up. Mathmatically is makes more sense to use all of it. Wealth building without negative cash flow and no work is what it sounds like you are seeking. You have equity and the ability to borrow money on a deal 3 to 4 times as big. I just heard you place an order. Who is going to fill it? A good broker can fill your order. Learn more about the art of exchanging equity, and it can be very powerful. Improve your position. Get off that negative eat. Own more real estate that will appreciate and provide tax shelter. Have more tenants to lower your risk in case one doesn't pay. Use the old negative cash flow to payoff or buy another investment. Use a little more leverage and keep paying down your loans increasing your net worth. There are too many benifits to owning properties that you can have that today you are not getting. The new has worn off the car.
@Jason Dillard I sat down with a lender today. I came away from the discussion thinking two tools should be leveraged to move forward. One, a HELOC on property one so I can fund rehab(s) for property 2, 3, 4, etc. After rehab I refi property 2 to cashout its equity and payoff HELOC on property 1. I would be able to tap property 1’s HELOC again for rehab of property 3, then cashout refi on 3 to pay one again. The goal would be to pull enough equity from property 2, 3, 4, ... to both payoff property 1’s Heloc and fund the down payment for subsequent investments. Also from the discussion with the lender I’m leaning toward a 15-year VA IRRL cashout refi on property 1. It adds 11 years to the mortgage, but improves cash flow while cashing out that couch potato equity.
@Douglas Pollock What if I took your property as a down payment on a package of houses worth 500k. I'll sell em at a 10 cap and finance you at 7%. Would that get you more benifits? Compare that to a refinance. You can get money to flip houses from other sources. So now you owe 325k and own 500k in real estate. Same amount of equity. However, your cash flow has improved. What other benifits to owning real estate has improved? Tax shelter? Appreciation? Safety because of more tenants? What new obligations does trading create? If the benifits out weigh the obligations, then trade. If refinancing give you the benifits you seek, then refi. As you compare, remember a trade rolls ALL of your equity forward, a refinance puts SOME of your equity in cash. You still gotta do something with the cash. It took me having some cash with QI for 5 months one time to realize I didn't want cash. I definitely don't want stagnant cash. Get my cash back to work fast. An exchangor doesn't go to cash. He or she skips a step. Straight from equity to equity that improves the benifits.

When a income property can not produce positive cash flow with a hypothetical 100% financing it is a poor investment. Your equity is far too valuable for it to suffer a slow death or risk to a down turn in the markets. Paying down a mortggae does not increase the cash flow produced by a PROPERTY. This is by far the biggest mistake inexperienced investors will make. What you are actually doing is buying additional cash flow at a higher cost than it is producing do to the built in opportunity value of your money. This will produce overall negative, not positive cash flow, when compared to investing in additional properties.

This is not a property you should hold. It is a very poor investment as a income property. $250K of dead equity with a opportunity value of 10% is worth over $2K per month in income. If you subtract that from your rental income that is your true cost of buying cash flow (dead equity). Do you still see this as a good income property investment down the road….not likely. 

Sell and redistribute your cash into worthwhile investment properties.

Originally posted by @Jon Paszkiewicz :
@Jason Dillard who takes property on trade like that? I've not seen anything like that posted on listings here yet. This could save you the fees of selling? Seems like the seller costs might be making a refi/heloc seem more appealing than just to dump it.

 I don't think MR. Dillard literally means I will trade you my one marble for your two marbles.. I think he means sell and use a 1031 to trade up.. at least that is what I am gleaming from his posts.. and if your goal is to be a large landlord and do that for a living that is very sound advice.

For the OP the risk of heloc's getting locked and or called is far greater than you getting sued.. don't let paranoia of lawsuits wage the dog..  Land lording ( as long as your not a slumlord) is not a high risk of lawsuit enterprise.. if it was  insurance rates would be through the roof.. 

And of course I am in the vast minority of this thinking but I like paid for real estate most of the wealthiest clients I work with have a lot of paid off real estate.. if not no debt at all.. But I get it to scale a real estate empire you need debt if you don't have big income from your other business and or profession or sold your business for 50 million and just pay cash for grade A investment props.

Originally posted by @Jon Paszkiewicz :

Thank you!

 I looked at the site Mr. Dillard mentioned It looks like in the commercial world guys may trade one marble for a sack of marbles.. 

but Bill Exeter is a sponsor and he is a 1031 expert / accommodator.. so I suspect that happens.

on a SFR I would think the trading aspect could be a little tougher.

and now that I come to think of it.. I have taken and Airplane   a Mercedes and a Boat  few other odd items as trade for real estate .. with the airplane being the best one.. but its hard to get them to do that because most that want cash and all I had to trade was vacant building parcels.. so with cash flow that might be different but they would have to come up with cash to settle your mortgage or put a loan on it to take your mortgage out.. you don't want to sell sub too in that instance as its fraught with seller risk and it will impinged your ability to get new financing.. 

Originally posted by @Douglas Pollock :
@Jason Dillard I sat down with a lender today. I came away from the discussion thinking two tools should be leveraged to move forward. One, a HELOC on property one so I can fund rehab(s) for property 2, 3, 4, etc. After rehab I refi property 2 to cashout its equity and payoff HELOC on property 1. I would be able to tap property 1’s HELOC again for rehab of property 3, then cashout refi on 3 to pay one again. The goal would be to pull enough equity from property 2, 3, 4, ... to both payoff property 1’s Heloc and fund the down payment for subsequent investments. Also from the discussion with the lender I’m leaning toward a 15-year VA IRRL cashout refi on property 1. It adds 11 years to the mortgage, but improves cash flow while cashing out that couch potato equity.

The Heloc on your primary for expansion is inexpensive and pretty standard fare if you plan to keep the house. I have one, but truly as a line of credit. I buy with organic savings, having the LOC just in case. But I'm further along my path and can buy organically or pay off my higher rate and risk loans. Another 50 tenants and toilets sounds more like a nightmare than a dream to me.

I'm with Jay in mindset. I am good with paid off property to build legacy wealth with less hassle.  My ROE is about 7% and the loans I paid off for good were at least 6% and higher risk like commercial or seller-financed.  To maximize my equity above a hassle-free 7% to me would be too much, well, too much hassle;) And the fees!  Refinancing everything all the time is not easy and definitely not cheap. They'll run you $4k plus a piece and shorten your life 1 year each time in stress and aggravation.

To keep a high equity target off my back like you mention, I use my generic-sounding mgt co s-corp to put mortgages on my free and clear houses.  My commercial assets were in LLCs from day 1, so more protection.  Seek competent, local, non-salesman angle legal advice on equity protection when you get there!

@Steve Vaughan I used to calculate my ROI with what I have in the property as a starting point. So my returns were great. When someone asked me what my return is on the equity I have in the property, it really hurt my feelings. I paid 50k and get 5k a year net income. I'm making 10%. However, if the property is worth 150k now, then my real return on my equity is 3.3% and getting worse as my property appreciates. Now, if I'm holding enough free and clear equity on the side and getting cash flow to cover my living expenses, then I am getting a different benifit. That's safe cash flow. It's my keepers that make me unemployable. On the other hand, if I'm wanting to grow wealth, why I'm I content with low returns? The quicker I trade up, with or without debt, the faster my bundle of benifits are increasing. It's could be a 1031 to go up or I could offer my deed in on a bigger property. We have done houses and cash for office. Trailers as down on multifamily. Taken paper and cash for our stuff. Taken a house as an assignment fee. We took a mix use property as a down payment on apartments this year. We bought our own note we owed on, with 2nds on new houses. And on and on.

@Jason Dillard

The reality is that most small investors have next to no concern regarding maximising returns. Few actually understand finances well enough to understand much beyond being debt free. They prioritise money going out over money coming in and as a result, long term, generally will only break even on most real estate investments except in areas of continual and significant appreciation. The cost of living generally eats most small investors profits when owning properities outright.  

Originally posted by @Jason Dillard :
@Steve Vaughan I used to calculate my ROI with what I have in the property as a starting point. So my returns were great. When someone asked me what my return is on the equity I have in the property, it really hurt my feelings. I paid 50k and get 5k a year net income. I'm making 10%. However, if the property is worth 150k now, then my real return on my equity is 3.3% and getting worse as my property appreciates. Now, if I'm holding enough free and clear equity on the side and getting cash flow to cover my living expenses, then I am getting a different benifit. That's safe cash flow. It's my keepers that make me unemployable. On the other hand, if I'm wanting to grow wealth, why I'm I content with low returns? The quicker I trade up, with or without debt, the faster my bundle of benifits are increasing. It's could be a 1031 to go up or I could offer my deed in on a bigger property. We have done houses and cash for office. Trailers as down on multifamily. Taken paper and cash for our stuff. Taken a house as an assignment fee. We took a mix use property as a down payment on apartments this year. We bought our own note we owed on, with 2nds on new houses. And on and on.

 Got it, yes.  But this is a new investor dealing with a primary res.  Mentioning an unallowed 1031 and going deep tends to confuse.  I understand where you're coming from, I'm just keeping simple for the OP.

@Steve Vaughan I accept that growth, at a fast pace will likely require leveraging by cashing out. And yes, I also accept that as equity builds my ROI goes down because it’s not just about how much money was used as a down payment. However, the devil’s advocate in me says that there is a switch that gets flipped after the bank cashes that final check. Then, the calculation says cash flow shifts from the bank to me as the owner. Before the final check, my net increase is $200 (-200 cashflow, +400 equity, is $200). After the final payment to the bank, I’m receiving $1,200 per month. The standard financial advice I hear is that for every $100,000 invested a person can use 4% ($4,000) without tapping into the investment. So, $1,000,000 translates to $40,000 annually. Now, with a little squeezing I can foresee netting $1,333.33 per month in cashflow by my final payment. If I repeated the process two more times, I’d have a greater annual income from a smaller investment. And the headache factor of three doors is very low compared to the planes, Mercedes, 1031, and other items mentioned in the thread. You’ll be wealthier for sure, but if all I want to do is stack $36,000 of rental income on top of my pension, then doesn’t fewer paid off doors give me less headaches than the countless hours it took to build what you currently have? I want to work less hours. Not because I’m lazy, but because I’d rather spend time with my kids.
Originally posted by @Douglas Pollock :
@Steve Vaughan I accept that growth, at a fast pace will likely require leveraging by cashing out. And yes, I also accept that as equity builds my ROI goes down because it’s not just about how much money was used as a down payment. However, the devil’s advocate in me says that there is a switch that gets flipped after the bank cashes that final check. Then, the calculation says cash flow shifts from the bank to me as the owner. Before the final check, my net increase is $200 (-200 cashflow, +400 equity, is $200). After the final payment to the bank, I’m receiving $1,200 per month. The standard financial advice I hear is that for every $100,000 invested a person can use 4% ($4,000) without tapping into the investment. So, $1,000,000 translates to $40,000 annually. Now, with a little squeezing I can foresee netting $1,333.33 per month in cashflow by my final payment. If I repeated the process two more times, I’d have a greater annual income from a smaller investment. And the headache factor of three doors is very low compared to the planes, Mercedes, 1031, and other items mentioned in the thread. You’ll be wealthier for sure, but if all I want to do is stack $36,000 of rental income on top of my pension, then doesn’t fewer paid off doors give me less headaches than the countless hours it took to build what you currently have? I want to work less hours. Not because I’m lazy, but because I’d rather spend time with my kids.

 Nothing wrong at all with being content with a really nice passive income debt-free and stopping.  I have the same mindset.  I paid off last year what would have taken an additional 15-20 units bought right equal in cashflow so I'm with you.

Normal people on the street and our families and friends would be more than happy with an additional $36k a year in retirement for not much more work.  Remember that. On BP there is a lot of 10Xing goals so you can fly your plane around to oversee your empire.  Nothing wrong with being nicely comfortable and content and doing what matters most to you Instead of hunting for another deal or optimizing every dollar of equity!

Originally posted by @Douglas Pollock :
If I’m looking to buy and hold SFR for cash flow, how do you recommend proceeding? Purchased SFR foreclosure in 2009 with $194K VA loan having 15 year fixed at 4.5 % APR. Current balance is $75K with estimated home value of $250K. We’re only 5 years away from payoff, and an $1,165 projected cash flow (not counting rent increases). Current rent is $1,800 per month, with negative $200 cash flow (if you don’t count equity as income). The thought of one property cash flowing over $1,165 is appealing, but the risk of lawsuit on a paid property makes me want to get a HELOC or refi and cash out. My credit score is usually at or near 850. Even if I don’t cash out, I’d like to buy property #2. Tapping equity in property number one would make financing number #2 a lot easier. Am I better off waiting a year and using my saved cash for a down payment, or tapping equity? After all, tapping the equity would delay the cash flow results I’m looking at seeing in 5 years. If I tap equity, what’s the best way (refi, HELOC, other) if my goal is to buy a second property?

A far as I saw, you haven't mentioned your current primary situation? Seems to me that your VA resource could allow you to re-use your borrowing allowance each time you refinanced out of your previous primary mortgage. For example, your current negative cash flow could become very positive if you took out a conventional investment mortgage for just the $75k that you still owe VA, payable over say 20 years starting now. 

[Not that I'm recommending only refinancing the amount owed].  

It will serve your purpose if you start looking at each subsequent primary purchase as a future investment property from the outset (rather than be caught up paying a high price just because you can pay zero down). 

ie. It should already be potentially worth significantly more than you'd be paying! 

[$194k in 2009; only $250k in 2018 = not particularly great!] Thank you for your service. All the best...

@Jason Dillard Great point on maintaining tabs on current basis in the house instead of only at the time of acquisition. Why do some people hold at 100% equity, while others flip ASAP or 2,5,or10 years? Is there a rule of thumb for useful points to exit or tap equity? Dollar amount? Time frame? Etc?
Originally posted by @Douglas Pollock :
@Brent Coombs at the time I was buying a home, and not considering or knowledgeable enough to discern a true deal. I also had some time constraints and family factors to consider.

Yeah, I got that. (You're certainly not alone with past non-optimal buying). But, from now on... right? 

@Brent Coombs My $250K estimate was a dated valuation from about two years ago. If Zillow is right, it’s closer to $300K. Still, if I hadn’t bought then the money would have paid someone else’s mortgage while I rented. While it’s not technically accurate to say the amount we paid while we lived in it was like paying rent to ourselves...it does feel that way. So my two years of use ‘feels’ like a freebie even though it doesn’t take a CPA to show otherwise. The bulk of buying has been paid for by my rent-to-myself method, and two tenants in 7 years. Extra principal payments knocked off a year, so that’s why I’m down to five years.

@Douglas Pollock , hmm. If you're serious about investing for cash flow (while not ignoring appreciation/value-adding potential), then you probably should reassess your "neither of us are ready to let number one go" philosophy. Yes, buy-n-hold is a good strategy overall, but, an exception can be when you already admitted that you were "not considering or knowledgeable enough to discern a true deal"! ie. I agree with Jason: Sell* that one.

* Especially if its market value is upward of $300k, not $250k. ie. Gross $1800/m is an even poorer ROI if that's the case!

Face it: "time constraints and family factors to consider" are not (as) applicable to your ex-primary anymore!...