Cash out refinance will turn cash flow negative?

33 Replies

I'm looking for ways to finance my next purchase. I'm could do a cash-out refinance on a rental I own since the LTV is 57%. Currently, it has $150/month cash flow. If I refinanced to an 80% LTV, I could get $180,000 to spend, but at that maximum level the cash flow would plummet to an $850/month loss. I wouldn't do THAT much, but how low would you let your cash flow go in order to unlock home equity for a new purchase?

@Douglas Goldstein if your new property covers the 850/month and gives you more than 150/month cashflow, then do it

Originally posted by @Fili Aguirre :

@Douglas Goldstein if your new property covers the 850/month and gives you more than 150/month cashflow, then do it

 Why?  That makes no sense?

@Douglas Goldstein if unlocking the equity gives you negative cash flow on property A, bit that allows you to purchase property B which gives you more than $150/mo cash flow, you now have 2 properties with more cash flow than you had previously. That’s a no brainer. If you took the equity and bought a non income producing asset (aka a liability aka a boat or nice car) that would be a big mistake.

Hope this helps and good luck!

@Douglas Goldstein

Are you using the cashout as downpayment to flip next property or buy and hold?

Reason I ask is... if its just temporary access to capital for a flip, then i would suggest trying a HELOC instead cashout.

In LA, prices are ridiculously high right now and its safer to assume theres a possible correction coming. That said, cashing out 80% would overextending your risk... especially if your at negative cashflow on 1st property.

Does this really need explaining?

Imagine he took the $180k out of property “A” and bought a $180k property “B” that brought in $1500/mo.

He now has $650 per month cash flow combined with zero more out of pocket. 

So you quadrupled your cashflow and control another $180k worth of property that you hope will also appreciate. Having one rental property is the most risky situation you can have. 

Ps. You’d be even better off putting down $90k each on 2 x $180k properties which would then cost you $2,000/mo based on your post saying $180k would cost you $1,000/mo. With that plan you’d have property “A” at negative $150/mo. Property B at positive $1000 ($1500-$500 new loan) and property C with same figures. 

Now you control an additionally $360k worth of property and have $1150/mo positive cash flow ($2k from B&C minus $850 from property A). Instead of $150. Almost 8 x the monthly cashflow, 3 x the properties, and LESS risk. 

Your income on your equity is exactly your current interest rate, if you can’t make more than that on another rental you’re in trouble. 

Originally posted by @Fili Aguirre :

@Joe Villeneuve What Michael said.

 You're rationalizing a bad deal by saying you can afford to make a bad deal.  Here's what's really happening.  You have a good deal (the 2nd property), that is being robbed by the bad deal (the 1st property).

Look at it this way.  Your money is working two jobs.  One job you are getting paid to work.  The other one, you are paying your boss for the privilege to work...and you're OK with that because you're working two jobs, and the 2nd one is the one paying your boss.  If your money started with the second job, and you added the first one to it, that would mean your money would be working twice as hard for less money. 

If the value of the 1st deal is the equity, and you want to access it (I would too), you have 2 choices:

1 - REFI it, and make the 1st deal a bad one now, or...

2 - Sell it, and replace it with another good deal like the 2nd one.  Either way, you would have two properties...but in the 2nd option both deals making money for you.

Don't get emotionally attached to your properties...or specific money in any property.

@Douglas Goldstein hmmm great question you can look at your next income property and make sure it cash flow above 850 cash flow and,/or you can do a heloc

@Joe Villeneuve believes that the value of a RE investment is dictated by the current cash flow.  This could be quite true in his market and be what constitutes a good buy n hold in his market.  However, the general value of an RE is the total return. 

The original poster has $180K of equity. I am assuming he put no where near $180K down (57% LTV). In addition, OP states it currently has $150/month cash flow. This cash flow is based on his original purchase price or last refinance. This property has produced an outstanding return if he purchased it at a high LTV. If he purchased this RE with a high LTV, his return on investment far exceeds the return from cash flow in the zero appreciation markets.

In traditional appreciation markets, the rent appreciation has an association with market appreciation; typically market appreciation is followed by rent appreciation.

The cash flow of a property is not dictated by the initial cash flow, it is dictated by the cash flow over the holding period.  High appreciation markets virtually always have better cash flow over any long term holding period.

So items to consider on whether to sell is: Can you handle $850/month negative cash flow?  For sure if you are purchasing RE that replaces that negative cash flow.  How confident are you of continuing long term market appreciation?  How confident are you of long term rent appreciation?  Can you find an investment that is likely to produce better overall returns?  How rentable is the RE? 

Do not judge the value of an RE solely based only on its initial/current cash flow as that is just one way that a buy n hold RE provides return.

Good luck

@Dan Heuschele

Here’s the history of the property if you’re curious:

It’s a stand-alone townhouse-style condo in Pasadena, CA, where rents are high and I’m confident it’ll appreciate in the future.

Bought it in 2012 as a short sale for $380k, $80k down.

Cash-out refinance in 2017. We used the money for down payment of the house we’re currently living in.

It now appraises at $800k. We owe $460k. If we take out 180k we’ll owe $640k.

Tenants currently pay $3,275/month which, after everything, is positive $150/month.

Pasadena is only getting more and more expensive, but it has risen in value so quickly that I worry about a correction or at least a long plateau.

@Douglas Goldstein

First, since no one else will probably say it, good job and well done. 

Second, for tax reasons of course you can count the $160k you took out to purchase of your primary home as an expense, but when figuring the property’s income you could exclude that amount. 

Realistically you have negative $80k invested in this deal, your returns are infinite already. 

I hate it when people say sell that sucker and buy a couple cheaper properties, and if you love your current property, don’t. But you are only collecting 0.4% of value in rent if it’s really worth $800k. 

The best financial decision would be to sell and buy something that makes more money. But that’s not the easiest decision. If you’re happy stay where you’re at with what you have. Maybe sell if/when current tenant moves out? 

Originally posted by @Douglas Goldstein :

@Dan Heuschele

Here’s the history of the property if you’re curious:

It’s a stand-alone townhouse-style condo in Pasadena, CA, where rents are high and I’m confident it’ll appreciate in the future.

Bought it in 2012 as a short sale for $380k, $80k down.

Cash-out refinance in 2017. We used the money for down payment of the house we’re currently living in.

It now appraises at $800k. We owe $460k. If we take out 180k we’ll owe $640k.

Tenants currently pay $3,275/month which, after everything, is positive $150/month.

Pasadena is only getting more and more expensive, but it has risen in value so quickly that I worry about a correction or at least a long plateau.

It has been an outstanding investment that would be cash flowing significantly more if you had not already extracted a significant amount of equity.  Your appreciation is $420K in 7 years on an $80K down.  The annual return from just the appreciation is in the area of 35% (hard to determine exactly without knowing the amount of equity a result of equity pay down).  In addition, your cash flow numbers would be very different if you had not already pulled out equity and you would have an additional significant return from the cash flow.  Then you have the return from the equity pay down and from being able to depreciate the asset.  I suspect without the refinance you may have achieved 40% annual return on your investment.

You have to decide based on market research what is the expectations going forward.  I always recommend to use conservative appreciation numbers; actually I recommend using conservative numbers (including maintenance/cap ex) for everything when calculating projected return.

You made an outstanding investment.

Good luck

Originally posted by @Douglas Goldstein :

@Dan Heuschele

Here’s the history of the property if you’re curious:

It’s a stand-alone townhouse-style condo in Pasadena, CA, where rents are high and I’m confident it’ll appreciate in the future.

Bought it in 2012 as a short sale for $380k, $80k down.

Cash-out refinance in 2017. We used the money for down payment of the house we’re currently living in.

It now appraises at $800k. We owe $460k. If we take out 180k we’ll owe $640k.

Tenants currently pay $3,275/month which, after everything, is positive $150/month.

Pasadena is only getting more and more expensive, but it has risen in value so quickly that I worry about a correction or at least a long plateau.

You basically turned an 80K investment into $340K in equity along with $150 per month net cash flow. And on top of that, the investment provided you with a downpayment on your primary home.  Yeah, that sounds like a real bad deal (this is extreme sarcasm in case any cash-flow zealots aren't picking up on it). 

I was in a similar situation as you last year as I had a few properties in prime Los Angeles areas that had skyrocketed. I decided to spread the risk out and did a 1031 exchange with one of the properties into a 4-unit in a gentrifying area of Los Angeles. The property is cash-flowing really well and I expect the value to go up over time as the area is changing for the better and the city is investing in the local infrastructure in preparation for the '28 Olympics. 

But every situation is different. As you mentioned, if you consider where we are in the current real-estate cycle, it might not be a good idea to max out your leverage at this time unless you can find a very good deal that will provide you with the kind of cash flow that will allow you to weather any corrections or plateaus. I personally got very lucky with my 4 unit deal as the seller was in a rush situation and desperately wanted to sell.

Is anyone concerned that if you are vacant 1 month you loose almost 2 years of cash flow?

Originally posted by @Douglas Goldstein :

I'm looking for ways to finance my next purchase. I'm could do a cash-out refinance on a rental I own since the LTV is 57%. Currently, it has $150/month cash flow. If I refinanced to an 80% LTV, I could get $180,000 to spend, but at that maximum level the cash flow would plummet to an $850/month loss. I wouldn't do THAT much, but how low would you let your cash flow go in order to unlock home equity for a new purchase?

Why not sell the property? Or do the cash out refi and then sell the property? $180k can be used to create much more than $150/month in income especially if you're able to BRRRR.

Everything is good until you have a vacancy on one or both properties?

@Fili Aguirre

Shawn means he’ll lose his $150/mo in cash flow times 24 months with 1 empty month because the rent is so high ($3300) one month empty out of 2 years will cost $137.50/mo. 

He’s not counting the $5,000 per month he’s made in appreciation every single month for 7 years straight. That’s why the $150/mo positive or negative just doesn’t matter. 

@Douglas Goldstein

Holy smokes! Sell it and find something with better rental numbers locally or buy multiple properties in another market! That was some serious appreciation. Nice!

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