New to REI, but considering a move ourselves - House Hack?

Question

My wife and I are just starting out in REI -- we are coming into some money from my stocks from my job and we want to invest some of it to work toward a goal of early retirement / financial freedom. We've been considering a long distance BRRR of a MFH, but at the same time, from a personal perspective, we're not happy with the neighborhood we live in for our primary residence, and we are considering a move. We would like to be in a nicer neighborhood (for those who know the area, we are currently in Lynnwood, and we would like to move to Seattle or Edmonds). But housing prices are still absurdly high in those areas, and it looks like future values are predicted to flatten out or even drop in some area. I'm concerned that a recession in 2020 could drive home values even lower, so I'm nervous about buying right now for fear we are still at the top of a bubble. From what I've seen we can get a lot more house for our money by renting, but my wife doesn't really want to rent because she wants to be able to make changes to whatever home we're in (paint walls, minor improvements, etc). Either way, we only plan to stay in the Pacific Northwest area for another 5-8 years until my daughter is little older, then we plan to get the heck out of here. Options we are considering:

A) Find some off-market deal (fixer-upper), then house hack it with the plan to rehab it, live in it ourselves, then refi on the new appraised value after 6-12 months to reclaim the capital so we can use it for more REI. Questions: will this work if we buy the property with a conventional loan? Would we need to buy in cash via a hard money lender? Can you even do this with a primary residence? I'm concerned that given how insane / saturated the real estate market is around here, there is almost no such thing good deal in Seattle / Edmonds.

B) Wait and see if values drop, then potentially buy on the dip (we have been waiting for a year to move - not crazy about this option since it involves waiting another year, and maybe being wrong about the downturn).

C) Tell my wife to suck it up, sell our house in Lynnwood so we can leverage that capital for REI as well, then rent somewhere in Seattle or Edmonds for our primary residence. (My preferred option)

Any thoughts?

Michael Haas · Answer

@Jesse Watson you can definitely pull any equity you create above 20% out of that deal - the "Rental" part of the BRRRR strategy isn't something the banks need for the loan, although having the rental income may improve your Debt-to-Income ratio and allow you to qualify for larger and more bank loans in the future.

Remember, refinancing will usually cost you a couple thousand dollars in fees, so you want to pull out a large enough stack of cash to justify those costs. Your interest rate will also drop a bit if you chose to leave more than 20% in the property.

Here's a real life example from one of Jess Haas and my recent deals, broken down with the different rates depending on how much equity you leave in the property. In this example our credit score is 740, we bought the property with cash (private money lender), and the property appraised for $675,000 after renovations.

80% Loan to value: loan $540,000

30 Year Fixed Rate: 4.375%; Rate Costs: 0.442 ($2,386); Principal and Interest Payment: $2,696

75% Loan to value: loan $506,250

30 Year Fixed Rate: 4.05%; Rate Costs: 0.29 ($1,468); Principal and Interest Payment: $2,431

70% Loan to value: loan $472,500

30 Year Fixed Rate: 3.85%; Rate Costs: 0; Principal and Interest Payment: $2,215

Hope that helps! Feel free to reach out to Jess or I anytime if you'd like to grab a coffee and chat more.

Michael Haas · Answer

@Jesse Watson - I'm not a lender, and I'm sure your lender will be able to explain this more clearly (message me for the contact info of some good ones!), but its your "I should be able to cash out some of the new equity for the same monthly payment" reasoning that is messing you up. Pulling cash out of your home through a refinance will almost always increase your monthly payment, because your payments are connected to the balance of the loan. Most investors pull the maximum equity out of their property in order to finance other deals, and accept that their monthly mortgage payment will be higher. A cash-out refinance has different goals than a rate refinance (which is what I think you're thinking of), where you leave your equity in the home and simply get a new loan to take advantage of lower mortgage rates. On a rate refinance you would see lower mortgage payments, but you wouldn't get your cash out.

In your example, if you fully refinance to keep you LTV at 80% you're refinancing a $600,000 mortgage into $720,000 mortgage. You're trading $120,000 of your equity for cash and that cash is coming from a higher mortgage amount.

Its worth noting that your equity and net worth has gone up as well - before you had $150,000 equity (20% of $750,000) and now you have $180,000 equity (20% of $900,000).

Does that make sense?

Jess Haas · Answer

Are you looking primarily in north Seattle? Personally, I have bought at the top of the market. It was a heavy fixer. I’m still not super pumped about how much I paid but I know that by adding a 2nd bath(making it a 3/2) will pay off. The house is also located close to a light rail station opening in 2023. Living in a heavy fixer is a pain in my experience. You are constantly dealing with construction mess and you never get the house to 100% completion. Right now at our house we have a big wall cavity open around our fridge because we haven’t decided how to do it and have learned to live without it finished. if I were you I would run the numbers on buying a fixer. There are also closing costs you would have to pay if you sold it in 5 years.

Jesse Watson · Answer

Good to know, thanks, @Dave Skow!

Dave Skow · Answer

Jesse - good luck with the options ...maybe  take a  few deep dives in the area you are interested in to see if there is anything even remotely close to  what you are  envisioning  ....this time of year is  not the best as  supply  is low ....if your  plans do  entail buying a new place - make sure your  loan/ financing needs  are  all in place  via  being pre aprproved ......as  far  as the  " cash back " refinance  question - two things to note  1) most lenders  will want to have you own the property  for  6 months ( or longer )  before being able to use the new appraised  value for a new loan  2) most  cash  back refinance  loans int eh range you are  mentioning  have a  max loan to value of  75%

Jesse Watson · Answer

Totally makes sense. Thanks for the explanation, @Michael Haas! I can take on a higher payment to access more of that equity. I think I am starting to get the refinance concept!

Jesse Watson · Answer

Thanks for the reply, @Michael Haas - Just to clarify, though -- I am still feeling stupid about how refinancing works... Lets say I buy a property for $750K with 20% down ($150k, $600K borrowed). I put $50K of my own cash into to rehab it, and then it re-appraises for $900K. I've created $150K of additional equity, and I originally put $150 down, so I now have $300K of total equity in the home. I turn right around 6 months later and refinance. Let's assume same rate, same terms. I'm getting a loan on the amount of $600K that I still owe, but now I have a 67% LTV, which means I should be able to cash out some of the new equity for the same monthly payment...

Using a refi calculator like this one, I plugged the numbers above in...https://www.lendingtree.com/home/mortgage/calculators/cash-out-refinance-calculator/...And playing with that, it seems like I can only pull out about $47K before the payment is higher than my original mortgage payment... Which is basically what I put into the rehab costs to begin with :-(

Sort of surprising-- I recoup my costs, but nothing more. That equity is not accessible unless I sell the home. Am I thinking about this right?

Seems like you either have to put a ton of cash down to begin with (or pay all cash), or you need to add an intense amount of value to re-access the equity via a refinance...

Jesse Watson · Answer

@Jess Haas - Yeah - we are tethered to the north Seattle area for the next 6-8 years at least, so looking at everywhere north of downtown, south of Shoreline. I ran some numbers on a fixer I found near Greenwood and it looks like we could get very good ROI by updating the space, and if possible, adding a bathroom. But I hear you on the pains of living in a heavy fixer.

Let me know if you need a good contractor - I have a guy I've started working with who is awesome.

The big thing I'm curious about is if I can pull the equity back out of the deal after improving the property. If I buy the property with 20% down conventional mortgage, improve it with my own cash, and then I get an appraisal post-remodel that appraises for more, can I get a new loan on the property and pull some of the equity out for more investments? It's sort of like a BRRR strategy, except without the rental part since we'll just stay living in the house.

Jesse Watson · Answer

@John Barrett - Sage advise, John. Thanks.

I think we are close to the same page now, it's just that we don't know how to meet our needs for living in a nice home and neighborhood in the present Seattle market, while also preserving some of our capital for some longer distance REI in more profitable markets. I am now leaning toward looking for compromise where we look for a cheaper Seattle property that has the potential to add a bedroom or a bathroom to improve its value.

One (perhaps foolish) idea I wanted to put out here was if anyone had experience planning to refinance after forcing its value to increase via a strategic rehab, with the goal of recouping some of the capital that went into the rehab?

Obviously, the key would be selecting the right property in the first place -- first of all, getting a good deal on something, under market valye, then choosing a property with potential for adding a bedroom or even a bathroom. Maybe an unfinished basement laid out in a way that would support adding a bedroom or a new bathroom on an existing water wall --  or choosing a property with an especially large bedroom with a layout that would support splitting it into two bedrooms via a new interior wall. It would be one of those "it either works or it doesn't" situations, depending on the floor plan, and I would aim not to try to increase the footprint of the existing structure unless there was an obvious "sunroom" opportunity (and no HOA to contend with). We would just have to be very strategic about the property and do some pre-research on the logistics of such projects.

For example, if I could get a good deal (under market value) on a 2 bed 1 bath (with decent square footage) into a 3 bed 2 bath, it could appraise for much higher after-the-fact, and we could pull some cash back out of the deal -- though probably not as much as I put into the rehab.

I've heard of doing these kinds of things as part of a BRRRR, but curious if there would be any reasons we couldn't do it as part of a house-hack / longer term flip? We plan on holding the property for at least 5 years.

John Barrett · Answer

@Jesse Watson I would suggest you and your wife spend some time to review all the options (benefits & drawbacks) and work to get on the same page.  No matter what strategy you choose to utilize it will depend on you both being on the same page and working towards the same goal.  I couldn't help but think of the saying, "a house divided against itself cannot stand."  Someone a lot smarter than me said that so it has to be true. :)

You have options but really no one is going to be able to determine the best living situation for you other than you and your wife.  Timing the market generally doesn't work out well for those that attempt it, you absolutely could be the exception but the odds aren't great.  Besides the downside risk of a market correction, don't forget to take into account all the transaction costs on a house hack.  While you will likely not pay any capital gains the transaction fees could easily eat up the majority of your profits.

Best of luck,

John

New to REI, but considering a move ourselves - House Hack?

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