Explain how cash-out financing or HELOC will help me grow.

6 Replies

Let's say I own $1M in real estate, 100% equity (I don't, but round numbers are easier). I want to either HELOC or cash-out finance in order to purchase more rental property. Can you just read my line of thinking below, and tell me if this is how it works, or if I'm completely missing the strategy?

So - if I borrow 75% of my equity ($750k) at 6%, and subsequently buy a 10 cap property (10% return on a cash purchase, about average for my area) for $750k, that will net me a 4% overall return on that new property, or roughly $30,000 annually.

I've already taken into account taxes, vacancy, repairs, management, etc. in the 10-cap figure, so the 4% return after the loan is a true 4%.  Am I on the right track with this thinking? 

It is obviously much more complicated than that, but yes, you are on the right track. You borrow for less and invest for more than your cost to borrow. Personally, I would seek much better numbers, though. And you need to make sure that your numbers are correct. There are a lot of variables in real estate and the mistake a lot of investors make is to not factor in all of the expenses they will face. So I would not just go off of a cap rate, but off of the actual (hopefully realistic) numbers that I project for a given investment.

Exactly right.  Now lets add in two benefits you didn't mention.

1) If you had 100% equity, your cash flow probably exceeded your depreciation expense. Therefore, in addition to property taxes, you will pay income taxes Once you have leveraged up, you can get to a point where you will pay ZERO income tax even with the increased cash flow. (Awesome, isn't it!)

2) Now you own $2M in assets instead of $1M. Assume there is zero appreciation. After your tenant has helped you pay off the loans, you are now worth $2M instead of $1M. However, if you do get appreciation, you now have x2 increase in net worth over time. (Also awesome)

If you manage it well, leverage is your friend.

Or even better-and rather simply- you invest that $750K you borrowed against your property not into $750K worth of additional property but you put it down on $1.5MM (or more!) in additional property- then you are the proud owner of $2.5MM in property will all the other benefits you and Greg Scott have discussed..

A cap rate only measures what the market is paying for the current years POSSIBLE NOI. In todays market a 10% crap rate probably means someone is trying to unload their crap on you.