At what interest rate would a refinance no longer make sense?

39 Replies

I have investment properties with fixed rates of 3.375%, 4.5%, and 4.375%. There has been several six figures $$ in equity growth over the last several years, and my LTVs have recently been pushing 50%. I am looking to refi one or more of these back up to at or near 80% LTV, to pull out all that equity just sitting there.

I know interest rates are up, but at what point (0.5%, 0.75%) etc. higher rate would you say that it wouldn't be worth doing this? I appreciate your feedback.

@Andrey Y. the interest rate is completely irrelevant. If its 4% or 18% it doesnt matter. what matters is what are you doing with that money. Are you going on a $20,000 vacation or buying a new car or are you reinvesting the money and getting a return on that investment? I borrow money at 15% sometimes and I make a lot of money in return.

To summarize. Buy assets. Buy good investments. Borrow money at the lowest rate possible but dont let the interest rate cloud your judgement.  

Originally posted by @Alex Deacon :

@Andrey Y. the interest rate is completely irrelevant. If its 4% or 18% it doesnt matter. what matters is what are you doing with that money. Are you going on a $20,000 vacation or buying a new car or are you reinvesting the money and getting a return on that investment? I borrow money at 15% sometimes and I make a lot of money in return.

To summarize. Buy assets. Buy good investments. Borrow money at the lowest rate possible but dont let the interest rate cloud your judgement.  

Most likely, the funds would go to fund large apartment syndications as a passive investor. These should generate a 10-12% annualized ROI and 15-19% IRR (projected).

As with anything be careful that this is a slam dunk investment and the question to you is what is an acceptable return for your time and money? it sounds like you could borrow at 4% and make a nice return. Is that acceptable to you?

I think average LOCs will run from 3.5-5 depending on the terms, conditions and your financial strength. 

Originally posted by @Alex Deacon :

As with anything be careful that this is a slam dunk investment and the question to you is what is an acceptable return for your time and money? it sounds like you could borrow at 4% and make a nice return. Is that acceptable to you?

I think average LOCs will run from 3.5-5 depending on the terms, conditions and your financial strength. 

 Pardon my ignorance, I am not familiar with the term "LOCs".. are you referring to the time it takes to exit the investment?

If the new interest rates I am able to get are say 5.375-5.5% (seems very high to me).. would you still do the refi if I was able to pull out $50-150K per property? Cheers.

@Andrey Y.

So which is better?

- Pulling out the money at a cost of 5% annually to earn 10% annually OR

- Leaving the money in dead equity at a cost of 0% annually to earn 0% annually.

LOC is Line of Credit, an alternative to refinancing. LOC can be set up based on the equity of your properties.

Cheers... Immanuel

The simplest answer is to calculate what your additional interest expense will be due to the refinance (say an additional expense of $3,000 per year), and compare it to what your annual return will be from what you do with the money. If the second number is higher than the first, then it makes sense to re-allocate your equity.

Just make sure, of course, that you remain cash-flow positive after the refi, and that you're comfortable with the risk level of the new investment.

Hey Andrey.  Alex covered it pretty well...borrow at X% and invest it at X+% and make a profit on the spread.  Your investment vehicle (syndications) makes it a more interesting question because the membership would likely make a higher spread with their investment vehicle.  I would not bank on 15-19% IRRs.  If those returns were sustainable over long time periods, none of us would need to invest actively.  Maybe you can figure out what minimum return you would expect from syndications (through cycles), determine your spread from the borrowing interest rate, and decide if this spread is high enough to justify the risk.

I have a similar post that you may be interested in...trying to get feedback on expected returns from syndication during a downturn.  https://www.biggerpockets.com/forums/61/topics/478...

Originally posted by @Mike Dymski :

Hey Andrey.  Alex covered it pretty well...borrow at X% and invest it at X+% and make a profit on the spread.  Your investment vehicle (syndications) makes it a more interesting question because the membership would likely make a higher spread with their investment vehicle.  I would not bank on 15-19% IRRs.  If those returns were sustainable over long time periods, none of us would need to invest actively.  Maybe you can figure out what minimum return you would expect from syndications (through cycles), determine your spread from the borrowing interest rate, and decide if this spread is high enough to justify the risk.

I have a similar post that you may be interested in...trying to get feedback on expected returns from syndication during a downturn.  https://www.biggerpockets.com/forums/61/topics/478...

 I will take a look at that thread. If the syndicator is underwriting to a 13% vacancy for years 1 and 2.. the current building vacancy being around 95% without any improvements, and vacancy in the submarket and neighborhood is 98-99%, I'd say that should be a good hedge for any potential market downturn. Also, I have heard that vacancies stayed put or in some cases got LOWER during the last downturn in many "B" communities.

Originally posted by @Alex Deacon :

@Andrey Y. the interest rate is completely irrelevant. If its 4% or 18% it doesnt matter. what matters is what are you doing with that money. Are you going on a $20,000 vacation or buying a new car or are you reinvesting the money and getting a return on that investment? I borrow money at 15% sometimes and I make a lot of money in return.

To summarize. Buy assets. Buy good investments. Borrow money at the lowest rate possible but dont let the interest rate cloud your judgement.  

 

"the interest rate is completely irrelevant. If its 4% or 18% it doesnt matter."

I somewhat came to the conclusion that I can take the HML route to refi my property and scale up that way. As far as my understanding HML are usually high at 8%-12% for 30 year terms. I ran all the numbers with the BP rental calculator at 8% w/ 30 years and i still CF $300+ after all expenses as long as i continue to manage. I think most people would say 8% is on the high side compared to the typical conventional @ 4%. My question, Is there any HML out there with better terms ? Should i scale using HML or should i sacrifice getting the high paying job to offset my DTI to be able to get lending from a traditional bank ? I always thought stay away from higher rates.

Originally posted by @Andrey Y. :

I have investment properties with fixed rates of 3.375%, 4.5%, and 4.375%. There has been several six figures $$ in equity growth over the last several years, and my LTVs have recently been pushing 50%. I am looking to refi one or more of these back up to at or near 80% LTV, to pull out all that equity just sitting there.

I know interest rates are up, but at what point (0.5%, 0.75%) etc. higher rate would you say that it wouldn't be worth doing this? I appreciate your feedback.

Do a commercial loan on the new property, then lean on the free equity of the older ones vs refi. You keep your old rates and use the cash in the next deal.

@Andrey Y. I calculate my return on equity (cash flow divided by equity) to make that decision.  So, if I can pull out equity and put it to work at significantly higher rate on a larger deal (and the current property is still cash flow positive with the new debt)it's a no brainer for me.

Originally posted by @Ivan Barratt :

@Andrey Y. I calculate my return on equity (cash flow divided by equity) to make that decision.  So, if I can pull out equity and put it to work at significantly higher rate on a larger deal (and the current property is still cash flow positive with the new debt)it's a no brainer for me.

 Ivan, thanks for your feedback. At what return on equity would you say its too low, to go ahead and pull the trigger?

Detailed ROE on these properties are here in my OP:

https://www.biggerpockets.com/forums/88/topics/456...


Originally posted by @Ivan Barratt :

@Andrey Y. those figures would be too low for me to "stay in the deal." I'd look to extract cash and put it back to work in something else yielding more...

 Thanks Ivan. Do you look at return on equity in similar terms to return on cash invested? If the annualized return on cash is good, do you place a large emphasis on this.

Originally posted by @Andrey Y. :
Originally posted by @Ivan Barratt:

@Andrey Y. those figures would be too low for me to "stay in the deal." I'd look to extract cash and put it back to work in something else yielding more...

 Thanks Ivan. Do you look at return on equity in similar terms to return on cash invested? If the annualized return on cash is good, do you place a large emphasis on this.

Depends on how long I have owned the deal. If I have increased the value and/or paid off a lot of debt; ROE becomes more important. COC is more important in the beginning in my opinion. The name of the game is getting your money to work hard for you. From there it's up to each investor to look through their respective lens and decide what matters most to them.

Originally posted by @Andrey Y. :

I have investment properties with fixed rates of 3.375%, 4.5%, and 4.375%. There has been several six figures $$ in equity growth over the last several years, and my LTVs have recently been pushing 50%. I am looking to refi one or more of these back up to at or near 80% LTV, to pull out all that equity just sitting there.

I know interest rates are up, but at what point (0.5%, 0.75%) etc. higher rate would you say that it wouldn't be worth doing this? I appreciate your feedback.

 Nice round numbers below, not actual numbers. I'm not including amortization, or that you may be able to write off the interest, for simplicity sake. 

Current balance: $400k @ 4.25%, ~$17k/yr in interest

New balance: $500k @ 4.75%, ~$23,750/yr in interest.

Difference of $6750. But we're paying that $6750 in interest for access to just the new $100k, we were already paying $17k for the old amount anyways. So what does it mean if I'm paying $6750 extra for access to $100k?

Well, the price of access to money is always expressed as an interest rate. There is no reason we should change that here. What's the price just on this $100k I pulled out?

$6750 / $100k = 6.75%.

Is your cash on cash return on investment going to beat 6.75%? Yes? Great, go for it. No, it's not going to beat 6.75%? Go listen to more podcasts, network more, and read more BP. :)

Obviously, I'm sure you can see that the existing 4.5% one is more tempting to do than the 3.375% one. As you look at giving up the lower and lower interest rates, you as an investor need to be finding better and better deals, or the marginal cost of money wont make sense. 

@Chris Mason fair points my friend however, my RESIDENTS/TENANTS pay the debt down for me. The obligation comes out of rental income not my pocket. The true cost to me is less than you stated IF the property can support the higher debt load. ROE on existing properties should also go up.

Originally posted by @Ivan Barratt :

@Chris Mason fair points my friend however, my RESIDENTS/TENANTS pay the debt down for me. The obligation comes out of rental income not my pocket. The true cost to me is less than you stated IF the property can support the higher debt load. ROE on existing properties should also go up.

 No disagreement, I did leave that out, in addition to the tax benefits and amortization as mentioned. If my suggested uber conservative calculation above yields 18% or 25%, then you've got more number crunching to do along the lines you suggest and who knows what the final yes/no answer will be (it'll depend on how financially conservative or liberal the investor is). 

But when that most conservative calculation possible comes out at a Wall Street index fund number, and we know we beat index funds with real estate anyways (or we wouldn't be here), then we're done. :)

@Andrey Y. Oh boy, I'm the ONLY person here (and in all of the forums) that will come out and say 50% LTV isn't a bad thing. I think I'm around there if you factor in my personal residence into the equation. I'm not opposed to "more debt" but I wouldn't go in and trade out of a 3.375% interest rate. Others would. It makes sense on a spreadsheet. Analytically it's a smart play. You get to capture the spread when you deploy the capital and get a return. But you also do maximize risk. There's something nice (for me) knowing that if the real estate market drops 20% I'm fine. If collected rents drop for me, I'm fine. I'm probably not *happy* but I don't have to sell, liquidate, etc. If you're at 80/20 across the entire loan portfolio and values drop by 20% then...well...you're...not fine. Or, more accurately, you've now limited your options. With zero equity you're coming out-of-pocket with any costs to sell. Will this happen? Probably not. In fact, I'd guess that it won't, I'd wager that it won't, and if I thought it would I'd probably have my properties on the market.

But I do have to sleep at night so carrying a 50% LTV makes me (personally) all warm and cuddly. I can't speak for you. For others here having 50% LTV would probably send them into cold-sweats because of suboptimal capital allocation!

And to make this even *more* anti-BP-traditional-wisdom I'd have to look at the absolute dollar-value benefit for me.  If I have a good (easy) thing going, never have to worry about making mortgage payments with cash-flow, etc. I'm not going to monkey with that for another $100 per month or $200 per month (net, after taxes, etc.)  

Okay, BP realm, I'm ready to be castigated and thrown out for awful heretical thoughts...     

I agree with Andrew Johnson on this one, for this phase in the RE cycle. To throw in a contrarian spin ... if you are going to go cash out refinance to invest the equity, then the best time to do that IMO is AFTER the market crashes. 1)If all the numbers still work out with the property you are cashing out on in a crashed market, then you probably have a good margin of safety. 2)There are more great deals to buy with the money you pull out after a market crashes. 3)Often times the best (lower) rates are to be had when the economy is in distress. To be fair the counter arguments are that it can be harder to cash out refi after a crashed market, but I've never had an issue, and cash out refinancing after a crash probably won't likely make you all feel all "warm and cuddly", which is part of the reason it works so well.

Originally posted by @David Faulkner :

I agree with Andrew Johnson on this one, for this phase in the RE cycle. To throw in a contrarian spin ... if you are going to go cash out refinance to invest the equity, then the best time to do that IMO is AFTER the market crashes. 1)If all the numbers still work out with the property you are cashing out on in a crashed market, then you probably have a good margin of safety. 2)There are more great deals to buy with the money you pull out after a market crashes. 3)Often times the best (lower) rates are to be had when the economy is in distress. To be fair the counter arguments are that it can be harder to cash out refi after a crashed market, but I've never had an issue, and cash out refinancing after a crash probably won't likely make you all feel all "warm and cuddly", which is part of the reason it works so well.

 After a market crash, lets say Hawaii properties lose 15-20% of their value (like they did in 2008-2010. Some condos in Vegas, Pheonix, and Miami lost 80-90%). Even if there were lower rates, wouldn't I be able to pull out LESS equity since appraisals will be lower?

Great question!

I really can't answer since I don't know what you are going to do with the money you are taking out.

If it's holding you back from making 15% returns from rental property the rate you are going to get on the cash-out shouldn't matter that much.  Right?