cashout refi vs HELOC on investment property

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cashout refi vs HELOC on investment property

Michinori Kaneko
Rental Property Investor · NY · Member since 2018 · 571 posts · 332 votes

Hi all,

There was a property i was hoping to perform a BRRRR strategy, but realized rent is not high enough to support mortgage on 75% LTV to yield enough positive cashflow after cashout refi. the cashflow is like $30 a month, but the principal repayment is about $3600+ per year. Moreover, unlike a true BRRRR, even with 75% LTV cash refi, i'd still be short about $5-10k of cash (meaning i can't pull out all the money i put in between purchase, rehab, and closing cost), which puts me around 40~70% total return only including principal repayment + annual cashflow (exclude appreciation in the property and 25% equity that i built). So looking at it as a whole, even though I end up with some cash in the investment i think it would turn out to be a great investment. The question is, what if I don't cashout refi? What if I setup a HELOC instead? this essentially allows greater cashflow when i don't need the money, but will also allow me to take out cash as I need. Even if I cashout refi, the cash will be sitting at a bank earning 2% interest rate (annually) until i source another deal and put the money to work, where as with HELOC i wouldn't have to pay mortgage/interest on it until I pull out the money. the only downside is probably that interest rate on HELOC will be higher than if i used freddie/fannie loans and its variable rate. Are there any other considerations I should have? why would people prefer cashout refi over HELOC in the BRRRR strategy? Thanks for your help and clarification.

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  • Mike Roy
    Rental Property Investor · Bath, ME · Member since 2014 · 220 posts · 288 votes
    7y

    @Michinori Kaneko - The primary purpose of the BRRRR strategy is to recycle your capital continually into more deals and create infinite returns on your initial investment. In order to achieve this, you need to identify deals that are priced well enough such that you can rehab to an ARV that enables you to refi out all of your initial investment and still generate enough cash flow to mitigate your holding costs and have a little left over for yourself. The great thing about BRRRR is that, if you do enough of them, the accumulating cash flow from each one will eventually add up to enough to cover your living expenses and let you retire.

    It sounds like you have a deal that is close to BRRRR-worthy, but not quite. If you just buy deals that let you pull almost all of your money out and produce negligible cash flow, it wont be long before you are out of investment capital and have hardly any cash flow to show for it.

    I would suggest that a "good" investment is one that pays you a reasonable return for putting your capital at risk.  If you're annual cash flow is $360 and you still have $10k left in the deal, that's a 3.6% cash on cash return.  Is that enough to compensate for the risks of ownership as well as the effort to rehab the property?  Also, with a margin that microscopically thin, what are the odds that you're down $30/month (or more) instead for a negative return?

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  • Michinori Kaneko
    OP
    Rental Property Investor · NY · Member since 2018 · 571 posts · 332 votes
    7y

    Hey Mike, I've been primarily focusing on cash on cash return until now as well, but why are some of us not looking at principal repayments? That's also a gain because i can technically pull out cash out of it if it accumulates enough, which can be reinvested.  true, cash on cash return is low, but that's also because my mortgage payment will be larger, and therefore larger principal repayment as well.  

    I've been hunting for BRRRR deals but i have not found any in the area I'm investing in. even the deal i mentioned above came to market yesterday 4pm, my broker went to look at it today at 9:30 Am, we had an offer by 11:30 but they already had few offers and they got so many that they are only accepting best and final offer by tomorrow.

    Good news: my PM went to look at it, she thinks we can pull another $100-$150 rent per month. that increases the cashflow quite a bit.

    Bad news: she also thought the we need way more rehab then my broker thought, which doubles the amount of cash i am unable to pull out.

    All in: about 7.5% cash on cash return, and 30% "return" if you include principal repayment. Probably not pursuing this project as I do not want to tie up $20k of capital on this one. 

    However, my question remains what the benefit and drawback of using HELOC over cashout refi. not whether this is a good deal or not. I was just using this deal to illustrate an example. With cashout refi, you can "count" the principal repayment as a return because you are technically building equity. But you also pay interest on it, which allows you tax deductions. With HELOC, you don't have to pay principal or interest, so you get to pocket that money. it's just that you don't get tax deduction on the interest. I think it ends up being the same, but HELOC allows more flexibility in utilizing the equity. with cashout refi, you can only use the equity you built by cash out refi again in the future. HELOC you can draw and payback as much as you want. What am i missing?

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  • Nicole Hoss
    Johnston, IA · Member since 2016 · 129 posts · 50 votes
    7y

    @Michinori Kaneko I use our HELOC to purchase properties in cash and then do a cash out refi to pay back a portion of my HELOC loan. So I do both and take all the tax advantages that my accountant can find for me. Also, the TK properties I purchase are pretty low priced in Indy and I can still make it all cash flow very nicely.

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