To Re-Fi or not to Re-Fi?

Question

I'm a newbie investor in the NYC area. I'm focused on starting out with small apartment deals through buying and holding. My family currently owns a six unit multifamily free and clear of debt. I was recently talking with a broker and he recommended re-financing the six family first and have that cash on hand before I venture out to look for my first deal. His point being that I shouldn't wait to find a deal and then have to scramble to pull the money out of our existing property to buy.

This sounds right to me, but is it?

Giovanni Isaksen · Answer

@Luther Smith

Just to add on to what @Mike B. said, the $750k proceeds from the refi is 25% down on a $3,000,000 building.

I would go a step even further than @Jerry W. and say don't use the equity in your home to leverage into a deal via a HELOC. People forget that we spent thousands and thousands of years chasing tigers, bears and who knows what out of caves just to secure shelter and now we can buy shelter for little to no money down, but it still is shelter that protects us and our families. The last time people forgot that and started thinking of their home as a cash machine instead of shelter things didn't turn out too well.

Good hunting-

Jerry W. · Answer

@Luther Smith  welcome to BP.  If you have not already done so read the Learn section above it is loaded with great info.  I have never used a HELOC but it is my understanding those are only used on your personal residence.  I would suggest getting a line of credit on your apartment building, not a true refinance loan.  One you will be paying interest on every penny you borrow even if you never spend it.  Wit a line of credit you only pay interest on what you use.  You can always refi your new purchase later as it is owned free and clear as you used a line of credit to buy it.  With your refi pay your line of credit back down and repeat.  Just my 2 cents.  Good luck.

Mike B. · Answer

@Luther Smith Owning a property free and clear can be great for cash-flow, but depending on what your goals are, refinancing should be a consideration. You have only mentioned that you are looking for future deals, so I will assume you want to continue to grow your money. If you are living off of any of the current cash-flow, then that will be a consideration of how much financing you will choose to place on the existing property. Today's interest rates are some of the best seen in years, so taking advantage of this by placing as long of a term loan as possible with a fixed rate, will help you grow your money faster.

Leveraging your property with low interest money allows your to make a greater return on the remaining equity and allows you to make another return with the cash you pulled out. For example: Lets say your current 6 unit is valued at $1,000,000 and it produces an annual Net Operating Income of $100,000 (it could happen, right?) This means you have that $1,000,000 value with no debt as your equity amount. With the $100,000 NOI, you are seeing a Cash on Cash return of 10% (not too shabby).  Now lets say you don't need any of the cash-flow from the property to live on and can take out a 75% Loan to Value financing, with a 10 year term, 30 year amortization, and todays rates of around 4.25%. This means the loan value will be $750,000 (of which you will place in your pocket tax free to find another deal) and the annual debt service to pay the loan will be roughly $44,120. That means your cash-flow is now $55,880 ($100,000 NOI minus the $44,120 DS). If you divide this new cash-flow by your remaining equity ($250,000) you will find your new Cash on Cash return is over 22% (just a tad better than a Bank CD!!). And if you can keep pushing your annual rents by a greater percentage than your annual inflation on expenses, the return will go higher each year. Some additional benefits will also be growing the equity as the tenants pay down the mortgage each month and the tax savings from the interest payments making your taxable income lower.

Now you have a higher return, lower taxes, growing equity AND cash to go find a new deal to continue to grow your money (and you should surely consider leveraging the new property as well, in order to realize a greater return on that cash). This is called the Velocity of Money, and leverage (debt) can be a very good tool to increase that velocity. Just remember to use the tool responsibly so you don't over-leverage and have cash-flow problems, as that is where people get themselves into trouble.

Side note: There will also be financing expenses, so you might not get the full $750,000 in your pocket, but even if it is only $725,000 and you use that money in another leveraged investment, I will guarantee you will still be making a higher overall return than your original 10%. Hope that helps you make your decision and is not too rudimentary of an explanation.

Franklin Romine · Answer

Refinance with a fixed rate commercial loan.   If the property is free and clear what is your return on equity?  If the property will comfortably carry a 70% ltv, take the money out and go shopping.  Shopping for assets not a toy.

Frank

Derek Carroll · Answer

@Luther Smith  although i agree with @Mike B. and @Joe Fairless with the general idea of using your equity to leverage up and get a new property, be careful about how you do it.  You dont necessarily need to go out and do a refi or a line of credit right now.

You can wait until you find the next larger deal and then use this building as your down payment.  You'll cross collateralize both properties for one new loan and can come to closing with $0 out of pocket.  Just remember that total combined LTV should be around the 75% range.

This is almost the same as doing the refi now and then using the cash as a down payment, however you'll now have two sets of closing costs, you'll have interest expense until you find the next deal, and you might not get as much of a loan for a straight refi than you would if you combined the two into one loan.

Happy to explain further if you'd like.

Joe Fairless · Answer

@Luther Smith sounds like a re-fi is a very good option from what you've stated

Luther Smith · Answer

Oh, I see. Thanks. I'll be sure to look into it.

Mark Mosch · Answer

Home Equity Line Of Credit...

Luther Smith · Answer

Thanks for the feedback Chris. @Jassem, can you help me with the acronym HELOC? Thanks.

Jassem A. · Answer

I would probably go with a HELOC because the fees and interest rate to get started can be lower and you only pay interest on the amount you decide you need.

To Re-Fi or not to Re-Fi?

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