Your opinion to risky to refi now?

Question

I am considering trying to refi a property. The reason for this would be to buy more real estate. However I think we may be at the top of the market and I am concerned that there could be no equity in it if there is a correction?

Love to hear your opinions.

Todd Dexheimer · Answer

I am buying value add deals, where the deal will be worth in most cases 2-4% more than the market cap. I use conservative underwriting with high vacancy and low rent. For instance, a 20 unit I bought and renovated the entire thing will be at a 12% Cap using my analysis. I used 10% for vacancy (market is 5.2%), $595/month/unit rent (currently getting $625/mo). I also use high repair expenses, etc. I would not go into a deal that doesn't have room for mistakes/market movement, so I don't think you're conservative. You can always get a line of credit set up, so if you find the right deal you are ready. Then if you buy something you can change the debt to long term.

Anthony Mott · Answer

ABSOLUTELY NO RISK, THIS IS A MYTH

If you are cash-flowing and generating profit from your properties, use your equity. I would do this up to whatever LTV you can get loans on them and only be concerned with my ability to cash-flow the property. The Real Estate Market is always going to fluctuate. In fact, the idea that the market dropping on commercial or multi-family properties being a negative or stress-inducing area, especially in regards to properties that are cash flowing is somewhat illogical from an investor's perspective. There are basically only two reasons why it can be a bad thing.

1) Your Cash-flow is your source of income. If you are relying on your Cap for income, then the solution isn't to modify your loan by increasing your equity. I would suggest that you are over-capitalized within a single sector.

Effective Cap rates are the only thing that matters. Here are a few ideas that I think are grossly misunderstood and taught within the industry:

1) Equity has an effect on future equity- Absolutely !! Unfortunately not in the way that drive most of the common homeowner or investor thinks. It absolutely has an effect on your ability to create wealth at an accelerated rate. Suppose my commercial building is worth 3.5 million at 5.5%. I can go to 70%, I would be at 2.8- $19,261

I can get it to 95% so this leaves me at 3.325 million with payment of -$22,872 - I am cash-flowing $282,064 with a Cash on Cash return above 8%.

This gives me 525,000 in cash, which because I am netting 300k annually on my leases, I'm in a better position at 95% than I am at 70%.  I use the "dead" money to acquire 2 other properties at 1 million each. What did I risk? What did I save?  I risk the first years improvements on my property and the leases of 900k, which is now offset by a loss on the land of 22%. Suppose I only net 25k annually on each property- I have maintained my "equity", I haven't lost anything. I actually would have incurred a net loss on my cash-flow by reducing my LTV to 70%.

I have a higher basis in the event that I want to 1031( I am using the assumption that I only operate one llc for the example of a 1031 exchange.( I don't want to delve into this too much but in order to meet 1031 requirement, this is why I use a single purpose llc for every acquisition, gives me hundreds of options to 1031, most of which have nothing to do with Real Property). I only bring this up because whether you are planning on a 1031 or wealth building for generations, I want to realize my basis as early as possible in order to avoid eating up years of paying a loan down.

I only care about my Cash on Cash return, Total Return on Investment, and  my annual cash-flow.  As long as these are positive, LTV should only impact decisions of how much I can borrow on my property.

I broker and acquire deals( they are only deals because someone used the illogical thought that LTV's impact equity)all of the time because of these two themes. my partners and I just acquired a business for 2.1 million( 300k above the valuation that the seller listed but 400k lower than the listing. In just these 5 years, the previous owners spent 4.8 million. While netting 140k annually. I made the offer of 2.1 because they had paid off their 1.8 million dollar loan, pulled out 400k to start another entity, and then made some absolutely preposterous decisions which resulted in a 2.8 million dollar tax credit. I bought them separately so I could adjust their accounting for depreciation( 150k). I then sold the entity solely for the credits at 70 cents/ dollar and assets for 560k. We now own the property and assets, this deal cost us 400k. I paid 10 on the money for 60 days.

It may seem like I'm tooting my horn, this is not my intent. I also immediately borrowed money on the land at 150% LTV,based on the surrounding land comps of 11.50 per sq. ft.

I point this out because most of the theories are the problems with SFR's and overextending yourself. The best thing that banks perpetuate during a downshift in sales prices is the problems caused by the result of poor Consumer spending choices, which gets blamed on equity. I used the "dreaded" option arm, or negative amortization loan, to increase my equity in my Primary Residence by 650k in 4.5 years. I saw my loan increase by over 125k from negative am and  my LTV went to 106%( though my actual basis increased by 37% offsetting the 16% shown on my loan statement.

Joshua D. · Answer

@Eric Bilderback

I see what your saying, It is fun to talk in generalities about what might happen. I truly enjoy talking markets and different investing strategies.

However, at the end of the conversation, buying GREAT deals always wins out for me. You never reduce equity positions when you get great deals. You just transfer it, and watch it grow.

For ME the right answer is use equity to buy more deals, especially if i can get ARV's that are double of  the purchase price.  I know the market would have to drop by 50% for me to be underwater and rents would have to do the same.  I am comfortable with it as long as I hit those numbers.

And i never use up the equity, I just move it to the next house and double it.  Puts me in a stronger position for the next crash.

Also I am in Montana, we skipped out on the last few recessions, we hardly got hit here. but we hardly go up in value as well.

Just more of my rambling...

Joshua D. · Answer

Great question! However not one you actually want to get a specific answer on because their are a million variables...

To help recession proof your investing you want to only buy GREAT deals. Cash flow like a cow, have tons of built in or forced equity, and will be desirable as a place to live no mater what (Location).

If you are cashing out to buy deals like I described above than you will be in good shape. If however you buy Properties where you had to blur your eyes at the projections to make the numbers look black instead of red, then you might want to hold the phone... like permanently.

Buy good deals...

Eric Bilderback · Answer

@Joshua D.

Here in Oregon we are a microcosm of California and MF has close to doubled I bet.  Damn California’s come up here and complicate my investment strategies, no wonder my grandpa is paranoid about them.  Only a joke people.

Todd Dexheimer · Answer

I did a refi on a lot of my properties recently. I pulled out equity, but kept the LTV at 70%. My properties have commercial loans on them and I was able to lock in at 4.5% for 10 years with a 20 year am. If the market crashes. I don't have a lot to worry about. The properties currently cash flow very nicely and I have 10 years to pay down the mortgage and wait for the market to come back up. If the market goes for 5-7 more years, which I think it will, then I can sell then or hold or even refi once again for another 10 years.

I would say refi now if you can get longer term debt.

Adam Adams · Answer

Sounds like you're in a pickle!

Refinance while you can and interest rates are low, and invest the balance into something conservative.

Goodluck!

Anthony Mott · Answer

.

@EricBilderback

Anthony Mott · Answer

I don't want to sound conspiratorial but we need to get rid of GSE's, repeal Dodd-Frank( I literally could write a book about how terrible this is for Consumers), eliminate all bureaus and their illogical and sham operations( hopefully they go bankrupt through Class action). MA, AG filed suit just recently. Most importantly, we need smaller banks to get back into lending

I apologize for the length of my response. I did want to make two additional comments. 1) You said:

Rents have gone up considerably in the last few years which makes my property more valuable??? ( This might be where you feel like we disagree.) I actually think you are spot on with this statement. Because of this and the facts that for Rents to drop, it would take some serious changes( changes that won't happen because of any kind of reform from the Government) to our entire economy before you were kind of close to being in a position where that happens.

Most importantly, you are being so overly conservative on your assumptions that I believe it actually doesn't benefit you. Todd's response ( IMO) was fairly close to spot on. I wouldn't get a line of credit, in a market where you would want it, it would be accelerated or forgiven at a discount.

Equity- utilize it. You are actually increasing your risk.

1) Having it sit dormant does nothing for your, rents have beat inflation over the last fifteen years. As a mental exercise, close your eyes and pretend I am a financial advisor, seeking an investment from you. Eric, I would like you to invest 500k into one of our funds. The actual yields of 10% AROR are actually just the percentage I had our fund manager input into the Pro Forma we sent you. The reality is our Annualized Rate of Return has been 0% since the funds inception( 500 million years ago). I hope we can continue to input that % or even higher. **Full disclosure**Here is a chart courtesy of CBPP on Rents Rise Median ( included with utilities) vs. Median Income

https://www.google.com/url?sa=i&rct=j&q=&esrc=s&so...

In fact almost all data available shows that Rents haven't dropped significantly since mid 80's.  Can we count on you to invest in our fund( even though you will lose money).  We should also include that as you contribute more capital to the fund, your Revenue will be higher, but your net income will drop as a result of your tax basis. We also need to warn you of your exposure to liability in a Civil dispute.

I hope you understand my point, I am not making fun of you. I actually have closed 100's of borrowers by asking them if they would seek and investment like this( No way!, Not a Chance, etc.)

I have clients that pull equity out so that they can keep it working for them. I completely disagree with your conclusion that you cant beat the market, you already are.

Anthony Mott · Answer

You are very welcome. Thank you kindly for the response as well as some feedback to be wary of??? I will try to give you my opinion in a much shorter response than the book I wrote earlier( Haha). I will outline some bullet points and I would love to hear alternative thoughts, opinions, and a specific flaw( understanding I cant see the future)

- Rent contractions of 20% in the near future is essentially impossible. In retail, yes, but that's only one sector that I would be worried about and rent would be the least of my worries.  As far as rents from Multi-family,Commercial Business, and SFR's( not a chance).

A few statistics which leads me to believe this:

1) Multi-family construction- 30 yr. high -b)7%= drop in Vacancy( lowest in 30 years) c) 3.5% increase in rent( fastest in 30 years. Every measured level from Age, Income, to Household type have increased the Rental market share.

2)It's a Supply and Demand Issue, both in SFR rentals and multi-family- 15 year incline. It's also a Macro-economic issue. Wages are increasing but not at same levels of Rents.

3) Wages could triple and go up but we would still be in a very similar situation. Federal growth has dropped an average of 100k+ housing units which are subsidized. I have worked on Section 8 projects through HUD to utilizing almost every subsidy available.  This wouldn't make much of a dent even if it was increasing. The housing market and subsequent rents continuous rise is predicated on the costs of construction because of over-regulation, etc., etc.

4) Technology and efficiency- I am an advocate of innovation and capitalism, unfortunately where Technology has made purchasing or pricing out a rental a million times easier, one of the primary reasons why this wont have a net-positive impact is because it eliminates the income that would be generated throughout the entire Industry.  As someone who has sold and bought hundreds of properties, what used to take me 2-3 days can be done in less than fifteen minutes. ( My 1st flip made me around 80k, it took me 3 months, and I netted around 46k. I knew plenty of buyers and people who wanted to fix and flip/hold. I went and met with the Portfolio/ Inventory Manager of National to regional banks. I would look at 3 criteria: 1) length of mortgage the bank had held 2) length of time it had been unoccupied 3) Comps.  I would offer 40-50% LTV on assessed value( 20-30% under appraisal if in good condition. I had to spend hours sifting through records. I would then sell it at 10-15% over my price to someone looking for a deal. Reciprocal Strategy created a great pathway for myself, the buyer, and the bank( they usually had already made 2X on the assessed value. Revenue now becomes Write-off). I can do this within 5 minutes right now.

5) I worked with 5 million dollar funds to 5 billion dollar funds, and they all stopped lending. They waited for the full impact of recession, Rental properties( both SFR and Multi0 are 90% controlled by Funds i.e. banks. They control the market. =70% swing in 3 years

Your opinion to risky to refi now?

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