Use exisiting equity to buy another investment property?

18 Replies

Hi, I am a newbie from California here on BiggerPockets and I love all the great information I've been reading. I have lots of questions now but hope to be able to answer some in the not-to-distant future!

Here's my situation:

  • The home that I live in has about $400K in equity. I refinanced it two years ago for 30years @ 3.5% and I have pretty low payments (It's worth around $600K).
  • I have a rental condo with about $125K in equity. Rent covers principle, interest and assoc. fees but does not cover about $3400 in taxes.

My original plan was to let the condo get about $200K in equity and then sell it and pay off my home. However, I am wondering if I'd be better off taking some of the equity out of the house and buying something like a duplex and hold on to it.

Here's my dilemma, while I have quite a bit of equity, I own my own business and show very little income. I also am an adjunct online college professor and receive very small W-2 wages that I can account for.

Does anyone have any suggestions about how to go about getting financed to purchase a duplex? I also have about 350K in 401k accounts and I'm over 59 years old so I can tap that money without penalty. I also have a HELOC on my home for $100K and it currently has about 20K of that which is used. I have an excellent FICO score. Keep in mind that California duplexes are probably in the $775K - $900K range or more.

Thanks in advance!

Bill Briscoe

Have you considered allowing your retirement plan to purchase the property? Your funds could be used as a down payment conjunction with a non-recourse loan to purchase the property.

Hey Bill! Welcome to BP. I'm up in Venice, so not too far north of you. Sounds like you've done great with your properties here.

My first thought is, definitely use the equity to buy more. It's the best way to snowball yourself towards financial freedom. However, don't use the equity to put yourself in non-performing debt. What I mean by that is, if you buy an investment property that will keep you negative every month, that isn't good. A duplex costing $775k-900k is extremely expensive because you will never be able to collect enough rent on those to actually make money on them. So in that case, you would just be paying compounding interest to go further in debt. Unfortunately it's very hard to find CA properties that would actually allow for a profit. Other states, very easy, but here not so much.

So I recommend using equity to buy more properties IF they will produce positive cash flow. If they won't, I'd hold off because it won't get you anything.

Thanks for the quick replies. I have considered using my 401K to purchase the duplex though I had some concerns:

  • I understand that there are a lot of restrictions. For example, I would never have the option of moving into one side at a later date, should I decide to or need to.
  • I was hoping to put some of the equity (from my home) to work that doesn't have the restrictions
  • Due to the self-employment issue, still wondering if I could even qualify
Originally posted by @William Briscoe :
Hi, I am a newbie from California here on BiggerPockets and I love all the great information I've been reading. I have lots of questions now but hope to be able to answer some in the not-to-distant future!

Here's my situation:

  • The home that I live in has about $400K in equity. I refinanced it two years ago for 30years @ 3.5% and I have pretty low payments (It's worth around $600K).
  • I have a rental condo with about $125K in equity. Rent covers principle, interest and assoc. fees but does not cover about $3400 in taxes.

My original plan was to let the condo get about $200K in equity and then sell it and pay off my home. However, I am wondering if I'd be better off taking some of the equity out of the house and buying something like a duplex and hold on to it.

Here's my dilemma, while I have quite a bit of equity, I own my own business and show very little income. I also am an adjunct online college professor and receive very small W-2 wages that I can account for.

Does anyone have any suggestions about how to go about getting financed to purchase a duplex? I also have about 350K in 401k accounts and I'm over 59 years old so I can tap that money without penalty. I also have a HELOC on my home for $100K and it currently has about 20K of that which is used. Keep in mind that California duplexes are probably in the $775K - $900K range or more.

Thanks in advance!

Bill Briscoe

HI William,

With Fannie Mae loans against financial assets are not counted in your qualification (debt to income - DTI ratio) so this means you could as an "option," acquire up to 50% or 50k which ever is lower on your 401k funds to put as a down payment on your duplex or pay down debt. The loan provisions depending on where you work may have additional restrictions but usually its a 5 year loan term on personal loans to your 401k with interest and principal payments back to your 401k and on primary residences you can obtain up to 15 year terms (generally).

Since you have such a great rate with the first I would only consider taking a 2nd on your home if the terms are favorable enough but the advantage of taking your 401k loan is that you'll be paying interest back to yourself usually around 4.25% depending on who administers your 401k program.

If you're purchasing a duplex you will need more down payment min of 20% but preferably 25% if you'd like the better pricing. The 5% down payment difference will be a huge difference for investment property pricing.

If I were you I would obtain funds from the least expensive places first like your 401k, then HELOC which is 2nd least expensive/tax deductible, and then move on to the equity within your condo rental, and then your cash/savings or other portfolio assets to purchase the Duplex.

Another question that was not asked was what you hope to achieve in purchasing this duplex?

Albert Bui, Lender in CA (#345453), WA (#345453), TX (#345453), and TN (#345453)
949-514-5106
Originally posted by @William Briscoe :
Thanks for the quick replies. I have considered using my 401K to purchase the duplex though I had some concerns:
  • I understand that there are a lot of restrictions. For example, I would never have the option of moving into one side at a later date, should I decide to or need to.
  • I was hoping to put some of the equity (from my home) to work that doesn't have the restrictions
  • Due to the self-employment issue, still wondering if I could even qualify

I would be willing to help you review your qualification on the third bullet you mentioned if you'd like. There are only 3 basic areas: Credit, Income, and Assets.

- Assets - you seem like you should have no problem rather your dilemma is probably how do you best utilize and put your equity to work as tax favorably as possible with the most upside and the least downside it seems

- Credit - will need to be processed to determine scoring and credit history, will be important

- Income - sounds like it will need to be reviewed or may be of concern because to qualify for the duplex you'll need approx 2.25 dollars of gross income for each dollar of monthly obligation. So for instance if you have 3000 mortgage, net rental on condo is -325 per month, 500 credit cards you'd have a total of 3825 in monthly obligations X 2.25 factor = min income of $8606.25 monthly or $103,275 needed

Albert Bui, Lender in CA (#345453), WA (#345453), TX (#345453), and TN (#345453)
949-514-5106
Originally posted by @Ali Boone :
Hey Bill! Welcome to BP. I'm up in Venice, so not too far north of you. Sounds like you've done great with your properties here.

My first thought is, definitely use the equity to buy more. It's the best way to snowball yourself towards financial freedom. However, don't use the equity to put yourself in non-performing debt. What I mean by that is, if you buy an investment property that will keep you negative every month, that isn't good. A duplex costing $775k-900k is extremely expensive because you will never be able to collect enough rent on those to actually make money on them. So in that case, you would just be paying compounding interest to go further in debt. Unfortunately it's very hard to find CA properties that would actually allow for a profit. Other states, very easy, but here not so much.

So I recommend using equity to buy more properties IF they will produce positive cash flow. If they won't, I'd hold off because it won't get you anything.

Agreed Ali!

I believe a duplex in southern CA is merely a capital gains or appreciation play especially in areas like Huntington beach, Seal Beach, etc because the cash flow will barely coverage the mortgage/tax/insurance in most cases if not probably negative cash flow and that's probably being generous with expenses and managing the property yourself.

In some rare instances in east LA, inland empire, non coastal, Kern county, or other you may be able to find cash flow focused properties though.

Albert Bui, Lender in CA (#345453), WA (#345453), TX (#345453), and TN (#345453)
949-514-5106

If you are currently losing money on that condo why not sell it and use the money for a profitable investment? Like Ali, I am also failing to see how another losing proposition, such as a 775k duplex, is going to help you.

I see you are in CA, where values never go down ;) but do remember that equity is never 'real money' until you sell. If I were in your shoes I'd be looking for some cash flow.

Yeah if your condo is negative cash flow you're spending money to service your obligation while your equity is being taken hostage with only tax advantage paper loss, equity gain/loss = gamble, neg cash flow, and perhaps a bit of loan amortization each month the mtg payment is made.

freeing up that equity my be a better bet, agreed.

Albert Bui, Lender in CA (#345453), WA (#345453), TX (#345453), and TN (#345453)
949-514-5106
Originally posted by @Ali Boone :

My first thought is, definitely use the equity to buy more. It's the best way to snowball yourself towards financial freedom. However, don't use the equity to put yourself in non-performing debt. What I mean by that is, if you buy an investment property that will keep you negative every month, that isn't good. A duplex costing $775k-900k is extremely expensive because you will never be able to collect enough rent on those to actually make money on them. So in that case, you would just be paying compounding interest to go further in debt. Unfortunately it's very hard to find CA properties that would actually allow for a profit. Other states, very easy, but here not so much.

.

I would strongly disagree with this based on my almost 40 years of investing in non initial cash flowing areas. You will 99% have MORE profit on an investment in SCal, or NCal as long as you can afford a few years of negative cashflow and NOT sell in a low market.

My experience is that rent growth is 6-7% a year so negative becomes positive in a few years and appreciation rate of 9-11% is your profit. Definitely look at the historical numbers for the type and area of your investing.

How much of the equity that you have for investing comes from appreciation? That would be a good clue as to where PROFITABILITY is.

I would get rid of the condo if you aren't making cash flow. Sell it, use the capital to assist in your next investment purchase.

What is your goal with the duplex purchase?

@William Briscoe

I agree with much the logic above but I'm biased when it comes to California. I grew up in Santa Cruz, CA and lived there for almost 30 years. In my opinion, CA is a riskier area than others.

If you have any questions about the retirement account side of the equation, don't hesitate to PM me or continue asking questions. I'm happy to tell you about all your options.

Cheers!

I must chime in here, as I agree with what @Bob Bowling said and disagree with virtually everyone else. Think about it. You have made over $500,000 in your RE purchases. How? Due to equity build up because you were wise enough to have invested in So Cal. What do you think would have happened if you did the same in fly over states? I seriously doubt you'd be sitting on half a mil, contemplating your next acquisition!

The advice to sell your condo is a knee jerk reaction. Is it in a solid location? You will offset the $3400 in taxes with about $300 in rent increases. That will probably happen in the next 2-3 years, and it's covering itself. We probably have at least 2 years, maybe more to go in this upwards RE cycle, so you can expect more appreciation. I wouldn't be surprised if you gain over $100k in the next 2-3 years. Just make sure it's in a solid location, and that the bldg isn't suffering from major issues.

Your intuition to leverage and buy another So Cal property is spot on- that's exactly how I made all my money here in San Francisco. You also have rehab experience. I strongly advise you to look for a fixer, with some challenges. Especially if you get a good deal on it, you will add value right away with the rehab, and it will be easier to break even on it. You really need to search for the right neighborhood, one that is up and coming will give you the most potential. I'd also open my search up for 2-4 units. Maybe 4 smaller units is better cash flow wise than 2 larger ones. The other advantage of buying a distressed bldg is that you lock in a lower tax rate. Do this next move right, and you I'll be set up nicely for retirement!

Your biggest issue, however, is qualifying for the loan. And, you will need access to some cash for the renovations. I really don't recommend hard money, certainly not for the purchase side. You need to lock in a low 30 year fixed rate, and just keep that long term. But how to qualify? Can you get a family member as a cosigner? Also keep in mind that the bank should also add the income of the new bldgs to your income stream. My bank allows for empty units (75%), and the appraiser gave pretty generous rent numbers, so that was an advantage. Only other option is to up the income on the returns (less deductions to show more income), but you'll probably need 2 years of that, which kinda sucks. I actually had to do that in 1 year. So I paid about $3500 in extra taxes, but I ended up qualifying for a loan, on a purchase that will yield me not only positive cash flow, but also several hundred thousand dollars in equity. So yeah, I'd say it was worth it.

Good luck, and keep searching for a creative solution that is right for you!

Thank you for the great responses. Yes, I understand that should I move forward with purchasing the income property, income is going to be my biggest challenge. I'm not sure, but I may be able to start taking regular draws on my 401K and have that count as income. But then, I would not be able to also use that money for the purchase. Does anyone have knowledge about counting 401k automated draws as income?

I have to say I like @Amit M. and @Bob Bowling 's point about appreciation on this one. I like @Ali Boone 's life philosophy also, and investment style, and had the opportunity to meet @Sarah B. the other night in Sacramento. But it's not all about cash flow..

@William Briscoe , have you considered investing in areas near where you live where you can get cash flow and some good appreciation in an area where there is nowhere to build? I've been getting great cash flow and appreciation in lower-income areas in the Bay, and like Amit, buying beat-up units (usually vacant) to get great equity going in, and great appreciation on the way up.. Working on cash-out on an FHA 4plex deal from a year and a half ago.. And looking at about 15-20% built-in equity on my rehab project right now in Oakland. Probably do cash out next year.. So you don't actually have to sell it to realize the returns, @Albert Bui ..

Originally posted by @William Briscoe :
Thank you for the great responses. Yes, I understand that should I move forward with purchasing the income property, income is going to be my biggest challenge. I'm not sure, but I may be able to start taking regular draws on my 401K and have that count as income. But then, I would not be able to also use that money for the purchase. Does anyone have knowledge about counting 401k automated draws as income?

You will need to be of age for an underwriter to utilize regular draws of your 401k to be used as income you look pretty young definitely not 59.5 years old +.

Albert Bui, Lender in CA (#345453), WA (#345453), TX (#345453), and TN (#345453)
949-514-5106

@Albert Bui

Thanks for the compliment. I"m 63...but the picture's 3 years old :)

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