Contractor · Carolina Beach, NC · Member since 2014 · 157 posts · 89 votes
Often I have seen advice given to always reinvest off the properties you are acquiring, my simple question would be (and there may not be an easy answer) would you take cash flow and pay down mortgage(s) so you could leverage that equity later for another deal, or save cash for the next deal?
I am starting out as a new home builder, and want to take anything over what I need to live on to build up a portfolio of buy and hold over the next 10-15yrs.
@Joe Villeneuve I have seen this advice a few times and just want to clarify (as I have the same question as @Keith Bloemendaal as well. By #1 Pay cash, do you mean using our own cash? and then by #2, when is the appropriate time to do this?
@Duncan Lai Yes...use your own cash, or a cash like substance (meaning non-lien able debt). When you refi, you get it all back, as long as you season the property long enough for the lender to recognize the comps to set the ARV instead of what you bought the property for.
When to refi depends on when the lender will recognize the comps to set the ARV, so you can get all of your cash you put in back (assuming you bought at a discount)
@Joe Villeneuve gotcha. I guess this strategy is for applying to homes where you rehab it or bought at a discount. When you refinance, I guess you also need to leave some equity in it, or not? Does this mean you won't be able to take 100% of all your money out?
What about in a buy and hold situation where the property value is already in line with the market value, is it more preferable to keep the cash or throw it back into the mortgage to reduce interest expense, build up equity quicker and do a refinance?
@Joe Villeneuve This seems a little counter productive for someone like me. I could possibly start in year one with 20% down, or I could wait 3-5yrs while properties are appreciating and I could be building equity?
Sorry, I am just a fan of using other peoples money wherever possible.
@Duncan Lai I always get all of my money out when I refi a buy/rehab/hold...that's the whole point.
@Keith Bloemendaal Not at all. Equity is where your cash goes to die. Think about this. Even if you put only 20% in of your own money, and you made $200/month ($2400/yr) in NCF, you are behind until you that 2400/year equals the 20% you "left behind"...and, you probably can't refinance that 20% out.
If, on the other hand, you use your own cash for all of it, then you can refi to get it all back, and thus you ARE using OMP...you're just not spending any of your own...you're just using it over and over again.
@Joe Villeneuve I might be missing something here and not understand the rules in the US. But doesn't the bank will always require you to have some equity? Can you please illustrate with a simple example with some numbers?
AFter 6 months of owning the property (seasoning) many lenders will use the equity in the property as your "skin in the game". You are buying and either rehabbing to force the value up, or you were buying below market value to begin with.
You want to finance as much as you can to maximize leverage. Using your own cash, or hard money, is a great way to do this if you are buying at a discount, and will be able to have all or some of your equity by the value. In most situations you will need 20% equity in a property, if you can buy a house and rehab, and have a $100k house and only have $85k in it, then you won't need much cash when you refinance. Those deals, in my market, are very, very hard to find (a few years ago deals with no real out of pocket cash were fairly common).
You need to figure out how you are going to finance the properties, if you have fewer than 10 mortgages, most people prefer to use conforming mortgages, after you get past 4 conventional mortgages the rules for pulling cash out get very tricky,, so talk to your mortgage broker (buying for cash and financing them to pull your cash out in less than 6 months is one way to do it).
If your using commercial financing you don't have that hassle, but your paying higher rates with a shorter lock on the rates
4 - Live off of remaining cash flow after refinancing
...rinse, and repeat
Can you please give an example with real numbers. I'm very intrigued by what your saying and I think I get it, but an example would really help. I buy all my properties in cash and have never refinanced anything. cash out refi on something you own free and clear?
Everyone has their own opinion and thoughts! Personally we put as little down into the houses as possible. We buy stressed properties (short sales and foreclosures) that have something wrong with them. Enough that when we solve the "simple" problem there is alot of forced equity. We than lease that equity and use the cash flow and our frugal ness to invest in the next house. This strategy has allowed us to acquire 5 houses in the past 3 years with the goal of another 5 in the next 18 months!
I find it much simpler to only do the closing process ONCE along with having my tenants pay off the mortgage. Don't forget that mortgage rates are VERY low right now, so leverage debt is CHEAP. Also in SOME areas such as mine, houses are still way below the peak. So buying as many as possible now, really helps.
4 - Live off of remaining cash flow after refinancing
...rinse, and repeat
Can you please give an example with real numbers. I'm very intrigued by what your saying and I think I get it, but an example would really help. I buy all my properties in cash and have never refinanced anything. cash out refi on something you own free and clear?
You buy a house for say $50k... you put $20k of work into the house. After the work, the house now appraises for $100,000. After proper seasoning (3, 6, 12 months depending on the bank and other circumstances) you can refinance (or finance for the 1st time, or do a home equity loan) against the appraised value instead of the purchase price. If you do a 70% LTV on the $100k appraisal, you'll have a $70,000 loan at a low fixed interest rate and you'll have your $70,000 in cash back in your pocket to do again.
To do this you either need to buy significantly under market value (purchase equity) or be good at renovations (essentially you're a flipper "selling" to yourself).
Cash rules... there are no questions about it. Dependent on your risk tolerance, the general answer is to leverage highly given the low interest rates and preserve your cash to continue to invest and grow your portfolio.
4 - Live off of remaining cash flow after refinancing
...rinse, and repeat
Can you please give an example with real numbers. I'm very intrigued by what your saying and I think I get it, but an example would really help. I buy all my properties in cash and have never refinanced anything. cash out refi on something you own free and clear?
You don't own it...it owns you. Here's why.
Let's say you put $50k in cash into the house to buy/rehab/etc...and leave it there. Also, you have $400/month CF. Your cash just died. Let's follow the money:
The Money Event Net Income/Expense
1 - $50k In from the start - $50,000 2 - $4800k out At end of year 1 - $45,200
3 - $4800k out At end of year 2 - $40,400 . .
11 - $4800 x 8 At end of year 10 - $ 2,000 ...10 years later your still behind
... .or, you can refinance after 1 year (I can after 6 months) and...
New CF: $500 - 250 (debt) = $250/month
The Money Event Net Income/Expense
1 - $50k In from the start - $50,000 2 - $1500k out At end of 6 months - $48,500 3 - $50,000 out At end of 6 months (RefI) + $ 1,500 (you're now ahead)
...and, you might be able to get out more than you put in when you refinance.
This we are doing on a regular basis. I just analyzed 3 more properties this morning that would allow for this.
There are probably 100 threads on BP about whether or not to leverage your investments. Suffice it to say that there is a tradeoff with risk and reward by leveraging. In general I am a fan of leverage to a point. However, many can get themselves in trouble leveraging too much without the necessary liquidity to ride out the bad times. Cash equals staying power and debt won't be your friend in a bad market cycle; especially as a builder.
A lot also depends on your balance sheet and your access to capital to build projects. If you can still procure guidance lines or bank money at low interest rates by stuffing your cash in a project you may be better off using more of your own money. Cash gives you the ability to move on GREAT deals quickly while syndicating the other good ones. It is your "backstop" in case you can't get the raise done on your terms.
Are you planning to run a small, custom home building shop? Do you plan to do many specs? Will you pre-sell the projects to buyers or only sell them as specs? Do you plan to build them and lease what you build?
It is unclear what your precise business model is so my advice would be to ignore any advice you've received thus far. People need to understand your whole picture, business model, cash position, and needs before they can really help you much. Your cash position will be very important as you try to grow your building business as will your access to outside capital from investors. If you plan to use hard money this becomes less of a need, but you still want to keep adequate cash to shore up your risk and staying power during market cycles.
@Bryan Hancock is right in that investment advice is much like parenting advice, you're usually best to ignore it until you can define what you want and need.
I'm still trying to figure out the concrete steps I need to take to make @Joe Villeneuve model work for me, but it is the way I want to go.
I discuss me just getting started on my own, how I secured funding (part investor/partner, part bank) for my first 3 spec homes, etc..
I plan to build 90% spec (I don't want to deal with people as much, let the realtors do that) and my goal is to get to 10-12 specs per year. We are just in the planning stages for this, but I am thinking we want to have between $100-@200k in cash reserves for the building company for working capital before we invest in anything for rentals.
How much cash do you need to finance an average deal? What is the price of the dirt you plan to purchase on an intended deal, how much cash do you need, and what do you plan to leverage and with whom? Have you tried talking to the local lenders to see if they'll lend to you? What is your track record?
In general you want at least 5-10% compensating balance based on your contingent liabilities with the specs. So that is the minimum you want to keep in cash.
Do you have outside collateral to offer to a lender to entice them to loan you money? Again, people need to understand your balance sheet and income to comment precisely. I'm not sure if you're comfortable sharing that on a message board. If you're not then my suggestion would be to talk to MANY (not one) local lenders that actually underwrite you as the borrower and get their feedback on your position. Hard money lenders are unlikely to do this to the extent a local lender will.
Do you have access to a commercial broker or an investor network where you intend to build? They can cut through a lot of the bs with locating lenders that are in the market to lend. My suggestion would be to approach some of the more conservative lenders from this pool FIRST, get their feedback, fix it, and THEN approach the more aggressive lenders with the file cleaned up based on the feedback you get.
The more information you give people in the thread the more they'll be able to help you. I'm glad my advice has been helpful. Even a blind squirrel finds a nut from time to time ;-)
I would like to amend a bit what @Joe Villeneuve says. In my brand of investing, the first step would read:
1. Pay Other People's Cash
Everything I've ever bought has been leveraged 100%. The backdrop to this, however, is that I ended up tools like Substitution of Security and Blanket Notes which needed to be cashed out in 5-7 years. Obviously I had to re-invest CF into these - this was part of my strategy from the get-go.
On the other hand, why would you throw CF at a fully amortized 30-year note at 5%. This money is cheap it might as well be free...
Now - doing things my way carries definite amount of risk, as @Bryan Hancock alludes to. For this reason I had to become considerably more educated than the average Joe. However, I had no better options available to me, and with my back to the wall I did what I had to. It worked - this year I was able to reverse the time paradigm...every month I get financially stronger, and the process is automated. Leveraging 100% and working like hell did it for me :)
What I was focused on was how to use your own cash. The "cash like substance" I always refer to, IS a form of other people's cash though...and if you can bring on a partner with cash...well, now your're talkin'
Another age old debate that will bring a multitude of opinions from both sides. Rather than add to those, I will just point out the following:
Paying down a mortgage with extra cash, cash flow, etc. is saying that YOU are not capable of investing in an asset that returns a rate higher than what you borrow at. Would you ever want to say that? I know I wouldn't which is why I have no concerns or desire to pay anything extra towards a mortgage considering the fact that it holds a cost much less than what I can make by investing that same cash into any number of other assets.
Paying cash to acquire places you in a very strong position over other competitors, if you have the means to do that and get that cash back quickly, great. If you can leverage and use OPM as cash to acquire and refi out to a conventional mortgage, all the better. Partners (those with cash but not the time or know how) are another great avenue for this.