living off of cashing out appreciation?
Member since 2008 · 155 posts · 2 votes
I am still having a tough time understanding 'cashing out the appreciation' of a house - I still don't fully understand how it works, but I was wondering, does anyone here live off of that? IE - buy property for $150k that is worth $225k, cash out the $75k and live off of that until they buy their next deal?
I understand the theory but I also believe that is part of the reason we're in the current mortgage meltdown. People cashed the appreciation out of their properties and started living off of it. In essence it was like a million people that don't know how to handle money winning the lotto at the same time.
-Michael
oh very interesting! it sounds like it is not adviseable to do. What if they cash in on the built in equity of a good deal, as oppossed to the appreciation? Or is that not wise as well?
Jason,
It would be easier to follow your questions if you would continue in a single thread, rather than starting a new one. If members don't follow all your posts, they won't fully understand your thinking. This thread should have just been continued in this one: http://forums.biggerpockets.com/viewtopic.php?t=19995
Several of your threads talk about appreciation. Many books and investment gurus also talk a lot about appreciation. I've seen numerous examples where various folks try to make a bad deal look better by throwing in long term appreciation. Over the long term, real estate does tend to appreciate. However, the appreciation is pretty much just inflation. If you factor inflation out, real estate prices have been flat for the last 100+ years.
Have a look at this post:
http://forums.biggerpockets.com/viewtopic.php?t=16573
I though this same graph appears somewhere in the blog, but I can't find it. This goes back to 1890 and is adjusted for inflation. Prices were flat until World War I. They fell significantly, and then remained flat until the end of WWII. With the baby boomers, and chaging lending guidelines, prices jumped up. Then they remained flat, on a long term basis, until the late 1990's. Then, again thanks to dramatic changes in lending guidelines, IMHO, prices skyrocketed. That's never happened before. So, I think we have an enormous bubble that has to be worked off.
Now, this varies a lot from place to place. Some places experienced dramatic increases and are very like to continue to see dramatic falls. Other places saw little increase and will be less affected by the decline.
The theory is simple. Buy a house. It appreciates. You refi or do a HELOC and take some of the cash. It appreciates some more. You do it again.
In practice, I doubt this works at all. Doing these loans is expensive, as I explained in the other post. Then, you have to pay interest on this money. This may have worked for a few years, but many of the people who did this are the same ones now losing their houses.
mouschi
Are you talking about, pulling the equity out through a loan or just selling the property? If you mean by refinancing after rehab and holding the property, you have to remember that if you are holding that home, then you have a monthly mort payment, including all of the other holding cost. Living off this money would be very foolish. I cash out some of the equity after a rehab, I never cash out more then 60% of LTV. Then I dump that money right back into another purchase. The money is used strictly for the business. By purchasing another home, this allows me to now have another monthly cash flowing property.
If my new PITI is $300 per month now on the property that I cashed out 25K, and I am getting $600 a month in rents from it, I want to get my next property that I have 20K into rented as quickly as possible, to offset that $300 per month that I am paying toward that new mort. By playing this game, I am taking the risk while I am rehabbing the new property, that no major expenses will come up with the old property that will put me in the red for that month.
If you are talking about flipping a property, then sure you will live off part of that income while using the profit for another purchase. As long as you can do both comfortably, then you have just created yourself a job that you love.
ok, perhaps i will stay away from it then - i was speaking of doing this with rental property :)
Can you explain how you were going to do this? I am curious as to how you could pull enough money out to live on, don't reinvest and still cash flow? My goal is to obtain enough properties, that each one cash flows enough to pay a mort payment, covers business expenses and then still provides a little per house to pay me a salary.
it was just a half baked idea to begin with, but here was my thinking:
buy a 100k house at 70k. pull the 30k to live off of (fyi i have residuals of 2k a month from my existing business)
use the time to get another property and do the same thing over and over. this would assume that i have lower bills each month after my own house is paid off.
Jon, do you have a direct link to that graph? I didn't see it in the thread you posted above.
Thanks,
-Michael
One of the smartest ways to go is to buy and hold....pay down your properties until you own them free and clear...then live off the cash flow.
Now that's the ticket. Get all 20 year fixed rate loans that leave you with a little bit of cash flow, build your business for 5 years. Once one of them is paid off snow ball that payment into the others and they're paid off in 17 years.
-Michael
now, thats what i'm talkin about! I actually am thinking now that more is better if i can get setup with the right property management company. Heck, why not do 50 properties? 30 years down the road, at 1k each, that's 50k a month :)
Well it would probably be about 25K a month after expenses, but yes its a good plan!
I hope to have have 20-25 properties by the time I am 27-30 and have them paid off by the time I am 35-40. Up here they would rent for an average of 700 (on the very low end). Your looking at 6 figures a year if that happens. Now it's time to make it happen.
Sorry, I had posted the same link twice. I've fixed it.
I'm all for the buy, pay off, live off the cash flow plan. That's my plan, too. Pretty sure you can't manage to live off just refing again and again.
First time poster, great site! I also go to some other landlord sights, but this is a good one. You can cash-out refi, but you have to BUY right. You need to start with your business goals. Are you in rentals for 30 years or 10 years? Why ask this? Because your goals change. If you are in a property for 30 years, you are buying, renting and paying down the debt to own it. Me, I like to own for 10 years, and work to sell the property to a tenant, sort of a lease to own, and then move on to new properties.
But storm clouds are on the horizon. Banks have lots of REO property. The same bank may sell you a house for 60k, and it may require 20k of work, I love brick and block homes (no more wood frame, no matter how good a deal) as these are the easiest to fix and maintain. So you have 80k plus holding and closing costs. Can you get the magical 1% of costs for rent (to cover mortgage, insurance, taxes)? With the last huge housing boom, especially here in the SE, no, you cannot. Apartment complexes here are giving away 2 months of free rent, so you probably will lease losing money for 1 or 2 years.
Here is where the cash-out works best, imo. You buy the house, fix it up, upgrade everything for at least 10 years (how long the AC units last here in the SE), and if the bank only gives you 80% of ARV (which is 130k), you have 104k loan, closer to 110k once you figure in closing costs. Your monthly costs are now $900 and you can only get 700 in rent, so you lose $200 a month or $2400 per year. You were able to get it rented for 700, next year, it will be 725, then 750, so on and so forth. (maybe you can get more). At some point, you will reach close to the break-even point during the 10 year period for the rent. But, you will also have 20k from the cash-out, and you can use that FOR THAT HOUSE or YOUR COMPANY. Never use cash-out money for personal living expenses. You will not pay it back, it does not happen.
My plan is to old for 10 years, get rents to within 5-15% of the montly costs and buy homes right so that when the bank comes back with the ARV, I can get enough cash out, to cover the "nut" for the period of holding.
My experience with appreciation is that if you look for it, like a ghost, you will never find it. Never count on appreciation to rescue you, because in a down market, you may not see it for that year.
If the rent is $700, and the PITI is $900, you're losing quite a bit more than $200/month. Vacancies, economic vacancy (like the "two months free" you mention), advertising, utilities when vacant, evictions, tenant damage (brand new or not, tenants can still do damage), CPA, Lawyer, maintenance, property management, etc. The rule of thumb a lot of folks here use is expenses are 50% of rent. That include the taxes and insurance included in the payment, as well as vacancies.
Say that payment breaks down as $750 payment and $150 taxes and insurance. Rent is $700, then estimated expenses are $350. Maybe less in the south east, due to the milder climate. Call it $300. That leaves NOI of $400. After the $750 P&I, you're in the hole $350/month. Won't come all at once, but even a nice, neat one month vacancy is a loss of $700 in income, plus make ready. Over the course of a year, thats $58/month.
If you're hoping for inflation to bail you out, you have to wait quite a while. Assuming 4% inflation (I think it will be higher for a while) and that it affects rent and expenses equally (not a good assumption, IMHO), it takes 17 years before you're cash flow positive. In the mean time you've accumulated almost $40,000 in negative cash flow.
Even banks will deduct 25% of the rent, then subtract out the PITI when qualifying you for a loan. So, they would estimate your month loss on this one at $375.
$40,000 in negative cash flow based on how many years? My business plan is 10 years and I do not factor in appreciation. My expenses are not 50%, since I starting using some of Jeffrey Taylor's ideas, I now have good tenants who are leasing to own, I credit back $100 of the equity back to them to buy the house at the end of the 10 year period. This belongs in the landlord area, but it is important to point out that good long term renters can save you thousands in repair/fix issues.
For someone starting out in a cash-out refi program, do as much of the work on your own, to see what the actual costs are. Sure you have a CPA, lawyer, and other items, unless you are a CPA and a Lawyer and you make more money as property manager with both skills. Save the money, do it yourself, learn about real costs in the market, then hire out those expenses. I respectfully disagree on your costs for outside assistance. I do not incur that much cost on my properties, but everyone is different.
The real issue here, that no one has mentioned, is for new real estate investors, you need to have a business plan. You need to have a playbook for every occurrance, and when you get a new occurrance, have a plan for it as well. Buy/Hold, Buy/Flip, whatever, get a plan and then WORK THE PLAN. Educate the tenants and others in the business and share what you know. That is how we all become better real estate investors. You get back 10x what you sow.
The $40,000 is based on the 17 years it takes to get to positive cash flow. The expense ratio I used was 43%. Even with rent to own and with careful tenant screening, you will have other expenses. Taxes and insurance are a given. Paying for a CPA for your taxes is a given. If your local laws call for a certain habitability standard, some maintenance is a given. Over the course of 10 years, some vacancy is a given. The 50% ratio assumes you have good, well-screened and well-behaved tenants. Doesn't take much to get that ratio up much higher, or even over 100%.
Even a very optimistic 35% ratio (that's $100 more than your PITI payment) generates a $24,500 loss over 10 years.
Did I ever say that the rent would be static? Sure inflation rises, but so do the items that renters want. I'd like this upgrade for $25 and a new X for $25, rent increases because people ask for nicities, and as the landlord, you work on keeping the units rented. Sure if the rent stayed at 700 for 120 payments, you would lose your shirt.
I think that 50% ratio is lower than you think. You will always have more income for X or Y or Z with tenants, because you want to offer more and keep them there. Again, it depends on your business philosophy. If you want to leave your properties as slums, your expense ratios will be much higher due to so many revolving tenants.
However, taking money off the top for cash-out deals is a good thing and works, if you maintain a discipline. If you are the type of investor who cannot pay off your 18% credit card each month, don't even bother with this idea. Buy right and this is the best investment vehicle I have found, in this market!
July 5, 2008
FYI, try buying reo and recycle them back on the market.
There are alot of variables.
Regards,
I have had rentals that negative cashflowed. In the hayday of rapid appreciation it was well (and I mean well) worth it. Fortunately I took the money and ran on those. And you really have to stay on top of that plan and keep up with all your expenses or it will be a loser.
This is a different real estate climate. If you go in losing $200+/month you should have something else going for you. Appreciation is tough to count on right now and at that negative the renter is not even paying down your mortgage. This plan might work for some but I would not use it.
I do agree that some landlords don't have to count on as many expenses as other. When you can do it all yourself, manage, maintenance, etc and have a good system in place that you know minimizes vacancies and property destruction, your expenses are much less.
For the cash out refi idea..not bad if you can make that money make you some more money and you don't negative cash flow on the rental by doing that. But if you have borrowed 100% of the value, which is not really possible right now, and have no cash flow, you need something going for the investment or it is not an investment. It needs to have good appreciation, cash flow or it allowed you to make big $$s by taking that extra cash. If no positive quality then it is a liability only.
Well, Freddie Mac just outlined that if they buy your new mortgage you can only have 3 properties mortgaged plus the investment you're borrowing on.
That limits how fast any of us can move in traditional financing markets with a stock piling dream. Some investors only hold for 5-6 years and sell off their properties. I don't know why but they do.
Investors with 10-30 years experience who make a living on investments buy smart and low. Most buyers simply don't have the banking contacts or experience or the cash to move quickly to make those buys.
They're not sitting in an office thinking they can manage properties riding a desk. They're on call 24/7 and don't trust anyone to manage their holdings like they would. They're similar to top realtors who say it's every day with no days off--not those holding an open house on Sundays thinking that'll do the trick. They have what I call bull dog instinct and many times even they break even when selling a property.
I have 0 Freddie Mac/Fannie Mae properties. All of my 8 are owned by local banks holding their own local commercial paper. Commercial properties, in an LLC, are not hog-tied by Fannie and Freddie. Of course, you need good credit and cash, so find some good partners, silent are best and build a business. Now is the time to buy, if you are not, you are missing the boat. I am backing up the truck and loading up at 50-60% off of retail. Banks also have money, you just need to work on finding the banks that hold their own paper. There are even construction loans available from some banks, and you don't need 700 credit scores either. You need to show cash flow in, my case.