Dead Equity - How much money do you leave in rentals?

108 Replies

Hello Bigger Pockets!

My main question is how much money do you leave in your rentals? I've got one rental property worth $280k, about 60% LTV (115k in equity). I just closed on my first "Live in Flip" and I'm moving in there next month (this should be fun). I'll then be turning this house into a rental property. This one is worth $400k, about 55% LTV (180k in equity). If I do REFI, I should probably do it before I move out? (thinking yes)

I'd love any feedback. I'm not scared of risk and have told myself that I should just pull money out of both up to the 80%. Then take that money and buy one or two more rentals. What does everyone think about this?

Thanks!

Josh Bustle

I personally wouldn't leave more than 20-30% max depending if SFH or MFH.

Basically whatever the max LTV (70-80%) that I'm able to get from my lender.

Old dude here. Once I had enough rental income to cash flow life, I went to 100% dead equity.  Personally, debt bugs me and I prefer not having a dog in the fight regarding what the markets are doing.  If we hit another good buyer's market E.g. 2008-2012, I might leverage up 20% or so.  Not during a seller's market though. I wish you good fortune. 

I pull out every dollar I can as equity grows in a property. I turn equity into income rather than leave high levels of cash at risk in real estate. I have reinvested in other properties but have also diversified my investments and by doing so insure I have available reserves to ride out any market fluctuations. I do not subscribe to the risk adverse investors belief that dead equity increases cash flow. 

Equity does not increase the cash flow a property produces. Cash flow is artificially increased only by reducing interest payments on the mortgage. Unfortunate that locks your return on your equity at the prevailing mortgage interest rate. It buys cash flow at a cost higher than I am willing to pay. For this reason I have a aversion to dead equity. I have chosen to invest rather than hoard cash.

I would not leave cash in a property where it can not earn a acceptable return. I invest in a manner that provides me with more available cash reserves earning a higher return than dead equity while not leaving it at risk in a real estate market adjustment. 

I see this as a win/win by forcing my equity to earn it's keep at a descent return while still having a reasonable amount of available "equity" on standby. This is my modified form of equity, now at about 70%, earning  a 10% average return over the past decade.

Originally posted by @Terrell Garren :

Old dude here. Once I had enough rental income to cash flow life, I went to 100% dead equity.  Personally, debt bugs me and I prefer not having a dog in the fight regarding what the markets are doing.  If we hit another good buyer's market E.g. 2008-2012, I might leverage up 20% or so.  Not during a seller's market though. I wish you good fortune. 

 Thanks "Old dude"!

I have the same game plan but I feel like I can get there a lot faster if I use the banks money to grow my portfolio. Another thing I thought about is if (and when) the market does dip again, my "dead equity" will be gone. Thanks for the good fortune Terrell and I hope to be cash flow rich one day!! 

Originally posted by @Thomas S. :

I pull out every dollar I can as equity grows in a property. I turn equity into income rather than leave high levels of cash at risk in real estate. I have reinvested in other properties but have also diversified my investments and by doing so insure I have available reserves to ride out any market fluctuations. I do not subscribe to the risk adverse investors belief that dead equity increases cash flow. 

Equity does not increase the cash flow a property produces. Cash flow is artificially increased only by reducing interest payments on the mortgage. Unfortunate that locks your return on your equity at the prevailing mortgage interest rate. It buys cash flow at a cost higher than I am willing to pay. For this reason I have a aversion to dead equity. I have chosen to invest rather than hoard cash.

I would not leave cash in a property where it can not earn a acceptable return. I invest in a manner that provides me with more available cash reserves earning a higher return than dead equity while not leaving it at risk in a real estate market adjustment. 

I see this as a win/win by forcing my equity to earn it's keep at a descent return while still having a reasonable amount of available "equity" on standby. This is my modified form of equity, now at about 70%, earning  a 10% average return over the past decade.

Well said Sir! I Love it, I feel like this is the best path for me. Doing this also protects me from lawsuits correct? Instead if having 6 figures of equity in a rental property that I could lose in a lawsuit 

@Terrell Garren I agree. People who haven’t lived long enough underestimate the risk of being wiped out from a change in the housing market, stock market, divorce, and unexpected loss of job. We only hear people brag about their earnings/growth for 2-5 years and then suddenly are nowhere to be found. I’ve seen it too many times. Leverage cuts more people to pieces than it helps after considering all costs. I personally think if you can’t pay all the mortgages on all your properties if they are vacant 6-8 months, it is a problem (unless they are no recourse loans).

@Thomas S.

"I do not subscribe to the risk adverse investors belief that dead equity increases cash flow. '

That's a good one. May I let you in on one of my phrases? I don't let the banks in on my profits.

@Josh Bustle There isn't one percentage number that works for everyone in every situation. 

It comes down to the marginal return of your current investment compared to the anticipated marginal return of another conservatively underwritten investment.  If you get a better return somewhere else, pull the money out, if not leave it where it is. 

Taking money out just because it's "dead equity" without another investment yielding a higher return, however you choice to measure yield, is foolish and hurts your overall portfolio returns.

@Bill F.   I think it all depends on what your doing in your life and what your business is.

for those that their SOLE goal and business is owning rentals.. and to the extent the banks will still give them loans at high LTV's and they are comfortable with that.. then of course mathematically no one can argue the leverage position as long as as you state you have something to put the money into.

@Terrell Garren   I am totally in your camp..  I have dead equity .. but that dead equity i needed to tap in 08 to 2011.. 

were rents went to zero and things were not good..  had i been leveraged to the hilt i would have been like so many other investors in those years  wiped out. 

I get it that those starting out need to heed @Thomas S. advice and philosophy.. but there is a balance and much of it is personal desires and what your comfortable with.. me personally its limited to no debt at least long term contingent debt. I take on 5 to 12 million in debt each year but thats all short term flip debt that gets retired.. If i become  a landlord again it will be becasue my spec homes did not sell and i was forced to turn them into rentals. but as long as i can borrow construction money and make on one house what 10 years of cash flow would bring me at a fully levered rental i will do that and suffer the tax consequences.   then to go to the next level were you can borrow this kind of money you cant do that with a balance sheet of 80 to 90% of debt..  Banks want to see equity and cash .. thats what i need for my business.

but if i was just going to run rentals i would do what you guys do and just leverage them to a point i was comfortable with.

Frankly though my high net worth clients i have sold larger properties too paid cash  like 5 to 10 million cash for MF.. they dont want debt.

Depending on where you buy and the price range, have you thought about camping out in the house for a while, get a HELOC, and practice short term BRRRs? You could still be subject to huge market adjustments, but just wanted to put that out there.

"I personally think if you can’t pay all the mortgages on all your properties if they are vacant 6-8 months, it is a problem..."

Holy, dude. If I have a vacancy for 8 months, I either should not have been buying in this area, or my rental is garbage and way overpriced. 

But anyway, it's all about your goals, and your personal level of risk. Kind of like the stock market. How much should I have in stocks in bonds? Well, I don't know, what are your goals and timeframe? 

I plan on leveraging and buying more properties until I die. I take early retirement in 5 years, and not taking a paycheck from rentals until then. Even at the interest rates of today, it's still better to be buying and investing. I want my tenants paying the bank. But, the properties still have to cash flow and be self sustaining after the refinance. You can't refinance up to 80% (you still have 20% equity, you're not broke!) if the rents don't cover the expenses. 

I lived in California when the  market went bust. My personal home lost all it's equity, and then some. But, industries and people went broke because they were taking out mortgages at 110% of value, interest only loans, 3 year balloon payments, with no income, on many properties. Today, just because you leverage, doesn't mean you're broke. Are you using rents to fund that capex, maintenance, vacancy fund, before you pay yourself? 

But again, it's all about your personal goals and your stomach for risk. Some people can't sleep at night if their 401k is losing money, like this month. They need that steady 4-5% gain. I have a co-worker like that. We've been in the same job for the same number of years. His retirement portfolio is about 1/5 the value of mine. Maybe I got lucky. But it seems like the harder I work, the luckier I get...

One observation on these forums is that this question elicits strong opinions.  Either debt is the worst thing in the world or people are advocating nearly maxing it out!

Originally posted by @Daniel Long :
@Jay Hinrichs, where are you getting new construction money? My banks that finance my flips, rehabs and holds are all a firm no on investment new construction.

 its not easy but I have bank construction money in Portland Oregon and Charleston SC..  and yes these are very tough to get. 

ergo as I stated above the careful manipulation of TRUE equity and Net worth along with cash on hand.

it used to be prior to 08 builders could get construction loans with Zero money in the deals NOT one cent.. and an interest reserve to boot.  there was no better OPM prior to 08 than being a new home builder..  now the banks require cash.  strong balance sheet net worth and experience.   For SPEC loans.. pre sales could be much easier of course.  And many banks will only do the construction loans for their builders in a pre sale environment.. mine are true spec we don't even start to market the homes until sheet rock and sometimes until they are finished and staged.. 

However its highly regional I think like Texas when I was snooping around Dallas for new construction money it seemed like it would be easier than other states I was working in..  

I think the general consensus is if you have a better home for that money then take it out and use it, otherwise just leave it there.  I was recently offered a portfolio loan for a significant amount at 6.15% 10 year fixed interest only.  I would happily have borrowed except I can't find a home for the money.   Our goal is for cashflow so I have the option to stop working.   I just don't see the benefit of borrowing money so I can pay interest while getting .025% from the bank.  If I was in heavy acquisition mode, then I probably would.  

There is no one size fits all solution to this, as the internet has proven time after time.  

Optimally, you should only have the minimum 20% equity (conventional loan) in the property and the property should rent for at least 1% of market value. This is if you buy MLS (i.e. at market). If you have excessive equity in a property and it can command 1% of market value in market rent, then a cash-out refinance is optimal and would leave 25% equity in the property (per Fannie Mae requirements). 

You mention two properties - one worth $280k and one worth $400k. Unless these two can command rents of $2,800 and $4,000, respectively, then this is a terrible rental strategy and would be better offer divesting and buying properties that fit the most optimal confines I previously outlined. 

Of important note. Equity can be considered cash as it is trapped cash. So, the higher the equity in your property, the lower your cash on cash return is. Your most optimal cash on cash return will be when you leverage at ~18% to 22% equity and Market Rent is at least 1% market value of the property.

Originally posted by @Anthony Wick :

"I personally think if you can’t pay all the mortgages on all your properties if they are vacant 6-8 months, it is a problem..."

Holy, dude. If I have a vacancy for 8 months, I either should not have been buying in this area, or my rental is garbage and way overpriced. 

But anyway, it's all about your goals, and your personal level of risk. Kind of like the stock market. How much should I have in stocks in bonds? Well, I don't know, what are your goals and timeframe? 

I plan on leveraging and buying more properties until I die. I take early retirement in 5 years, and not taking a paycheck from rentals until then. Even at the interest rates of today, it's still better to be buying and investing. I want my tenants paying the bank. But, the properties still have to cash flow and be self sustaining after the refinance. You can't refinance up to 80% (you still have 20% equity, you're not broke!) if the rents don't cover the expenses. 

I lived in California when the  market went bust. My personal home lost all it's equity, and then some. But, industries and people went broke because they were taking out mortgages at 110% of value, interest only loans, 3 year balloon payments, with no income, on many properties. Today, just because you leverage, doesn't mean you're broke. Are you using rents to fund that capex, maintenance, vacancy fund, before you pay yourself? 

But again, it's all about your personal goals and your stomach for risk. Some people can't sleep at night if their 401k is losing money, like this month. They need that steady 4-5% gain. I have a co-worker like that. We've been in the same job for the same number of years. His retirement portfolio is about 1/5 the value of mine. Maybe I got lucky. But it seems like the harder I work, the luckier I get...

I know this is extreme but I had personal clients that we brokered MF to in 04 05 up in PDX .. they also bought a bunch of 4 plexs in PHX.. and during the crash those 4 plex's ALL went 100% vacant and stayed that way for more than a year.  areas dominated by construction the rental pool was heavy to those folks.. anyway our PDX one's rode through with bumps.. but the PHX one's were all let go to the lender they lost it all.. and those properties they paid 350k per 4 plex in 2009 2010 as they sat vacant you could buy them for 80 to 90k per 4 plex.. so some folks loss was some folks gain..  building is back as we know so is occupancy in those markets.. but it happened.. will it repeat who knows.  but you do want to have protect yourself and of course no gain without risk 

It is interesting the two ends of the argument - maximum leverage vs. no debt. On some of the podcasts some investors talk about how they Can get into a home by only needing to put down 3% as a down payment, and they are encouraged to do so if they can. Then in other podcasts or forum posts some investors talk about not being overleveraged over 75 to 80%. 

I think it really does depend on where you are in your investing career and how you invest the money that is leveraged. It makes no sense to leverage as much as possible just to have money hanging out in the bank. But then again, @Jay Hinrichs has a really good point about how not being too highly leveraged and having some money in the bank helped him get through the crash of 08 and 09.

As for us we do feel comfortable being leveraged at 75 -80% but we are in a state of  growth right now so it works for us to be leveraged to that point right now. 

Originally posted by @Shiloh Lundahl :

It is interesting the two ends of the argument - maximum leverage vs. no debt. On some of the podcasts some investors talk about how they Can get into a home by only needing to put down 3% as a down payment, and they are encouraged to do so if they can. Then in other podcasts or forum posts some investors talk about not being overleveraged over 75 to 80%. 

I think it really does depend on where you are in your investing career and how you invest the money that is leveraged. It makes no sense to leverage as much as possible just to have money hanging out in the bank. But then again, @Jay Hinrichs has a really good point about how not being too highly leveraged and having some money in the bank helped him get through the crash of 08 and 09.

As for us we do feel comfortable being leveraged at 75 -80% but we are in a state of  growth right now so it works for us to be leveraged to that point right now. 

 to be fair the 3% down is OWNER OCC and the bedrock of the American housing market..  and the fed guarantees the loans to the investors that buy them.. so as long as the fed's guarantee is worth anything investors are going to buy those mortgages by the billions each week and keep our economy going.. 

@Jay Hinrichs that is also very true, goals and skills are the driver of most everything in investing. Debt does magnify returns, but also risk, which isn't often talked about, but no one needs to tell you that!

A lot of the different points of views about REI come from different perspectives of debt. Some view an asset's "natural" state as being debt free and loans are used only as a means to an end, a tool to get more assets when they are undervalued, to scale up, a way to get capital back tax free, ect. Others view the natural state as leveraged and if the LTV falls to low cash is left on the table, which is true.

 Different strokes for different folks, but as a young-ish investor who studies older investors and their methods to see what work over the long term, the vast majority of very successful investors who have survived multiple market corrections tend to view debt as a tool, but one that should be used carefully due to its risks. You need to look no further than RJR Nabasico, Sears, iHeartRadio, to see the extreme risks that over leverage poses.

I could be way off here, but in the past few years I've seen a shift from getting quality rentals (ones that have a decent chance of making returns across all four wealth generators) at a reasonable rate when the market presets opportunists to the "freedom number" idea of REI; the idea of pulling "dead equity" out is a symptom. Getting as many doors as you can as fast as you can is another symptom.

 To me it puts the cart before the horse. Investors pull all this $$ out of a quality investment because "its not working for them" and they dump it into a checking account making 50 basis points and/or into a rental of significantly less quality than their other one, because they needed more doors or want to reach that cash flow number. 

Finally, and this has always bothered me, unless the property isn't appreciating, then the equity isn't dead, it simply isn't getting optimized yield and as a corollary it does not have maximum risk.

Dead equity? Of course the title sparked a polarized (but I've seen worse) discussion of no debt vs max debt.  

Like usual, the arguments assume all debt discussed is fixed for 30yrs at 5% or less and the refinances are free. And painless. No mention of the $5k+ each costs or the 6-week financial orifice exploration marathon each refi is. LOL

I have more equity than debt, but my equity isn't dead. It was also acquired with purpose. I didn't accidentally pay down high rate, high risk PITA loans that bother you.  My avg ROE is 7% and can be tapped for the right opportunity.  

 In a desert of deal flow in a frothy market cycle? 7% risk-free, tax-free and hassle-free while napping isn't so bad.  Play to your strengths and risk tolerance .Play to your own effort/reward, cost/benefit analysis.

Also play to what the market gives you.  Refi till you dies act like its the buyers market hayday of the GRC or something. Not so smart to go through the pain and costs of a refi only to feel rushed/ forced to buy a mediocre deal. Or invest in the market at 26,000 with large swings weekly.

As the market shifts more to the buyers, I will consider opening credit lines against my 'dead equity' if needed.  Remember, dead equity means no stupid payments.  The lines probably won't be needed but they are there and my equity is not dead.  Carry on.

I am old school.  I like dead equity.  Once I have it paid off I know I can sleep real good.  I am not going to take on debt to leverage to get more debt.   Do I want to get 20 houses netting me $200 a door?  I have to worry about 20 properties with loans.   I rather have 5 homes paid off that will net me the same.   I am also not against pulling cash out if the right opportunity is available. Like Jay mention in his PHX example.  If I see something like that.  I will surely pull cash to buy those up. 

Dead equity gives you tremendous holding power.

Originally posted by @Larry Hawkins:

Of important note. Equity can be considered cash as it is trapped cash. So, the higher the equity in your property, the lower your cash on cash return is.

 @Larry Hawkins

I am not an expert, but I believe that you are speaking about ROE (return on equity), cash on cash return is different

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