How does leveraging (refinancing) work in practice?

Question

Hello BP,

My wife and I own one rental income property (outright, San Diego) and are looking to invest in a second or more (Houston area) to increase cash flow. I have been reading the forum posts on the debate between buying all-cash and financing as we are trying to decide which to plan for (I guess cash-out refi on the current property would be a third option?). If the purpose is to increase cash flow in absolute terms, the avenues to that seem to be 1) buying all-cash or 2) financing and using leverage to acquire multiple properties.

For example, one might say we could buy one property for $250k call cash, or buy 5 properties for $50k down each to achieve the same cash flow. My questions is - how does the financing in the second scenario work in practice? How would we qualify all those loans? Is realistic to assume we can get so many loans? How do our personal financial pictures fit into it?  How long would that take to get up 5 units? Meanwhile, we plan to take out a mortgage on our primary residence as well.

Thank you for your input and please do let me know if there is something wrong or too simplified in my assumptions. Lot's of great information and discussions on this site, it has been a wonderful resource for our REI education.

Jonathan

Scott W. · Answer

Hi Jonathan! The beauty of real estate is the ability to leverage other people’s money (OPM) and allowing yourself rental passive income and long-term appreciation. It depends on your risk tolerance, but I believe it’s a fine balance of leveraging a little and using some cash equity so you aren’t upside down. It’s also important to have cash reserves in case the world goes into a pandemic! I personal believe that it’s a more prudent to have 3-4 properties that are leveraged vs just one fully paid off property. I hope that helps!

David Robinson · Answer

@Jonathan Fuchs Yes it is realistic to have so many homes. You can keep personal finances separated with an LLC. You could have 5 properties within 21 days with multiple lenders I work with. You should decide on your formula and go for it, if you want to stay debt free find 5 lower priced properties with cash. There is options of leverging cash out after the purchase as well. If you want to leverage financing, research and create a formula for the value of the cost, is it worth it? Can I get more money, quicker money, do I get connections with a professional that helps your network and using someones else money while keeping more cash in hand.

AJ Shepard · Answer

@Dan Heuschele concept on having 25% equity and having 100% equity is spot on.

As far as in practice, as you obtain more rental properties and have income coming in from those rental properties a mortgage lender will look at that income and it will be added to your regular income.   This is what qualifies you to buy more than just one.  This is the difference between buying an income property vs buying a second home.  Much easier to qualify for income properties.  Definitely consult a mortgage professional in the area you want to buy.

Our market it is a lot harder to find SFH that cash flow very well.  If you are entering a market like Houston I would assume the same thing.  Might be worth it to look at duplexes and 4 plexes to see if they cash flow better than a SFH does.

As far as the equity in your current home, obtaining a refinance now while interest rates are low is probably prudent.  After you’ve done that, since it’s your primary, finding a HELOC (Home equity line of credit) that goes up to 90% would be helpful as well.  The ones we’ve always got have asked what we intend to use the money for and the best answer I have found is to improve the house of course.  HELOCs can take a bit of effort to get, but you can never get one if you need it, so better to get one when you don’t so you have it in the future.

Sebastian Marroquin · Answer

All great suggestions and comments from many smart people on here.

The only thing I would add is (even if you can get 3,4,5 homes at once with loans or without by paying all cash)

Get one additional rental property in the area you want to go into (after doing plenty of research, talking to a local realtor, talking to a local lender, a local property manager, a RE attorney... etc ).

The first mistake that I see people make is that you want to do things yesterday...

Get the first property and learn:

1. Buying cash and then getting a loan for it: there will be all lot of ins and outs you will benefit from.

2. You will learn from the transaction also: the offer process in that state, the escrow process...etc

3. Stabilizing the property: getting it ready, maybe renovations, assisting with the interviews for the tenants, interviewing vendors etc

4. Collecting payments, softwares, bank accounts.... etc

5. Collecting data for taxes, saving on taxes, depreciation etc

Once you have stabilize the home: maybe 6 months or maybe 12 months (what ever you feel comfortable with), then buy 1 or 2 more. Maybe more, depends on how fast you learn and availability of funds.

* have an emergency fund for each property.

* have an exit strategy

I see too many people on bigger pockets wanting to leverage way too much, wanting to get to 10, 50, 100 units way too fast... and using partners or using other people's money and investing it without having the experience for it.

Stress kills... Learn, enjoy the process, and achieve your goals!

Good luck

Deanna O. · Answer

Part of the equation has to be taxes (consult a professional who understands RE taxes). Homeowner deductions, annual income, cost of financing, and your own personal comfort level dealing with renters (or PMs) all play into it. The capital gains tax alone could make or break a deal.

Jonathan Fuchs · Answer

@AJ Shepard thank you, that is the bit on information I was missing! That the rental revenue is counted additional  income for us. Thanks for the other tips as well. Our investment in Houston will be dependent on finding an area in or around town that does cash flow, assuming they can still be found. Duplex or more is also a possibility.

Dan H. · Answer

There is no cheaper money than a Fanny/Freddy (F/F) conventional loan.  It is the closest to free money as there is.

Let’s do some scenarios ... if I have a property with 25% equity appreciates 10% the return is 40% from appreciation.  If I have 100% equity and a property appreciates 10%, I have a return of 10% from appreciation.  My F/F loans are from just below 3% to 3.125%.   As indicated this is basically free money.  Any return above the loan rate is margin that provides additional return on the money.   The lifetime return of the S&P500 is over 9%.   This is a passive, liquid investment that over long periods has shown to be reliable.  Note this easy investment produces a margin spread of 6% using lifetime S&p500 return.   Note if you want to put forth much more effort such as a BRRRR, the achievable return should be much higher most of our BRRRR have produced infinite return).  Then there are numerous other options such as investing in a syndication, NNN, private lending, notes, traditional buy n hold, flipping, etc.    The point is achieving a return above 3% should be very easy to achieve over the long term.  I am not advocating being over extended.   It is possible to have high LTV on every property and not to be over extended.  This would be achieved via diversity.  I do not understand not leveraging money to optimize returns in a low risk approach.  I do not believe having 100% equity is a property is optimizing the return from the money.

How does leveraging (refinancing) work in practice?

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