How is using equity to fun a new property profitable?

Question

Can someone please help explain to me how you keep building equity when using equity to fund the down on your next investment?  I understand the idea but I can't get my head wrapped around it because when you borrow against the equity you're going to have to get a loan from the bank to do that so you're going to have a payment.  If you're not making much beyond 6% ROI on that property you may not be able to cover that payment with all the other expenses.  With the mortgage from the new property, if you add the loan for the equity borrow, it may be hard to find a deal good enough to cover both loans.  Can someone clear this up for me?  Maybe I'm just way overthinking it.

John Cardinale · Answer

Equity is earned by: making a great purchase by buying under valued property, forcing property appreciation through rehabbing, paying down the debt over time, and having market values move in your favor or stay put. Using your existing equity to scale into more rentals can be a way to do it quicker. Now just happens to be a more difficult time to borrow and so more and more deals that would have been actionable when interest rates were 3-4 percent are now more expensive to get into. In my market, real estate values seem to be adjusting to these new realties with longer days on the market, more price decreases, lower prices per square foot.

So if you can use your equity to find your next deal that happens to make a positive cash flow, maybe it doesn’t all the way cover you 2nd loan from accessing your equity, you can then decide if it’s worth doing. Are you better off owning that property than not ? Will it appreciate in a year or 2? If it’s a break even, should you flip it instead of hold? can you negotiate harder to get a better return to compensate for higher rates?

I hope this helps!

Nathaniel Fulford · Answer

When you use equity from one property to fund the down payment on another, you're essentially spreading the value of your initial investment to acquire more assets. It's true that you will have a new loan and, consequently, a new payment. The key to making this strategy work is ensuring that the return on your new investment exceeds the cost of borrowing against your equity.

For instance, if you're earning a 6% ROI on a property but the loan costs you 4%, you're still ahead by 2%. However, this doesn't factor in other costs like maintenance, vacancies, and other variables. The trick is to find an investment that will give you a high enough return to not only cover the loan on the equity but also the mortgage and other expenses on the new property, while still leaving you some profit. It's not just about covering your costs, though. This is where thorough market research, careful property selection, and sometimes a bit of patience come into play.

Yes, it's a balancing act, and it's smart to be cautious. Over-leveraging can be risky if the market turns or if the property doesn't perform as expected. That's why many investors stick to a conservative LTV ratio when borrowing against their equity and why they choose their new investments judiciously.

Mike Dymski · Answer

Most of us can borrow at X% and generate an IRR of at least 3-4x that amount (which includes the cost of debt).  6% is too low...can get that with an online savings account...need 20+% to make it worthwhile for real estate, which takes a lot of work.  The IRR includes ALL cash flows (including monthly cash flow, principal paydown, market appreciation, forced appreciation, etc.).  Whether the borrowing comes from equity in another property or from the purchased property is not that relevant to the math.

Steffen Cushing · Answer

i struggled with this idea for a while. unfortunately took me longer to realize the advantage. if you put money into a deal, that value increases then you can take money out of that original deal to fund another one. you have no money vested in the first deal and your funding another. my thought is, as long as the original deal is not a negative cashflow situation, then it works out. cycle repeats itself.

example, lets say you put 40k into a deal, a year later you can get the 40k out with a loan and the rent still allows the property to cash flow, but now you can use the 40k for another deal that will cash flow. you got two properties with the original 40k invested.

Bill B. · Answer

I usually do it when the first property will still be profitable making the new payments on its equity being borrowed. This isn’t day 1 or even year 1 stuff. This is after not only has your equity increased but your rents have increased. If you’re raising rents $100-$200/yr for 4-5 years that property can now make a $500-$1000/mo higher payment itself. While “borrowing” the money to the other property.

Imagine you have a $400k property and it goes up 8% per year. After 5 years it’s worth more than $560k. You can borrow 8o% of that, or $128k to use on a downpayment of another $500k property. Assuming property as increased rent can make e higher payment.

You don’t ask the new property to make that payment just like you wouldn’t as it to pay you interest in your downpayment on top of the regular cash flow it produces.

Real estate is get rich slow and easy and almost risk free. it’s not get rich fast and risk free. People spend 40+ years building their retirement 401k or Roth retirement funds. Feel free to let real estate take 10-20 years, it’s still insanely better than the next best choice.

How is using equity to fun a new property profitable?

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