Does this HELOC logic make sense for a Rental Property?

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Does this HELOC logic make sense for a Rental Property?

James M.
Investor · San Antonio, TX · Member since 2017 · 27 posts · 6 votes

Hello BP!

I'm a small time investor (when do you get to be big time?) with just one rental property. I am looking to obtain two more rental properties this year!

I currently live in a house with about 100k Equity in it and 120k left to pay off. So LTV HELOC as I understand it, I could get a line of probably 80-90k.

I have an oppurtunity with a family member for a non-arms length deal. I could easily save up for the down payment, but I wanted to see if the following logic makes sense if I used a HELOC instead:

  1. House sale is 135k, could likely go for 150k today, it will appreciate by 7 percent over the next year or two.
  2. Lets assume a full 20 percent down payment from the HELOC (27k)
  3. Cashflow is about 450 a month, not including vacancy/capex/repairs, in which case real cash flow is closer to 150 a month. I plan to PM myself as I do today for a very long time and then PM to another later. I'm not too concerned with calculating PM costs into it until later in life when its either paid off or refinanced at a lower payment.
  4. All combined the leverage would be a conventional loan for 80 percent and a HELOC for the other 20, none of my direct cash.

With all that in mind, the following questions come to mind about whether this makes sense or not.

  • Technically, if I'm using the HELOC completely or majority of the purchase, would that mean my CoC return is effectively much higher since its not my own money (directly, I know its my equity) as long as I don't make my own payments on the HELOC?
  • Does it make sense to use the Cashflow from my first property, and my second property to pay down this HELOC as a strategy? I figure after a year I could see where its at and refinance-cash-out (I have not tried this yet) and pay off the remainder, or continue to pay it off. This does tie up that rental money but I'm okay with that.
  • Or, should I just wait to see if appreciation happen and refinance-cash-out. And pay off the HELOC?

To ease tensions, I am in a very grateful situation to where I have no debt (besides my current residence and rental) and bring in 10k of free cash flow a month, so defaulting on a HELOC pull of 27k is unlikely. I could/might do 50/50 where i do 13.5k of HELOC and 13.5k of my own cash.

Sorry for the long post, but does my logic of HELOC pay off hold water in this situation?

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Jaysen Medhurst
Rental Property Investor · Greenwich, CT · Member since 2015 · 4k+ posts · 2k+ votes
6y

A few things at the top, @James M.

  • The $150 cash flow, is that after you pay the HELOC each month or before?
  • Discuss this strategy with the lender that will provide the mortgage. They may not be okay with the property essentially being 100% financed. Better to know at the outset so you can either find a different lender or use a different strategy.
  • Would your family member be open to owner financing? That would alleviate the potential problem above.
  • Lastly, I'd love to see your full rental analysis. With a $150k FMV, you're starting to get into the range where SFRs are hard to make work. BTW: you should always plan for management expense, even when self-managing. You need to know that the property is viable should you no longer be able to manage. Don't fudge your math here.
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  • Jaysen Medhurst
    Rental Property Investor · Greenwich, CT · Member since 2015 · 4k+ posts · 2k+ votes
    6y

    A few things at the top, @James M.

    • The $150 cash flow, is that after you pay the HELOC each month or before?
    • Discuss this strategy with the lender that will provide the mortgage. They may not be okay with the property essentially being 100% financed. Better to know at the outset so you can either find a different lender or use a different strategy.
    • Would your family member be open to owner financing? That would alleviate the potential problem above.
    • Lastly, I'd love to see your full rental analysis. With a $150k FMV, you're starting to get into the range where SFRs are hard to make work. BTW: you should always plan for management expense, even when self-managing. You need to know that the property is viable should you no longer be able to manage. Don't fudge your math here.
    1Reply
  • James M.
    OP
    Investor · San Antonio, TX · Member since 2017 · 27 posts · 6 votes
    6y

    Thanks @Jaysen Medhurst fair point on the PM pieces. I try to be very conservative everywhere else, rent included so I shouldn't leave it out.

    • The 150 cash flow is a good question and one I didn't consider. It is before. My intention was to put all money, not just free cash flow, towards it. In reality that may be about 400 from this rental per month. And I'd use the HELOC as a capex/repair account if it came up since I'd be using that money already to pay it off. I do have another rental so I played with the idea of using that rentals cash as well to pay it off faster. Goal would be to pay it off in less then 2 years over time if I wasn't doing a refinance-cash out (Which I have not done before so not sure if this is a full option).
    • Family member is unlikely to be approved for two home loans at once so them doing an owners finance still makes it look like they have a loan with Bank 1, when they try to make another loan with Bank 2 it's unlikely their income will allow them to be approved, but this thought has crossed my mind. And to be fair, they have not looked into their second loan viability. And also to be fair, I also have no experience with owner financing so I only assume their original loan will still show up as owed since it would be "wrapped" around the owner financed one, yet still exist.
    • I will definitely discuss this with my lender, first time using a HELOC and I'd rather be clear with all parties what I'm doing. Again I could make this work with my own capital, but the goal was to see if I could get more "bang for my buck" long term on equity I already own.
    • I will reply here later on with the full layout of the analysis, I should have started with that. I'll update my top post here as soon as I can.

    P.S. I am actually VERY interested in the Owner Financing bit, if their credit/income was better it'd probably be my first option. Any advice in what I should look into to make this happen? Any tips on how to go about this "wrapped" owner financing I'd assume they'd have to do since they still have a mortgage?

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  • James M.
    OP
    Investor · San Antonio, TX · Member since 2017 · 27 posts · 6 votes
    6y

    @Jaysen Medhurst I updated my original post, annoyingly it didn't format as I wanted to so I'll repeat it here. As you can see the numbers are a bit tight and definitely not worth it CoC return wise if I used my own money. I took your advice and put in PM and it squished my CoC from 8 percent to 4 percent, if it were my own money. I tend to try and hit at least 8 percent, perhaps that is too low or misguided for others as a CoC return, open to thoughts on that.

    In any case, assuming half of this would be my HELOC and half my money, would that artificially increase my CoC return assuming I pay the HELOC back via the cash I'm receiving and then perhaps a year or so later refinance and pay it off? Or does it not work like that?



    • Purchase Price: 135k 
    • FMV: 150k
    • Rent - 1250-1300 
    • P&I/Property/Insurance - 848 
    • Vacancy/Repair/Capex - 7/5/5 percent - 221 a month
    • Management - 10 percent - 130 
    • Cash Flow (renting for 1300) - 100 with PM, 230 without
    • Cashflow (renting for 1250) - 50 with PM, 180 without.

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  • Account Closed
    Member since 2019 · 1k+ posts · 1k+ votes
    6y

    @James M.

    7% appreciation over the next “year or two” is either 3.5% (good!) or 7%(great!) appreciation, which is it? What leads you to predict that number?

    If you have $100k equity in a $220k property I would not recommend leveraging it to 95% by putting $90,000 of heloc on it. Even though it sounds like you’ve got a absolutely solid financials and a good grasp of all this, over leveraging is the easiest path to becoming a motivated seller. And that’s a target you’re going to want to avoid!

    1Reply
  • James M.
    OP
    Investor · San Antonio, TX · Member since 2017 · 27 posts · 6 votes
    6y

    Makes sense, I guess I didn't think about it in that sense. I really just need/want 20-30k. I assumed a line of credit was just there but it makes sense if I leverage the whole thing, it doesn't matter how much I take out it'll still be a bit over leveraged.

    Never did a HELOC before so I will definitely just HELOC for 30k or so if its an option.

    To be fair appreciation is a general guess  based on the trend. I also know the area decently well and I noticed its been going up in general. For better or worse there are a lot of flippers in the area and this house happens to be where my current rental is as well so I know the neihborhood, its about 3 blocks from my current rental as luck would have it.

    Thanks @Account Closed

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  • Account Closed
    Member since 2019 · 1k+ posts · 1k+ votes
    6y

    @James M.

    I also wouldn’t necessarily recommend getting the heloc for only exactly what you want to use. Just, be cognizant of leverage is what I’m saying. And don’t be scared to err on the side of UNDER leveraged as a whole. Some lenders will offer lower interest rates above a certain dollar amount, and then some shady character brokers will charge a fee for putting your application in below a certain dollar amount also. Keep in mind if your goal is to gain more property, even if you only have $10k of a heloc used lenders will evaluate the scenario as if fully leveraged. Or at least, here they always do. Same as a credit card your dsr will be calculated as if it was maxed. My personal threshold is 80% on personal residence and less on investment properties. Definitely have a firm plan to pay down the heloc also (sounds like you definitely do!).

    1Reply
  • James M.
    OP
    Investor · San Antonio, TX · Member since 2017 · 27 posts · 6 votes
    6y

    Great point on the leveraged account @Account Closed forgot about the factor with the credit limit. If I had a 50k HELOC and pulled 30k for this deal, could impact credit in a good way. Thankfully I have excellent credit, but that doesn't stop an almost maxed out credit card from hitting it pretty hard.

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  • Jacob Villalobos
    Whittier , CA · Member since 2013 · 176 posts · 96 votes
    6y

    1. Small spread of equity. Maybe find something with more meat on the bone. Never assume future equity/appreciation

    2. HELOC can be expensive (use if you must, but only for a great deal)

    3. Always include vacancy/capex/repairs. Always! They are there for a reason. Don't get deal (beer) goggles.

    Calculate for a PM as well at least for a little while until you understand fully the business/legal side of being a landlord. It's very easy to make expensive mistakes.

    4. Over leverage is the iceberg that took the titanic down. 100% financing is usually expensive. Use it if you must, but tread carefully

    1Reply
  • Jaysen Medhurst
    Rental Property Investor · Greenwich, CT · Member since 2015 · 4k+ posts · 2k+ votes
    6y

    @James M., I would figure ROI, based on the actual cash in the deal. The HELOC is debt.

    8% ROI wouldn't be enough for me in a "normal" deal, but might be worth considering if there was very little capital required. Typically I like to see mid-teens or better.

    1Reply
  • James M.
    OP
    Investor · San Antonio, TX · Member since 2017 · 27 posts · 6 votes
    6y

    @Jaysen Medhurst I'm assuming when you refer to ROI, you mean the total picture correct? So CoC return over time and then if I sell that gets figured into it, obvously divided over how many years I was holding and the money I inputted. Just wanted to make sure my knowledge of that term is right.

    In San Antonio, its tough to even find a 1 percent rule deal, let alone a 10 percent CoC return and hell will freeze over if I found mid-teens in the wild. To be fair though, I have not networked, at all. So my goal for the next 6 months as I accrue cash is to network very hard and get to know all the wholesalers, etc. in my area. Mostly through BP and my local Real Estate Group.

    @Jacob Villalobos Definitely hear you on the vacancy/capex/repair. Sorry if it wasn't clear but yes I always, always include it. Roughly around 17-20 percent of my return cash. I've only got experience with one rental, so I am currently a landlord for about 2.5 years now and its worked out for me thus far. But I may be lucky as well. Also hear you on the debt piece, my goal is to pay off anything I took out of the HELOC in less then 2 years, preferably 1.5 years. Is that sensible you feel? And if it is, would you basically still just not use it unless it was a fantastic deal? I'm trying to leverage the equity in my house because it "sits" there. I do realize the risk, but I have a large savings that shadows any HELOC spending I do. It does feel I'm trying to put lipstick on a pig sometimes, I'm just trying to see what I can do to accelerate, but do it in a careful manner and not be irresponsible.

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  • Jacob Villalobos
    Whittier , CA · Member since 2013 · 176 posts · 96 votes
    6y
    Originally posted by @James M.:

    @Jaysen Medhurst I'm assuming when you refer to ROI, you mean the total picture correct? So CoC return over time and then if I sell that gets figured into it, obvously divided over how many years I was holding and the money I inputted. Just wanted to make sure my knowledge of that term is right.

    In San Antonio, its tough to even find a 1 percent rule deal, let alone a 10 percent CoC return and hell will freeze over if I found mid-teens in the wild. To be fair though, I have not networked, at all. So my goal for the next 6 months as I accrue cash is to network very hard and get to know all the wholesalers, etc. in my area. Mostly through BP and my local Real Estate Group.

    @Jacob Villalobos Definitely hear you on the vacancy/capex/repair. Sorry if it wasn't clear but yes I always, always include it. Roughly around 17-20 percent of my return cash. I've only got experience with one rental, so I am currently a landlord for about 2.5 years now and its worked out for me thus far. But I may be lucky as well. Also hear you on the debt piece, my goal is to pay off anything I took out of the HELOC in less then 2 years, preferably 1.5 years. Is that sensible you feel? And if it is, would you basically still just not use it unless it was a fantastic deal? I'm trying to leverage the equity in my house because it "sits" there. I do realize the risk, but I have a large savings that shadows any HELOC spending I do. It does feel I'm trying to put lipstick on a pig sometimes, I'm just trying to see what I can do to accelerate, but do it in a careful manner and not be irresponsible.

    Sounds like your smashing it! Excellent work! 

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  • Jaysen Medhurst
    Rental Property Investor · Greenwich, CT · Member since 2015 · 4k+ posts · 2k+ votes
    6y

    No, @James M., I'm referring to just Cash on Cash ROI. I figure appreciation, depreciation, and mortgage pay down (along with cash flow) into my Internal Rate of Return (IRR) calculations

    1Reply
  • James M.
    OP
    Investor · San Antonio, TX · Member since 2017 · 27 posts · 6 votes
    6y

    Thank you @Jaysen Medhurst I agree I would much prefer a 10 percent or greater CoC ROI. Sounds like I need to get off my butt and network then, obviously MLS, Zillow, etc. has nothing that will be of value in that range nowadays. What is crazy you could on Zillow just 5 years ago. Time flys.

    Thank you very much Jaysen for your advice and help and everyone on here. Guess I have some things to think about to make this deal with the family member more palatable. I think I should figure out a way to at least get 10 percent CoC.

    One more thing @Jaysen Medhurst you had mentioned you would shy away from SFR at 150k range. Is that because you'd transition to Multi-family past around there? Better returns I assume for your money I assume? Also of course I know it does mean holding back more money for repairs (two of everything, except for roof etc).

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  • Jaysen Medhurst
    Rental Property Investor · Greenwich, CT · Member since 2015 · 4k+ posts · 2k+ votes
    6y

    @James M., I definitely prefer MFR over SFR. The economics just work better. But a lot of people do very well with SFR.

    The reason $150k+ gets difficult is because you start to get into a range where rents don't keep up with values. You stop hitting the 1% rule and, broadly speaking, it's hard to cash flow below that point. Your rental pool really starts to shrink, too. Anyone who can afford $2k in rent, can certainly afford a $200k house, so...

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  • James M.
    OP
    Investor · San Antonio, TX · Member since 2017 · 27 posts · 6 votes
    6y
    Originally posted by @Jaysen Medhurst:

    @James M., I definitely prefer MFR over SFR. The economics just work better. But a lot of people do very well with SFR.

    The reason $150k+ gets difficult is because you start to get into a range where rents don't keep up with values. You stop hitting the 1% rule and, broadly speaking, it's hard to cash flow below that point. Your rental pool really starts to shrink, too. Anyone who can afford $2k in rent, can certainly afford a $200k house, so...

    Very fair point and exactly what I was thinking. But being I've only rented one place and did one deal wanted to solidify that thought process. Thanks again Jaysen and lets hope 2020 I can find 2-3 great deals through networking :) Maybe I can even make this family one work, we'll see. I'll have to get creative. This thread has renewed my sense of being more conservative then I have been, I haven't gotten a new deal in well over a year, so I became lazy. 

    1Reply
  • Jason TougasPro Member
    Rental Property Investor · San Antonio, TX · Member since 2019 · 51 posts · 24 votes
    6y

    @James M.

    If you only need $20-$30k you can likely get a personal line of credit for that amount and very similar rates. This LOC can be used

    For anything you desire and would simplify your situation.

    I use my LOC to fund my rehabs and pay it off after the flip or refinance and start all over again on the next property.

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