Thoughts on cash-out-refi into stocks.

10 Replies

I'd like your thoughts on this as I'm thinking of doing something similar:

A friend of mine has a paid off 4 plex in Utah County and is thinking about doing a cash out refi into some some stocks(Something simple that tracks the s and p 500).  He can pull out around 500K.  He's not ready to buy another property but would like his money working a little harder for him during this time.  The bank will charge him 4% on the money he pulls out and he feels he can do better than 4% these funds.

I've run some rough numbers. The rent income should still cover his mortgage and repairs.  He'll be paying roughly 20K interest on his mortgage this per year. I'm not an accountant but I'm not sure he'll be able to write off this 20K in interest because he's pulling the money out and not re-investing it in the property.  That's one of the down sides but not possibly a deal breaker to me. 

What are your thoughts?  Haven't heard of many people following this strategy.  Is he crazy?  

(including @David K. Loveless )

Without knowing anymore about your friends situation, if I were him I would rather put my money into a TIC (tenant in common) interest or DST (deferred sales trust). That way he'd still be purchasing real estate, but with the same level of involvement as just leaving the money in stocks. The returns are usually a little better in TICs and DSTs as well.

I’ll invite an accountant or tax attorney to correct me if I’m wrong, but I’m pretty sure he can still write off his mortgage interest whether or not he reinvests the cash out money in the property. 

The extremely low interest rates do present an opportunity to re-deploy some capital.   Since the property will still appreciate at the same rate with or without the mortgage on it the decision point is the rate of interest he would pay on the cash he accesses.  If he's paying 3% and can earn >3% in anything else then it's a go in my opinion.  Personally I would pay 3% to have a fully funded opportunity fund for whatever happened to come by.  

Stocks aren't my area of expertise.  I do know that in terms of PE ratio the market in genera could be considered expensive or over valued right now.  If your friend in confident about his expected returns in the market then the general market conditions shouldn't stop him.  

For any investment I think the advice to stick to what you know is really solid.  It would be terrible to take money earned from a good investment and put it into a bad one.  

@Ray Loveless the idea to borrow the money is good I personally probably wouldn’t do murals fund stocks because I can beat stock market many times over with RE. Over 30-40 years he should do better with this strategy than free and clear places but he must not pull out loses or it could backfire on him.

@Ray Loveless Not a good idea IMHO. Well maybe I should say I wouldn't do it. The long term s&p 500 average is 8%. Less 4% for margin leaves you with a potential 4% spread/gain with majority volatility, at all-time high valuations, with record low dividend yields. It also depends on the individual, his or her total plan, time horizon, and other factors.

@Ray Loveless - the stock market is very volatile. I like investing in the market for long-term growth for capital you plan to use in retirement. The returns over 20+ years are fairly predictable, however, the returns in 1-5 years can be all over the map. If your friend did this, they should be prepared for a 20-40% drawdown that could last for a few years. We saw a 30%+ drawdown in 2020, albeit short lived. If they plan to invest and leave it for 10+ years, then it might not be a bad idea, however, if they want to use the cash to do another RE deal next year, they might want to rethink.

Thank you for all your feed back. Very helpful. I think the most important point with this is to not panic when stocks go down which they definitely will.  Buying high and selling low is never good and will happen for some individuals if and when things go south.  That being said if we're on the brink of another 2008 this strategy would be great.  In 2008 your stocks would crash(you don't panic and keep your money in place) and when 2012 comes around you're stocks have bounced back and you're in a perfect place to jump back into realestate when prices are at rock bottom.  Obviously the next crash won't mirror 2008 but it makes sense to me to pull some money out of realest while rates so low.  Getting a line of credit isn't as good as money in the bank... especially if real-estate prices drop and the bank cancels your line of credit.  

Regarding taxes, it's complicated,  My cpa got back with me and mentioned there are ways to write off the 20K in interest.

@Ray Loveless

While I am in agreement with most of the post the stock market is currently very volatile, however portfolio diversity is a great approach to build wealth and mitigate risk. Having a good Financial Advisor that can direct appropriation between, bond, stocks and futures could be invaluable. Moving to a conservative portfolio during the high and waiting for that bear market correction and moving back in at the low can yield high returns. This year alone one of the highest real estate markets rose 9% great returns but the Dow at its low rose 75%.

@Chris Borden , Thanks. You got me thinking a lot.  In the biggerpocket money podcast( eposode 14. the first 7 minutes) they mention that it's super difficult to choose a manager that out performs the stock market. I think I'm leaning toward a broad based low cost index fund.  Have a listen to that section. I'd be interested in your thoughts.