Is a Cash out refinance a good idea in my situation?

Question

I was recently passed down a property that has a return on equity of around 10%. The property is paid off in full. The logical thing to do should be to refinance the property and use the money for other investments.

The problem I'm having is finding another investment that cash flows me the same amount every month.

For example: this property cash flows me $4k monthly. If I refinance and pull a loan of $800,000, the debt service will eat away my cash flow from the current property and I can't find another property that will combine with the current property to cash flow $4k monthly.

Basically, if I refinance I will be cash flow negative from my current net income on the property.

Is it better not to refinance in my scenario?

Simon Ashbaugh · Answer

Why pull the full 800k out? why not only pull what you need for a down payment or two in a high cashflowing market like Cleveland Oh?

Scott E. · Answer

Your return on equity is not 10%.

If you have $800k in equity, you would need $80k per year ($6,666.67 per month) in net cash flow to achieve a 10% return on equity.

At $4k per month in cash flow, your return on equity is actually around 6%. Still not bad. But this may change your perspective.

If I were in your shoes I wouldn't be thinking about whether or not I should refinance. I would be thinking about whether or not I should sell.

Henry Clark · Answer

Several approaches:

1. Do nothing. Looks like you just joined BP. Spend some time getting up to speed

2. Don’t do a refi. Just use the house as collateral on a working line of credit. Take on debt as you need it. Not all at once. Takes the pressure off having to make a deal.

3. Did you receive the property through a deceased? Was the basis stepped up? Easier decision to liquidate into different investments.

4. If basis was not stepped up. You have lived in your existing house for 2 consecutive years out of five. You could sell your house with no taxes. Live in this house if it has a basis, for 2 years then sell it with no taxes. You could also rent your house out and sell it before the end of the five years for no taxes. Talk with your tax accountant.

5. Does this property have any value add features? Extra ground you could subdivide and sell off lots? Could you add more garages or BR/BR’s? Clean up the landscaping? Repaint? Redo the drive? Etc.
6. Post pictures and data.m and market. You will get a lot more valuable feedback the more info you supply.
7. Could do a 1031 into smaller properties if your tax basis was not reset.
8. Disregard whether the above fit or are right. Take your time and decide if you want to get into real estate or not. If you don’t want to get into real estate and you have a better place to use the money then sell. Although a $1mm sounds like a lot it really isn’t unless you use it as collateral.
9. Look at your personal situation. Age, kids, retirement, staying out or moving, etc.

Andrew Postell · Answer

@Alex Skeg congratulations on receiving a property. It sounds weird but not everybody owns a home. Only 4% of Americans own 2 homes. You are in rarified air already. Now, I cannot tell what market you are in so I'll make some suggestions based on what you mentioned. These are CONCEPTS to understand. No one is telling you what to do....but this is what we do. And we've been doing it for 20+ years.

1. House Value - Normally we don't have investment properties that are valued at $1million+ The reason is that they don't cash flow as well as lower valued homes. For example, if you chose to SELL the property outright, you would not receive $800,000 but ALL of the equity....so let's just call it $1million for ease of math. With that $1million, if you were to buy 4 $250,000 houses your cashflow each month would be about $6,300 ($7400 in gross income minus an expense ratio of 15%). It sounds strange but this is the reality of what makes a good rental property. More people rent at lower values. If the economy goes south (which it might be heading that way) people downsize to lower valued homes. This is why we invest at a lower price point.

2. Current Cash Flow - If you do borrow money right now the chances of you cashflowing on a single family home are pretty slim. Rates are high, rents are lagging behind on value, etc. Don't forget though, you will raise your rents next year...and the year after...and so forth. 20+ years of owning rental properties I have never decreased rent. Don't just look at cashflow this year. Real estate is a LOOOOONG term game. Analyze it that way and you'll be ok. Read this post on some good conceptual stuff: https://www.biggerpockets.com/...

Again, these are concepts. The good thing is you don't have to do anything right now. You don't have a hard deadline or anything (I think). So keep gathering information and you'll make a good decision on it.

Feel free to post anything else if you need. Thanks!

Fernando Figueroa · Answer

Sell it and use that cash to leverage. With 800k you could buy over 100 homes in the midwest, live off the rent forever and ever.

Basit Siddiqi · Answer

If this is your first property - I would manage this property for a few months to get a hang of real estate investing before going into your next deal.

Once you have the experience, whether you should refinance will be more clear to you.

As others have mentioned, you are likely not making 10% return on equity on this property.

Eliott Elias · Answer

You have to make the call, is the cash on hand more valuable than your cash flow? You can decrease your LTV to be able to cash flow

Ricardo Hidalgo · Answer

I would sell the property and try to find better cash flowing opportunities. You could always buy land if you were wanting to build multi family or townhomes for a better cash flowing opportunity.

Alex Bekeza · Answer

@Alex Skeg Many investors are looking forward to the opportunities on the horizon in terms of interest rates pulling down prices, increase in foreclosures, panic sales, etc and therefore they are looking to stack as much dry powder as they can to take advantage in the near future. That being said, you don't necessarily need to have the next property lined up to see the value in extracting the cash ahead of time especially as rates continue to rise. The transaction could only seem to become more costly in the near term the longer you wait.

Erik Estrada · Answer

Find the deal first and then look into doing a hard money loan of some sort. You can always cross collateralize the property paid in full with the purchase loan. Or you can look into a line of credit and draw when something comes up.

Is a Cash out refinance a good idea in my situation?

Is a Cash out refinance a good idea in my situation?

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