When to tap into equity?

Question

Hey everyone earlier this year I had a possible opportunity to move on to a possible 2nd deal for myself. I didn’t end up doing it as it would have cut down my gross rental cash flow from $1000 to less than $300 depending on the rate we would get. My overall cash flow would have been roughly around $700 between the two properties and decided to wait and not take on the extra risk. My current rate is 6.5% I’m curious to see what other people’s risk tolerances are especially starting out. Also I want to note the rehab for that deal would have cut my reserves very low.

Noah Wright · Answer

Cody, passing on a deal that would have drained your reserves isn't being timid, it's the call a lot of people only learn to make after it costs them once. You did the math and listened to it, and that habit is worth more than a second door this year.

When the next one shows up, test it before you're in contract: run it with rent a bit under what you expect and one big repair in year one, and see whether you still clear your costs with reserves intact. If you'd use a DSCR loan, most programs want reserves in the bank too, so a thin cushion narrows your options even when the deal pencils. And since a small rate move swung your numbers that much, run it at a rate somewhat above your quote.

What reserve number would let you say yes to the next one without losing sleep? That's a better frame for the question, and it's a personal risk tolerance reflection

David Krulac · Answer

@Cody Drumheller Here's what I did, it is NOT what I recommend to others. The first 11 propertis that I bought were financed 100% in one form or another. I got second mortgages, HELOCs, private money, unsecured lines of credit and secured lines of credit. To re-plumb the second property, I sold a car, which provided all the money for the plumbers who spemt 2 guys for a week at the property. My philosophy was to "Borrow as much as I can for as long as I can." I also had 13 Master Cards and Visas. Like I said I do NOT recommend.

Igor Ganapolsky · Answer

i think the reserves question matters more than the cash flow math honestly. i buy at tax deed auctions in florida where the entry price is so low that reserves aren't really the issue, but i've still passed on deals because the timing wasn't right. if doing the second deal means you're one unexpected repair away from trouble, wait a year like you said. the deals will still be there.

Arman Ahmed · Answer

I think waiting makes sense when the deal would leave you thin on reserves and cut your cash flow that much. I’d rather have room to handle the unexpected than force the next purchase. If you’re open to looking outside your current market, the Midwest is worth comparing where lower entry points can sometimes make it easier to keep more reserves intact.

Cody Drumheller · Answer

@Seth McGathey thanks for your insight Seth. I agree 100% with what you're saying. Ultimately I decided to wait a year to get my reserves to a point where I'd the same deal crossed my path I could pull the trigger. My current property just went through a rehab to where any possible big expenses aren't really a worry as it's all new. But after the experience from my first rehab I know expenses add up fast and don't want to put myself in a compromising position.

Seth McGathey · Answer

For me I don't consider cashflow much during the building stage of my portfolio. It is still important but is not my goal. As long as I cover all my expenses including capex and reserves, etc and have at least $200 a month in cashflow after that, then I am good. I would absolutely sacrifice $700 in cashflow to gain another property. And realistically in this case you really only sacrificed $300 in cashflow because the new deal apparently added $400 in cashflow. I would take that deal all day. Because cashflow is nice but the only thing I use cashflow for currently is to build up reserves and cover unexpected expenses that come up faster than my capex fund can cover.

The reserves issue is a different story. As they say on the BiggerPockets Podcast often, Real Estate works for those who can hold on long enough. Never do a deal that risks you losing properties, and you will win in real estate. So if you do not have the reserves if something big happens, then you are not in a place to buy the next deal. You can, but just know you are risking everything and could start back at 0. That could work out, but at that point I think you are more gambling than investing.

When to tap into equity?

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