Originally posted by @Joe Villeneuve:
1 - When you put 20% down on the property, you are buying equity (that's your cost), and the starting Property value is set. A 20% DP means your cash (DP) bought a property worth 5 times the DP. That also means that ratio of your cost to PV is 1 to 5.
2 - Property values go up based on appreciation (mostly).
3 - For every dollar of appreciation, you gain that same dollar in equity...and it's free equity.
4 - If the property appreciated 20%, that means your PV also went up 20%...and your equity doubled.
This may seem like a good thing, and it is. You just doubled your equity and didn't have to pay for it...and your property went up in value. However...
5 - The new ratio between equity and PV is now 1 to 3. This means for every dollar of equity, you only have $3 in PV. This is less than the 1 to 5 ratio you started out with when you bought the property. This also means the value of your equity has gone down.
Refinancing doesn't recover all of the equity. What it does is take that free equity you got from appreciation, and make you pay for it. You are NOT getting your money out of the property when you refi. You are using your money as collateral so the bank can sell you new money.
If you are using that money you got out of the refi property as a down payment on the next property, it isn't free...like the original cash DP was on the how you refied. That DP comes from the refi, which is a loan, with attached interest, and that is a cost. In other words you are paying for the DP money on that next house.
Hi All,
I am relatively new to real estate investing with a duplex, a vacation condo, and now recently a triplex that I just picked up, but I wanted to jump in on this thread, because it seems to be that folks are misunderstanding the challenges being brought up by refinancing.
Joe is technically correct that you are not getting your "money" out of the deal by refinancing, in that the actual gain or money comes from the forced appreciation from the rehab or business turn around that you are doing in the BRRRR. What you are however doing is converting one asset on your balance sheet (Equity in the property), to another type of asset (cash). There is no net increase in your balance sheet from refinancing, and in fact there is a decrease (closing costs, appraisal, points etc.) Converting one asset (equity) to another asset (cash) can be done a number of ways: refinancing, using a home equity loan or line of credit, or selling. All of these options have some sort of cost and opportunity cost.
What Joe seems to have a challenge with is paying costs for the pleasure of accessing your own money, but costs always need to be spent to convert an illiquid asset like a home or apartment complex into a liquid asset like cash. This applies to all types of illiquid assets (cars, homes, property, plants equipment), and is the nature of the game when running a business that largely involves large amounts of illiquid assets. The reason some investors might choose to use debt to convert equity to cash is if they did not want to sell that asset, but still have liquidity available for the next deal. This is also something that is not just done in the real estate realm and is very common in the business realm. It's why companies like Apple will have billions of dollars of debt and billions of dollars of cash on their balance sheet at the same time. They are borrowing money to fund additional investments because the cost of capital is so low.
Additionally as many have pointed out there are risks with using leverage in any sort of investing, and some investors might feel more comfortable using less leverage than others, or having less illiquid assets on their balance sheet. This all comes down to the individuals risk tolerance and approach to investing. It's perfectly ok to want to be more conservative and keep more cash on hand and not have debt, or to leverage debt to fund your investments as long as you know the risks involved.
