The Approach

How Do You Know When to Refinance Your Investment Properties?

March 17, 2016

Oops, I did it. I upset the internet masses last week.

I asked if it made sense to refinance my investment property in Atlanta to use the money, combined with a little of my own, to purchase a new rental (see Let’s Double Down! Cash Out Refinance on a Rental Property for the analysis).

The reader comments include “I would not refinance for a measly 17k” and “I would be very concerned about needing to borrow $15k to make a purchase”.

Both true. Valid points. I asked for opinions and that’s what I got.

However this isn’t where the analysis ends. Let’s dig a little bit deeper.

Reviewing Investment Property Refinance Basics

Imagine a property with a $45k mortgage that is worth $100k. It has $55k of equity, or 55%.

The return on investment doesn’t really change if I have 20%, 55%, or 85% equity. Either way it has the same cash flow and appreciation benefit.

A cash out refinance is basically starting a brand new mortgage with only 25% equity. There is a fee to do the refinance and you get the difference in cash.

For the example with $55k in equity on a $100k house, the new mortgage balance would be $25k. If the fee is $3k, you would get to pocket $27k. Untaxed. Lump sum.

This is why it is important for people to do their research into mortgage refinancing from websites like sebastianfriedman.com so that they are equipped to move onto this stage at the right time to align correctly with their finances. That said, besides gaining knowledge regarding mortgage refinancing from websites, it would also be a good idea to talk to a certified mortgage broker who might have more in-depth knowledge regarding the same. Wondering how to find them? For instance, if you are from Etobicoke, Canada, then looking up keywords like CMB Etobicoke on the Web can help you find them easily.

The Power of the Cash Out Refi

The cash out refinance can be a powerful way to more quickly build up your portfolio of rentals. You can take that $27k and use it as a down payment on a new investment property.

Just like that, Property 1 clones itself and creates Property 2. Then seven years down the line, after slowly building equity, perhaps you do it again: Property 1 clones itself and creates Property 3. Property 2 clones itself and creates Property 4.

Same initial investment, but after 7 years it has turned into four properties!

The Patient Alternative Approach

Rather than doing a cash out refinance, you can certainly leave the equity in the house. Once the equity gets to 100%, you no longer have a mortgage to pay and the cash flow is much greater.

If you want to buy more rental properties with this approach, you have to do it the old fashioned way – save your money for a down payment!

There’s nothing wrong with this approach, but it will take much much longer to get to 4 properties (or whatever number of rentals you are shooting for).

More importantly, it will also take much longer to hit whatever cash flow goal you have to be financially independent.

Viewing My Rental Properties as a Portfolio

I want to go about rental property investing as would a portfolio manager. All proceeds are reinvested to grow the portfolio. I also contribute an additional $1000 a month to save up for more investments.

The goal is to optimize the portfolio so it makes the most money in the long-run. How do I do it?

I actually sat down and ran some numbers over 10 years.

Here is the complete spreadsheet with all the calculations. Disclaimer: this is a rough model

The Inputs

Start with my portfolio now (a property in Atlanta purchased in 2011 and a property in Memphis purchased in 2014) and $10k in cash. Contribute $1k per month to the portfolio for the first 5 years. Assume the cash flow from each property is $167 per month, principle pay down is $100 per month, and appreciation is 3% per year.

Each new property purchased will be 20% down for a $100k property. With $3k in closing costs and $2k added to cash reserves for unexpected repairs, let’s assume each new property requires $25k in cash. A refinance will cost $3k.

The calculations also won’t go beyond 10 properties (although the spreadsheet includes notes when additional properties can be added).

The Scenarios

Even though the model isn’t perfect, it should help compare different strategies – the relative numbers is what matters, not that it is a perfect calculation.

Scenario 1: Never Refinance

This approach is to just use the cash flow and $1k per month contribution to build the portfolio.

Scenario 2: Refinance only for a full property

This approach is to wait until a property has enough equity built up that it can be used to purchase a complete new property. With the assumptions, it takes 53% equity in order to get the $28k required ($20k down payment, $6k fees for refi + new mortgage, $2k in reserves). It takes almost 8 years to build up that much equity.

Scenario 3: Refinance now and for a full property

This is the approach I was asking about in last week’s article. Refinance now when Property 1 is at 44% equity, then from now on, wait until each property has 53% equity to refinance.

Scenario 4: Refinance aggressively at 40% equity

Rather than waiting to get to 53% equity, what if I refinanced every time a property reached 40% equity? With the given assumptions, it takes just under 6 years to get to the refinance rather than 8.

The Results

It should come as no surprise that doing cash out refinances will significantly improve the results.

Scenario 1: Never Refinance

Purchase 5th property after 3 years 8 months
Will have 9 properties after 10 years
After 10 years, the portfolio value is $434,750

Scenario 2: Refinance only for a full property

Purchase 5th property after 2 years 5 months
Purchase 10th property after 7 years 5 months
After 10 years and stopping at 10 properties, the portfolio value is $509,067
Could purchase another 5 properties if I wanted, or put $53,667 in cash to work in another way

Scenario 3: Refinance now and for a full property

Purchase 5th property after 2 years 9 months
Purchase 10th property after 6 years 10 months
After 10 years and stopping at 10 properties, the portfolio value is $505,217
Could purchase another 4 properties if I wanted, or put $70,167 in cash to work in another way

Scenario 4: Refinance aggressively at 40% equity

Purchase 5th property after 2 years 9 months
Purchase 10th property after 5 years 10 months
After 10 years and stopping at 10 properties, the portfolio value is $542,950
Could purchase another 7 properties if I wanted, or put $97,300 in cash to work in another way

Interpreting the Data

It should come as no surprise that doing cash out refinances will drastically improve the results over 10 years.

The ending portfolio value is very similar in Scenario 2 and 3. The only difference between those scenarios is whether or not to refinance Property 1 now, so perhaps it doesn’t matter either way.

However, if I were to continually refinance at 40% equity, it would lead to a substantially better result. This jump is comparable to the jump from not refinancing at all to refinancing at 53% equity.

So in conclusion…

I still don’t know that there is a conclusion yet.

If I have a set number of properties I would like to get to, it is a good idea to refinance aggressively.

If I want to keep adding properties past 10, it is a good idea to refinance aggressively.

If using this for an actual long term plan, I would have to build a more complex model and possibly look to get more info about software that could help me with scenario analysis. We can draw some simple conclusions from the data above, but shouldn’t read too far into it.

Also, with new blockchain companies (if unclear, check what is a block chain company) introducing tools for new market overviews, neighbourhood insights, property analysis, I do have other options to consider. It’s nice to have choices. Let’s see.

What do you think?

Are these results surprising?

Does it change your opinion of refinancing now?

Let’s Double Down! Cash Out Refinance on a Rental Property

March 10, 2016

Vegas baby! I avoid gambling in risky investments outside of my control, but have you ever played blackjack? Or roulette on a gambling website for that matter?

The thrill when you push all your chips in and get an 11 against the dealer’s 7. You gotta double down!

When you double down, you are betting more of your own money – it would be so much better if your chips just multiplied on their own. Or split like a cell and all of a sudden you had two identical copies. [Mitosis for you science nerds out there]

Did you know rental properties can clone themselves?

Silently Building Equity

For four and a half years I have been cashing rent checks and paying expenses for my Atlanta property. Well, I guess my property manager does most the work – but I read the reports and keep an eye on things!

I’m definitely aware of the cash added to my bank account every month, as well as the tax benefits at the end of the year. Combined they are a cool $7,627 – averaging $1,700 a year from this one property.

This whole time equity has been secretly building without any effort required! Most investors don’t realize the 5 Components of Rental Property Return.

Every year the tenant has been slowly paying down the mortgage for me (1.5% to 2% a year in the first several years of a 30 year mortgage). And the property has appreciated 30% (better than the expected 15%, pretty much due to lucky timing).

When I purchased the property I only had 20% equity. Fast forward four and a half years and I now have 42% equity.

Put Your Money to Work

If you haven’t noticed yet, the focus of this entire website is how to make your money work for you. Passive income. Rental properties.

Equity is a nice cushion, but it doesn’t earn any additional money. Whether my equity is 20% or 75%, the rent is still the same.

The expenses are pretty much the same, such as basic maintenance costs, repairs, some new installations such as chain link fences in Edmonton (or another location), advanced gate systems or CCTV for increased security.

There is something we can do to put that equity to work…

The Cash Out Refinance

You can refinance an investment property up to 75% of the loan value. Basically trading that equity for cash.

That cash is not taxed – it’s already your money, you are just accessing it.

Doubling Down – When A Rental Property Clones Itself

You can take that lump sum of cash and plow it directly into another investment property. You still own the original and will now have another that is producing cash flow, tax benefits, and building equity. Double your pleasure, double your fun!

Pay attention, this is where the compound returns come in. My rental property 1 will clone itself and purchase rental property 3. It won’t require me to save another $20k for a down payment.

Can you imagine if every property cloned itself after 5 to 8 years? Boom!

Any Downsides?

Yes, of course. Most obvious – you have to pay to do it. In my case, the estimate is $3,200.

You will also have a larger loan, likely with a larger payment depending on the interest rates. If you are at a point where you have enough loans and want to start paying them down, a cash out refinance might not be right for you.

You are resetting the 30 year repayment schedule, so if you want to live off the cash flow of your rentals soon, a cash out refinance might not be right for you.

If you are young and still building up your portfolio, go for it!

A Closer Look at My Decision

Let’s examine the details and see if it makes sense for me to do right now.

The current mortgage is at 5.5% and has a balance of $60,655. The monthly payments of principle and interest are $370.

The new mortgage would be at 4.625%. If the property appraises at $105k, the mortgage will be for $78,750 with monthly payments of principle and interest of $405.

Thanks to the interest rate going down, the increase in monthly payments is just $35. It will hurt the cash flow numbers for this property, but the gains in cash flow from a new property will be at least $150 a month.

So it makes sense from a straight cash flow perspective. When you look at the other components of rental property return (appreciation, paying down mortgage, taxes) it becomes a home run.

Feels a Little Tight Though…

Refinancing this loan would be a gain of $18,200. But it will also cost $3,200 to do. So the net is $15k that I can use to purchase another property. I would have to contribute another $6-8k to get a property in my preferred price range.

This is also largely dependent upon the appraisal of the property. If it appraises at $98k I will only pocket $13k. If it appraises at $113k I will pocket $17k.

At what appraisal number does this no longer make sense?

Now or Later?

Now:

Double down sooner to have twice as many properties providing cash flow and building equity
Lock in the low interest rate now in case things change (unlikely, but even a .1% change is $5 more a month)

Later:

Let the property build more equity so when I take it out, the fee isn’t as significant a portion

What do you think, what should I do?

Photo: Images Money

The Money-Time-Risk-Return Investment Continuum – What is Your Sweet Spot?

March 7, 2016

Have you ever heard of the space time continuum? It’s a very hard to imagine way of viewing the universe used by physicists like Einstein. The idea is that in addition to the 3 dimensions of space that we are all familiar with, there is a 4th dimension of time.

Most physicists believe time can only be traveled forwards though. You can’t go back in time like you can move forward in space, then head back to where you were.

Believe it or not, this thinking just might be relevant to investing.

Money-Time-Risk-Return Investment Continuum

Let’s create our own continuum for investments that includes money, time, risk, and return.

Mo Money Mo Problems

Having more money is a good thing (I like money). But it can become a burden at some point – good thing most of us will never have to worry deal with it!

If you are investing $1, what kind of options do you have to invest and what are the returns? Pretty much just putting it in the bank with a lousy interest rate. If you are investing $1k you have different options with greater returns. $100k even more options with greater returns. $1M even better. Then at some point, say at $1B, it gets worse there are few places you can put all that money to work. Of course, you could get a financial advisor to help you make better investments. But, sometimes, even these brokers and financial professionals can make errors in investment recommendations, which can cause you huge financial losses. Fortunately, you can approach a securities lawyer from the likes of The Law Offices of Robert Wayne Pearce to seek the deserved compensation in the event that you face any financial losses made by the financial professionals.

Time is Money

You could put $1B to work just like the investor with $1M, just do it a thousand times. That takes a lot of time and effort.

The average investor can usually put in more time to find a better return. This might mean researching and finding a way to invest in small private companies or doing your own real estate deals. However, there also automated trading apps in markets like cryptocurrency, such as these Bitcoin Up Erfahrungen, for example. This will save you time as you don’t have to do the investing yourself. On a similar note, more and more people tend to see cryptocurrencies as a good investment. These days, people choose to buy cryptocurrencies, like Bitcoin, Ethereum, and even Dogecoin, with the hope that their value can rise in the future, leading to them being able to cash them out later (visit https://www.coin.cloud/blog/how-to-cash-out-dogecoin for information on how to sell cryptocurrencies.)

High Risk, High Reward

Riskier investments should have a greater expected return, otherwise why would anyone take on that risk?

Lending money to a stable company like Walmart might return 3% and a “who knows if it will survive” company like Yelp might return 11% (with a small chance you get zero, so expected return of something a little lower). This is generally true across all assets: stocks, bonds, real estate, peer to peer lending, etc.

Let’s Graph It!

For a given investment, what is the money, time, risk, and expected return? If you were to graph all possible investments in 4 dimensions, you would be able to visualize the best return for money, time, and risk.

Too bad that’s hard and this is just a thought exercise. If you are thinking in terms of all these dimensions, what is the best investment for you?

Finding Your Advantage

I bet you don’t have a hundred million dollars to invest, where you can push people around and name your terms.

I bet you aren’t an expert at understanding risk, able to notice the flaws in the models of Wall Street.

But you do have time. If we had the 4-dimensional graph, I would imagine there is a sizable bump in expected return by devoting 1 hour a week to your investments.

If you could take your investments from a 8% expected return to 20%, would that be worth an hour a week to you? This is why I chose rental property investing.

Revisiting Space-Time and “Time is Money”

Remember when I said at the beginning that within the space-time continuum, time only travels forwards? You can’t go back in time.

People generally accept the statement that time is money. Time can be easily turned into money, but the opposite isn’t really true. It is much harder to turn money into time. Just look at the richest people in the world – they are running around more stressed out than the rest of us, not sitting on a beach!

With rental property investing there are always more responsibilities you can take on for a greater return. Landlord work, handyman work, increased effort sourcing deals, more aggressive negotiations to only purchase at extreme discounts.

For extra effort might push your return from 20% to 25% with another 1 hour a week per property. Unfortunately it doesn’t scale that well at 5+ properties. Since it is hard to turn money into time, I jump at the chance to pay for someone else to handle those responsibilities.

That’s why I chose turnkey rental properties. I get the benefits of much higher returns through rental property investing, but still fairly low effort.

Managing Risk

Some people have bad experiences with turnkey rental property investing and will be happy to share their nightmare story with you. It is an industry with hundreds of small operations fixing up and selling houses to investors – and many suck.

I could navigate this on my own, but there is certainly a little risk involved. Instead I think it is smart to go through a reputable national marketer like Norada or Jason Hartman. They both have a decade long reputation to maintain and much more experience vetting turnkey providers than me.

The purchase price might be ever so slightly higher than I could find on my own, but I view this as a trade-off between the money and risk dimensions.

Is Rental Property Investing the Perfect Money-Time-Risk-Return for You?

Everyone is different and will come to their own conclusions. For example, maybe spending an hour a week to go from 8% return to 20% return isn’t worth it in your mind. Or maybe you aren’t comfortable with the risk of being directly in charge of your own investments.

For me, rental property investing represents the sweet spot of the theoretical money-time-risk-return continuum. What do you think?

Photo: Etahos
Graph: Jon Waterschoot

The Impressive Returns of Remote Rental Property Investing

February 5, 2016

You are surrounded by zombies. Your neighbors, your coworkers, even your friends and family. All zombies. I just hope it’s not too late for you. If you aren’t careful, you will be an investing zombie too.

Zombies all do exactly the same thing without even thinking – retirement accounts with mutual funds. If everyone is doing it, that must be the way to go. Why even bother thinking for yourself?

What if with a little up front effort you could get drastically different results? I’m talking a million dollars different over the next 15 years – would that break you out of your zombie trance?

Break Out of the Trance

To understand why anyone should care about out of state rental properties, you need to have an understanding of the benefits. This article is going to explain it with words, then later we will look at the math which is even more convincing. But you have to go into it with an open mind.

Evaluating an investment can’t be done in a vacuum, it is always done relative to an alternative. Sometimes the alternative is money under your mattress earning no interest. Often it is money sitting in your bank earning 0.1% interest. But I am going to assume you are more sophisticated than that – you have money in the stock market through mutual or index funds, generally considered to average an 8% return.

How can remote rental properties beat that? The basics of the conservative approach I recommend are to put 20% down and hold the property for years. The tenant will pay your mortgage for you and after all expenses you get to pocket a couple hundred dollars each month. If you hold it for many years, you will be handsomely rewarded far beyond those couple hundred dollars a month. Expect above a 25% annual return!

Also, you can purchase remote properties in foreign countries and rent them out to earn monthly income. Real estate investment in a country with a growing housing market can be quite profitable, and if you purchase a townhouse, apartment, or maisonette in a location like Malta, you can rent it periodically and also use it as a vacation home. You can additionally hire a real estate agent to handle property maintenance and create tenancy contracts for the tenants. Before going forward with a purchase, you could explore various luxury properties online or through an agent.

Timeshare property investment is another type of investment that can benefit those who enjoy traveling to a specific location quite frequently. While timeshares can be an exciting and possibly cost-effective way to travel on a regular basis, they frequently have both initial and ongoing costs that need to be considered. Many people do not think of timeshares as investments because most of these assets lose value in the secondary market and do not generate income for owners. Timeshare properties are often larger and more luxurious than standard hotels, and they are generally located in desirable areas. However, the resale market is crowded, so if you decide to sell, you may incur a loss due to plentiful supply. Besides, the resale market is rife with con artists looking to take advantage of those looking to get out of their timeshare. As a result, partners who want to get out of a timeshare agreement are frequently seen looking for timeshare exit companies like Wesley Financial Group to assist them with all of the necessary legal procedures required to exit the contract.

Low Risk Leverage – Multiply Your Return By Five

Leverage and loans sound risky. They can be, but there is a conservative approach to real estate investing: cash flow rental properties. The houses will be rented out to a tenant for significantly more than your expenses each month. This includes real expenses like a property manager and insurance, as well as future expected expenses like repairs and vacancy.

As long as you go about it in the right way, there is very little risk involved. This includes:

Rents well above expenses for a large margin of safety
Fixed rate loans so you always know what the expenses will be
Purchasing properties in markets that don’t experience huge run-ups and crashes
Cash reserves to handle the worst case scenario

The benefit of financing your property is that you only need 20% of the price of the home for a down payment. Considering you have the same upside, this gives you five times the return on your investment.

Earn Money in Multiple Ways – The Five Components of Rental Property Returns

Usually there is only one component to consider for return on investment. For a bank account it is interest – the bank actually pays you a tiny amount money for keeping your funds there. Most stocks don’t pay you any money, so you are hoping that after you buy it, the stock’s price goes up. Some stocks actually pay a dividend, which is a second component to consider. You add that to the amount the stock went up to get your overall return. It might be worth reading about Durable dividends if you’re interested in investing.

Rental properties have five components that add up to an overall return. This type of investing is often underestimated because people usually only focus on one or two of the components. Here are all five:

Rental income – after taking account for all the expenses (insurance, property management, repairs) and expected vacancies, we will get an 8% yearly return on the money invested. This component alone compares well to the stock market.
Appreciation – we aren’t trying to time a volatile market for double digit appreciation, instead let’s estimate conservatively in the 2-3% range, which is roughly the rate of inflation. Considering you get all the upside and only had to put 20% of the money into the investment, you get a 5x multiplier on that. So your return is 10-15% per year.
Tax benefits – there are some huge tax benefits on real estate, the most important being depreciation. I will go into this more later, but expect tax savings that are equal to at least another 4% return.
Mortgage pay down – the longer you own the house, the more you pay down the mortgage. Or more accurately: the more the tenant pays down the mortgage for you. After year 1 you will only have paid down 1.5% of your mortgage balance, but with the leverage this is at least another 6% return per year.
Inflation mortgage destruction – this one is more complicated so I will leave it out of this estimate. But there are huge returns here as well. The basics: you have the same $500 mortgage payment per month at the beginning of the loan and at the end. Over a long time period inflation makes it so that same $500 payment gets easier and easier… in 30 years a ticket to Disneyland will be $500 (and everything else will be nearly four times as expensive).

Add them all up: above a 25% annual return. It’s so good I am using very conservative projections so you don’t think it is too good to be true.

Start Now – The Power of Compound Interest

We have all heard the advice to save early for retirement. This isn’t just so you will have an extra 5 years of savings. That’s nice, but insignificant. Rather, it is because your investment gains will compound with time – you earn interest on the interest you previously earned, not just the amount of money you originally put in. Those looking for ways to invest their retirement savings should investigate the strategies put forward here – https://www.moneytalksnews.com/2-minute-money-manager-im-retiring-soon-how-should-i-invest-my-savings/. With regards to compounding investment gains, the same holds for real estate.

Each month a property will net the investor $150-250 which can be invested back into more properties. After 5-7 years you will likely have built up enough equity to refinance, using the proceeds as a down payment on another property. This snowball effect starts slowly, you will hardly notice it at the beginning – but if you start now, you can build some serious monthly cash flow and long term wealth.

A Deeper Understanding – Crunch the Numbers

Does this sound appealing? I thought so. Use this as your motivation to dig deeper and really understand how it works. How did I come up with these numbers and are they realistic? How do each of the individual components work?

Take the time now to understand it fully. Don’t be a skeptic and disregard it as too good to be true. But don’t blindly follow what someone says on the internet either. Do the research required, embrace the math. Math is fun when you are adding up your money!

Photo: Daniel Hollister