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
It would be great if you could do a HELOC on that rental property. I don’t think you can in rentals now. Less cost to access the funds and continued access to the funds as you pay the balance down. You don’t get the locked in rate, but the cost savings vs the full refi would likely win out.
A lower price would be nice, but even as expensive as it is, I think it makes sense. Maybe the rules will change in the future.
Brian,
I love the cash out refi approach, particularly if it makes sense to boost cash flow, like you pointed out. In most cases, if you’re doing it right, the new cash from an additional property will more than compensate for the increased mortgage on the existing property.
The fees are kind of a pain, but you’ll also second principal paydown and more tax deductions on the new property, so that nuisance is easily offset.
It’s a great way to grow a real estate empire. In my situation, unfortunately, I’m unable to find good deals, so I just pulled out the cash and am sitting on it… Not something I would recommend for anyone else!
But I’m pretty stubborn when it comes to real estate, I’m learning.
All the best!
Given your preferences for real estate, I was wondering if the Orlando market might be appealing to you right now. It is cyclical in nature, but a little bit later in the foreclosure cycle – their courts take a long time to process the foreclosures. The prices are still low and there is nice upside potential, while still cashflowing. Knowing what I do about your real estate preferences, I think it might be a fit to put your cash to work!
Here is a podcast with the Orlando market overview: http://www.jasonhartman.com/cw-629-achieving-cash-flow-and-appreciation-in-the-orlando-real-estate-market/. There are some good linear / cyclical market talk minutes 13-16, then the Orlando talk starting at 17:45.
I’m interested to hear your take!
I would not refinance for a measly $17K. If you do not have that in savings, keep saving and get a larger investment balance. Most likely, you will need at least 20% down for the next property.
I have properties that are worth over $400K and are debt free. They cash flow like a madman.
Everyone starts somewhere! The properties I like are around a $22k investment so it’s a matter of waiting or using my assets that aren’t working for me right now.
Congrats on the debt free properties – you are a great example of how to reach success with rental properties.
Paying $3200 to pull get $15k is an 21% fee to access that money + the 4.625% interest.
That is a huge interest rate to pay for just $18k. You could almost take a personal loan with repayments over 5 years for cheaper.
I would be very concerned about needing to borrow $15k to make a purchase. What if the HVAC goes out a week before you need to replace the roof? Where does the next $15k come from?
Great points, there are many ways to look at it. Yes, the fee is 18% on the equity being pulled out. Then there is the difference of the monthly payment, that might equivalent to a .5% interest rate hike (without calculating it).
Or viewed as an asset that isn’t being put to work, putting 4/5 of it to work for free sounds pretty appealing.
Cash reserves are very important, I’ll have to do a post about that as well.
I just looked into refinancing my investment property and determined I could pull $100k out to keep the mortgage and taxes at what the rent is without getting a jumbo mortgage that carries higher interest rates. It would also push back the maturity date by 7 years. I have no idea where I would invest the money though, and I am in payoff debt mode so I can “retire” in 7 years so I’m not prepared to take that step and take on more risk.
7 years, very exciting! Everyone is at different points in their life – right now I’m in “add properties” mode and some day I’ll get to “payoff debt” mode.
Are the rates today significantly lower than your current mortgage? If so, you would likely come out ahead just by using that $100k to pay down the refinanced loan faster.
You needs to know your debt to income ratio. Make sure you qualify for new loan before you plan refinance and buy a new one.
Great point – a refi + purchase is a lot of new debt, so you’ll want to make sure before you qualify before getting started.
Thank you for the article!
I’m having a hard time getting equity out of my 5 properties, 1 paid off, the rest with plenty of equity, but my debt to income ratio of 60-65% and the fact that most of my income is coming from short term rentals (airbnb, between 75k-85k income), is making qualifying really difficult even though I have 2 years of history, 740 credit score. Am I out of luck and should try hard money lenders?
That’s tough. I think the DTI ratio is pretty set, but I’d recommend talking to Aaron Chapman. He’s well known in the rental property financing space and would be able to share the options.
I personally wouldn’t recommend a hard money loan for buy and hold rentals. Only if you need a bridge for a few months for some reason.
Hi there, thanks for your insights and ideas! Could you verify if this is the Aaron Chapman you’re referring to?
https://www.linkedin.com/in/aaronbchapman/
Thanks!
That’s the one.
thank you!
Hey Brian,
Nice blog, I like your work and ideas. I find my thought process very similar to yours.
I’m 26 and have a duplex(with a mortgage at about 70%LTV) and a single family home(no mortgage) as rentals. I had another single family home last year but sold it to cash out the equity and attempt to get another property cheaper, at a foreclosure auction. That is where my current single family rental came from, that money I made with some other savings allowed to pay 49K cash for it. It brings in 875/mo now with only 250 going to taxes and insurance each month. So cash flow is pretty good.
I want to continue to build my portfolio up and I agree with you that there is good debt. I am working on doing a cash out “refi” on that property I have paid off. My concern is and what I would like your advice on, is what can the bank stop you from doing with that money?
Like you I have had one lender I work with. She’s great and like working with her. During this refi application, she asked what are you going to use the money for. I told her I would re-inves… before I could finish, she interupted and said “you’ll use it for reserves? okay, good.” She proceeded to tell me that it was not allowed to reinvest money taken out with this deal.
So, I’m still in the works of closing and getting my check. The house I think will appraise around 100K, giving me 75K out of the refi. Have you had any trouble with this, or know of any details regarding this? With the 75K, I am hoping to get another property at auction, hopefully around 40K, then using the other 35K as a down payment on another duplex. Then eventually, in six months after getting the foreclosure property, refi that for cash out and restarting the cycle.
Let me know what you think!
Thanks
Cory
Sounds like you are off to a great start!
Interesting – I’ve never heard any restrictions like that on what you do with the money on a refi. I have on a personal residence HELOC. Is it a conventional Fannie Mae / Freddie Mac loan? Perhaps they have the right to decline your refi if they know, but once it hits your account, I’m sure you are free to “change your mind”.
I do like your plan – to me the sooner you can pull your money out to reinvest the better. Of course more cash reserves will be required to make sure you aren’t spreading yourself too thin.
Are you local and go to the foreclosure auctions yourself? How’d you get into that way of doing it for the 1st property?
Your response should have been, “Yes, that is what I plan to use the funds for” and then moved on with the signing.
There are a lot of times they just want to hear you are addressing unexpected maintenance, and nothing else you say will help the situation.
Good afternoon. Many thanks 🙂 Really enjoyed reading this page.
I would like to do a cash out refinance on one of my rental properties to payoff the mortgage balance to my primary home. Is that a good idea?
Does the math work out in your favor? Usually primary homes have better rate mortgages. Or is this for more of a psychological benefit?
Psychological benefit. Our house has a great rate but it is a 10 term, which means it is a high payment. Our house was paid off but we borrowed from it to buy our rental properties. If it is paid off then I feel we have one less mortgage and more cash flow. Then I would pour more money into the principle of the rental. The rental has gone up in value in this market and there is a lot of equity available. The rental income more than covers the mortgage. We purchased the property only 3 years ago so a reset to 30 year is not that bad.
Thanks!
Gotta go with the math on this one. “If it is paid off then I feel we have one less mortgage and more cash flow.” You will have one less mortgage, but worse cash flow and additional closing costs for the refi. I think if you sit down and run the numbers, you’ll find the slight psychological benefit is very pricey.
I’ve really enjoyed reading your article and the comments! I’ve actually done this same thing a few times, and I’ve discussed this strategy in my recently published book “Retire on Real Estate”. For the book, I interviewed many everyday people and discovered that this is also how SO many people have gone from nothing to quite-a-lot! Right now I’m doing using this strategy to pick up a (very) small beach cottage.
Very cool, I’ll check it out.
Real estate is definitely a tried and true way to build wealth, especially when starting with not that much. Sure there are ways for money to make more money, but it is a pretty rare chance to go from nothing to something.
Nice post!