Another Way to Use Real Estate Debt Wisely

What do you think of “debt?”

More so in recent years, debt has been viewed as more of a “bad thing” than “good.”

Examples such as sovereign countries being overrun by debt and regular folks being overwhelmed by student loans and credit cards made debt such a scary thing. Yes, for the most part, debt can completely own you. It can take away your things, which is all too familiar for former homeowners out there.

On the other hand, careful use of debt can be a powerful tool. After all, debt is not only used for consumption. It is also used for investment. I have written about the benefits of debt in real estate before. However, I think I might have missed a couple of ideas.

What Should I Do Next?

I came across this idea recently when I was thinking my next strategic step in real estate. Based in Vegas, I have seen the town experience a much higher increase in prices during the past year and a half than most of the other towns out there. I had never expected the rise to come this fast, although I knew that the forces like the government and banks worked together to make it so. Nevertheless, this pace of home prices had to stop at some point. The housing market does not only contain investors and hedge funds. The housing market needs the regular Joes out there to buy. And for the past year and a half, regular Joes out there didn’t have many chances to acquire properties.

But the chances are coming back. The smart money is starting to liquidate. If you scan the news carefully you can see many hedge funds are exiting real estate investments by either getting sold to another company or starting an IPO (while in the first housing bubble the homeowners were the last ones left standing, I do wonder whether in this mini bubble certain hedge funds are going to get stuck with an overvalued portfolio). There is inventory again and it is slowly growing as well. Investors who are trying to sell are soon realizing that they cannot reach for the sky in their pricing.

So I fear that in the next several months real estate prices may go down. Am I happy? Yes and no. I have to admit I don’t like seeing my equity go away, but I also want to buy more properties. I want to purchase at good prices so I can get a higher yield on my rentals. If the market goes through troughs and crests, why shouldn’t I try to time it?

So after a long winded update, I think this is where debt can play a significant role in increasing your portfolio value. Currently almost all my capital is tied to real estate. I do not have much liquid assets. I can’t really take advantage of the fall in the housing market because I have no money. So what can I do to get money?

Tips for Cashing in on the Future

One way is to refinance your free and clear properties. By refinancing when your property value is high, you can pull quite a bit of cash out of the property. Now you have cash to buy something if the prices do go down. Whereas if you do not refinance, you will just watch the opportunity to buy low again go by.

So what if the value of your house drops after the refinance?

It doesn’t matter (well, as long as you’re not going way too cash flow negative)!

You are now able to gain an additional property at a bargain price. You did it by uncovering the hidden equity in your free and clear property at a great time. You wouldn’t have been able to borrow as much if you waited for the housing market to go down before you buy.

By realizing cash at that level (did I mention nowadays rates are still low anyways?), you are able to lock in on a property at a good price and you will get a good yield on the rental as well. In a way, using debt this way in real estate, you can further capture opportunities when prices are low. Of course, the caveat is that hopefully the debt payment you gain out of this will not hurt your cash flow too much. To me, this is a less painful way of seeing my equity go down.

Conclusion

So I will start looking for funding and hopefully refinance my free and clear properties. Even if I have to pay 6-7%, I think it is worth a try to free up some cash and be prepared for a slow 2014. If I am wrong, I don’t really lose that much. I can always buy more real estate or pay back the money. But without it, I will never have a chance to buy properties at cheap prices again (this is all speculation of course. We all have our views on real estate trends after all, don’t we?).

What do you think? Share your comments below!

Photo: chedder

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.