How to Use Equity in Your Home to Reach Financial Freedom Faster

Mindy:
Welcome to the BiggerPockets Money podcast, where we interview Chris Lopez and talk about what to do with the equity that is stuck in your house.

Chris:
So I think it always comes down to, “Hey, what are your goals?” And be realistic about what your goals are, because all real estate is is a vehicle to get you to your goal. So, I think it’s very good as people reevaluate this new problem they have. And while they’re reevaluating the problem, the market, also take stock as to what your goals are right now and how they’ve evolved. Because that gives us the North Star where to go, and helps us make the appropriate decisions.

Mindy:
Hello. Hello. Hello. My name is Mindy Jensen, and with me as always is my mind-on-his-money-and-his-money-on-his-mind co-host, Scott Trench.

Scott:
Awesome. What a wonderful intro from my notorious co-host.

Mindy:
That’s Snoop. Scott and I are here to make financial independence less scary. Did you really think that was the Notorious B.I.G.? That’s okay. That was even better. Scott and I are here to make financial independence less scary, less just-for-somebody-else. To introduce you to every money story, because we truly believe financial freedom is attainable for everyone, no matter when or where you’re starting.

Scott:
That’s right. Whether you want to retire early and travel the world, go on to make big-time investments in assets like real estate, start your own business, or reassess your already-built real-estate portfolio, we’ll help you reach your financial goals and get money out of the way so you can launch yourself towards your dreams.

Mindy:
Scott, I am super excited to talk to Chris Lopez today. He is a local Denver investor and agent, and we are going to talk to him about what to do with all of that equity that’s stuck in your house. But before we do, we have a new segment on the BiggerPockets Money Podcast called Money Moment, where we share a money hack, tip, or trick to help you on your financial journey. Today’s Money Moment is, if you have trouble saving, use the savings ladder. This is where you pick a reward, like AirPods or a spa day, and multiply the cost of the item by two to three times its value. Once you hit that savings goal plus the cost of the item, reward yourself. Get that item. After that, pick a more expensive item and start the process all over again. If you have a money tip for us, please share it by emailing [email protected].

Scott:
And as a reminder, we’re always looking for guests to come on the show to share their money story, or come on as a guest for our Finance Friday episodes. So if you’re interested, please apply at biggerpockets.com/guest or bigger pockets.com/financereview.

Mindy:
Before we bring in Chris, let’s take a quick break.
And we’re are back. Chris Lopez is a Denver real estate agent and investor. He can be seen on the BiggerPockets YouTube channel, and he is also the founder of Envision Advisors. Chris, welcome to the BiggerPockets Money Podcast.

Chris:
Hey, Mindy. I’m excited to be here, and ready to talk some money and some shop.

Mindy:
Well, we are going to talk real estate today. Chris, tell us a little bit about yourself and what specifically you specialize in.

Chris:
So, like a lot of people, being a real estate agent and being a real estate investor was not my first career. I turned 40 recently, and about eight years ago I was ready for my second act in life. Which was moving on from my first businesses, which was a lot of internet marketing, and a lot of day trading on the stock market and the foreign currency market. So short answer is, I learned a lot on internet marketing, had lot success there. And I did horrible, like most people do, in day trading and foreign currency trading. So all that made me go back to realize, “You know what? Real estate is where I wanted to go to when I was 20, but I didn’t have the resources or money to. But now I’m in my early 30s. I got experience, got some money, got a lot more experience. I can go out there and start doing it.”
So at that time I decided to pivot my career towards real estate, because I needed a new source of income for my business, and I also wanted to get into real estate investing. So I’m a big believer in, the more I can merge my interest and my career with my long-term retirement goals, investing goals, the better it is. So I did a fix-and-flip, made money, but hated it. Tried wholesaling. That was not for me. But going out there and talking to real estate agents, and going out there and starting to do real estate deals, I realized, “Wow. There’s a huge opportunity out there in the real estate agent world to go out there and be agent, and to help people go out there and do what I want to do.” Which is not fix-and-flip or making short-term money wholesaling, but how to go out there and invest so over the next 20 years I can hit my retirement goals.
So I took my internet marketing skills, leveraged that to become a real estate agent. To start building my business, getting my name out there, engineering leads. And I did the niche on helping people invest in real estate here local in Denver. So I very much have focused on the Denver locality and that longer-term real estate investing mindset and trends. So, that brings us to present.

Scott:
Yeah. So one of the challenges that Denver real estate investors, myself included, probably you included, Chris, and Mindy, you as well, is we’ve done really well over the last 10 years investing in property here. Property values have gone up a tremendous amount. You bought a property five, six, seven, eight years ago, it may have doubled in value, or close to it. We may have cash-out refinanced a few properties. I’m sitting on, personally, a pile of equity, and I feel stuck. I’m very happy to have this problem. I’m not complaining about this problem, but I am stuck. Right?
Because if I sell the property, I’ve got to pay taxes on the gain. I’ve got to pay off my mortgage, and then I’ve got to redeploy this cash into something else that’s going to make sense. If I bought another property, for example, without a 1031 exchange, I’d be swapping my 3% mortgage for a 5 or 6% mortgage. If I 1031 exchange, I’m doing the same thing. Got to exchange the mortgages. If I cash-out refinance to pull cash out, same deal. I’m swapping my low interest rate. So this problem of rising interest rates, I think, has really created an interesting problem for those of us who have been investing. And I was wondering what your thoughts are in accessing that equity, and how do investors deal with this good problem?

Chris:
Yeah, and that’s the way to start off with it. It is a great problem to have. It is the first-world successful problem, and places like Denver, Austin, Salt Lake City, a lot of the markets that have seen appreciation the last decade, they’re having this problem. Essentially what it is, is someone bought a property a few years ago at a 7, 8, 9% cap rate. A very good rental. Fast-forward, rents have gone up, 40, 50%. The values have doubled or tripled. So now, cap rates have compressed. So now, cap rates are 4% and 5%. And the lower the cap rates, usually the worse the rental is as a rule-of-thumb. So it brings up this interesting challenge for people who say, “Hey, I’m making pretty good cashflow on my property. 800 to $1,200 a month off a single-family rental here in Denver. I’ve got $200,000 left on my mortgage balance at 3.25%, but my property’s worth $800,000.” And it’s all the points you laid out, Scott, as to, “What do you do?”
So I think it’s really important for people to first take a step back and do the global overview of what their goals are, because I’ll use myself an example. I started buying real estate when I was single. Well, now I’m married, I have a new business, and I have two little kids. My life has dramatically changed. So my goals have changed, and also how much time I want to put into my real estate investments have changed as well. I want to spend time with my kids, not going out there and painting walls. So I think it always comes down to, “Hey, what are your goals?” And be realistic about what your goals are, because all real estate is is a vehicle to get you to your goal. So, I think it’s very good as people reevaluate this new problem they have. And while they’re revaluing the problem, the market, also take stock as to what your goals are right now and how they’ve evolved. Because that gives us the North Star where to go, and helps us make the appropriate decisions.
And, I mean, a lot of times there’s no right or wrong answer for people when it comes with equity. And I think it’s very important to first look at, “Hey, if I sell this, what are my tax consequences?” I mean, I’ve house hacked. Scott, you’ve house hacked. A lot of the BiggerPockets listeners have House hacked. If you’re in an opportunity where you can sell a property and you’re in that two-out-of-the-five-year capital gains exclusion, well, then it might be a really good time to buy and just take 200, $300,000 of equity off the table. Take that gift from Uncle Sam and run with it. Now, the vast majority of people cannot access that capital gains exclusion. And then people get fixated on, “Oh, well, I don’t want to get rid of my 3% interest rate.” Well, yes, but I would not just look at that one metric. Because there’s a lot of scenarios where, by holding that 3%, while you are saving money in interest, you’re saving a dollar over here. But you’re actually missing out on $10 in wealth creation over here by not redeploying it with leverage and a better-cap-rate property.
So, it comes down to actually running multiple scenarios a lot of times. Hey, figure out what your goals are. And then, “What can I do with that property? Let me actually just run scenarios. Should I pay it off?” And for a lot of people, that’s not the right answer. Because if you need to accumulate more properties for your retirement goals, well, paying off a property is not going to get you there.

Scott:
Can I ask a quick question here? You said redeploying the equity from my property into a higher-cap-rate property could be a good idea. But I’m an investor here in Denver, and I’m arrogant as all heck. And I think that I bought some of the best rental properties, cash-flowing rental properties here, and I’m not convinced that the cap rate on another property here in Denver is going to be higher than the ones that I own. I think I constructed a reasonably good portfolio with this. So are you suggesting in this case that I go out-of-state, for example, and go into another property? I wonder if many investors feel like their portfolio has reasonable cap rates there, and is, at least for the condition of their property, among the better types of cashing-flowing investments in their area.

Chris:
What’s a cap rate of one of your properties, ballpark?

Scott:
Sure. I’d say, and I use rent-to-price ratios as more of a rule-of-thumb, but I’d say it’s in the 0.65 range rents-to-value.

Chris:
So, what? So, a 5 to 6% cap rate?

Scott:
Sure, if we’re being nice. Yeah.

Chris:
Well, I mean, okay. So, I mean-

Scott:
And that’s high for Denver.

Chris:
Yeah.

Scott:
Yeah.

Chris:
So a lot of times a lot of people have bought … Especially in here in Denver. I’m going to use an extreme scenario, because it does depend on what the current valuation of the property is. A lot of people make the mistake, “Oh, I bought this property seven years ago.” Great. That doesn’t matter anymore. You bought a 9% cap rate property. We got to use today’s numbers. So from all the analysis I’ve done the rule-of-thumb has been, if it’s below a 4% cap rate property, 4% cap rate with a PM fee, it often makes sense to sell and redeploy, or a 1031. If it’s above a 4% cap rate property, a lot of times that means, hey, refi and redeploy.
Now, with higher interest rates, things have changed. The spreads are harder, but I found that 4% cap rate to be the threshold. And a lot of times it’s like, “Hey, people have a 3.5% cap rate property.” Because they bought a property in Sloan’s Lake, which is a area that’s gone through massive appreciation in Denver. Will sell a 3.5% cap rate property. And I’d say, “You need about a 1.5 to 2% cap rate increase along with increased leverage.” So a higher cap rate, higher leverage is the key to making it worthwhile in that transaction.

Mindy:
Okay. I hang out in the BiggerPockets forums all the time, and you can find those at biggerpockets.com/forums, and I find that the concept of cap rate is confusing to even some very experienced investors. Can you explain what you’re talking about, so that people who are listening who are probably very confused can understand?

Chris:
Absolutely, and thanks for bringing it up. So, cap rate is essentially your net operating income divided by the current value of your house. So what that means is, you take your rent. You subtract all your operating data. So basically, everything other than your mortgage payment. PM, repairs and maintenance, taxes, insurance, HOA fees, landscaping, whatever it is. That gives you your net operating income, and it’s just another way to evaluate how that property is performing. I personally, I do cap rates. That’s worked well for me, and it’s also good because you have debt or no debt. It’s a way just to understand from a high level how properties can perform. I know a lot of people use GRM, or gross rate multiplier, cap rate. Very similar concept, just a little bit more advanced and nuanced. But I find it’s a very good way to help for high-level talking, sniff test. “Hey, this looks good.” Or, “Hey, you got a 4% cap rate property. Here’s some high-level stuff you can do.”

Scott:
So, I was using kind of a concept of GRM. Rent-to price ratio is an inversion of GRM to think about my property’s cashflow. You’re saying cap rates. Cap rates are better. I should be using cap rates. But I’m really looking at it as rent-to-price ratio at the highest level, although I can easily spin it that way. But anyways, so you’re saying that a low-cap-rate property, something in the 4 or lower range right now, which many investors may find they have in Denver specifically, could be re-traded for a property that can earn a 6 or 7% cap rate in the market. And this could multiply your returns, depending on how you leverage and the assumptions you make.
So, tons of caveats in there. But you could be suboptimally deployed, is what you’re saying, with one of these properties. How do I justify … I have to make so many assumptions and I have to believe so many things to get to arrive at the destination that you’re at. I have to believe that my appreciation’s going to be this level. I’ve got to understand the difference between the interest rates on the debt I have currently versus that I’m going to get on a new property. How do I wrap my head around all of those puts and takes to feel confident that if I’m at the conclusion, “Oh, if I own a property at a 4% cap rate, it’s time to sell it and redeploy it into a higher-cap-rate property”?

Chris:
You turn to your calculators and spreadsheets. So, I mean, a real simple thing is, I mean, hey, go use the BP calculators and go plug in the rental spread … Go take the rental spreadsheet calculator and plug in the rental you have today. But don’t use the numbers you used five years when you bought it. Use today’s numbers. “Hey, what is today’s value? What is today’s rent? What is today’s operating data?” And underwrite it as if you’re buying the property today. Because every time you sign a new tenant, or sign a new lease, or you refinance it, you’re essentially kind of repurchasing the property for a while. So go you through scenario and say, “Hey, does this property make sense?” So you can do that with the BP calculator, and then figure out how it performs.
So I looked at a client’s property last week, and this is a very common example. They bought the property for $300,000 in Denver. Now it’s worth like 650. They got a $200,000 mortgage, a 3% interest rate loan, and 400K in equity. But it’s a 3.5, 3.6% cap rate property. Great. Go plug in calculator and see how it performs, and then figure out how much equity you have. In this case, let’s say $400,000. And just round up or round down for some selling cost, fees. Assume a 1031, and play some scenarios like that. And the say, “Great. If I got $500,000 to put down, I’m going to go buy this other cap rate property.” It might be in Denver, might be in your local market, or it might be out-of-state. Just, hey, whatever properties you’re looking at, go plug in, “Hey, if I sold this, took the equity, and bought this higher-cap-rate property, how’s that perform?”
Now, what we’re often seeing … And again, take this from a Denver perspective. That person sells that property for $650,000. They pay their realtor fees and closing fees, 1031 it. They’re going to buy a place like $1.1 million or so. But to make a cashflow, we’re at a 35, 40% down-payment at a 7% interest rate. So what happens a lot of times is, in that scenario, they sold it, 35% down, and they go from a 3.5 to a 5.5 cap rate property. So, pretty conservative and pretty realistic. Their cashflow will stay about the same. However, their total valuation goes up and their net operating income oftentimes more than doubles. So I often look at that, “Hey, that is a future dollar. That is a future value.”
And this is for really, I’ll say, more hands-off investing for people that want to go out there and find a value-add property. This is more like, “Hey, I just want to go out there, look at some properties, redeploy my capital. I’m a busy professional. I’m a busy person.” For that type of speed, you’re really more just looking at redeploying your capital. And that’s where it comes down to, for a lot of the clients I talk to, myself included, I’m not living off my cash with my properties today. I have other income that does that, and all my rentals is for … It’s my retirement. It’s my investing pool. So, I don’t need massive cashflow there.
Now, I want my properties to cash flow, but it kind of comes down to, “Hey, do you want more cashflow today, or do you want to trade up to make more cashflow in the future?” So a lot of times, even with these very extreme examples of a low-cap-rate, high-equity property, while it’s not as good as it was a year ago, it still makes sense in the 10, 20, 30-year chess game of real estate investing. I don’t know if I answered your question there or muddied the water.

Scott:
No, I think that’s right. And I think that I love your answer, and not just because it was a plug for our calculators at biggerpockets.com/calc. But it’s like “Hey, that’s the answer, is go plug this stuff into a spreadsheet and make some decisions and make some assumptions.” And one of the key assumptions that’s going to be in there is, look, if you analyzing a new property, you’re going to be able to get the down-payment, all of the basic numbers around rents, cashflow, and all those kinds of things. Hopefully, if you’re a real estate investor, you’re pretty comfortable with making those types of assumptions.
But the key ones in this analysis are going to be the interest rate on your debt that you’re going to get on the new property, and the appreciation rates you have on rent growth and price growth over the next 30 years, and in particular in the next couple of years with that. Well, 30 years if you’re thinking long-term, or a shorter term if you’re thinking shorter-term. That really matters, and I think it will be really interesting. I think folks will find that if they don’t believe that appreciation’s going to be very high, the redeploying strategy could cost them. It could be pretty consequential. But if you do believe in appreciation over the next couple of years, and you can put in a 3, 4, 5% appreciation number, then what you’re saying will work out really, really well. Is that largely accurate, Chris, in your experience?

Chris:
Yes, but I have to push back on the appreciation assumption. So, you’re right. I mean, I don’t recommend underwriting 6%, 8%, 10% appreciation. I didn’t recommend that years ago. I kind of underwrite 3 to 5% for historical means. Now, the next year or two I’m saying, “Hey, we’ll probably be flat, at least in Denver. We might give a point, we might make a point, but just kind of assume no appreciation.” I think the more important thing there is … Because you’re right. If you do crazy assumptions, you will get out-of-whack. But even if you buy another property, let’s say you sell in Denver and buy in Denver from a 3.5 to a 5.5 cap rate property. If you’re actually doing a real underwriting on there, you’re still better off from a pure wealth experience or wealth-building experience, because that is still a higher cap rate.
Now, if it appreciates or the rents grow faster, that is a big, fat cherry on the top, which will increase your returns. But even if appreciation and rent growth is relatively flat, which for most of the country I think it’s how it’s going to be for a year or two, or it’ll be -3 to +3 for a lot of the areas, so flat, it can still make a lot of sense and still be the right move in the long-term wealth-building. So, appreciation is not going to make or break it. I would just underwrite very, very conservatively at a 0, 1% for the next year or two, and then it probably goes back to 3 or 4% in the long run.
The other thing too is, you look at opportunities. This has been a few things things, because I recommend people go out there and just, I mean, play around with a ton of calculations. In this case, “Hey, I’m a Denver investor. Sell in Denver, buy in Denver.” And you do that in your market. Now, you also say, “Hey, sell in Denver and buy out-of-state at a better cap rate.” Because Denver is what? The most expensive non-costal city now, I believe. So cashflow is very, very tough to find. So go underwrite, “Hey, if I bought this.” And then I went on a crazy amount of underwriting deals where we’re like, “Hey, well, I don’t want to give up my 1031 exchange. What if I sold it and rolled into a DST, a Delaware statuary trust?” Yeah, you save your money on the taxes. But over the next five years, since you’re making a 5% return, you actually start losing money in the long run.
I ran scenarios of, “Hey, if I actually just paid capital gains, I should walk with $400,000, but $100,000 goes elsewhere.” But I take out $300,000 and make another investment in real estate, into a syndication, into another business. But I get such a higher IRR, it can still make sense and say, “You know what? It’s worthwhile to eat those capital gains.” So, I’m not giving you recommendations on here. My point is, a lot of people do a lot of what-if stuff. Well, do the what-if stuff, and run the calculations through a spreadsheet or the BiggerPockets calculator. And then you can take that one calculator and do it all for your property, a property in your market, an out-of-state place, a DST. You can figure out a passive investing, things like that. “Hey, what are those returns like, and what do those tax consequences look like?” Get the big picture of things.
And then the next level is, actually go through and make sure you talk through your CPA. What are the tax consequences? Because a lot of times, I know for my own personal use I estimate what I would own in depreciation or capturing capital gains, and my guesstimate are not very good. So, I talked to my CPA. And I’ll also look at the stuff as, “Yeah, you can go out-of-state and cap rates are higher, more attractive. But now you have to have the added expense of traveling and developing a new network in the market.” Which is not good or bad, but those hours and expenses usually don’t show up on the property underwriting. So I’m a big believer in, run a bunch of scenarios and then look at the metrics. And then also look at the tax consequences and look at, “Hey, how much bandwidth and money does it take for me to actually go execute this new strategy?” And just have fun running scenarios.

Mindy:
I like this advice a lot, because it can be really easy to get caught up in FOMO or whatever the market is doing right now. You’re a real estate agent. Remember spring of last year, when everybody was buying, and you couldn’t even get a showing sometimes on some of these hotter houses? Or you would go in, and it’s just this revolving door of people, and you would lose. You’re 1 of 37 offers. So I can see people getting really, really excited about that. This spring, from what I’ve seen so far, it’s starting to look like that again. Not to the extent, because we don’t have the great interest rates. But it’s still, in the Denver area, getting really, really hot. So, it could be tempting to sell. “Oh, I’m listening to Chris on the BiggerPockets Money Podcast. And he said that my cap rate isn’t great, so I should sell.”
No, he’s not saying that. He’s saying run scenarios. Run a lot of scenarios. Talk to your agent and see what they think you could get for your property. Run the numbers based on that amount, maybe a little bit less, maybe a little bit more. But see what all of these options are going to get you before you jump in with both feet. You sell it, and then you’re like, “Oh, I can’t do a 1031 because my timeline ran out.” I know enough about 1031s to be dangerous. There is a very specific set of time that you have to buy a new property, to identify three properties. And if you don’t, your 1031 is out the door. If you don’t get somebody in advance to take possession of the money for you and hold it, your 1031 is out the door. If you take possession of the money, then you now owe all those taxes. So, there’s a lot of planning involved. But if you’re thinking about selling, run the numbers. Make sure it makes sense. Run all the numbers. Talk to people. I love this so much.

Scott:
Yeah. Chris, it sounds like there are a couple of options here. I can sell the property, I can refinance the property, or I can do nothing and let my low-interest debt amortize. I have chosen, let my low-interest rate debt amortize. That’s been my approach currently. I’m not sure if that’s the right approach, and I need to question it. And in the case of selling the property, I have two options there. 1031 exchange or just harvesting … I have option A. Sell part A is 1031, and sell part B is harvest the gain. Do you have any case studies or maybe scenarios you could walk us through of folks who have chosen each of those options and why they’ve done it, or maybe examples from your personal portfolio?

Chris:
Yeah. Absolutely. One thing, I want to jump back around to what Mindy was saying. My favorite thing about … What I would recommend after you do all the scenarios and talk to people, and I do this all the time. My favorite feature of BiggerPockets is the forum. I like reading other people’s posts, but I also post my own. And don’t post, “Hey, guys. I’m thinking about selling the property. What should I do?” Don’t do a lame post like that. Do a post like, “Hey, I ran a scenario. Here are the numbers. And I ran three upsides for this, this, and this. Here are my numbers. Here’s my thoughts. BP community, give me your feedback.” And you’ll get a lot of great feedback. You’ll also get people reaching out to you to bring other opportunities. So, always do due diligence. But the community on there, I think that is the absolute best part of BiggerPockets, or my favorite part. So do all that, and then share it with the forum and get the group-think going on.

Scott:
Love it. BiggerPockets calculators and BiggerPockets forums. That’s right. Post a smart question and you’ll get smart answers.

Mindy:
A smart response. And you’ll get a lot of different responses. “Hey, I like what this person’s saying, but I don’t think they took this factor into account.” You’ll get people who are very experienced telling you what they would do in that situation, and most likely they will expound on why. People in the forums love talking about real estate. And it’s a little bit different for us, because we’re in real estate. But when you love talking about real estate and you’re a real estate investor, nobody else in your life cares. They don’t want to hear it. They only want to tell you about the bad experience they had. But in the BiggerPockets forums, you’ve got people who are doing it. People who’ve been doing it longer than you who have scenarios that you may not have been through yet where they can give you experienced advice.

Chris:
Yes.

Mindy:
And I didn’t mean that to sound like a commercial, but-

Chris:
No. But, I mean, is a asset out there, guys? Use it. I mean, that’s been one of the best assets I’ve used in my real estate career as an agent, as an investor. All right. So, going back to some examples here. So to take one step back, my degree’s in financial planning, and I’ve always had that longer-term planning desire. I don’t like doing it in stocks and bonds where I’m like, “Hey, put it in an index fund, and that’s boring and set-it-and-forget-it.” Real estate’s a lot more complex. So what I do for myself and what I do for my clients, I’ve kind of put together a five-step framework. I’ll frame it with this, and this will walk through a couple common scenarios we see out there in the marketplace.
So step one is, what is your goals? Like I talked about, revisit what your goals are. Real estate’s a vehicle to go there. Step two, look at your total portfolio. A lot of people look at their rentals isolated. But hey, across your 5, or 7, or 10 rentals, how’s it perform as a whole? Just like you would look at your IRA, your 401(k), this. “Hey, how’s it all performing as a whole?” The third step is to go out there and start looking at your individual properties, your individual assets. “Hey, what are the opportunities? What are the numbers?” Do a SWOT analysis on there. Step four, run those scenarios like we talked about. And then step five is, write your action plan.
So, this is very good for investors. Also, if you’re an agent out there, I have found this to be an amazing client value-add tool to my clients. So, me and my team do about 30 to 40 of these portfolio sessions a year. Or, I’m sorry, a month. These are kind of like your annual financial planning sessions with our clients and for ourself as investors. So, we get to a lot of good data. We see some trends on there. And to bucket some common examples out there is, it comes down to, a lot of people are nearing retirement. Well, for them, they’re less growth-focused and they’re more income-focused. So they might be in their 50s or 60s, starting to retire or want to take a step back. Kids are going to college or out of the house. They don’t need a ton of future income or a ton of future growth. They need more income the next couple years.
So that’s a very different case than someone that’s like me, where I still need to accumulate more real estate to retire at the level I want to over the next 10 or 20 years. I’m still my accumulation phase. So for people that are often in their nearing-retirement phase, it can make sense to pay off the properties and say, “Hey, if you have these properties paid off, what’s the cashflow?” But at the same time, you run scenarios, “Hey, at that same time, if you pay off these properties, hey, look at a triple net. Hey, look at a debt fund that might pay 8 or 10% in yield.” You can do different things like that, but you have to make sure that aligns with that goal. So for a lot of the people that are in that retirement phase, a lot opt to go out there and just continue to pay off their properties. So you’re like, “Hey, if you just pay off your properties, you’re at your income goals.”
So then a lot of times they’ll take the debt snowball approach, and start paying off one property, or the lowest balance, or the highest interest rate. So, “Hey, start paying that off.” And then pay off the next one, pay off the next one. And a lot of times they’ll sell one property that’s their dog property or [inaudible 00:30:40]. Like, “Hey, this property, it’s the pain in the butt. I hate it. It doesn’t perform well.” Great. Well, get rid of that. Appreciation party. We’ll move on. So for a lot of people, paying off their property can be a really good move. Now, however, if you say, “Hey, if I pay off the property and I don’t have the income I want,” we have a problem there.

Scott:
So we had a great discussion about a topic like this on BiggerPockets Money show 322, Why Your Rental Property Cashflow Isn’t What You Think It Is. We had a guest there who had nine rental properties and was living paycheck-to-paycheck because the cashflow was not there. So if you’re wondering about this, if you’re not sure, you could be in that situation if you have a couple of rentals where at least a few of them are break-even at best, and maybe negative cashflow. And I think in that situation, you will discover that by following the five steps that Chris outlined. And in that specific property-by-property analysis, you’ll determine which ones probably you should consider selling or exiting. So Chris, have you done this with your own portfolio in the last year or two?

Chris:
I have. So, I did my own portfolio review. I did not make any moves this year, and that was more because my portfolio is actually … It’s pretty well-optimized with the cap rates, the loan-to-value. But also going into the outside factors is, my career and my business is, a real estate agent, all real-estate related. Well, I’m very conservative. And since we’re going through choppy times, and most people’s income in real estate has dropped this year, and … For 2022 and ’23 it’s lower for a lot of people. So I’m like, “Hey, I’m going to be very conservative of my investing, because I got to make sure my day-to-day income is fine. So I don’t want to go out there and start treading up or tightening on cashflow.” While it makes sense from the investing standpoint, it doesn’t make sense from the global standpoint of what I need to do as an investor right now.
So what I’m doing is, I’ve got two properties here in Denver Metro that … I mean, they’re good rentals. Like I said, they’re not my favorite ones. I would not be unhappy to move them. So, I’ve talked to my property manager. Leases will come up due around December-time is what we’re shooting for, because the best time to sell properties here in Denver is springtime. Right around mid-February to end-of-May, sweet spot for listing a property. So I’m going to make sure those leases are up, and then I have time to get the tenants out so they can go find a new place to live, and hopefully I have three to six weeks to go on there and do any type of updates I need to do. Because most rentals, they need some love. They need some TLC. And a lot of times you’re better-off putting in 5 to $15,000 in some work and then sell it to an owner-occupant. For every dollar I spend in making it prettier, I should get three to four more dollars in return on that. So, “Hey, where’s that sweet spot for me to make it very owner-occupant-friendly to maximize my dollar?”
So, I’m starting to plan on that. A lot of clients are doing that. One really interesting thing. This has been so fascinating. So going back to this high-equity, low-interest-rate scenario. A lot of people are like, “Hey, my rental is good.” They’re a 4, 5% cap rate. They like the rental, good part of town. They don’t want to touch it, but they want to redeploy the equity. We’ve been doing a lot of HELOCs. There’s one bank that I know of in Colorado … They’re usually very tough to find banks that’ll do investment HELOCs on investment properties. So a HELOC is a home equity line of credit, and they’re not like a 30-year-mortgage, but it’s more like that the check, credit card on your property.
We have a lot of people who are doing an investment HELOC on their investment property, and then they’re going from … They had a 30% LTV. They’re taking out 20 or 30% of their equity, and then redeploying it either into a rental or some type of syndication strategy. And they’re able to have their cake and eat it too, because they have that low-30-year-fixed interest rate, and they’re able to handle some variable interest rate, but borrow at 6, 7%, but go get a 15 to 20% return.

Mindy:
Who is doing this HELOC for investment properties? Because I have not been able to find anybody that does investment HELOCs.

Chris:
Well, DM me on BiggerPockets, and I’ll tell you, Mindy. No. So, a lot of this comes from … So with this, so these are … I mean, happy to share that name with you and give my contact over there, Mindy. Awesome guy. But you want to look for local banks. The big banks, and national lenders, and probably the person that gave you your 30-year-fixed conventional loan, they’re not going to be the right guy or girl to give you that loan. They’re Fannie and Freddie conventional lenders.
So, the big banks will not give you this. But find a local bank, like a state-chartered bank or credit union a lot of times, and they’re the ones that do HELOCs. And that just comes down to, I talked to 30 banks, plus I got my network out here. And I know a couple banks that’ll do it, but very few will do it if they don’t own the first position. And a lot of times, they don’t the first position. So it gets very, very nuanced. But that is where a lot of people get frustrated at real estate, especially tech guys and stock guys. I’m like, “Well, real estate’s not efficient.” Yeah, call 30 lenders. It’s not fun, but that’s how you find the gold.

Scott:
So, I love this as an approach and as a tool. I do want to caution that I am not a fan of using an investment HELOC at 6, 7% interest to then redeploy into syndication-type investments. I think that’s really tough arbitrage, and the cashflows and timings from those syndications cannot be quite as good in some of those cases. It’s a very aggressive play. So, just remember that if you’re going to do that kind of strategy. It’s much more aggressive than redeploying the equity from a rental property into another property, in my opinion, using 30-year-fixed-rate debt.

Chris:
Yeah. This is where, like I said, for a lot of people doing it, they own eight rentals and they’re doing it on one or two. So they’re still staying very balanced in overall equity position, and their blended fixed interest rate is 3.5, and now they’re adding on a very small amount of variables. So I totally agree with you, Scott. It is more advanced. It is higher-risk. And we have people doing that to rentals, doing that to funds or syndications. But it’s definitely a much more advanced technique, and make sure you have the cash to ride any waves from there or ride any punches from there.

Scott:
I do want to say, I think it is wise to go out and see what you can get for an investor HELOC if that’s available to you. It’s always good to have access to the credit, even if you aren’t going to use it.

Mindy:
Yes. That definitely saved my skin on our property. It wasn’t an investor HELOC. It was a HELOC on my own house. But I did some financial monkey business, and I needed access to quick cash. And I thought I might need access to quick cash, so I opened it up, but I didn’t take anything out. It was just sitting there. But then when I needed it, it was there to pull. Is an investment HELOC at the same or similar rate to a personal property HELOC?

Chris:
No. A lot of times it’s more like prime plus 1 to 3%, where a lot of times owner-occ can be prime plus 0 or prime plus 0 to 1. So, you see the spread there. The other thing is, for a lot of primaries, I mean, there’s a lot of credit unions and banks around town that’ll go up to a 95% or 100% combined LTV. They’ll do very high LTVs. Again, go in there with caution. You have to be smart with a big credit card. But an investor HELOC, where they tap out a lot of times is a total combined LTV of 70 to 80%. And combined LTV means, “Hey, what’s the percent of that 30-year-fixed first-position payment? And we add the HELOC on top of there. What’s those two combined?” So investment HELOC’s the best I’ve seen. I say best. The highest LTV is 80% combined LTV, which is still incredibly high for an investment HELOC.

Scott:
Can we go through a couple of examples from perhaps clients that you’ve worked with of folks maybe going through various of these options? Have you talked with somebody and they’re like, “You know what? I’m just going to pay the thing off and say forget it”? Or, “I’m just going to let it sit and do nothing. I’m not going to pay off the debt early. I’m just going to let it amortize.” And then have you had some folks that have gone through this, and what was their rationale in the recent past?

Chris:
Yeah. I mean, it’s all of the above, and a lot of it comes down to what their goals are and what their overall risk tolerance is. I mean, I’ve got clients right now that are selling a property and they’re going to do a 1031. Some are staying local. Some are going out-of-state. Great. Various options on there. And their rationale in that case is, “Hey, the appreciation party is over.” For Denver, the crazy appreciation, it’s over. Now, you sell now, you might give a couple points back. But who cares? You made 40%. Give two points back the last two years. And they’re still saying, “In the long run, I want to go out there … A lot of people are saying, “Hey, this property is a class C property, a headache property. It’s no longer a great rental. I want to move it into a better location, or class A property, lower headache.” So it should be lower-maintenance, a similar or higher cap rate, but more hands-off. That’s partly investment, and it also partly just makes their life easier as an investor.
I got a lot of people as well … Actually, a majority of people saying, “You know what? I’m hanging tight for the year.” Which hanging tight for the year and just kind of letting cash stay in the bank, build, and continue to pay off the debt is never a bad move. If you’re not sure, pumping the brakes is not going to hurt you. There’s no one deal that you’ll miss out on that’s going to make or break your career. But if you do a transaction, there is a deal that could break your career. So, don’t worry about the big one that’s going to make you rich. Worry about the one that’s going to blow you up and set you back 10 years. And that’s what can happen. So, it’s always being mindful. So, a lot of people are sitting tight. Like I said, they’re doing what I am. “Hey, I’m in a good position. My properties performed well. I’m at a good LTV. I’m sitting tight for a year.”
And then the people that are doing more the advanced strategies of putting a second on there, like a second fixed or a second HELOC, these are not people with one property that are doing it. These are people with 5 to 10 properties, and they have good cashflow, and they’re doing it on 1 or 2 properties to increase their global LTV from 30% to 40%. So they’re still at very low LTV, and their blended interest rate goes up by a little bit. And they also have the cash in the bank and the rental coming in to be able to fund all the payments. And to also withstand, “Oh, I made that move, and I thought I was going to make 20% IR, and I’m making the 7% IR now on this property.” They can handle that black eye. But the risk-reward ratio is correct for them, but they are properly capitalized and they have good income coming in.

Mindy:
Chris, in this market, is there ever a good case for a cashout refi? I mean, I am old enough to remember 7%. My first mortgage was a 7% loan, and I thought I was hot snot for getting that 7% loan. And now we’ve had 2, 3, 4% loans for 20 years. People are freaking out about these current interest rates, and I can understand why a cashout refi seems like a bad idea on paper, but it can’t be all bad.

Chris:
As with most things, it depends. But some high-level stuff. So going back to that example where I said, “If a property’s at a 4% cap rate, that’s my rule-of-thumb.” That works well in Denver. I don’t know how that translates to other markets. I assume similarities. But again, that’s my disclaimer. High-level, if the property’s above a 4% cap rate property, a cashout refinance can make sense. If it’s below a 4% cap rate property, it usually doesn’t make sense. But now it’s probably a little bit higher. I probably need to up my rules-of-thumb for cap rates in the new market. Because if you do a cashout refi, you are repurchasing the property. And I seriously doubt if you did a full cashout refi, the property would still cashflow. Most of the times, it’s not a negative cashflow.
So out of all the reviews I’ve done and out of all the clients I’ve worked with, I can’t think of anyone that’s done a cashout refi right now in the current market. There might be one or two, but I’d say it’s as close to zero as I’d feel comfortable publicly saying it’s zero. Most people are opting to sit tight and do nothing, sell and move the money, or put a HELOC on there to access the equity. But if you already have a poor rental property, doing a cashout refi at 7% is usually not a good thing. Because now you have a negative cash-flowing asset that’s at a poor cap rate that you’re now reinvesting.
So for the vast majority of people, I don’t think it really makes sense to have negative cash-flowing properties. Once in a while, for a small part of the portfolio, yeah, I can make the exception to that rule. But for most people, why do you want to have a asset that will not pay for itself? So if you do a cashout refi, a lot of time that’s becomes negative. And that’s where it becomes a liability for most people. So I haven’t seen any cashout refis, and I don’t see my investors or clients doing it either.

Mindy:
I get that question a lot, and I haven’t seen any reason to do a cashout refi either. If you have a property that you bought before the interest rates started going up last June, then if you want to keep it, keep it and HELOC to access the equity. Short-term, I do agree with Scott that HELOC money should be short-term money. But then, yeah, you either keep it or sell it. And if you’re going to keep it, then keep the low interest rate. It just doesn’t make sense. I don’t know what you would do with that. But again, it depends. Most likely it’s not going to work out. Run your scenarios, just like you said before. If you can access that cash in such a way that it will … You found a killer deal and this is the only cash you have, that could be a very, very specific way to use the cashout refi. But yeah, I agree with you.

Scott:
Yeah. Except for in the cases of those who are extreme bulls about the real estate market, and want to just buy a lot more, and pull out their cash, refinancing from a low-interest-rate mortgage to a much higher one does not make much sense. So I see the use case for this slowly coming back over the next couple of years, as people buy with interest rates at current rates. So if you’re buying a new property at 6, 7, 7.5% with an investor loan, and then you BRRRR it next year, if you want to refinance at a 7% rate and pull some cash out, that would make sense to me. So, I think you’re going to see a temporary lull in most refinancing activity. That’s obviously already here. I think that’s going to continue and come back slowly over the next couple of years.

Chris:
Yeah. I mean, I talk to a lot of lenders, and, I mean, the refi party ended about a year ago. That’s why we saw a lot of layoffs in the lending world as well, because the refi party ended. I agree. It’s just not a big play right now. So, it’s a very small use of cases right now. Usually makes sense for someone, but that’s 0.1% out there.

Scott:
Chris, this has been fantastic. Thank you for coming on and showing and talking about this good problem. How to deal with the equity that you’ve got perhaps trapped in your rental portfolio if you’ve been a long-term investor. Where can people find out more about you?

Chris:
Well, you can always Google me. I’m a marketer here in Denver. So if you google Chris Lopez, Denver, you’ll find me. But the absolute best place to do it is BiggerPockets. I’m on the forums there, and shoot me a DM. That’s really the only social platform I actually use myself and respond to, because it’s actually useful information. So I would love to connect to people on BiggerPockets because I truly love jamming and talking about real estate, and also learning what other people are doing. So, BiggerPockets is the best place to go.

Scott:
Awesome. Yeah. If you’re in Denver, Chris is always willing to meet up. I’ve met with you a couple times recently. Yeah. Feel free to also, if you go into BiggerPockets forums, reach out to me as well. I’ll be happy to meet with you. So, Denver’s a fun place for investors. We love to grow the network.

Chris:
Awesome. Well, thank you guys. This was a blast to come on here. I love talking more technical stuff like this, so this is my absolute cup of tea. So, thank you guys.

Mindy:
Thank you, Chris. This was super fun, and we’ll talk to you soon.

Chris:
Bye, guys.

Mindy:
All right. That was Chris Lopez. That was a lot of fun. Scott, we brought up a lot of things that I hadn’t really considered before. But also, the advice that sticks out over again just with every show we do is, run your numbers. Do your homework. Run the different scenarios. Don’t just fly by the seat of your pants. See what is the most financially advantageous path for you to take. Don’t just, “Everybody else is selling, so I should sell too.” That might not be the best option. That might be the best option. But make a solid decision based on math, not emotion.

Scott:
Yep. Love it. Chris says, “Start with your portfolio. Ask yourself the question, ‘Is that going to achieve what I want it to achieve?'” Then, boil that down inside of the real estate component of your portfolio on a deal-by-deal basis. Are each one of these deals contributing to that larger goal? And if not, am I going to pay it off? Am I going to do nothing and let my current note amortize, or am I going to sell and exchange or sell and capture the gains? Complex set of decisions that you have to make here. A lot of thought and energy, and a lot of knowhow needs to go into that. Luckily, we’ve got a platform called BiggerPockets to help you discover all the ins and outs of those types of things, and make those kinds of analyses on the properties component of that.
But I do want to also give one other question. I want to pose one other question to this issue. Which is, what would you do if you converted your entire portfolio to cash? If I just handed you that in cash, how would you deploy it? Would it be the same way that you’ve got it deployed today, or would it be something different? And if it’s something different, why don’t you back into that and say, “How do I begin making moves today with all the additional cash I accumulate, or maybe even redeploying some of the assets in my current portfolio to get to that state that is my desired portfolio”?

Mindy:
Ooh, I like that question a lot, Scott. How would you deploy the cash? Would you deploy it the exact same way, or would you make changes? That’s interesting. I think, honestly, I would be pretty much the same way that I am right now. I like my portfolio.

Scott:
Yeah. I’m pretty happy with my portfolio, but I do think that a big one for folks to ponder is debt. I’ve been talking about this a lot lately. But I got a question the other day from a BP Money listener, and they’re like, “Hey, I’ve got this big portfolio, but I don’t generate any cashflow.” “The portfolio’s like 2.5 $3 million. How are you not generating cashflow?” “Oh, it’s because we’re deployed like this.” Well, if you bought a mortgage, if you literally … Investment mortgages are 7 and 7.5% right now for 30-year mortgages on investment properties. You just put a couple-hundred grand into one of those mortgages. Buy a single mortgage, and you’ve got, just from the interest, your 30, $40,000 a year in passive cashflow. So something to noodle on for folks out there that are wondering what to do with their portfolio, consider debt as one of those places where you might redeploy to a larger degree, especially if you want that passive income.

Mindy:
That’s an interesting scenario, Scott. I like it. All right. Should we get out of here?

Scott:
Let’s do it.

Mindy:
Okay. That wraps up this episode of the BiggerPockets Money Podcast. He is Scott Trench and I am Mindy Jensen saying, “Talk to you soon, baboon.”

Scott:
If you enjoyed today’s episode, please give us a five-star review on Spotify or Apple. And if you’re looking for even more money content, feel free to visit our YouTube channel at youtube.com/biggerpocketsmoney.

Mindy:
BiggerPockets Money was created by Mindy Jensen and Scott Trench, produced by Kailyn Bennett. Editing by Exodus Media. Copywriting by Nate Weintraub. Lastly, a big thank-you to the BiggerPockets team for making this show possible.