Predetermined "trigger points" for selling or pulling equity?

Question

Hello BP Forum World!

My partner and I have kicked around the idea of establishing a "get our cash and run" system. The idea would be that once the equity in a particular property reached a certain level (trigger point), we would sell or refinance to turn that equity into usable cash before the market had a chance to squash it.

For example, we might make it a foundational part of our business model that anytime we achieve 50% equity on a property, we automatically sell or refi.

We'd like to get that cash and use it while it's there instead of leaving locked in the property and exposed to market swings.

Has anyone ever built a mechanism like this into their business model? If so, what trigger points did you use and has it proved successful?

Thank you.

Steven J. · Answer

I think a system like that starts to disregard your long term goals. I would suggest approaching each deal on a case by case basis. I, for one, prefer to see cash flow over time. If I can refi my money in order to purchase another better deal that adds to my cash flow then I'll do it. If the market is over priced, as it is now, are you really willing to refi your deals so you can buy prices that are too high and lose that great cash flow you've got?

Just like BP has rules of thumb I think you can call it that and leave at that. I would use your system as a 'hey, we should consider this' but not a means to an end.

Aaron Montague · Answer

@Harv Yergin IV

Flipping would be a "cut and run" strategy.

As Steven J. mentioned, REI is a day by day endeavor.  You might not make a move for 4 months, then buy 3 places in 3 weeks.  What you want to be aware of is the availability of money in your properties, bank accounts and investors' checkbooks at all times.  With the ability to raise this capital quickly, you are in a position to make quick deals when the timing is right.

At the same token, money sitting in a bank account isn't making any money worth mentioning.  What I recommend is striking a balance across the portfolio.  Always have a few deals within reach, a few out of reach and a plan on getting to all of them.

Skyler Smith · Answer

The fact that you guys are sitting down and thinking about this alone will probably help you find the best answer for your situation. Not everyone gets that far in their thought process!

First define "usable cash." Do you want to issue dividends to your stockholders (you and your partner,) or do you want to use the cash to invest in fresh acquisitions? The ROI on cold hard cash is pretty low right now, though if your goal is to avoid market swings, cash is a good way to go. For your purposes I can see two schools of thought:

1) Track your equity exposure to avoid losing during market shifts

2) Maximize return on your invested equity

I would for sure not make the trigger at just a certain amount of equity, but what your ROI is on the equity invested, or what the exposure is of your equity invested. You could easily have your system or spreadsheet throw off a report every month that shows what sort of return you're getting off of your full equity position in each property, and you could run a Monte Carlo or some other walk forward calculation to see how your exposure is effected during market changes.

Do you want to...

Avoid market shifts?

If you're scared of downturns in the market, you'll want to stay close to two extremes - 100% equity and 0% equity. In a crappy market, those that have 100% equity are unlikely to lose their investment, and you'll have more options than other investors if you need to wait it out, or liquidate the asset quickly. The next best position is 0% equity. If the market turns and you're left holding the bag, at least you aren't losing too much of your own equity if you have to split. Not an ideal situation, but better than leaving thousands on the table. For your purposes, you'd probably be either paying off assets as quickly as possible, or refinancing once you get x amount of equity.

Maximize the return on your equity?

This is the most exciting reason to have a trigger point. Say you have a 12% ROI on your invested capital in property ABC today. 5 years from now, if you've had 10-20% appreciation and you've been paying down your note the whole time, your ROI on equity might only be 5-10%. Do you see how I got there? The calculation would be:

Net Annual Income / (Current Market Value - Mortgage or Debt) = Return on Equity

Be sure you're using the current market rate and NOT the price you paid for the investment. You need to make sure you're maximizing your equity, so keeping track of how you look based on the market changes will show you where to move your equity and keep it moving farthest.

Account Closed · Answer

What is the average ARV of houses  that you deal in and what is the typical yearly increase in value in the market where you do business in? Are you purchasing at a substantial discount or just anticipating the increase in value just from appreciation? Also what happens when you refinance (instead of selling) and market value declines hence you get stuck with a mortgage in excess of the assets market value?

Predetermined "trigger points" for selling or pulling equity?

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