Cash Out or Save Up to Get Started?

Question

Hi BP Community, this is my first post after lurking here for a while soaking up as much as I can. I am an accidental landlord with a condo in San Diego, CA. I bought in April 2020 and recently moved to the Bay Area for a new job, so my condo is now rented out. (I also am renting my current place... it's so expensive here.) The SD condo is cash flow positive (~$300/mon.) and has gained significant appreciation the last two years. I would like to use this an opportunity to begin my real estate investment journey.

I'm wondering if it makes more sense to fund my next purchase by using the equity in the condo or by continuing to save up. I bought the condo for $670k with 10% down (no PMI) @ 3% interest rate. Latest comp - same exact floor plan as mine - sold for $900k in July and another back in May for $1.125M (!!!). I definitely see the market there cooling down though recently.

I think even conservatively I could access $150k+ in equity from a cash-out refi or a HELOC. I've seen tons of advise about pulling equity out using those financing tools, but I'm wary about high interest rates and a potential housing market decline.  Alternatively, I could tap into my savings and hope to have close to $100k to invest by the end of next year. I'm leaning toward the latter because I don't think it's worth losing my current mortgage rate, and I'd like to take the next year to continue educating myself (hopefully I avoid analysis paralysis!). This is probably the safer route. Looking for some insight.

As for my target market, I plan to invest out-of-state because unfortunately my local market is the most expensive in the country... fun times. I'll save that for my next post! Thank you!

Ben Kagel · Answer

Thanks, agreed. I'd have to crunch some numbers, but I think you're right - my cash flow would disappear from a refi.

Dan H. · Answer

>I think even conservatively I could access $150k+ in equity from a cash-out refi or a HELOC. I've seen tons of advise about pulling equity out using those financing tools, but I'm wary about high interest rates and a potential housing market decline.

It is as much about your achieved return as it is about the rate you pay.  For example, if my cost of money is 20% and I can achieve 25% return it is well worth pursuing.  Do not let the higher cost of money deter a good investment.

We have done quite a few BRRRR in San Diego.  It is our experience that REFI appraisals are very conservative.  We forecast for REFI appraisals 10% below value that would be appraised if we were selling at that price.  If you plan for this and you get a high refi appraisal you are out nothing.  If you do not p,an for this but it happens it could negatively impact your ROI and future plans.

Good luck

Nathan Gesner · Answer

In my opinion, the current market is more suitable for safe moves than for risky ones.

You have a lot of equity because the market went nuts. We're benefiting from pure luck and appreciation, not because we're wise investors that make all the right choices and predict the future. I would keep the equity where it is because it may not last if the market experiences a drop, which is highly likely.

Dan H. · Answer

>I guess I've been looking through the lens of investing in cash flowing property, which is not a strategy that typically succeeds in coastal CA cities.

I would compare my San Diego cash flow with any low appreciation US market.  What do you think happens to rents as properties appreciate?  My primary market has had 2 years in a row with over 20% average rent increase (source ApartmentList.com).

The reality is there is a poor relationship between initial cash flow and actual cash flow over a long hold.  This is not by chance.  Properties with best initial cash flow typically have poor appreciation and small rent increases.   Properties with expected significant appreciation typically have low initial cash flow.  As the properties appreciate, the rents increase and the cash flow improves.

The market with greater rent growth will always eventually have the better cash flow (assuming rents grow more than expenses which is a virtual guarantee with a fixed rate loan).  It is basic math.

Good luck

Ben Kagel · Answer

Good to know! Thanks for that insight.

Joshua J Cawthorn · Answer

Hi Ben,

Some great input on this thread about your increased rate on the condo killing your current cash flow. That's inevitably accurate, you may even be negative. However, San Diego is a better appreciation market rather than a cash flow market. I think the better question (as Mr. Heuschele alluded) is in regards to the cash you pull out: can you increase your overall net cash flow, even with the increased rate/decreased cash flow on your current condo? Building equity in two properties is probably pretty valuable. Building equity in two southern California properties probably pretty valuable.

If you're investing for immediate cash flow, then I bet investing in some of midwest markets is a "safe" bet. If you're pursuing wealth, I personally think investing in appreciation is going to be more lucrative. I feel positively about the long term future of southern California real estate. Moreover, the prices in 2022 will (likely) be so deliciously appealing in, say, 2042.

"Oh wow, you bought a place in San Diego for $1M @ 7%? What an idiot," says no one in twenty years.

Malcomb Stapel · Answer

@Ben Kagel  the cash out refi at current rates is going to kill your cashflow. In which case you will have to subsidize your monthly payment on the condo in order to hold that $150k of cash. Setting up the HELOC now, then waiting for an opportunity to deploy your capital would seem to make more sense in your situation.

As for investing out of state, if your target market buy chance is the Midwest, feel free to PM me. We've purchased 7 properties here since July of last year and the ROI's have been impressive. Once we get done investing this next round of capital we will consider taking on partners to scale.

Cash Out or Save Up to Get Started?

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