Using your home equity to purchase rental units

[Amy Zemser]

Hi BP friends, 

I'm a landlord in upstate NY looking for some advice about generating revenues to purchase another buy and hold.  

For the past few months, I've been reading a great deal about wholesaling (I even started blogging about my journey here on the BP site). I took an excellent day-long course on wholesaling here in upstate NY that was incredibly informative. But, in the end, I'm circumspect, and when I shared my hesitation with someone here on BP -- and shared the fact that I have about 250k in equity in my own home -- he encouraged me to put this money toward buying another rental property.  And to forget about wholesaling altogether. 

That's hard to do.  I've spent so much time planning for wholesaling.  But, okay.  

Can someone here explain the process of using home equity to buy a rental property in a bit of detail for me?  Or recommend some further reading on the subject? Forgive me if I have overlooked a vital BP post on the subject. 

Here's what I understand thus far (forgive my novice naivete): I take out 100k on my home and purchase a buy and hold for the same price that cash flows out enough to pay off the equity line, pay all rental costs, and provide cash on the plus side to reinvest in the next property.  Where I get a little confused comes next: How would a potential refinance go on the new rental property? And would I then take out another equity line on the new buy and hold to purchase the next?  If I think about this too hard I imagine myself holding up a mirror to a mirror where my eyes are rolling into the back of my head like a pathogenic animal and I'm trapped inside infinite regress...

I love landlording and want to build a rental empire that includes retirement income alongside a way to revitalize my neighborhood. But we're levered up on our 1 main rental property and I admit I'm pretty scared to take out $$ on our house.  Not that I wouldn't, but I need to spend some time reading and learning about how this scenario plays out in the long term.  

Thank you in advance for taking the time to proffer up insights. All best.    

[Mike H.]

I would also second the advice you were given on forgetting about wholesaling and using your equity instead.

Most people recommend going the wholesale route because they simply have no money to use to invest. But you have 250k to use (granted thats the equity and your heloc can only use up to 80 or 90% of the LTV of your homes).

Why spend all the time, energy and effort to find a deal only to turn around and sell it to another investor for 4 or 5k? If your goal is to make some extra money then sure, wholesaling makes sense.

If your goal is to start building a portfolio, then keep the deals to yourself and use your heloc to make it happen.

As far as an example of what you can do, here are two scenarios that might be used to grow a portfolio with a heloc.   One thing I'd preface this with though is that I started with a 42k heloc and now have 41 houses (#42 under contract) in about 8 years' time.   These aren't war zone houses either. 3/2's, 1500 sq ft, in nice areas with good schools that rent for between 1200 to 1600 depending on the home and area. 

I'll let you know which one I went with but here are two scenarios you could consider for using a heloc to grow a portfolio.

OPTION 1) USE HELOC TO BUY HOUSES AS CASH - THEN DO CASH OUT REFI'S TO PULL MONEY BACK OUT.

a) Take your 150k heloc and pay cash for the house (say 80k) and pay for the rehab as well (say 20k). So you're all in at 100k. The house should be worth 135k to 145k or so (70 to 75% ARV is what you'd want to target for a deal).

b) After you rehab and rent the house, then you can do a cash out refi up to 70 or sometimes 75% of the newly appraised value. Fannie mae has a special cash out refi program for people that pay all cash for the deal.  Technically, they'll only allow you to get your purchase money and rehab costs back out up to 70% of the appraisal value, so its not truly a cash out refi.  

But in your case, if you bought the deal right, you could get all your money back and then pay it back to your heloc and look for another deal.

Or maybe you end up having to come out of pocket 5 or 6k to make the numbers work. That would still leave you with 94k of your 100k heloc. 

c) At some point, you will hit a ceiling on the number of loans you can do this way. At that point, you'll need to find local banks and do commercial loans that will allow you to do cash out refi's.  Not as easy as you think as most local banks want to see skin in the game when doing cash out refi's.  So you might have to leave 10k or so into each deal.  At some point, you'd run out of money.

But you'd also be building revenue/cash flow with each deal you add. And you'll reach a point where the rental income will be able to feed your deals. But still, 10k (10%) is a bit pricey.

OPTION 2) Use hard money lender to finance the deals and use your heloc to feed the points/fees.

a) Find a hard money lender that will lend 100% of the purchase plus rehab costs. That leaves you having to pay points (typically 4) and a higher interest rate. But once you rehab and rent it, you would then do a rate/term refi for the 100k with a conventional lender (up to 10 properties) and after 10 properties, you'd be going to local banks to do commercial loans.

The benefit to rate/term refi's are that most banks are much more likely to do rate/term refi's on investment properties than cash out refi's. Seasoning is easier as well.

Again though, you'd be pulling out money out of your heloc after each deal to pay the points. At some point, though, you should have enough income to where your rental income starts to pay for the points directly.

A lot depends on how many houses you intend on buying a year.....

For me, I started out with Option 2. I pulled out the entire wad of money from the heloc (42k or 43k) and set it in my bank account.  I now had plenty of reserves to qualify for loans. 

I then bought houses via hard money loans and only had to come out of pocket for closing costs/points. Tax credit helped offset most of that though.  I was buying about 3 houses a year. And all my rental profits were going right back into the business to buy more houses.

Over the last 2 years, I've bought about 20 houses and seem to have settled into a pace of about 1 a month. Even with having to come out of pocket, my monthly rental profits have now far exceeded the amount i'm having to feed into my deals.

But there's nothing wrong with going slow and steady either. Pick a pace you're comfortable with and stick with it. You'll be surprised at how fast the time goes by and how much income your portfolio is able to start generating.

1 house a year making 200 to 300 a month would not be that big of a burden. In 10 years, thats 10 houses making 2k to 3k a month!

To me, I would definitely not want to spend the time, energy and effort for wholesaling to build enough capital to start building a portfolio. By the time you did, you may find that the cash flow numbers don't work anywhere near as well as they do today. 

Use your equity in your home and keep every deal you find. 

That would be my 2 cents (maybe 3 cents given how long this post was). :-)