Funding RE investments with home equity

[Michael Willis]

Long time lurker here who doesn't post often. I live in the Bay Area with a lot of equity tied up in our home. As many already know, Bay Area prices are crazy high. I am wondering if it is unwise to fund a RE investment with an equity line from my primarily residence? Any things to consider and watch out for?

[J. Martin]

Originally posted by @Arlen Chou:

@Michael Willis it is a great way to go if you are disciplined enough to keep your spending under control. If you go crazy, you can ruin your life, so be careful. I have purchased 11 doors in Oakland using a HELOC off of my primary residence and will continue to use this strategy into the near future.

 Michael, 
My buddy Arlen is right. It's a dual-edged sword. 
Many people in the Bay Area use HELOC's on their primary residence. But many also have the cushion to do so.
And finding the right investment is key. It's an arbitrage between low borrowing costs and your investment yield/risk. 

#1) TALK TO YOUR WIFE/PARTNER/CO-OWNER ABOUT IT! What does she think? Is she comfortable with that debt hanging over the family house? Discussed it already? 

Besides that, keep in mind most HELOCS are 10 years interest only, then a full amortization on 15 years. So know the payment at the 10yr period when you switch from I/O to the heavy amortization. (And what kind of interest rate change can you afford?) 2017 is still a rough year for a lot of the people that got big HELOC's back in 2007. Don't wait until you get there to burn that bridge, and I generally don't recommend on being able to always refinance later, because banks change their standards over economic cycles (unless you're pretty golden on LTV, credit, & DTI/DSCR ratios, you're safer.) Not to say next time will be anything like last time, but just a general thing to think about. (and as @Account Closed likes to say, history doesn't repeat, but it rhymes.)

Also, I think Brandon Turner or Josh had some wise words on a podcast by saying something like
"Just because the money is available, doesn't mean you should take it." Some lenders are offering something like 90% LTV HELOCs on jumbo loans in the SF Bay. If prices or rents dropped from this seemingly cyclical peak, how would that impact you? How would you refi? Or are you good either way? Not trying to discourage you by any means. Just to look at both sides of the sword ;)

About 4 years ago, back when there were more deals around, I wrote my only blog post on BP, called:

"If cash is king, then leverage is God" 
- this was based on the quote I heard from @Johnson H. even earlier, if I remember correctly. 
Those were the haydays. 
Like Arlen is saying, it's a dual-edged sword. The lord giveth, and the lord taketh away. 

Here are a few questions I asked myself about leverage during that time.. 

"The risk of leverage also changes over the economic cycle.. Having heavy debt loads going into economic downturns can produce disastrous results, while leverage with increasing prices magnifies gains dramatically. As an investor with fairly high leverage right now, I take several factors into consideration to assess the risk of this leverage, and get a level of comfort with what the risk mitigants I have in place:

- How much excess cash flow do I have to cover vacancies, potential decreases in rents, to catch up re-filling reserves, etc..

- How secure are my cash flows? How much comes from a salary job and how stable is that job/salary? How high-quality are my tenants? And my rents relative to market?

- How much liquidity do I have? And how fast can I replenish it?

- How much access to credit do I have? How fast can I get it if I need it? Can it be cut off at the lender’s choice? Will the rate change? How fast do I have to pay it back?

- What do I have coming due? Balloon payments on loans? Interest rate resets in the next year or two? Am I relying on price appreciation to be able to finance or refinance future debt or principally payments?

- Can I sleep well at night with the debt that I have?

- When should I reduce my leverage and/or sell? How should the price of real estate, yield/ROE of assets, or the economic cycle play into that decision?"

You don't need to answer any of this to us on the forums, but just some things to think about w/ leverage/HELOC, since you asked, and the same things I was thinking about years ago, with the expectation that we would be in a different place today.. (and we are!)