Entrance stradegy and what rate to accumulate?

Question

Hello all, I've been reading archived posts here for a while and decided to join.  This is my first post (on any forum ever).

Quick background:
I am 27, married, no kids yet.  I work in commercial construction and have a bachelors in mechanical engineering and my wife is a financial analyst and going for masters.  We bought our first house & primary residence about 18 months ago as a bank owned forclosure (animal piss scent, a few other problems, etc...).  I probably drove by 80 houses and looked in 40 before buying as I am extremely thorough and needed an undervalued structure to add the 20k for materials into the rehab loan.  I have done the roof, ceramic, hardwoods, major structural repair to foundation, built deck, removed partitions, added beams, redone the yard & landscaping, installed furnace...you name it.  I have about $100,000 in equity currently as I have done all this on my own, or through my close network of people (have access to masons, landscapers, etc with heavy equipment).

I need to reinvest this equity and have had the ultimate goal of owning rentals for several years now.  I plan on getting a 2-4 unit rental with a mortgage for 80% of the purchase price to avoid PMI and doing 20% off a home equity lone of credit.  As I begin to become secure in this buildings cost flow, I would like to leverage for another (depending on accrued equity at the time.)

My question is this:
How fast can I purchase houses using this method?  I know using equity to buy rentals is risky, but then couldn't I reign in debt down the road, once I have several established properties, by paying off one at a time and using the increased revenue to pay towards the next, etc?  It seems to me that in order to acrue wealth in cash, that I need to temporarily focus on growth using debt, since I am not currently rich.  Any advice or words of wisdom?  Thanks for the read, sorry for the long post - I have so many questions.

Jon Holdman · Answer

Sorry, but your plan is a little out of date.  A few years ago, this would have worked.  Today, its more limited.

If you have $100K equity in your house, you can probably get a HELOC to take some of that out.  Most likely you're going to be limited to about 90% LTV max total for all your loans on that property, maybe less.

You don't have to worry about PMI on the rentals because you'll never find a loan at higher than 80%.  More likely you'll be limited to 75% for the first three and 70% after that.  Getting the loan on the fourth rental property may be a challenge.  You need to work on developing a relationship with a smaller bank that does investment real estate loans.

HELOCs no long exist on investment property.  So, don't plan on being able to buy one rental with a 75% LTV loan and then take a HELOC to get some of that last 25% back.  What might work is to refinance.  If you buy cheap junkers and fix them up, you may be able to refi based on a new value.  You'll have to wait at least six months and probably a year to do that.

Be very conservative with your estimates of new values, both for the rentals and your own home.  Five years ago an appraiser would choose the highest comps.  These days its all you can do to avoid them choosing the lowest comps.

You will have to have income to support the loans.  It will have to show up on W2's or tax returns.  The rental income may or may not be able to be counted.  Fannie Mae guidelines require it be on two tax returns before it can be counted.  Some lender seem more lenient.  Again, develop that relationship and find out what your lender will actually do.

Read in the Rental Property forum about the reality of rental properties.   One of the big lies told new investors is "cash flow = rent - PITI payment".  A better estimate is "cash flow = (rent * 0.5) - P&I payment".  A bank will estimate net rental income as "net rental income = (rent * 0.75) - PITI".  If you try to buy a bunch of properties using the "rent - PITI" forumla, its only a matter of time before you hit one of the irregular but totally expected major hiccups (e.g., major tenant damage, lengthy eviction) and end up in a very tough spot.

Fannie Mae guidelines also require cash reserves.  For the first three loans they will want to see two months PITI (and anything else, like an HOA payment) for each of your existing properties and six months for the new one.  For the fifth through tenth, their guidelines require six months for all properties.  You can include a portion (60%?) of IRA and 401k money toward these reserves requirements.

John A · Answer

Jon, thanks for reply.  This information gives me alot to think about.  I really appreciate it.

I guess talking to lenders is the next step, along with adjusting my current model to be a little more conservative.  I was figuring something like the banks figure (0.75 x net income - PITI = cash flow)  using 50% means I would need a smaller mortgage for it to be financially self sustaining.

Maybe I should look into doing a couple rehabs initially that I would sell outright to grow some capital and continue on in a smiliar plan as above, but borrowing less.

PS - I should mention that I am in western NY where the real estate market has minimal fluxuation in either direction historically.