Should I go all in with my cash, HELOC, and investor?

Question

I have two properties in Louisiana, but I've just relocated back to my home state of Virginia.  I really want to build up a rental portfolio, and I've got about $50K cash, should have a HELOC for ~$80K soon, and also a cash investor who I'm testing the water with.  There are a decent amount of distressed properties on Zillow for $50-80K here, which I'm thinking about getting into.  Should I just go all in and make a cash purchase, rehab with all my resources, and refi?  Or is there a smarter way to do this?

Adam Gollatz · Answer

There are several schools of thought on that and I'll give the most generic answer possible, sorry,  It really depends on how you leverage. I haven't invested in real estate through a major downturn but from talking to people who have, this is what I picked up.

Be careful relying on leverage (or money you cant afford) to complete a project. If you are developing or rehabbing an unlivable rental, you run the risk of losing your money to complete the project and holding a major liability while you wait for prices to rebound so you can do cash out refi's/helocs, etc to complete the project.

Be mindful of your renter pool and what would happen if the job market took a big hit. For instance, is your renter pool dependent on one industry or company? Is your rental priced at the highest end of the rental market? If you are renting high end condos or mansions and the economy tanks, your renter pool might move into more modest housing, leaving you with much higher vacancy that you cant afford. People will always need a place to live, its just where they can afford to live is the question.

As for the mortgage with yourself, below is what I was referring to. Its designed to help you get around some of the LTV limits and waiting (seasoning) requirements. Its important to know that at the investor level banks offer their own products and terms can vary. Ive had some that say they need 12 months and will only do 65% LTV and others that will do 75% and 3 months seasoning. Its best to talk to a lender ahead of time and let them know what you want to do and they can help guide you. Let me know if you still have questions.

HOW TO CASH OUT ON 1-4 UNITSReceiving a cash out loan on an investment property can be a very confusing item. This post is designed to bring some clarity to taking cash out of a property with a conventional loan and help you navigate the sometimes-challenging cash out rules for properties. Admittedly, this post will probably be for the mid-level to expert level investor. There could be some important items in here if you are just starting out but it might get confusing in a hurry. If you have any questions, then please reach out. Lots of people on this forum can answer questions and many are very helpful individuals.

We will cover:1. The conventional rules for a cash out loan2. Buying a home with cash3. How to properly structure buying a property with cash

1. The Conventional Rules For a Cash Out LoanFannie Mae and Freddie Mac are the Government Agencies that sponsor conventional lending. Most banks will have these loans as an option. There are other loan types as well but for brevity we will limit this post to the “Conventional” lending (Fannie/Freddie).• Conventional Loans limit your cash out on an investment property to 75% of the “After Repair Value” on a Single-Family home (70% on a 2-4 unit home). This is also the same percentage that you need for a non-cash out refinance (more on why that is important later).• If you purchased the investment property with a loan, then conventional loans will require you to wait 6 month to take cash out.o This rule does not apply if you purchased the home with CASH (more on that in section 2).Let’s explore some examples here:• If you purchased a property with a 15% down conventional loan (85% loan to value) and you wanted to get cash out, you wouldn’t be able to do so since the cash out limit is 75% of the “Loan to Value”. The MAXIMUM cash out you can receive is 75% of the value of the property.• If you purchased a property with a loan, but did the rehab on with your own cash, then you would need to wait 6 months to get that cash back. Keep in mind you could only receive 75% back of the After Repair Value.o So if you bought a home with a loan of $50k, it required $30k in renovations, and it appraised for $100k after the repair work was complete then…. You would refinance the $50k loan, receive back $25k in cash…since $75k would be 75% of the After Repair Value.

2. Buying a home with CashBuying a home with cash has become increasingly popular for many investors but often an investor will be caught with the restrictions to cash out loans if they need to get their money back. There is a plan to avoid this entire section (In section 3) but it is important for us to know about these restrictions. If an investor is buying with cash and flipping they get their money back when they sell the property. But if they are seeking to hold a property for any length of time and want their cash investment back there are some important rules to understand with conventional loan:• If you buy a property with cash (or with a HELOC) you can receive a cash out loan on Day 1.o There is not a 6 month waiting period with receiving a cash out loan if you purchased a home with cash or with a HELOCo BUT you will be limited to the amount of…. Your purchase price + closing costs (costs when you purchased the home) OR 75% of the “After Repair Value”…WHICHEVER IS THE LOWER AMOUNT (super important)These rules are important to understand so here are two examples:• Example 1: If you purchased a home with $50k of cash, and put $30k of renovations into the loan, and the home was worth $100k. 75% is $75k and $50k is your purchase price. So you could only receive $50k in your first 6 months of ownership since the LOWER amount is your purchase price. After 6 months you could receive the full 75% of the ARV.• Example 2: If you purchased a home with $80k of cash, put $5k into the home, and the home was worth $100k. 75% would be $75k and your purchase price is $80k…so the lower amount is $75k.When buying a home with cash you can absolutely get cash back right away but you will be limited to the lower of those two amounts.

3. HOW TO PROPERLY STRUCTURE BUYING A HOME WITH CASHWith these rules, you can see how it can be confusing to get conventional lending when buying a home with cash but there is absolutely a proper method to structuring your deals when buying cash. Here’s the secret:• Create an LLC and have the LLC lend you a mortgage on the property you are receiving.The reason why this works is because instead of you needing cash or receiving a cash out loan, we are now refinancing a loan – your loan. There no reason to wait any time or have any “whichever is lower” rule come into play. We are just refinancing a loan.Here’s how it works:• You create an LLC• You buy a home• Your LLC gives you a loan for the home• You file the deed for that loan at the county courthouse• You use the money from the LLC to buy and fix up the property• Once the property is completed, your conventional lender comes to refinance the loan• Your conventional lender runs title and sees there is a loan.• Your conventional lender refinances you into a new loan, and cuts a check to your LLCâ�¦a check in the amount of 75% of the value.Please don't confuse this 75% with a "cash out" amount. The non-cash out LTV on a refinance is also 75%. We are refinancing a mortgage. Your LLC's mortgage. Essentially your LLC has become the bank/hard money lender/etc. However you want to think about it. You get to set the interest rate (it can be 0%) and you get your investment amount back sooner.Some things to think of:• To file a deed at the county courthouse is $100-$150 in cost (depending on which county)• And you want that note to be pretty close to 70% of the ARV for the property if you don't want to bring any money to closing. 70% will allow you to roll in your closing costs. If you want it to be at 75% just keep in mind you would need to bring your closing costs out of your pocket to complete the refinance.

The above information is designed for the "conforming, conventional" loan types that face this 6 month cash out restriction. There is an entirely different loan type that I will call "portfolio" (sometimes referred to as commercial loans) that may not have any restrictions. "Portfolio" loans come from the bank's own portfolio of money...thus the name. So the bank may not have a 6 month requirement but they also may have MORE of a requirement. Since each portfolio loan is governed by the bank itself you would literally have to call every bank out there to find out all the different portfolio loan options. However, most will not lend on such a small loan amount that you have. Most banks won't lend conventional money that amount either...but some will. Seek out a bank that would lend that small on a conventional loan and then perform step 3 above.

Anthony Arredondo · Answer

Thanks Adam.  I know people don't like questions like this, but do you think it's wise to leverage so hard before potential rate hikes and a possible market correction?

Also, what do you mean by mortgaging with yourself?  I had planned on paying cash then doing a cash out refi once the rehab is done, but is there an extra step I am leaving out?

Adam Gollatz · Answer

Personally Im a fan of leverage. But if you are only looking to do one deal at a time and you are comfortable investing it all, using your own cash is the way to go to maximize profits. Depending on the market and what your target ARV is, you might want to look into rolling the cost of the purchase, rehab, and carrying costs into a mortgage with yourself so you can do the delayed financing when you refinance.