Pull equity from a paid off rental?

Question

Hello,

First, a little back story.

I currently have one rental property and I'm looking to expand. The one property that I do have is now owned free and clear. My property is located in Las Vegas and I have a management company hired since I live in the Chicago area. The property value is now 3x what I paid for it. I'm currently saving for a down payment on my second property, but it's taking a while. I'm sure everyone else has noticed that to purchase a sfh that cashflows in this current market environment, approximately 40-50% down would be required. I'm looking to buy another sfh in the Vegas market. My credit score is over 800 and my dti is very low. My only debt is my primary residence.

So here's my question...

Would it be a bad idea to pull equity from my property to purchase one or two more properties? I could pull $200k-$300k out and put $100k-$150k down on each new property, or like $200k on one. It would still leave me cashflowing on my first property and my new one or ones would as well. I'm hesitant because of the interests rates I'm seeing on mortgages and the cash out refi that I would get though. Eventually when rates come down, even if it's years from now, I could refi to a lower rate and have each new property cashflow stronger.

I've always heard that once a property is paid for you just leave it alone. But having that much equity sitting around seems like a waste. Considering the cash out refi payment and new mortgage payments, my actual cashflow would be similar to what I'm receiving now but with the added benefits of principal paydown on multiple properties and the tax benefits each one would bring. Also, I do have enough money set aside to cover repairs on any new property, so the equity pulled out would just be to cover a down payment.

Also, I do have a primary residence with over $200k in equity but I'd rather leave that one alone.

Thank you in advance for any advice. I've been contemplating this for weeks now.

Ryan B. · Answer

@Jonathan Klemm, I have a few reasons why I'm not very interested in investing here in Illinois. I'm not sure if my reasons are based more on a feeling or if they're factual honestly.

- Illinois has had a net loss of residents in the recent years. Vegas has had a net positive which has been helped by people fleeing California.

- Illinois property taxes are really high and Nevada's are really low.

- I came to Illinois from Vegas, so as of now I'm more familiar with the areas of Vegas and not so much with Chicagoland.

- The weather here seems to beat up structures worse. The difference between the lowest temps of winter and the highest temps of summer is much greater in Illinois despite how hot Vegas gets. Vegas has about an 80 degree range and Chicago has like 140 degrees.

- Vegas has almost no basements. No foundations to leaks. Most Vegas homes are on slabs.

- Mostly shingle roofs in Illinois and Vegas is clay tile.

- Vegas homes typically have desert landscaping. Very low to no maintenance.

- I've heard (not sure how true it is) that Illinois laws protect tenants heavily and not the landlords so much.

Those are mosy of my reasons. I would be open to the idea if the right deal came my way, but right now I'm not actively seeking anything in Illinois.

Jonathan Klemm · Answer

Hey @Ryan Bobula - If it were me, I would FOR SURE pull some money out to do the next deal.....that literally is the power of leverage, which in my opinion is one of the biggest reasons to invest in real estate.  I wouldn't worry about interest rates as long as you still have a nice cushion.  As you said, you can just refi again when rates come back down at some point.

One of the most important calculations that most investors don't analyze is ROE = Return on Equity -> which might be the most important metric to ensure you are getting the most out of your property and scaling as quick as possible (if thats your goal).

How come you don't consider buying in Chicago if you live here?

Tons of old properties that need to be rehabbed and price points across the board.  Happy to connect if you decide Chicago might be a good fit.

Eudith Vacio · Answer

Hey @Ryan Bobula - great question!

Most of the clients that I have been working with have been taking out HELOCs on their properties, I know most traditional banks won't lend on a property this is an investment but I do have one lender that will if you're interested in that route. Regardless, pulling out equity might a better option for you, for many reasons aside from a down payment on a home, such as being able to rehab, etc.

Let us know what you decide on!

Jonathan Klemm · Answer

Hey @Ryan Bobula - I actually love and respect all of those reasons.  If I were you, I'd probably invest in Vegas too.

I think the most important thing when investing is the level of comfort.  To be truthfully honest, if I didn't know Chicago so well and have such a good network I am not sure I'd be investing here for some of the exact reasons you pointed out.

Illinois does have high taxes and unfavorable landlord laws.  Those items scare people away which also keeps Chicago a bit less saturated and allows for more opportunity for those who know the market well.

Keep doing your thing in Vegas because it sounds like you have a good thing going!

Greg Scott · Answer

The equity in that rent property provides you a terrible ROI.  Your job as CEO of your family business is to keep your assets producing the maximum long-term returns you can.  If you are buying in areas that cashflow, you should be able to increase your total cashflow and increase your tax deductions by adding leverage.

I 100% disagree that a paid-in-full rental is a good idea. Not only do you reduce your total returns, you add a lot of risk. You become a lawsuit target, and a target for criminal fraud.

Ryan B. · Answer

@Lawrence Potts I'm not completely risk adverse. I'm comfortable taking calculated risks. That typically leads to over analyzing though.

The immediate Real Estate goal is to build cashflow and replace my W-2 income.

I worked hard to pay the property off. I started making more money from my W-2 and didn't know what to do with it all, so I kept paying it towards the principal each month.

So yes, I'm kind of proud to have paid it off, but I do realize the opportunity cost of leaving the equity in the property.

Thank you!

Lawrence Potts · Answer

Depends on your level of risk and what you are wanting to accomplish with Real Estate. Not a lot of people can say they have a paid off rental. I would suggest speaking with your team (CPA, lenders, attorneys). Your CPA is going to know if you have completed your depreciation schedule. If you have, that's going to impact your taxable income. That would make sense for you to sell and do a 1031 exchange. Your lender is going to tell you what your payments will look like if you accessed your equity (selling, HELOC, refinance, etc.) so you can calculate your ROI, ROE, CoC, etc. And your attorney is going to tell you what liability you put yourself in if you decide to do either decisions.If you decide to keep no debt, you do put yourself at risk for a lawsuit. Prosecutors will see your free and clear rental. Carry debt on it to prevent a savy prosecutors from stealing your networth. They look at these things when representing their client that is suing you to maximize how much they think they can get.It seems you've done a lot of research and you may already know the answer to what you should be doing. You need to run the numbers with current interest rates (if that's what is holding you back) and figure out how much you can make from your equity. If you can't figure that out, you'll never make a decision. You need to see the numbers.@Grant Schroeder has a great 10% down no PMI mortgage product for investment properties, give him a call if you are considering lenders. He's helped quite a few investors in NV. Hope that helps!

John Clark · Answer

So the first question to ask is: "On what basis could I be sued?"

Basit Siddiqi · Answer

What is the interest rate that you would pay on the refinance?What is the rate of return that you would get with your future investments?If the answer to the second question is higher than the first, the answer is move forward.

Dan Gandee · Answer

I leverage to rinse & repeat. If the bank is going to provide the means to acquire, reposition or refinance for more cashflow, then why are you parking equity in an asset that isn't going to provide you a multiplier effect on income. If you are scared of being upside down, then leave 20% in every property you have as long as you cash flow more than $300 per door per month. That's my rule.

Pull equity from a paid off rental?

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