Cash out or hold equity?

Question

I recently completed the purchase of my 3rd sfh rental. As of now I have a total of 4 properties including my primary. I figure I have somewhere in the neighborhood of 1-1.2M in equity overall (300k equity in my primary and the rest in my rentals). If I do a cash out it'll obviously decrease the monthly cash flow which is really good at the moment. I've thought of a heloc but with the current market in Seattle as hot as it is, there hasn't been many attractive deals. I've always been pretty debt adverse, and like the idea of decreasing my mortgages even further, and waiting for a better time to jump in again.  Any thoughts?

Patrick Britton · Answer

@Mark Kao Firstly, congrats on your success thus far.

I would be cautious about "waiting for a better time to jump in."  A few people told me last summer that they were waiting for a better time and this cost them no less than $125,000.

In terms of paying off mortgage vs. getting more properties, I would make the argument that the only time you should pay off a mortgage would be when you interest rates are greater than your expected return on investment.  Thinking of an extreme case, if interest rates were 20%, i am certain you'd prefer to pay that off ASAP.  Whereas if rates were 0%, then why pay it off ever?  Clear as mudd?

Also, how would cashing out or not purchasing another property fit with you long term financing goals?  Do you really need the cashflow right now?  Are you in equity building mode still?

Here's a true and funny story.  Years ago when i was a financial advisor in Canada one of my younger clients owned about 11 properties.  He started when he was 19 in 2002 and kept acquiring more as he could.  In 2007 he cashed out, sold everything inside of 3 months and i saw his checking account, and down payment on his new Ferrari F430.  :)

With 2 million in his bank he decides to buy a restaurant.  Long story short, he sold his Ferrari a year later for a huge discount.

Point is that he stopped doing what he was good at.

It's entirely up to your risk tolerance, but might as well continue to enjoy the ride while everything is going well.

Dave Foster · Answer

@Mark Kao, unfortunately  you have to choose a lane.  The velocity and returns of flipping or the tax deferral of exchanges of buy and hold real estate.  Real estate intended primarily for resale does not qualify for 1031 exchanges.  The pure flipper relies on volume and velocity of money to offset the much larger tax bills.

Nghi Le · Answer

I'm also a proponent of taking out the money and doing something with it, especially with the low interest rates.

You can either refinance and buy properties, but you'll probably have to get out of King County (and maybe to a different state) to get cash flows.

Another thing you can do is take out HELOCs to do short-term private lending or JV with flippers.  It's much less stressful than having to deal with toilets and tenants, but you don't get appreciation.  But it can be great for cash flow.

Matt Turbitt · Answer

what are your short and long term real estate goals?

Sam LLoyd · Answer

With current rates, I'd say pulling money out is a good idea.  Historically the cost of money has been much higher, and getting money to play with for 30 years barely above inflation seams like a good idea.  This is something I've been doing... cash-out refi on two properties gave me a downpayment on a 4plex that allowed me to borrow several hundred more at the good rates.

Tricky part is assigning that debt to something worth while.  I know one person who took out a HELOC to reinvest, and ended up buying some big toys, paying for travel and other things, and now the house is underwater with no income to show for it.  So.... as long as the income from future investments covers the cost of the new cash.... and as long as you have enough of an income margin to handle any market corrections.... I'd say go for it.

Note: It's probably less stressful to go the other route and pay things down as you move forward... so if that's important to you, go with that... some things are hard to value.

Corby Goade · Answer

I was/am in the same boat. I went with a HELOC to give me flexibility to jump when I wanted without having to pay interest while I was shopping. The upside to the cash out is that you have cash (obv) and can sometimes get a little higher LTV, and are locked into a rate,  but you are paying interest from the day you close. With the HELOC, you have the cash available, but aren't paying for it until you use it. You can cash out your investment property after you buy it and get into a locked rate. Of course, you are then taking the risk that rates might go up. There's pros and cons to each, just have to decide what works best for your risk tolerance. Good luck!

Jonathan McKay · Answer

@Mark Kao - I would ask myself what sort of risk you are trying to diversify away from?

The obvious tradeoff of a cash out refinance is that you are increasing your leverage. Assuming that you applied all of the money gained from the refinance back into real-estate, it's probably safe to assume that you would increase your expected returns, and increase your exposure to a drop real estate prices. Whether or not that's worth it depends on your goals and the specifics of the deals you enter into.

Another less obvious tradeoff is income diversification. If your properties are in the Seattle market, most of the increase in value has come from appreciation, and relative cash flows/cap rates are pretty low now. Sounds like you're already on this path, but refinancing and investing in a more cash flow heavy market might make you a little less dependant on real estate prices for long term income.

George Despotopoulos · Answer

@Mark Kao. Congrats on your success thus far. There are a number of private lenders that will give you a longer term loan on your rental properties. If you obtain a loan with a 60-65% LTV, it gives you the ability to continue building your portfolio and will actually increase your monthly cash flow because you will be able to buy more properties. I have always been a big fan of "healthy leverage" which is what you should be thinking about as you continue to buy more properties.

Good Luck and happy to help with any other questions.

Peter Vekselman · Answer

@Mark Kao what you are doing is obviously working.  I have learned that you never want to stop things that are working.

Remember, there are always deals out there.  With the kind of money you could potentially pull out I would recommend putting some of it into marketing for off-market deals.

Don't over leverage yourself.  You may even consider another type of income stream other then just rentals.

But you seem to be on track.  Figure out a way to move forward, not a reason to stop....

Mark Kao · Answer

I think I'm fairly risk adverse, if I look at just equity I've added about 300k in "net worth" in about 13 months. I like the flexibility of free cash for either more property or stocks

Cash out or hold equity?

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