What should I do with the Equity in my Rental property?

Question

I purchased and rehabbed a 4 plex in Beaverton OR in June of 2014 and now I'm unsure as to what my next steps should be. I have approximately $350k or so of equity in the property from the BPO that my agent provided me. I'm having a hard time deciding whether I should try to do a 1031 exchange, cashout refi, find a lender willing to give me a HELOC on it (non-owner occcupied) or to just leave the equity there and save up another down payment for my next property on my own. I'll provide some details on the property below, my goals and current situation. I would appreciate any feedback that you're willing to provide!

My goal with real estate is to build up a decent sized portfolio that can cash flow $5k a month or so. Doing this will be pretty difficult in the Portland, OR / Beaverton, OR market due to the pricing here at this time. To grow, I am willing to consider markets outside of Portland and would consider selling my 4plex if I could go bigger in another market that cash flows well and is relatively safe (good economics, safe neighborhoods, etc).

I currently have a job that I plan on staying at for the foreseeable future that provides a good income. If I don't do a 1031 exchange, refi or borrow from the equity on the property it would take 6-8 months to make my next acquisition of a 2-4 unit building in my market. If I look elsewhere I could most likely do it faster which is appealing.

The 4plex is my only rental property currently and I own the home that I live in which has a mortgage on it.

Here are the current details on the building:

• 4.25% @ 30 year fixed. 39 months into the 30 year mortgage. Current balance is around $398k.
• Broker price opinion of the value is $750-775k
• Net Cash flow monthly after all expenses is $1350 (Self Managed)
• Building is in good shape, repair costs will be low for the foreseeable future due to the renovations I've already completed.
• Proceeds if sold would be around $320k-$330k after all fees/commissions

Fellow investors, what would you do in this situation? What am I missing or not thinking about? Any feedback, help or advice would be much appreciated!

Erik

Steve Vaughan · Answer

I would probably cash-out refi a quad. Appraisal shouldn't be crazy expensive, maybe $1200-$1500. You won't be able to beat the terms you have though.

If you capture that equity (70-75% of value), then you can shop. Worst-case, you find nothing and pay about $5k in closing costs for a higher rate loan. Maybe ID a market and some prospects first.

I would not sell a performing quad in your market just to capture equity unless value is approaching rebuild cost? That's my marker to grab a chair. Is $775 insured value also? I have a few 7 and 10 plexes that are getting close to what I never thought would happen. Sell on purpose, not just to get to equity.

Michele B. · Answer

Just FYI it is not a HELOC if you don't live there it is a cash out refinance. Or just a business line of credit. another idea is rinse and repeat. Sell this property and get another one that is bigger, more income coming in. I say you have time and that is what is important, wait till you find a deal that you want in a 5-10 unit in your area. TAhen put it under contract and put yours up. Make sure you write a contingency on the one you put under contract that is subject to you selling what you already have.

Dave Foster · Answer

@Erik Bood like @Steve Vaughan said you're going to have a tough time beating your current loan. If your next move is into a larger asset you'll most likely be moving into commercial money and a little steeper terms. A profitable smaller unit with excellent conforming debt as a complimentary asset would not be a bad thing to have even though it might slow you down a bit.

Or on the other hand you could try to keep as much debt on that property as you can to minimize the leverage on the commercial loan. Depending on your balance sheet it might be better to do that later to recapture as much equity appreciation as possible before buying the larger asset.

Either way, no need to sell right now.

Erik Bood · Answer

Thanks for the thoughtful reply Steve Vaughan. I think you bring up some good points and I'm strongly considering holding on to the property and either doing a cash out refi or looking for some sort of HELOC. I'm also just considering leaving the property as is since the loan is pretty good and using a small HELOC on my personal home to gather up the cash for my next deal.

I'm not a builder but I believe $775k is still under the rebuild cost. I don't remember what the insured value is, I'm going to verify that today.

I plan on never selling properties unless I'm immediately re-investing the money into another deal.

My goal was to try to pick up a 5-10 unit building in the near future but that'll be a bit difficult for me in my current area due to the pricing. I'm working on optimizing my cash position so anything is possible in the next 2-3 years if I wait.

Erik Bood · Answer

@Thomas S. at 100% financing it would have a negative cash flow and would not be an investment that I would hold. I'm going to start looking at deals in other markets and see if I can find cash flow like you're describing. Some of the top cash flowing markets make nervous due to the economic situations and the net loss or flat population growth. I've started creating a list of my target markets where I could 1031 to OR where I could purchase in while keeping my existing property.

If I could find that type of cash flow in the NW I would jump at that opportunity if I felt comfortable with the market and its future prospectus.

Thomas S. · Answer

"My goal with real estate is to build up a decent sized portfolio"

In order to grow efficiently you can not afford to leave dead equity in a income property. Your $350K of equity is presently earning a return of 4.25%. This is your prevailing mortgage interest rate and a very low by most investors standards. It is not considered a worthwhile return on investment.

If the opportunity value was to be 10% your $350K would be earning $2900/month.

My guess would be that without your equity buying your cash flow on this property it would have negative cash flow and not be a worthwhile income investment property. I would probably sell as opposed to pulling out the equity if that were the case.

Do your numbers based on 100% financing and you will see if this is a good investment or not. If it still produces good positive cash flow with a hypothetical 100% financing it is worth keeping and pulling out your equity otherwise you are artificially supporting a lame duck with your own cash. In that case it would be best to sell before the markets sink.

Erik Bood · Answer

@Dave Foster thanks for the feedback. I certainly feel like keeping the 4plex might slow me down on acquiring larger commercial properties. I normally move pretty fast and aggressively go after my goals, so the buying and holding a property long term is a bit of a struggle. Especially when I'm trying to grow my cash flow and unit count aggressively.

At this point I'll mainly consider the options that allow me to keep the property unless an amazing opportunity comes up that allows me to 1031 to great deal.

Steve Vaughan · Answer

Makes sense. Just check your structure replacement value on your insurance policy. One of my 7 families was insured for $800k when I bought in '05 for $345. A 10 unit mixed-use for $1M when I bought for $260 in '03. You can see why I was like- if rebuild and market value ever get to be the same.... find a chair!

The idea of a Heloc for shopping makes the most financial sense. We recently put a just in case an opportunity comes up Heloc on our house. Lowest cost credit available. I think we were all in for less than $300 to establish it. The bank just did a desk top appraisal. I think the annual maintenance fee is $100.

You can refi the quad if you find a juicy larger asset that's just too good to pass up!

What should I do with the Equity in my Rental property?

What should I do with the Equity in my Rental property?

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