What would you do if you were in my shoes? Guidance needed!

Question

Good afternoon,

I currently manage a small three-member LLC with my parents. My parents have provided 95% of the capital funding up to this point and have let me roll with things in terms of making executive decisions on purchasing as well as the general direction of the business. They currently own rental properties in the UK and as both have full-time jobs, our collaborative LLC is my 'baby'. I'm looking to turbo-charge business over the next 5 years with an aim of doubling revenue by this time next year.

As things stand, our company owns two rental properties free and clear in Philadelphia, PA. Current valuation of the properties is ~$700k with about $130k appreciation over the past 2 years. Both properties are tenant-occupied with a combined monthly rental income of $3500. Expenses come out to ~$1000/month with net profit at ~$2500/month. I currently serve as property manager and have learned a lot in the past 2 years both in terms of business management and property management. I aim to continue in this role for the foreseeable future as my current full-time job allows me to do so.

I would like to start pulling the equity out of these properties to fund other purchases. What would be the best way for me to tap that equity? I've noticed that the local market has started to soften over the past few months and I would like to gear up in time for our next purchase. I understand the basics of economic metrics when it comes to evaluating suitable purchases but would love to learn more about how other's assess their purchases or potential purchases. I'm open to all potential avenues - buy and holds, fixer-uppers, tenant-occupied purchases etc.

So - what would you do in my situation?

Jonathan Dempsey · Answer

Hi @Andrew Burt, congratulations to you and your family so far.  Sounds like you are in a great position.  $3500 in rental revenue from $700,000 worth of property does not sound optimal.  If you are looking to turbo charge the business as you say, it would be optimal to sell these properties, retain the capital, and position yourself into more lucrative holdings.  How you move forward will depend on your stomach for leverage.  Even with no leverage you could find yourself in position to net more than $2500 a month on $700,000 invested.

Anatole Doak · Answer

Hey Andrew - in terms of pulling equity out of the properties, you could do a cash out refinance or look at a home equity line of credit.  I'm not a lender so I don't know specific terms, but if you call around to local banks you should be able to pull out at least 75% of your equity with a cash out refinance.  Just be sure that your mortgage would be covered by your rentals.  Quick back of the envelope math doesn't sound like 3500 in total rental income minus 1k in expenses would cover 525k in a mortgage (est. 2,800 a month or so).

Agree with Jonathan above that the with 700k in property you could spin off much more than 3500 in rental revenue.  But again, depends on taste for leverage, how important cash flow is to you, stomach for dealing with difficult tenants, if you're going for more of an appreciation play, etc.

Joseph ODonovan · Answer

@Andrew Burt The cash out refi that @Anatole Doak suggested is basically a first mortgage on the properties since your LLC owns them free n clear. This is definitely an option to extract cash out of the asset in order to leverage into another asset(s). A LOC is always an option as well.  Interest rates are relatively low so your borrowing costs would be favorable. I can PM you my mortgage broker who is based in Philly if you interested. Best of luck!

Andrew Burt · Answer

Thanks Anatole, some good things to consider. Just to be clear, neither property is secured by a mortgage so a cash-out refi isn't an option. I should have been more specific there. As such, that's why I'm interested in getting that $700k in equity to work for me.

I'm assuming I should be looking at things like portfolio or asset loans (or even a commercial LOC) using the equity in the properties as collateral. There is some cash on hand (~$75k) to function as a downpayment on the next purchase.

I'm not averse to taking risks and I'd be happy using leverage in order to expand. I've dealt with a few bad tenants before but I'm generally happier with paying a slight premium to get in above the ground floor when it comes to properties and potential tenants.

Andrew Burt · Answer

Thanks for your reply, Jonathan. As you say, it's not optimal. The initial purchase prices were ~$575k (including closing costs etc.) combined and have taken some time to get up to scratch. Both properties are rented at slightly under market rates. If I didn't sell, I'd be looking to increase rents 10% on both properties when leases come up for renewal.

I would be happy to sell one of the properties (or 1031 it at least) and use the proceeds. The other property sits on the edge of valuable land that is being developed and I'd prefer not to miss out on what I anticipate to be healthy development in that particular neighborhood. I bought that property under market value and assumed some instant equity at the closing table. I'm treating it as my buy and hold.

What are your thoughts on pulling equity out of properties as opposed to selling? I don't really know too much about the pros and cons, let alone the process.

What would you do if you were in my shoes? Guidance needed!

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