Cash Out Refi To Buy 2nd Investment Property: Risky or Smart?

Question

I've posted my situation in another post, but I'm looking for more of a theoretical / applied answer to this question:

Why / When does it make sense to do a cash out refi to buy another investment property? I don't fully understand how the power of that leverage (borrowing money to borrow more money) makes financial sense.

In my situation, I can take $300K of equity out of a rental and still cash flow each month with a little buffer. But if I'm paying say, 5% for that 300K, and then use it to borrow, say another 600K for a multi family at 5% what do I need to make on my new investment to make it worth it?

I've read posts where people say "that's the power of leverage" but to me it seems risky, adding debt to debt.

I'd love an explanation as to why this strategy makes sense, or doesn't.

Thanks in advance.

Brian G. · Answer

@Aaron S. it only makes sense when you can acquire another property, safely service your total debt (after refi & new acquisition), have adequate reserves (ie to protect your investments) and increase your total combined profitability. Ideally, each acquisition can stand on it's own (ie pay for itself) and after each acquisition your total aggregate income (ie cash-flow) increases. Alternatively, you could consider getting a Heloc on your property and use that to purchase a distressed or value add deal (ie to Flip or Brrrr). If you do this successfully you can pay off the Heloc upon the sale of a flip or a refinance of the Brrrr property. This allows you to utilize your equity and recycle your Heloc funds over and over. The challenge here is this requires finding/buying great deals which admittedly at this time is difficult. Search "BRRRR" if this is a new concept and you will find a ton of content.

Aaron S. · Answer

Thanks, @Brian GerlachTo answer your question, I'm definitely not an experience REI, however, I've been doing my homework, reading, taking classes, and I have a couple friends who run large MF syndicates ( hundreds of millions of dollars in assets), so I am getting good advice and mentorship. That said, this would be my first MF deal. The issue / question I have with your suggestion of buying multiples in that on a 1031, I can only identify 3 properties (or the 200% rule), but in my market (Denver metro), unless I am doing fix and flips, I'm not going to get multiple safe investments that I know I'll close on, for that money. That said, I'm not going to go into any experimental areas. In fact, I'll probably under leverage and take a lower cap rate (5-6%) just to give me some buffer and safety for my first deal. Even then, cash flow is way better than my current 800K in equity is getting me. But again, that's where I hesitate...the San Francisco rental has had crazy appreciation. Part of me wants to keep it, leverage some of that equity and then maybe do an exchange on it down the road. At this point the San Francisco property is an appreciation hold (already more than doubled), not a cash flow property. Let me know if that changes anything for you:) Thanks, Aaron

Brian G. · Answer

@Aaron S. this is a highly personal question. I think it depends on your education/experience level, risk tolerance, personal goals (ie cash-flow vs appreciation), etc. If you have the education, know what you are doing and are fine selling and using a 1031 exchange and rolling into a bigger property then go for it. However, if you decide to do that, you may want to buy multiple properties so you are not putting all your eggs in one basket. In other words, if you take your equity and buy a bad deal it could wipe you out. On the other hand if you had a portfolio of 5-10 cash-flowing properties as a foundation, you could take 1 or more of those properties and roll into a larger property without taking as much risk, make sense? Anyhow, I don't know where you are at in your investing IQ, etc and therefore I can't give you a straight answer. Personally, I'm interested in larger properties but I would have a hard time rolling all my existing equity into one deal. Perhaps in the future I will have a different confidence level once I'm further down the road. The greater your knowledge and experience and team you have around you, the lower your risk will be because you are less likely to purchase a non-performing property. By all means, if you have the education and the right team around you, purchase the deal that is going to give you the best IRR over the next 5-10 years.

Aaron S. · Answer

Thanks @Brian@Brian Gerlach, So assuming all that is true...that I can cash out 300K, keep the same cash flow, and then buy another investment that also cash flows....at what point do I know if it's better to do that vs. sell current property and put in in something bigger (6-10 units, etc). Is it generally considered better to consolidate vs build a portfolio? I realize the most obvious answer is 'depends on the deal', but I'm asking more from a theoretical perspective. I'm guessing if I can use 300K to buy a $900K-1MM 4 or 5 door building at 6% CAP, I could probably cash flow pretty nicely and have a couple properties under my belt.