Should I cash out refinance or keep the cash flow?

Question

Sitting on 750K cash (well in the bank). 850K in equity there abouts with the hand full of rentals I own here. I moved back into one of my rentals almost 2 years ago and am considering taking out 150K equity before moving and renting back out and eventually 1031 exchanging.

I might do the same with another rental I may move back into (both of these were originally primary residences). That would give me another 150K, so if I do this with both of these I'll get another 300K in cash for a total of just over 1 mil in cash ready for investing opportunities in another crash.

OR...

I can keep the cash flow of the houses...the one I'm living in now will cash flow 1K a MONTH after all expenses and reserve funds set aside for cap ex, vacancy, etc.

The other one is about $500 a month currently. Both of them have enough cash flow that they show a profit on my taxes. If I cash out refinance while living in them, I'll tap that equity and it will show a loss on my taxes not this upcoming year but year after that.

So if I don't tap these two houses with cash out refinances, I'll get $1,500 cash flow from just these two, and another $1,000 from another two rentals combined for a total of about $2,500 a month cash flow. Or I can cash out refinance and get about $1,250 to $1,500 a month cash flow from all of them combined after the refinance and have another 300K in cash for opportunities.

Simcha Davidman · Answer

@Jack B. Where did the other two rentals come from? Are you bringing them up just to let the reader know of your income situation as it relates to answering the question?

It depends on what you're going to do with the money. If you're going to let it sit in a bank until the market crashes, you could be there for a while. Maybe not, but we just don't know. Personally, I'm not a fan of having lots of idle money lying around. If you're going to look for more properties immediately, go for it.

It sounds like your $300k in equity is providing you with approximately $1000-1250/month in cash ($2500 less the $1250-1500 you'd get if you refi)- approximately 4-5% annually. Can you beat that if you take the money out?

Alternatively, it seems like these properties are worth a lot more than they're renting for ($1500/month for well over $300k in equity (as you stated you want to pull out $300k) - looks like less than 6% cash on cash return) and you may want to consider selling them both and moving the cash to higher yielding opportunities. What are your goals in building your portfolio?

You also may want to consider selling the one you're living in now, if it's your primary residence, so you can take advantage of the tax exclusion. Can you do that and then move back into the second house and quickly qualify for the exclusion for that one, too? Depending on how much gain you're sitting on, you may not have to worry about the 1031.

Good luck!

Simcha Davidman · Answer

@Jaysen Medhurst said it better and way more succinctly :). But it's even less than 6% because the OP's trying to pull $300k out - meaning he might have substantially more equity in there.

Jaysen Medhurst · Answer

I think you need to take a hard look at the Return on Equity (ROE) of both investments, @Jack B. Your post is a little tough to follow, but it seems like you're getting $18k/year of cash flow from ~$300k of equity. That's a 6% return. Frankly, you can probably do a lot better. All things being equal, I'd sell and redeploy that capital.

Jack B. · Answer

So another way to think about it, is if I cash out refinance, based on remaining equity, principal pay down and cash flow, I'll have a 10% return on each of those properties mentioned. So my returns would go up, and I could put the 300K in a 3% CD making me 9K a year. So basically if I split that 3% between the two properties, it would be an 11.5% return per year per property and give me opportunities in the future as I'd now have 1 mil instead of 700k in cash on hand.

Only downside now is less cash flow for now. Plus I won't have a cheap place to live if I ever want one. Right now I live in a nearly 2K SF 3 bed 3 bath for $975 a month payment, $300 of which is principal pay down and $200 a month tax benefits. After adding costs for maintenance around $200 a month reserves, I'm looking at $675 a month cost to live in a large house (large for me) on transit line to down town Seattle.

Jack B. · Answer

Not refinancing and keeping cash on hand and saving for one more year gives me another two options:

-Right now I could have 2.5K a month cash flow, travel in an RV and live easily off that. Plus about 1.5K a month interest from high yield savings accounts and CD's.

-If I save for one  more year I'll have enough cash to pay off all four existing loans. Right now I'm 100K shy of paying them all off. That would net me about 6.5K a month cash flow which would be just under 2K from my current take home pay from ONE full time job. I currently have two full time six figure jobs though, but that's not going to last forever. Point being, if I just pay them off I'll be FI...My wealth will still grow over time but slower than if I keep hustling and buying more rentals for long term.

Jack B. · Answer

-They've been held as rentals too long, I have to 1031 exchange, the capital gains exclusion for either of them as a primary residence would be pro-rated at this point.

-The total equity is 450K between the two properties, and with principal pay down the return is about 6%, or about 4% with just cash flow no principal pay down factored in.

-Yes brought up two other rentals to demonstrate other cash flow. I've had those for 3 years and rent's will likely be at 1K cash flow each in another 3 years or so. It took this one 6 years to go from $50 a month to 1K a month even after all reserves.

-I live in the 6th most expensive city in the US. This is not a cash flow market. Money here is made through appreciation although the market has slowed and I'm taking a heavy cash position waiting for new opportunities.

-I'm not sure where on Earth I'm going to get a guaranteed 4-6% return that I am now.

-The question is really: am I better off with half the cash flow after a CO refinance, or am I better off adding another 300K cash to a 700K cash position I already have and sit on a million cash ready for opportunities. We are at a late stage in the cycle. Recession is looming. Whether it's stocks or real estate, opportunity will present in the next few years.

Should I cash out refinance or keep the cash flow?

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