Should I cash out in this environment? 43% CoC to 115% CoC!

Question

Hi guys!

I'm partnered up in a duplex that has joint title with me and my partner out in Phoenix, AZ.  Our original numbers were as follows.

Original Numbers

-$309K Purchase Price at 4.875% 30 year fixed

-$278K Loan Amount

-$43K Initial Investment

-$15.7K Annual cash flow or 38% CoC (15.7K/43K)

My partner was able to lock in a killer interest rate a couple of weeks ago when the rates dipped and rolled in a few thousand into the loan amount here's where the numbers fall in that scenario.  He is going to refinance in his name only and free me up for another loan.

Refinance

-$309K Purchase Price at 3.375% 30 year fixed

-$281K Loan Amount

-$43K Initial Investment

-$18.5K Annual cash flow or 41% CoC (18.5K/43K)

Cash Out

-$309K Purchase Price at 3.375% 30 year fixed

-$311K Loan Amount

-$16K Initial Investment (Take out $26K of the initial $43K)

-$16.9K Annual cash flow or 106% CoC (16.9K/15K)Here's my dilemma! The appraisal for the property recently came back at $415K and my lender suggested that we could take up to 26K cash out for 75% LTV.  We're currently at 68% LTV.  The numbers would look insane with CoC at 106%.  I've explained to my partner that we could both take out 13K each(half of 26K) and essentially have $16K total into the property versus the original $43K total.  Not only would our CoC be insane, but it would give me access to some capital should I invest down the road in this market downturn or have some stashed away as extra reserves for vacancies or emergencies during the COVID-19 crisis.  My partner does NOT want to do this and works in banking/lending so I'm trying to see his point of view.  Here are his main two reasons.

1.  Given the current scenario (he works in banking), he is bracing for the possibility of a reduced income up to 50% reduction(lack of bonuses or possible job transfer pay cut etc.  I'm sure everyone is bracing for this as its a real possibility).

2.  Should he want to invest down the road and has to secure loans under his name only, he is fearful of adding on any more leverage.  In this case his leverage in the property moves from $278K to $311K or an additional $33K.  If his income is reduced significantly he wants to not add on any new debt so his DTI continues to look good.

After he explained his situation I understand where he's coming from but was curious if there is any other reason we shouldn't do the cash out refi?  Even if I had to significantly reduce market rents, with higher CoC of 100+% we would be sitting pretty in the property.  Also, an extra $30K of financing comes out to $2000 a year which I don't believe puts a dent really in any sort of Debt to Income calculations.  I'm not old enough to have really felt the affects of the last crash but he was.  Is there anything I'm missing here? Even if there was a fear of being underwater in this property and somehow the value plummeted from $415K to $300K we both agreed that we're in this for the long haul and don't intend/need to sell soon.  We could simply weather any downturns in value until the market gets hot again.  If we wait for the current environment to settle I feel like future appraisals won't be as high.

Thanks for reading this!

Wes Blackwell · Answer

@Cameron Lam

I would listen to your banking friend in Phoenix on this one. I don't think the reward is worth the risk. Don't over-leverage when you don't have to. Plus if his name is going to be the only one on the loan then he certainly has the stronger say in this partnership.

You guys have played it smart up to this point and had some amazing returns. Don't get greedy and potentially ruin a good partnership should things go south. Especially in a time where we have yet to see the full lasting effects of the virus.

Wayne Marques · Answer

I believe that your concern about being over-leveraged is a legitimate concern given all of the uncertainty now and in the near future.  Having the ability to adjust rents to keep your property occupied shouldn't be overlooked.

Joseph Cacciapaglia · Answer

Leverage isn't good or bad. It just magnifies your underlying results. When your properties are performing well, leverage is amazing, but when rents or prices fall drastically, not so much. You also have to remember that cash flow isn't static. It can grow or shrink over time. Don't get me wrong, I personally would feel relatively comfortable in the cash out scenario that you described. However, I know plenty of old school investors that never lever past 65% LTV, and even some that only buy in cash.  These are usually guys that have been through several downturns, and that's the level they've decided is appropriate. It's really just a matter of your risk preference.

Cameron Lam · Answer

Joseph I honestly didn't think about that and that's a great way to think.  The way I was justifying this was our cashflow now is $1300/mo at 4.875 % and with the cashout refi of $26K we'd be cashflowing $1400/mo and be getting money in our pockets.  Yes I mentioned to him since he is bearing the risk with the loan in his name we would follow his lead but just trying to wrap my head around being overleveraged.  Isn't leverage great if your cash flow is high and you are buy and hold long term to weather the market storms?

Joseph Cacciapaglia · Answer

Your analysis is ignoring the return that you'll make on the money that you take out. If the CoC of that reinvestment is significantly below the 41% return of the rate and term refinance scenario, then your blended rate could be worse by taking cash out. You're essentially giving up a 41% return on the $26K, and probably putting that in a deal that will return less in the short run.

Also, in general, the more aggressive partner should always defer to the more conservative one, imho. Otherwise, half your partnership won't sleep at night. If there is too wide a divide in your preferences, then it's time to find a new partner. In any case, 68% LTV isn't terribly conservative heading into a recession. Of course, 75% isn't that bad either.

Cameron Lam · Answer

Do you have fear just in case you need to sell and owe more then the propertys worth? Should there be any fear if this is a long term play?

Cameron Lam · Answer

And that's what I'm wondering.  Are you afraid of being upside because you're more levered in debt and if you have to cheapen rent to entice tenants to be there you might not cover your expenses?  How much were you considering taking out as a cash out? I'm thinking we only take out 26K which wouldn't be huge.

Cameron Lam · Answer

Hey Mark, yes this was a home run deal.  Mortgage is $1780 + 150 for repairs and 240 for insurance.  Yes my tenants pay the utilities and even most of the landscaping bill.

Should I cash out in this environment? 43% CoC to 115% CoC!

Original Numbers

Refinance

Cash Out

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