Proper Use of Leverage

[Davion Malwah]

Hello BP Community,

Quick question on leverage. Say I purchase a home in need of rehabbing for 100k on a block where homes usually go for 250k. I put down 20%, $20,000 down leaving me with equity of 20k. I rehab the place bring it up to market value, and have it appraised for 250k. Would I be able to borrow on equity and get $170,000 out? If so would it be smart to then rinse and repeat? Taking that $170,000 and leveraging into say 5 more under valued homes and doing the same thing done before? My stragety would be to hold the properties and live off the cashflow from rents. Is this plan feasible at all? It would be a quick way to aquire a lot of properties fast right? The example is just hypothetical so don't say you wont find a property that undervalued please :)

[Jon Holdman]

Well, how undervalued this property is depends on the rehab. If you spend $20K on rehab, you have a screaming deal. You're all in at $120K on a property worth $250K. You spent 48% of its value. Yeah, I'll say you won't find a property like that.

OTOH, you spend $100K on rehab and you're at $200K on a property worth $250K. You've spent 80% of its value. That's certainly possible, even in CA.

Doing a "cash out" refi like you describe is possible, but not easy. You will probably need to hold the property for at least a year before you can do this. Some lenders may let you consider the rental income, some may not. Some may require you have the rental income on two tax returns. All will require you have good credit, sufficient income to support the property and cash reserves.

You'll also have several thousand in costs to do the refi. So, it really does take a very good deal to actually generate much cash out of this process.

You also need to be sure you don't leverage the property to the point is doesn't cash flow, since you goal is to "live off the cashflow from rents". A simple rule of thumb is that cash flow is half the rent less your P&I payment. Banks generally use the formula that net rental income is 75% of the rent less PITI, which is a little more optimistic. So, you need rents of at least $1800 to be break even if you're paying a 5%, 30 year, $170K mortgage.