Cash Out, Sell or Stay Put?

Question

I have a condo as a rental with minimal loan balance in San Diego.  I bought the unit about 10 years ago and it has appreciated nicely.  ROE is not that impressive with around 3.6-3.8%.  Basically the equity is generating return worse than the T-bill.

What should I do with the equity on paper?  I have 3 options.

1) Cash out refinance with above 7% interest rate. Use the cash out as down payment to buy another property in San Diego.

2) Sell the property to do 1031 into a bigger and nicer San Diego property.  10% of proceeds will go to renovation, agent fees and etc. Losing the low property tax. But compare to Option 1, it will allow more funds on the next property.

3) Stay put.  The housing price is so high compare to the rent.  The cash flow of the new property from Option 1 and 2 will  most likely be negative, unless putting a big down payment.  The 3-4% ROE is just the way it is in San Diego. But with Option 1 and 2, can use the deprecation to offset some rental income.  Would need the deprecation to offset the income after the loan is paid off.

Would appreciate your comments.

Dan H. · Answer

I see no way your ROE calculation is correct. I suspect you are missing one or more profit sources.   Per core logic average appreciation last year in San Diego.  I believe every year for last 10 years it was higher than your quoted ROE.  In some of those years 5x your quoted ROE.  Add cash flow and equity pay down for total return.  I suspect you return is much higher than you indicated.

You have incredible prop 13 discount by now. There is no way I recommend selling unless the HOA starts being too restrictive.

As for refinance/2nd/heloc, it is too bad you did not look at this option 2.5 years ago.  Today, it depends on what you plan to do with the money.  In theory financially it makes sense if you can achieve higher return than the refi/2nd/heloc rate accounting for the reduced cash flow resulting from the higher leverage.  However, this discounts effort and risk.  If you can achieve return that justifies the effort and risk then it is worth it.  To me, there are options I believe accomplish this.  I think even the s&p with its historical ~10% return and with recent returns much higher than 10% is likely to produce a better return than current rates.

Greg Robertson · Answer

Hi Angela,

It's so hard to be patient sitting on tons of equity with a low yield but that is the smartest thing you can do right now. Based on all macroeconomic indicators and housing trends, chances are high that rates and/or values will be lower in the 6-12 months. Rates being most important to your situation. Cash-out refi's are expensive, investment purchase rates are expensive, and it won't be easy to quickly refinance to a lower rate if you maximize your leverage and values drop. I also think the election results will trigger a material change in the financial markets and influence borrowing costs. This is all assuming you should use my favored strategy of holding property and using cash-out proceeds to purchase your next one. Selling can make sense at times, but definitely not in this rate & elevated value environment. I myself am getting antsy to make another property purchase but continually have to force myself to be patient. If Warren Buffet is happy to sit on piles of cash right now (equity for us), we probably should be too...

Jack Schwartz · Answer

Angela, refinancing your property at the current lower rate (Today's 15yr fixed purchase rate: 6.8% APR) can fund a down payment for another property, enhancing your portfolio.

Real estate typically appreciates over time, so it's wise to hold onto investments unless you have a real reason to sell.

Good luck on a  wealth-building journey,

AJ Exner · Answer

Angela,

Condos can get really tricky, not just in SD, but anything that adds an HOA can really cut into the cash flow.

Without really knowing the numbers, would refinancing at a reduced leverage be possible? I agree with Jack that assets are great to have, but I could also see the benefits of having that kind of capital to really invest in a solid STR down there. It really comes down to what you are looking at and how quickly you would need to move on it.

Good luck, happy to help where I can.

Natalie Bender · Answer

@Angela A. My family is in the exact same position as you. We own a 1 BR in PB bought in 2010 with a 3.85% 15 year loan (refied in 2015). It has appreciated almost 2.5X of the original purchase price, however the cash flow is typically $25 in the red every month sometimes more with maintenance issues.

I am in the Alternative Investment space and help investors transition from active real estate to passive using trapped equity so it is driving me crazy to be sitting on a huge amount of trapped equity.

That being said I believe the smartest play is to stay put and hold, the mortgage is being paid down, the interest rate is much lower than current rates. SD demand is not going anywhere.  You and I both know there is not much building in the area so supply will remain low.

Ultimately, my goal is to wait for rates to move down and lenders to allow HELCOs on investment properties with a fixed rate. Then take the HELCO funds and invest in a much higher cash flowing investment. Pay off HELCO, REPEAT.

If you are an accredited investor I can discuss some Alternative investments I am personally looking at to generate income that offer tax advantages to shelter some income. My contact is below, shoot me an email and we can talk further.

Jake Andronico · Answer

@Angela A.

No easy answer here. The good news is, you're in a fantastic spot!

ROE is good to calculate over time but in high appreciation markets like SD will sometimes be tough to swallow.

Are you looking to live off of the cash flow? Looking to grow equity to eventually create cash flow? What's the end goal and when do you want it to happen?

Michael E. Okoli, Jr. · Answer

Is your objective to be rich or wealthy. Stay put and use some cash to expand your asset base. It takes time but it  will make you wealthy.

Drew Sygit · Answer

@Angela A. rentals are a long-term game, despite what everyone thinks.

Why don't you look into rental rates and work backwards, to determine the max PITI payment those rental rates will support, and then calculate the max mortgage amount?

Wale Lawal · Answer

@Angela A.

You should consider your financial goals, risk tolerance, and market conditions to make an informed property investment decision. Your three options include Cash-Out Refinance, Sell and 1031 Exchange, and Stay Put. You need to balance these options with alternative markets, partial cash-out refinance, or holding and monitoring. Consult a financial advisor or real estate investment expert for suitable  advice.Good luck!

Basit Siddiqi · Answer

Is the 3.6% to 3.8% the cash-flow?If you want to know your true return, you should also add in your annual appreciation(This is assuming the prior number is just cash-flow).Current rates are high right now at around 7%.For it to make sense refinancing, you would need to find an investment that generates a return atleast higher than that, which may be hard.

Cash Out, Sell or Stay Put?

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