Pulling equity from our investment property

[Marcela Correa]

I’m a newbie investor with all my starting capital tied up on my second deal. I’m seeking advice whether to: (1) sell; (2) hold and pull equity out; or (3) a creative financing solution that I have not yet thought of…. Here’s the scenario:

My uncle and I own a general contracting business. We used a 203k to buy a single fam house that we totally rehabbed and converted into 2 units. Our mortgage is $670k and the property currently appraises for $1,050,000. We have the option of converting to condos, a process that will take about 6 months, and sell the two units for a total of $1.2 million. That’s a fair number given the comps within a 10 block radius. I believe I’d need to refinance to a commercial lender because my residential mortgage won’t allow me to do the conversion process. With conversion ($20k), refi ($7k), closing costs (7.5%) and a little debt ($20k) we still have from the renovation, we’d net about $393k.

The alternative is to hold the property. We are in year 2 of a 5 yr ARM with a $3500 monthly payment. We rent one unit for $3800 and occupy the second. In September, we can move out and rent the other unit for $3200. If I can hold on to the property till 2017, then I could sell and take advantage of the capital gains tax relief for holding the property for 5 yrs and occupying for 2 (and net $42k a year in rent). As I understand it, to pull equity, I would still have to refi to another bank (commercial lenders have said they'd charge me a point) and then I'd get 80% LTV or $170k (I'm at 64% assuming the $1,050,000 appraisal). I don't know if I could still do the conversion and hold both properties in a portfolio and then my LTV would improve. Back of the envelope tells me that I'd be around 58% LTV and I'd then have access to $263k in equity.

Our goal is to buy, fix and flip--no more condo conversions in the near future--and we want to access this equity to do so. Holding seems like the better option but is there something I'm not considering? Are there other ways to leverage this property? I welcome all advice on this scenario and on how to identify a mentor in the Wash, DC area. @J Scott, I will buy you coffee or lunch anytime. THANK YOU SO MUCH to @Josh Dorkin, @Brandon Turner and everyone on BP: this site is now the wind under our sails! 

[Eric Black]

Hi Marcela,

I'm not sure how it would work with the two-unit property but since you're an owner occupant you should be able to pull out a home equity line of credit (HELOC) on the property without refinancing. We just did this with one of our rentals, a SFR, and were able to get up to an 80% LTV through our credit union. If it's worth $1M (for easy math) and you owe $670k then that means you could pull out $130k with very little, if any, closing costs.

And just for clarification, you don't have to hold the property for 5 years to get the tax relief. You just have to have lived in it for at least 2 of the past 5 years but as long as you've owned it (and lived in it) for 2 years then you can sell it and not pay capital gains taxes. Not sure if you thought you had to hold it for 5 years or were just planning on holding it as long as possible while still getting the tax relief. 

Best of luck!

Eric