Does this HELOC logic make sense for a Rental Property?

Question

Hello BP!

I'm a small time investor (when do you get to be big time?) with just one rental property. I am looking to obtain two more rental properties this year!

I currently live in a house with about 100k Equity in it and 120k left to pay off. So LTV HELOC as I understand it, I could get a line of probably 80-90k.

I have an oppurtunity with a family member for a non-arms length deal. I could easily save up for the down payment, but I wanted to see if the following logic makes sense if I used a HELOC instead:

• House sale is 135k, could likely go for 150k today, it will appreciate by 7 percent over the next year or two.
• Lets assume a full 20 percent down payment from the HELOC (27k)
• Cashflow is about 450 a month, not including vacancy/capex/repairs, in which case real cash flow is closer to 150 a month. I plan to PM myself as I do today for a very long time and then PM to another later. I'm not too concerned with calculating PM costs into it until later in life when its either paid off or refinanced at a lower payment.
• All combined the leverage would be a conventional loan for 80 percent and a HELOC for the other 20, none of my direct cash.

With all that in mind, the following questions come to mind about whether this makes sense or not.

• Technically, if I'm using the HELOC completely or majority of the purchase, would that mean my CoC return is effectively much higher since its not my own money (directly, I know its my equity) as long as I don't make my own payments on the HELOC?
• Does it make sense to use the Cashflow from my first property, and my second property to pay down this HELOC as a strategy? I figure after a year I could see where its at and refinance-cash-out (I have not tried this yet) and pay off the remainder, or continue to pay it off. This does tie up that rental money but I'm okay with that.
• Or, should I just wait to see if appreciation happen and refinance-cash-out. And pay off the HELOC?

To ease tensions, I am in a very grateful situation to where I have no debt (besides my current residence and rental) and bring in 10k of free cash flow a month, so defaulting on a HELOC pull of 27k is unlikely. I could/might do 50/50 where i do 13.5k of HELOC and 13.5k of my own cash.

Sorry for the long post, but does my logic of HELOC pay off hold water in this situation?

Account Closed · Answer

@James M.

I also wouldn’t necessarily recommend getting the heloc for only exactly what you want to use. Just, be cognizant of leverage is what I’m saying. And don’t be scared to err on the side of UNDER leveraged as a whole. Some lenders will offer lower interest rates above a certain dollar amount, and then some shady character brokers will charge a fee for putting your application in below a certain dollar amount also. Keep in mind if your goal is to gain more property, even if you only have $10k of a heloc used lenders will evaluate the scenario as if fully leveraged. Or at least, here they always do. Same as a credit card your dsr will be calculated as if it was maxed. My personal threshold is 80% on personal residence and less on investment properties. Definitely have a firm plan to pay down the heloc also (sounds like you definitely do!).

Account Closed · Answer

@James M.

7% appreciation over the next “year or two” is either 3.5% (good!) or 7%(great!) appreciation, which is it? What leads you to predict that number?

If you have $100k equity in a $220k property I would not recommend leveraging it to 95% by putting $90,000 of heloc on it. Even though it sounds like you’ve got a absolutely solid financials and a good grasp of all this, over leveraging is the easiest path to becoming a motivated seller.  And that’s a target you’re going to want to avoid!

James M. · Answer

Very fair point and exactly what I was thinking. But being I've only rented one place and did one deal wanted to solidify that thought process. Thanks again Jaysen and lets hope 2020 I can find 2-3 great deals through networking :) Maybe I can even make this family one work, we'll see. I'll have to get creative. This thread has renewed my sense of being more conservative then I have been, I haven't gotten a new deal in well over a year, so I became lazy.

Jaysen Medhurst · Answer

No, @James M., I'm referring to just Cash on Cash ROI. I figure appreciation, depreciation, and mortgage pay down (along with cash flow) into my Internal Rate of Return (IRR) calculations

Jacob Villalobos · Answer

1. Small spread of equity. Maybe find something with more meat on the bone. Never assume future equity/appreciation

2. HELOC can be expensive (use if you must, but only for a great deal)

3. Always include vacancy/capex/repairs. Always! They are there for a reason. Don't get deal (beer) goggles.

Calculate for a PM as well at least for a little while until you understand fully the business/legal side of being a landlord.  It's very easy to make expensive mistakes.

4. Over leverage is the iceberg that took the titanic down. 100% financing is usually expensive.  Use it if you must, but tread carefully

Jaysen Medhurst · Answer

@James M., I would figure ROI, based on the actual cash in the deal. The HELOC is debt.

8% ROI wouldn't be enough for me in a "normal" deal, but might be worth considering if there was very little capital required. Typically I like to see mid-teens or better.

Jaysen Medhurst · Answer

A few things at the top, @James M.

• The $150 cash flow, is that after you pay the HELOC each month or before? 
• Discuss this strategy with the lender that will provide the mortgage. They may not be okay with the property essentially being 100% financed. Better to know at the outset so you can either find a different lender or use a different strategy.
• Would your family member be open to owner financing? That would alleviate the potential problem above.
• Lastly, I'd love to see your full rental analysis. With a $150k FMV, you're starting to get into the range where SFRs are hard to make work. BTW: you should always plan for management expense, even when self-managing. You need to know that the property is viable should you no longer be able to manage. Don't fudge your math here.

James M. · Answer

Great point on the leveraged account Account Closed forgot about the factor with the credit limit. If I had a 50k HELOC and pulled 30k for this deal, could impact credit in a good way. Thankfully I have excellent credit, but that doesn't stop an almost maxed out credit card from hitting it pretty hard.

James M. · Answer

Makes sense, I guess I didn't think about it in that sense. I really just need/want 20-30k. I assumed a line of credit was just there but it makes sense if I leverage the whole thing, it doesn't matter how much I take out it'll still be a bit over leveraged.

Never did a HELOC before so I will definitely just HELOC for 30k or so if its an option.

To be fair appreciation is a general guess  based on the trend. I also know the area decently well and I noticed its been going up in general. For better or worse there are a lot of flippers in the area and this house happens to be where my current rental is as well so I know the neihborhood, its about 3 blocks from my current rental as luck would have it.

Thanks Account Closed

Jason Tougas · Answer

@James M.

If you only need $20-$30k you can likely get a personal line of credit for that amount and very similar rates. This LOC can be used

For anything you desire and would simplify your situation.

I use my LOC to fund my rehabs and pay it off after the flip or refinance and start all over again on the next property.

Does this HELOC logic make sense for a Rental Property?

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