Cash-out refinancing as a cash flow strategy?

[James Free]

Hello BP,

Fairly new here, and I had a thought that I want to run by the group. It feels like there ought to be something wrong with this, but I'm not sure what it is.

Suppose you're at the stage of life where you're ready to retire, and you want your income to be truly passive. That is, you're not looking for great deals like Brandon on his sixth frappuccino every day; you want to lay on a beach and forget about it.

The trouble here is that it's hard to average over 10% net ROI (after taxes) when you're truly passive. Unleveraged real-estate generally rents for less than 10% of value, and then there's management fees, repairs, and taxes to consider. Leveraging means that most of your gains are in equity, not cash flow, with cash flow being far below 10% of equity.

Usually when people build a lot of equity here, they talk about selling, 1031s, etc. But why not simply do cash-out refis? I'm imagining a strategy where you refi upwards every year, extracting equity, and this basically causes your loan payments to keep pace with annually rising rent payments.

Conservatively, suppose your lenders require 25% down/equity, and your property appreciates at 4%/year. This means that the annual appreciation is 16% of your equity. You refi back to 25% at the end of each year, extracting an amount equal to 12% of your original equity. The refi fees roughly cancel out the principal payments you made over the course of that year. The mortgage payments increase as a result of your cash-out refi, but your rent also increases slightly each year, canceling out again.

Your cash flow, then, is 12% of equity COMPLETELY TAX FREE since you're increasing your debt along with it, plus whatever rent cash flow you might be making, which is probably small since your mortgages are substantial. And you get this without doing any work besides the refis once a year.

Ok, somebody shoot holes in this please.