Cash Out Refi? Cash flowing rental with a conventional mortgage

[Ariel Nelson]

Hi all, 

I am just starting out with real estate investing and looking for some insight.

Last year I purchased my first investment SFH in a desirable class A neighborhood for 260k with a conventional mortgage at 3.125%, 52k down out of my personal savings. The house appraised at purchase for 300k and I put 30k into it for new kitchen, new floors, new roof and updated electric. ARV is now 350k. The current monthly mortgage payment including P&I is $1435. It is renting is at $2900/month.

I am trying to decide if I should cash out refi to help fund the next deal or if it would be best to leave this property as it is cash flowing very well given current interest rates. To cash out with a .75 LTV and new 6% interest rate, monthly mortgage goes up significantly and my cash flow significantly decreases to a few hundred dollars. After closing costs I will get around 44k to put into the next deal. It is feasible for me to save this amount over the next year or so on my own or do a HELOC in my primary residence to fund the next rental.

Right now I am looking to do 1-2 properties per year and not looking to ramp up really significantly in the short term. 

[Andrew Postell]

@Ariel Nelson thanks for posting and sorry I did not see this post previously.  In situations like yours there's no "right" or "wrong" answer.  Sometimes situations have very definitive answers....yours is pretty fluid.  So rather than tell you what to do, I just want to give you some basic concepts.  These might open up MORE questions but I think these areas are the right way for you to explore the best direction for you.

1. The BRRRR method - The BRRRR method is often talked about in simple terms but it's pretty complicated. At least, the skills I need to have are pretty complicated. The math is only like 5th grade math, but knowing how to estimate my rehab correctly takes time and training. Knowing my ARV ahead of time also takes knowledge and experience. I am saying this because your current property could have been structured better. Now, my first few deals I had NO idea what I was doing so it sounds like you did MUCH better than I did....and I'm a millionaire from real estate.  I don't mean that in a bragging way.  I just mean that even though you didn't do this one perfectly - you will be fine.  VERY fine.  But in order to structure this loan correctly I would have needed to know my rehab amount before I purchased and the ARV before I purchased.  Maybe you did?  But if you did then that means we should have structured it differently.  If you did not know those numbers then know that those two areas you should focus on for your next BRRRR property.  If you have those two skills down, you can take down more properties with less out of pocket.

2. The Initial Loan - So if I could calculate my ARV at $350,000 ahead of time, then I could have used a different loan to acquire the property and kept $52,000 that I put down on the property and even SOME of that rehab money. I would still need to pay $27.5k out of pocket for all of those upgrades...but I'd be $52,500 ahead in math. The reason for this is that property acquisition loans provide me a loan based on that ARV. Essentially the right loan would lend me 75% of the ARV or $262,500. That's your new loan amount. You pay $260,000 for the house, $2,500 would go to rehab, and the rest out of pocket (don't forget your closing costs in all of this). Hard Money is ONE type of "acquisition" style loans that we use with the BRRRR method.

3. Cashflow - Now, you might have noticed...you are borrowing MORE money now.  Yeah, your loan amount is higher.  So if I owe more money, that means my payment is higher.  And if my payment is higher, that means my cash flow is less.  But that's ok.  This isn't a "one year" examination we are doing.  Real estate is long term growth.  I will increase rents next year.  Same the year after, and again, and again, and so forth.  Year 5 I will be very happy I purchased this home.  It will be worth more too!  But my cash flow is less because I have a higher loan amount.  We earn income 3 ways with "buy and hold" real estate - cash flow, appreciation, principle buy down.  If you don't have 1, then you still have the other 2!  And usually you don't have 1 for a short period of time.  Read this article on why keeping a property 5 years will net you $100,000 per year: https://www.biggerpockets.com/...  That article will knock your socks off.

4. Refinancing - And if I do go this route, I have to refinance. So I have to pay closing costs again. So we try to find a BUY lender that will give me 75% of the ARV and a REFINANCE lender that will give me 80% ARV. That way I can roll in closing costs when I refinance too.

5. Cash - the basic premise to just about everything we do as investors is that our cash is limited.  Even if you have $1,000,000....that just means your limit is higher than mine - but it's still a limit.  So what can we do to limit how much cash we have in a property. 

6. HELOCs - Two of the common areas of concern for HELOCs I see out there is the 10 year maturity date and the adjustable rate. Since HELOCs have adjustable rates they will often catch people off guard when they adjust. Rates are low now...but what will they be in 5 years?, it is likely that your rate will increase in the future. The 10 year maturity date is where the HELOC will modify into a different product all together. Meaning after opening the HELOC for 10 years it will cease to be a HELOC. It will "mature" into a 20 year Fixed Rate Mortgage that you can no longer draw on. And when is matures the rate will increase. I've seen typical numbers of 1%-2% higher than your current rate.  However, if you use it to say....buy another property. Then flip that property...thus paying back your Line of Credit. Then that's perfect! Because you will never get surprised by an adjusting rate or keeping a balance on it. Lines of Credit are PERFECT for people who have a plan to pay it back.

Some things to think about when analyzing right now:

1. Am I ok with sacrificing cash flow in the short term to gain more rental properties?

2. Have I improved my ARV and REHAB calculation skillsets?

3. Do I feel comfortable buying another house right now?

So if you can answer those questions to yourself, and understand some of those concepts above....well, you'd be in a much better place than I was when I started.  And I turned out ok.  Hope all of this makes sense.  Thanks!