Taking Equity out of Rental Property to Invest

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jim54521
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Taking Equity out of Rental Property to Invest

Post by jim54521 » Thu Oct 25, 2018 2:28 pm

Long time listener first time caller........

I am early thirties and I am in real estate (broker, developer, appraiser, general contractor) and I have rental houses as well. I have half of my rental houses paid off, my personal home I owe less than half of what it is worth and plan on turning this into a rental if and when we purchase a new home as I am getting married in a month (future wife has a great job and we have very little expenses and probably could live off of half of one of our incomes if we had too, also the house we would move into we would be walking into about half equity as well). All my properties I have essentially bought through foreclosure at essentially half of what they were worth at the time but I do not plan on selling for a long time and if I do I would 1031 exchange into something better.

I have a line of credit on one property that is renewed every year. I have never even used this line of credit and my plan is to only use it if I need the cash to quickly close on a rental property purchase (not going out buying cars and boats) I was trying to have the LOC extended for a couple of years so every year I did not have to go through this process and lock in an interest rate but they did not want to do it. Then I started thinking why dont I just draw the money out of the property a set up a loan like I had originally had when purchased the property and if anything I could put into a money market getting 1.5 interest or something low risk that had a little better return. I can justify writing off my interest on the property as long as used as a business expense which I would more than likely use the money to purchase properties because I generally like to buy at least two a year if I can find the right deals.

I just wanted to get some different view points and thoughts because I am kind of on the fence about it, to keep LOC or to go ahead and get my equity out of it and have in my possession which does kind of appeal to me because cash is king, especially in real estate. When I purchase properties I only buy with a ten year amortization which in real estate is a pretty quick payoff. My thought process is that I have a lot of equity in properties that is kind of not being put to work and god forbid if markets turn down and loans are harder to come by I would have that cash in my possession to purchase assets and if worse came to worse could just walk into the bank at anytime and pay off the loan.

Being in my early thirties and having some time in front of me I feel like I really need to multiply the number of properties right now so I can own a decent amount of properties free and clear by the time I reach retirement. My ultimate goal is the be able to let my kids inherit my roth ira and rely on my investment properties for retirement(I dont really plan to ever fully retire especially if I have properties) I work with my father who has been in real estate all his life and has rentals as well and his dad had rentals too. My father is not a big stock investment person but my other grandfather ended up with a decent size stock portfolio from where he started. Seeing both sides of real estate and stocks I believe the best thing is to have both but of course I have more real estate than stocks growing up with a more real estate focused father. I started in real estate and have built a decent portfolio but I did not know much of anything about stock investing but I have been trying to catch up quickly and have really enjoyed every minute of it and I learn something knew about real estate and equity investing just about every day. I have read a lot of the Intelligent investor type books etc. and honestly cant find enough stuff to read about and this forum has been an absolute delight to digest!

Anyway just wanted to get some thoughts on drawing out my equity to have in cash.

curmudgeon
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Re: Taking Equity out of Rental Property to Invest

Post by curmudgeon » Thu Oct 25, 2018 7:31 pm

It's really a question of how much leverage you are comfortable using. While leverage is powerful and has been the basis of many fortunes, it cuts both ways, and has also led to plenty of flameouts. If you are on a good financial trajectory, then amping up the risk may not be a wise choice. It sounds like you are paying down your properties at a pretty steady rate, which is good, but I'm not sure I would want to take everything out of those properties to lever into more, as you may reach a limit to how many you want to manage.

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grabiner
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Re: Taking Equity out of Rental Property to Invest

Post by grabiner » Thu Oct 25, 2018 9:23 pm

You need to look at the rate you will be paying, and whether this is an appropriate risk-adjusted level.

If you are in a 24% tax bracket, taking out a long-term loan at 5% costs you 3.80% after tax (if it is deductible; check with your tax advisor if the loan is not used to buy or improve the rental property), and an adjustable-rate loan at 4% costs you 3.04% after tax. Selling a muncipal bond of similar duration (if you hold one) costs you less than that. If you don't hold any municipal bonds, selling a bond fund in your IRA to buy more stock is a similar trade-off; you give up a higher return on the bonds, but you also get a higher return on the stock replacements. If you can't borrow at a higher rate than you can earn on low-risk investments, then borrowing more can only be right if you don't want any low-risk investments; that is, you are 100% stock outside of your real estate.

This isn't restricted to investment properties; Paying down loans versus investing, usually mortgages or student loans, is a common discussion topic on this forum. I don't make extra payments against my own mortgage because my rate is so low that I can earn more on investments without much risk, but I advise other people, who have higher-rate or non-deductible mortgages, to pay down their mortgages rather than making taxable investments.
Wiki David Grabiner

Nissanzx1
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Re: Taking Equity out of Rental Property to Invest

Post by Nissanzx1 » Thu Oct 25, 2018 10:55 pm

Real estate where money is still owed isn't really that much fun. Constant pressure if the tenant doesn't pay or if there is an vacancy. Do we take the one qualifying renter who we don't have a good gut feeling on because we don't want to make the payment out of "our" money this month. No thanks sorry.

We have one rental now and saving for another, will pay cash or we won't buy. Then we get to keep ALL of the rent, not send out to a lender.

I know most finance but you have to ask yourself if you are comfortable with the risk and interest expense. Or just spend a few years living lean and get fat later on the cash flows...

BoomXer
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Re: Taking Equity out of Rental Property to Invest

Post by BoomXer » Thu Oct 25, 2018 11:41 pm

If you're planning on deducting the interest from the borrowed proceeds it's good to know that the IRS uses "interest tracing" to determine if the interest is deductible. Tracing means that the interest expenses follows its actual use. If the borrowed funds are used to by investments, it is investment interest and falls under those rules for deductibility. If you buy another property, then the interest expense must be reported under the new property not the property that secures the loan. If you buy a boat with the proceeds, that is considered personal interest and is not deductible under current tax law (and has been that way for many years).

inbox788
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Re: Taking Equity out of Rental Property to Invest

Post by inbox788 » Thu Oct 25, 2018 11:54 pm

jim54521 wrote:
Thu Oct 25, 2018 2:28 pm
...I am in real estate (broker, developer, appraiser, general contractor) and I have rental houses as well.
...Anyway just wanted to get some thoughts on drawing out my equity to have in cash.
I'd imagine your time and equity is better used in the real estate business rather than dealing with rentals. If you flip a property, you make out in many ways and tie up your cash for short periods of time whereas using equity to leverage up rentals is a long term low return proposition. In your situation, I would keep leverage low and any excess equity in a low cost Total Stock Market Index and work on transactions that you can add the most value.

DaBombCat
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Re: Taking Equity out of Rental Property to Invest

Post by DaBombCat » Fri Oct 26, 2018 2:54 am

Jim54521,

These ideas may not be your cup of tea, and they are not complete strategies by themselves. However, if you want examples of what good debt can do, then these are some techniques to consider.

If you continue to purchase properties at a discount, then you may be able to refinance those properties for more than you put in. For instance, you buy a $100k rental for $50k, then put in $15k rehab for a total of $65k investment. Refinance for 70% of the final appraised value to pull out $70k, and you have $5000 in your pocket plus a $100k rental property that produces cashflow. It is like a flip, but you get tax free profit without ever selling the house. What is the risk if you lose a property that you were paid $5000 to own?

Imagine if that $100k rental was on a 15 year mortgage, and simply broke even on cash flow after all expenses/improvements, and there was no price or rent appreciation. At the end of 15 years, you could refi and pull out $70k cash, tax free to spend on anything that you wanted. Then, you could repeat with another $70k cash-out refi in another 15 years. Now, imagine if you had just 2% annual rent increases and/or price appreciation. What if you bought one such rental property every year for 15 years—you’ve already proven that you can? Then in 15 years, you would have a series of houses that could be refi’d one at a time for $70k each year—for the rest of your life.

If you are sued by the tenant, there is only 30% of exposed equity in a leveraged property. The lack of equity is a deterent from lawsuits—an extra layer on top of your other layers of asset protection.

Keep a big cash reserve to weather long periods of poor rental income. Honestly, even if you don’t use more leverage, you are already so far ahead of the game. Anything that you gain from these techniques would just be icing. Best wishes!

Josh

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4nursebee
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Re: Taking Equity out of Rental Property to Invest

Post by 4nursebee » Fri Oct 26, 2018 3:53 am

If your equity in real estate is not earning sufficiently that you think to do other things with it I would get out of real estate.

I think your first post here is mighty long winded and lacks substance sufficient to know what to advise.
4nursebee

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