In this episode of Ask an Investor, Envision Advisor’s House Hacking Specialist Ben Einspahr joined us to talk about how to plan for his next House Hack.  We went over the properties he currently owns and his options for funding the next house. 

Ben is an active house hacker in the Denver area.  A couple of months ago, he left his W2 to join Envision Advisors full-time, which changes his funding options. 

Ben’s Portfolio

Currently, Ben owns 3 properties with 4 doors.  The first property is an out of state home in Omaha, NE.  He bought the house in late 2016 and thanks to appreciation, he now has about $85K in equity.  From a cashflow standpoint, the property loses money because of some big CapEx repairs and under-market rent.  However, he has great tenants that have been there for years and are easy to work with. 

In April 2019, he purchased a property in Arvada, CO that started as a house hack.  He currently rents out the main house on a 24-month lease and does a medium-term lease for traveling nurses for the mother-in-law suite over the garage.  For more details on this house, check out our House Hack Ride Along episode.  That house has about $175K in equity. 

His current primary residence is a new build townhome in Wheat Ridge.  There is an income suite on the first level that he rents out as an Airbnb.  He’s seeing great equity in that property, too, thanks to current market conditions.  We talked with Ben about transitioning into this new property a few months ago. 

In total, he’s sitting on about $300K in equity and has $1K a month in cash flow.  Due to his career transition, Ben wants to be conservative with his estimates. 

Ben’s Long-Term Goals

Ben wants to take some time to get established in his new, non-W2 job.  In about 2 years, he wants to purchase House Hack #3.  Once he buys the new property, he plans to live in it for at least two years.  In 5 to 6 years, he wants to think about purchasing House Hack #4. 

While it’s difficult to create a plan this far in advance, it’s good to get an idea of how he’ll approach his next property.  Ben has a few different options for funding and isn’t sure which one is best.

Should I save, tap into my Roth IRA, or use my equity?

Chris says: If you have properties, I’m a big fan of using equity.  Equity is untapped money in your real estate piggy bank.  I would rather use that than cash to buy a property.  With cash, there of downsides of the opportunity cost and loss of liquidity. 

We’ve talked before about how returns start to drop as your equity grows because everything starts to compress.  To keep your returns high, you need to keep making your equity work for you.  Since you’re sitting on so much equity, use that first. 

How can I tap into equity from house hack #1?

Chris says: You could do a cash out refinance, but then you’d probably lose your low interest rate.  You could open a Home Equity Line of Credit (HELOC) to pull out money, even though it’s an investment property. 

I looked at HELOCs earlier this year and found that a lot of banks won’t do one on an investment property.  The best quote I could get was 70% Loan to Value (LTV).  The cash out refi was 75% LTV but it resets the payments.

Jenny says: Investment property HELOCs typically don’t have as beneficial a LTV as your primary home.  It’s definitely worth tapping into if you have a really good loan on the property and would lose those benefits with a cash out refi. 

How can I tap into equity from my primary residence?

Ben was one of the first buyers in his current neighborhood, so he’s got a lot equity in his current home. 

Chris says: Again, you could do a cash out refi or a HELOC.  For a primary residence HELOC, you can get up to 95% LTV.  That would mean more leverage, but the interest rate would be in the high-3% range, versus 5% for an investment property. 

What happens if I open a HELOC on a primary residence and then move out?

Chris says: HELOCs have different rules; there’s no one year residency requirement.  You can tell them it’s your primary residence, get money and put it in a checking account, then use that money as a down payment on your next home. 

Talk to the lender about doing a loan on a new house.  When you pull money out, it raises your debt-to-income ratio, which could impact qualifying for a loan.  Make sure the lender knows what you’re doing and helps you line it all up. 

Remember that since you’re planning on doing this in a few years, the market will be different than it is right now.  In today’s environment, these are your best options, but that could change. 

Should I sell one of the properties in my portfolio?

Chris says: I could make the case that it makes the most sense to sell House Hack #1 depending on appreciation and current performance. 

Jenny says: If you have $175K in equity, you could take that money and 1031 it into a fourplex in Colorado Springs.  Now, the 2 doors you currently have will turn into a 4-door investment property.  Keep in mind that you don’t need to go from house hack to house hack only. 

I’m good at house hacking and want to stick with it. Am I just chasing a shiny object by buying a straight investment property?

Chris: No, you’re good at house hacking and that allows you to acquire properties with a very low down payment and reduce your living expenses.  But as your properties appreciate, you’re sitting on a lot of equity. 

If you have half a million dollars in equity in your portfolio, you’re at the point that you’re not positioning yourself well.  You should shift your mindset and think about bigger properties. 

Jenny says: You put 5% down on your house hack and now you have a $600K asset.  That’s pretty amazing. 

What should I do with my out of state property?

Chris says: It’s out of state, and there’s nothing wrong with selling it.  Sometimes, you just want to sell the dog in your portfolio.  I would look into doing a 1031 on that property.  Make sure the timeline works and the tenants are gone.  You’ll want to sell it in good condition and vacant in order to get top dollar. 

Can I combine my equity from doing a 1031 on two properties to buy one bigger one?

Jenny says:  You could combine the equity from selling two properties into a multi family unit in the Springs, but it’s very difficult to time it correctly. 

Chris says: You have to identify the new property within 45 days of closing, which means they need to sell at the same time.  The more properties involved, the more complicated it gets.  If one sale falls apart, what do you do?

Should I look into a reverse 1031?

Jenny says: A reverse 1031 can be cost prohibitive.  It depends on how much gain you’re working with.  A Qualified Intermediary (QI) works with you to facilitate the exchange.  You cannot touch the sales proceeds, so it sits in their bank account.  You pay them for this service, and they can help you figure out if it’s worth doing ahead of time.

Chris says: In general, it costs about five times more to do a reverse 1031.  You have to figure out how you’re going to purchase the next property without money from a sale, and it’s hard to get a loan for that much.  Some QIs have connections, or you can talk to hard money lenders.  There are options out there, but few people do it because it’s so complicated. 

What are my loan options without a W2 job?

Jenny says: There are loan options worth exploring even though they have less favorable terms.  Non-qualified mortgage, or non-QM, loans are based off of asset performance and allow you to lock into prices now that will only rise later.  It’s worth considering with the intent to refinance as you get more established with your career. 

Chris says: These loans often have a 5-7% interest rate with an ARM at 3-7 years.  Most people refinance before that time, but it does make sense to take out a higher interest rate loan and refinance before the ARM when you have a better lending profile. 

There is a risk that interest rates could rise dramatically, though.  I wouldn’t do it personally, but it is an option. 

Is it a good idea to use my Roth IRA to purchase a property?

A Roth IRA is a retirement account that allows you to withdraw your principal without early termination fees or taxes.  If you put in $5K a year over a period of 5 years, you could theoretically have $25K in principal and $10K in earnings.  You are able to withdraw that $25K without it counting as income. 

Chris says: I have mixed emotions about that.  You could take out, say, $50K of principal and put that in real estate where you’re getting a better return. 

However, you’re getting about 10-15% return with your Roth IRA, which is a good return that isn’t leveraged.  You’re putting money into a vehicle that can compound tax free.  You pay the taxes on it when you’re younger and presumably in a lower tax bracket.  It’s hard for me to recommend pulling it out knowing you’ve got tax-free compounding returns for life. 

You could make the case that if you keep doing a 1031 forever—assuming there are no rule changes—you can also avoid taxes. 

Jenny says: I’m very torn on this subject.  Emotionally, it feels wrong to pull out money from a retirement account.  But mathematically, I can’t help but think it’s a good idea. 

If you assume the average stock market return is 10%, you are earning 10% on $50K that would compound annually.  If you leverage that into a real estate asset, you now have a $200K asset that will compound by appreciation alone, not to mention the other benefits of cashflow, depreciation, and debt paydown.  I’m curious what it would look like if you constantly re-leverage. 

Chris says: I’ve run these models before, and they are way better than the stock market because you stay in the 20-30% returns range most of the time.  This works if you sell and trade up every 3-5 years.  In real estate, you aren’t automatically reinvesting like you can do with stock market dividends.  You have to take the cashflow and reinvest it, which is difficult to do at $200 a month. 

With equity, you have to reinvest to keep the high returns.  Otherwise, at year 10 or 15, as your real estate becomes less leveraged, your returns are similar to the stock market.  You lose a lot of benefits once your returns become more compressed. 

If I’m getting better returns in real estate, why wouldn’t I use the Roth IRA to invest?

Chris says: You’re right that the spreadsheet says to repurpose the Roth IRA, assuming you’re constantly reinvesting it every 3-5 years. 

But take a step back: you currently have 2 sources of capital—your Roth IRA and the equity in your properties.  Getting money from your equity has fewer opportunity costs.  Once you take money out of your Roth IRA, you can’t put it back.  I lean toward using equity first because there are fewer tax consequences. 

Another reason to keep the IRA is liquidity.  Equity isn’t liquid.  If you keep the money in the retirement account, you have cash you can pull out if you lose your job or something catastrophic happens.  Equity is great until you can’t use it; if something happens and a lender won’t let you pull it out, what then?

Jenny says: Ben, you do have a traditional IRA, as well.  You can use that as a last resort for emergency funds, but then you have to pay taxes and penalties.  There’s a 10% penalty and taxes on the money, but it’s there if you really needed it.

I think it’s a fascinating concept.  There really is a thing in our brains that tells us not to take money out of a retirement account. 

Conclusion

The great part about real estate is that there’s a straightforward mathematical aspect to it, but there’s a lot of personal preference, too.  This discussion shows that there are a lot of valid approaches to the same problem and none of them are necessarily wrong. 

Connect with Us

If you have any questions or scenarios you’d like to talk through, reach out to us.  We love to discuss strategies and figure out the right move for you. 

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