Strategic Partner and lender Joe Massey of Castle & Cooke Mortgage joins me to look at an investor who did a cash out refinance this April. This refinance happened in the midst of the higher interest rate environment and shows that there is still an opportunity to redeploy equity in this environment for long term gains.
- Listen to the podcast “#391: Boosting Returns $10K by Investing Denver Equity in Pueblo ” Denver Real Estate Investing Podcast
- Watch the YouTube video (at the bottom).
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.
Investor and Property Profile
These investors are a husband and wife who Joe has worked with for five years. They’re a doctor and IT professional who have a great income and live in Denver. They started investing in real estate four years ago and now own four rentals, including one that’s out of state. The out of state property is located where their son goes to college, and he manages and runs that property.
The investors called Joe and told him they wanted to take cash out of two of their properties in order to buy another rental here and out of state. We’re going to focus on one of these transactions.
This property is a condo purchased three years ago for $210K. It recently appraised for $300K. They wanted to hold onto the property while taking advantage of the equity it gained.
Understanding What to Do with Equity
A lot of people are sitting on equity right now but are unsure of what to do with it as the market shifts. Cash out refinances haven’t been a focus for us lately because higher interest rates make borrowing capital more expensive. Understanding all of the nuances of real estate investing and ways to make money through property ownership are critical for investors to understand in the current market.
Different Options for Pulling Out Cash
The investors wanted to know what options they had to pull out cash.
The first one they looked at was a Home Equity Line of Credit (HELOC). A great aspect of using a HELOC is that you don’t have to make payments on money you’re not using. However, HELOCs have their own interest rate, and as rates rise, the interest rates on these are going up, too. This can lead to escalating payments in the future, so borrowers need to have a plan to cover the higher costs. A HELOC would work for these investors because of their high income and bonuses, but they didn’t want a variable rate.
The next option is to look at a refinance. In this environment, a refinance is likely to mean a higher interest rate. However, with a 30-year fixed rate, investors can hedge against inflation.
Using a Cash Out Refinance to Invest
The investors chose to go with the refinance. They were able to pull out $52K in cash, and their interest rate went from 4.25%-5.25%. This caused their mortgage payment to go from $980 a month to $1350 a month.
Once they had the cash, they started shopping for another investment property. They looked at properties in Colorado Springs, Denver, and Pueblo. Ultimately, they chose not to buy in Pueblo because it was too far from their Denver home to manage, and they didn’t know any property managers down there. They chose to invest near their son, since they have reason to visit the area and he’s proven a reliable property manager.
However, since this is an unlikely scenario for other investors to replicate, we’re going to look at what would happen if they did choose to invest in Pueblo. In our last deal analysis with Joe, we looked at a property in Pueblo that would be feasible for them to invest in with the cash they got from the refinance.
Investment Property Details
We’re updating the Rental Property spreadsheet we used in the previous deal analysis to reflect the current market. Right now, the interest rate would be 5.875%, putting their all-in cost at $44K. This property rents at $1400 a month.
First Year Returns
When we look at the returns, we see that the annual cash flow for the property is $3800, or $317 a month. This is less than the total payment increase on their refinanced condo. Ideally, they would be making more money than this to offset that increased payment.
But remember: cash flow isn’t everything. In real estate, you also make money through appreciation, depreciation, and debt paydown. Essentially, they’re borrowing money at 5.25% and reinvesting it at a return of 32%.
If we look at their first property, we can see that it rents for $1750 a month. With their increased mortgage payment, their cashflow is less than it was, but is still positive. They can choose to trade in some of that cashflow in order to get more cash flow, appreciation, depreciation, and debt paydown. In all, they’re making $14K in annual return on the new property by trading $370 a month in cash flow on their condo.
Why Shouldn’t I Focus on Cash Flow?
In this example, the investors would be making a $10K net increase in their first year. This amount will compound over time. Cash flow is getting tough in this market, which is why it’s so important to understand all the ways investors make money in real estate. The return profile of real estate as a whole is stronger than other investments, such as the stock market or cryptocurrency.
Interest rates are going up, but that doesn’t mean investing or wealth building stops. Joe knows people who invested at 10%, 8%, and 3% who are all wealthy people because of the overall returns they get from owning real estate.
One upside of this new environment is that it’s much easier for buyers to close today than it was three weeks ago. This trend is likely to continue for the foreseeable future.
Find Your Investing Strategy Today
Joe and I love to talk as a team, run scenarios, and find the best investment for you in the current market.
If you have questions on the numbers we’ve talked about today or are interested in a residential loan, reach out to Joe:
To find out how to grow or optimize your real estate portfolio, reach out to me for a free consultation.