Before reading this post, make sure you read the previous post, “Refinancing Your Primary Residence to Purchase Denver Investment Property” as this post builds upon the information in there. This post continues to explore different scenarios for pulling equity from your primary residence in order to buy rental properties.

Scenario Updates

My clients reviewed the first Real Estate Financial Plan™ model, and then we hopped on a call to discuss it. Not surprisingly, there were some updates to make. It takes at least a few meetings to get details fleshed out and to find the right path.

Here’s the summary of the updates for this round of scenarios:

• Their preference is to stay in their current house and not move. The difference between the previous scenarios was not enough to make them move. We’ll focus on refinancing options.
• I’m using a lower cap rate rental property to run a more conservative model. We’re going from a 6.3 cap rate to a 5.8 cap rate. This means we’re less focused on finding a “really good” deal, but let’s see the results for finding a “good” deal.
• They can increase their monthly savings rate by $1,000/mo, because one daughter is no longer in daycare.
• Since they are refinancing their primary, they are open to refinancing their current and future rental properties. I’m NOT running scenarios on refinancing their primary beyond the initial refinance to pull out cash.

Starting Assumptions:

• Total starting cash remains the same: $166,463 for investing
  • 75% LTV refi: $111,463 ($483,750 refi amount – $372,287 current loan balance)
  • $55,000 from their current capital
• Total cash for real estate investing: $2,901/mo
  • $901/mo is the difference between their current payment and the new refi payment ($3,107 – $2,206). Let’s take the savings and apply it towards buying more real estate!
  • $1,000/mo current savings rate
  • +$1,000/mo from their daycare savings.

Scenario Details

We’re exploring three different scenarios to see which one is the best one for getting them to their $5k/mo and $10k/mo goals.

• #1 – Refi Primary, buy 10 rentals w/ $1,901 savings, 6.3 cap rentals – This is the “winning” scenario from the previous post. It was titled “Refi Primary, buy 10 rentals” but renamed for clarification purposes. It’s here for comparison purposes to give us a baseline. It uses the original assumptions.
• #2 – Refi Primary, buy 10 rentals w/ $2,901 savings, 6.3 cap rentals – This is a copy of the scenario above, except the monthly savings rate has been increased from $1,901 to $2,901. It’s using the better cash flowing rentals at a 6.3 cap.
• #3 – Refi Primary, buy 10 Properties w/ $2,901 savings, 5.8 cap rentals – This scenario has the updated monthly savings of $2,901/mo and buys lower cap rate properties at 5.8 cap.
• #4 – Refi Primary, buy 10 Properties w/ $2,901 savings, 5.8 cap rentals, rental refis – This scenario is the same as above, except it will run cash-out refinances on their rental properties WHEN there is enough equity and cash-out can help them buy their next rental. It’s assuming 2.5 points in refinance costs for closing costs and point buydown.

Scenario Results for $5,000/mo

The “#2 – Refi Primary, buy 10 rentals w/ $2,901 savings, 6.3 cap rentals” scenario wins. It’s the scenario with the highest savings rate and buying the better cash flowing properties. In real life, they’ll most likely be buying a mix of properties at different cap rates – some better cash flowing than others! The four scenarios achieve the $5,000/mo goal within two years of each other. Since the time frame is so close, we know the ballpark range of when they’ll hit their goal.

Scenario Results for $10,000/mo

The “#2 – Refi Primary, buy 10 rentals w/ $2,901 savings, 6.3 cap rentals” scenario wins again. I was curious to see how the “#4 – Refi Primary, buy 10 Properties w/ $2,901 savings, 5.8 cap rentals, rental refis” scenario performed since extracting equity from properties is a powerful way for accumulating more properties faster. Read on to see why it did not win.

Total Mortgage Debt on Rentals

Refinancing the properties did accumulate the 10 properties the fastest:

The “#4 – Refi Primary, buy 10 Properties w/ $2,901 savings, 5.8 cap rentals,
rental refis” scenario gets to the goal of 10 properties much quicker than the other ones, but it doesn’t achieve the $10k goal any quicker than a month. Financing the rentals does increase the overall mortgage debt on the portfolio.

The “#4 – Refi Primary, buy 10 Properties w/ $2,901 savings, 5.8 cap rentals,
rental refis” scenario peaks with a lot more mortgage debt than the other scenarios. I’m assuming 2.5 points to refinance, which is a little on the high side. In reality, it’ll be different for every refinance depending on numerous factors.

There are two important notes about this cash-out refi modeling:

1. I’m assuming a 2.5% cash-out refi expense. That is on the higher side, but many people buy the interest rate down. What are the real costs and interest rate buy-down at a future time and interest rate environment? It’s hard to model and predict as each property will most likely be different.
2. The model is refinancing properties if there is any equity below a 75% LTV threshold. For example, a few times it’s refinancing 5 rental properties where each property has $10,000 or less in available equity. It’ll pull out close to $50,000 (about $10,000 from each property). In real life doing a cash-out refi for that minimal amount of cash often isn’t worth the hassle and expense.

After running the model, I’d probably assume a lower cash-out refi expense to not buy down the points. Buying down the interest rate makes sense if you hold the loan long enough to get your return. If you’re refinancing again soon, it doesn’t make sense!

Conclusion

Do these two points mean you shouldn’t do a cash-out refi? No, it doesn’t. It is one limitation of the software and my ability to model with it. It’s a great example that you cannot blindly follow models. In real life, you would look at the available equity and see if it makes sense to or not. The punch line here is to keep an open mind to it and follow my advice of annually reviewing your equity opportunity costs.

There is not a huge difference in the timing of achieving the goals of $5k/mo and $10k/mo. One of the biggest factors in achieving the goals is the fact they are starting out with a good chunk of cash from refinancing and pulling cash out from their current primary residence. Everyone has read the stock investing articles that talk about the power of putting in money in your 20’s and how much money a 30-year-old person has to contribute to play catch up. It’s a similar concept here. The more money you invest in the market soon, the more returns and compounding effect you’ll see later on, especially when you look beyond just cash flow!

Personally, I’d move forward with pulling the cash out of my primary to start the process. It’ll take three to four weeks to complete the refinance to pull out the cash.

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