Is 20% Equity TOO Much!?

[PEERless]

Some of you might have already suggested some ways for me to deal with my alligator. To recap:

• $175K, purchased with $35K (20%) in January @ 5.75%.
• $870 mortgage, insurance + $95 HOA - $800 rent = -$165 cashflow. :smxE:

I have now learned that 20% is a lot of equity for an investment property. I'm considering borrowing half of it and buying another property in the $175K range. Or two in the $87K range!

Can anyone help me analyze this idea with a formula of some kind? The variables I can think of are:

• The interest on the 2nd or HELOC.
• The interest on the new property (or properties).
• Standard cashflow analysis on the new property (or properties).

What else should I be considering? Thanks in advance!

 

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[Runum]

20% equity is too much in an investment property BUT that applies only when you're buying at some kind of discount. If you're buying anywhere near retail I don't see how you're going to get past 20% down. If you buy distressed properties you can work the financing where you don't have a lot of YOUR money into the deal. In your case you may have the property appraised and if it appraises high enough you may be able to take some cash out. However, if you get below 20% equity in the deal you will probably be required to pay PMI. Only you can make the call. I haven't ever paid PMI so I don't know what the rate for that is. Good luck.:cheers:

 

[I85]

Some of you might have already suggested some ways for me to deal with my alligator. To recap:

• $175K, purchased with $35K (20%) in January @ 5.75%.
• $870 mortgage, insurance + $95 HOA - $800 rent = -$165 cashflow. :smxE:

I have now learned that 20% is a lot of equity for an investment property. I'm considering borrowing half of it and buying another property in the $175K range. Or two in the $87K range!

Can anyone help me analyze this idea with a formula of some kind? The variables I can think of are:

• The interest on the 2nd or HELOC.
• The interest on the new property (or properties).
• Standard cashflow analysis on the new property (or properties).

What else should I be considering? Thanks in advance!

Do you not have any other funds to use as a down payment on another proprety? I'm not really the person to ask, nor listen to, but I would be worrying about adding debt to a property that is already taking money from you each month. Also, I would talk to your bank and see what they can even do for you for a heloc. What will the costs be, what will you need down on your next property etc.

If you don't have extra funds for a down payment, and do use a heloc, will you have sufficient funds to maintain this next property and the current one?

Is the current unit rented?

20% equity is too much in an investment property BUT that applies only when you're buying at some kind of discount. If you're buying anywhere near retail I don't see how you're going to get past 20% down. If you buy distressed properties you can work the financing where you don't have a lot of YOUR money into the deal. In your case you may have the property appraised and if it appraises high enough you may be able to take some cash out. However, if you get below 20% equity in the deal you will probably be required to pay PMI. Only you can make the call. I haven't ever paid PMI so I don't know what the rate for that is. Good luck.

Are you saying that 20% down is too much, or that having 20% equity is too much(or both)? I got kind of confused there. I can't really understand why having 20% equity would be such a bad thing. Having some equity seems like it would leave many more options for an exity strategy.

 

[Eric]

It can actually be broken down very simply...

There is a cost associated with acquiring half of your 20%. Depending on how you get that money (HELOC, refi, personal loan against property, etc), the cost of getting that money will translate into some % interest rate. For example, if you just take out a HELOC against the property, and withdraw half the equity (10%) at some interest rate, that interest rate is the cost of that capital.

To determine whether it's worth it to do so, you should be asking whether you can make more from that money than what it's costing you to acquire it. So, if the HELOC is charging a 10% interest rate, can you invest it in another property and earn more than 10% off of it?

To be fair, you could certainly do a more rigorous analysis using discount rates to determine net present value of the other investments, since the money you make later will be worth less than the money you make now, but to keep it simple, just compare the cost of acquiring the funds to the ROI you'd get from the funds.

Wouldn't another cost be the price of PMI since he would be dropping below the 20% equity mark?

Let me add a question here too... lets say a HELOC rate is at 10%, but he can only make 8-9% a ROI on that. Would it make sense to say that since you can use the tax write off on the HELOC, that it would cancel out the 1-2% loss on the investment?

 

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[MrPink]

"I have now learned that 20% is a lot of equity for an investment property."

I do not understand why you considered this to be a lot? Is it because you want more leverage?

 

[rcardin]

My thougts but they don't really count so just thinking out loud.

You put too much down on an investment property. 10% is the norm right now with a 700credit score.

On the flipside......35k down.... -165.00 a month investment. You are putting 165 a month into a retirement account (that already owns 35k equity) whether you want to or not. Will the appreciation offset the investment over the long run? Will it beat the mutual funds over the long run? Not my call but sounds like you may have to hold for 5-7 years to be a profit center.

 

[Bilgefisher]

In the interest of keeping this to one thread, I have a few questions along these lines.

I'll be purchasing an investment property(SFR) within the next 60 days. We currently have about 10%. Need the final 10% if placing 20% down. From what I am seeing and the professionals I have talked to, it is hard to skirt the 20% down right now.

-Option 1: Use the 10% we have plus use some of our credit line. Payback the credit line with a heloc in 6 months. I just don't know if thats feasible with the recent heloc freeze. My partner and I plan on putting extra cash in over the next 6 months to pay that off.

-Option 2: ATW suggested one way to get 20% is through a hard money loan. This would work, I just don't know how to pay off the hard money loan. The ones I have looked at require repayment within 6 months. This seems riskier and costs more. Again we would have to rely on a heloc.

-Option 3: Save for 6 more months to get the 20% needed. The down side of this, the area we are looking to invest deals are getting smaller and smaller.

Looking for suggestions. I don't think I can get to creative on the financing on these. This area was one of the hardest hit foreclosure areas in the country and most properties are bank owned or short sale.


I want to get in this area. The opportunity is excellent. The rents are around 1100 a month, the properties are around 100k. Most are worth 130k-190k. The market is artificially depressed right now due to the overwhelming number of foreclosures. The area is going through a major redevelopment and has a huge medical campus with 3 major hospitals. Currently the vacancy rate is at an all time low of 2%, but I used 16% vacancy(2 months) for my calculations. It still cash flows for $200/mo. This includes 3k a year maintenance. (I'm very conservative with my numbers). The high end it can cash flow for over $400/mo. Also, I have talked to a few landlords in the area and they are renting their places in 1-2 weeks with 1 month deposit right now.

 

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[PEERless]

YOU GUYS RULE!!! Thanks for all the help. In response...

20% equity is too much in an investment property BUT...If you're buying anywhere near retail I don't see how you're going to get past 20% down.

Yeah, I kind of figured there would be mortgage insurance involved, though I hadn't considered distressed vs. appraised values. Good idea for creating equity.

Do you not have any other funds to use as a down payment on another proprety?...Is the current unit rented?

I have some other money, but it's better spent retiring more expensive debts.

I am reviewing applications now.

...To determine whether it's worth it to do so, you should be asking whether you can make more from that money than what it's costing you to acquire it...

True. Using this analysis is hard with such a strange market outlook. Who knows? Then again, I'm under 25, so I have PLENTY of time to let the market cycle.

Would it make sense to say that since you can use the tax write off on the HELOC, that it would cancel out the 1-2% loss on the investment?

Because of the above, this seems too close to call.

The best way to do this (at least the best way I can think of), is to add up all the costs (fees, interest, loss of other income, etc), and amortize that over some fixed amount of time that you believe you'll be investing this income elsewhere. Then determine the equivalent APR associated with this loss over that period of time. Compare that APR (it's not really an APR, but the annualized percentage lost) to the ROI of the investment vehicle you're considering, and see which is bigger.

This is a very detailed solution, thank you! Unfortunately, the other investment vehicle I'm considering is still just imaginary. It takes some of the surety out of my analyses...

I do not understand why you considered [20%] to be a lot? Is it because you want more leverage?

Yes. I got razzed on this very forum for having too much equity.

You put too much down on an investment property. 10% is the norm right now with a 700credit score.

See?

 

[I85]

Have you thought about selling the current condo, even if it is at a loss?

 

[PEERless]

^ Mm... not really. I've only had it for 3 months. I bought it to hold it, so I don't want to lose my fortitude now. I realize that the negative cash-flow is ugly to some, but hey: the mortgage payment will stay the same while my rents will go up. I'll be profiting in no time.

...IF I don't go buy two more condos! Ha!

 

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[Eric]

^ Mm... not really. I've only had it for 3 months. I bought it to hold it, so I don't want to lose my fortitude now. I realize that the negative cash-flow is ugly to some, but hey: the mortgage payment will stay the same while my rents will go up. I'll be profiting in no time.

...IF I don't go buy two more condos! Ha!

Back to the tax write off thing... if you are loosing $165/Mo, thats $1980 a year. You could probably get all of that back and then some just by the tax deduction. So it might not be a loss at all.

I guess thats my way to see the glass half full..lol

 

[I85]

^ Mm... not really. I've only had it for 3 months. I bought it to hold it, so I don't want to lose my fortitude now. I realize that the negative cash-flow is ugly to some, but hey: the mortgage payment will stay the same while my rents will go up. I'll be profiting in no time.

...IF I don't go buy two more condos! Ha!

What if you were to sell the property and recoup $20k of your initial investment. Then use that $20k(plus 4k of savings) as a down payment on another similar property, only this time buying at 70% ltv. The cost would be (175k*.7)$122,500. 20% would be about 24k, leaving you with about 98K owed. I assume that the $15k loss(from the first property), can be used as a write off and end up saving you enough in taxes to hopefully pay all closing costs on the new property. (correct me if I'm wrong)

You may have "lost" $15k from selling the first property, but you still have the same property with only $4k more invested. However your principal balance is now 42K less, making your mortgage payment about $245 less per month.

This new place will cost you 4k out of pocket, however taking the negative cash flow you currently have...will cost you 3k-4k in the next 24 months as well.

You can spend that money over the next 24 months, or now. The only difference is, after those 24 months, one will be putting $245 more in your pocket every month.

By reducing your mortgage $245 it should take your cash into the positive range. Say over those 24 months you see a positive cash flow of $80/month(your negative 165+the $245 saving/month in mortgage payments), this puts almost 2k in your pocket.

By selling this place and getting a new one, you would have approx $2k out of pocket($4k extra out of pocket for new house-2k positive cash flow). If you keep your place you will spend about $3k-4K($1k-$2k more than if you were to trade into a property with more built in equity)over the next 24 months.
I would assume this small difference would be accounted for in tax benefits, but would the tax benefits make up for much more than that?

The way I see it is that either way you will be out the same amount of money after 2 years, the only difference is after 2 years property #2 would be making you an extra $245/month, $2940/year.

I have never believed in holding on to "bad inventory"(anything not making me money)in any business. However, I am completely new to real estate and know nothing about the tax benefits. I just don't understand how losing $100 will save me $150. Hopefully someone here knows a lot about the tax part and can add that to the equation.

This just an example with a bunch of "random" numbers, but I just wanted to try to show why losing money right now might not be the worst choice. Hopefully it made a little sense .

 

[lightning]

Yes. I got razzed on this very forum for having too much equity.

Peerless can you or someone else elaborate on this for me? Im not sure I understand why everyone is saying "too much" equity is a bad thing...

Although they originally pushed for me to bring 20% to the table, I put 10% down on my investment property because I wanted to stay as liquid as possible (and not WIPE OUT my bankt acount completely taking another 17k out for a down payment!). Because of this, I am forced to pay PMI and will have to do so ($120 a month) for the next 6 months until I have the property re-appraised, and can prove I have 20% equity or more in the place (NO problem at all as with my down payment factored in, I actually moved into the place with 20-30% equity). I was fortunate to get my place at well-below market-value.

Now, my confusion lies here; Why would having so much equity (as someone else said; a decent "exit strategy") be a bad thing? Isnt the whole point of paying down real-estate debt to get to the point where you have more equity, so that when you sell or "cash out" you can collect as much as possible from the appreciation?

Is it because I should be pulling as much money out of the property as possible to roll it into other investments? I just dont understand the downside to what everyone is saying... :coffee: It is true that the money is only on paper until you do sell the property, but I would think building equity across several houses at once gives you one helluva retirement plan as you mentioned correct?

Any info is appreciated!

 

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[Runum]

You want your money working for you as hard as you can get it to. Leaving equity in a deal is OK if you can't find a better opportunity for it. However, you have to position yourself to take advantage of opportunities before they present themselves. That preparation may mean taking on more risk(ie cashing out and having the money parked until opportunity knocks). It all depends on your goals and comfort level.

Basically, you have to know what you want out of your money and your investments. If you're getting what you want, you're OK. If your knowledge and desires change then you have to reassess whether your investments match your new goals.

From what I see the RE market is changing and not everyone is acknowledging it or understanding it. The loan requirements have gone up. Just last year I was still able to finance investment properties with 5% equity and no PMI. Now I see a few mortgage people that say they can do deals below 20% equity without PMI but I have yet to get one of those deals.

 

[MrPink]

Thanks lightning and rumum for flushing out more questions and answers to my earlier post (this may have been indirect, but were the issues that I also thought were interesting/worth considering - as well as others).

 

[PEERless]

if you are loosing $165/Mo, thats $1980 a year. You could probably get all of that back and then some just by the tax deduction. So it might not be a loss at all.

Explain that one to me: I can write off my mortgage payment?

What if you were to sell the property and recoup $20k of your initial investment...

Meh... It's a nice property and BRAND NEW. I have no doubt that I will make a hefty profit when I sell it decades from now. And that's my original plan: Buy and hold in an up-and-coming town.

Im not sure I understand why everyone is saying "too much" equity is a bad thing...

I think the fastlaners here were trying to tell me that if I can get the property for 10%, why use 20%. I could spread my money around. Have more properties. Have more diversity. Possibly get better return on another investment. (That's my understanding...)

You want your money working for you as hard as you can get it to. Leaving equity in a deal is OK if you can't find a better opportunity for it. However, you have to position yourself to take advantage of opportunities before they present themselves.

Right! That's the point of the game, Cashflow, right? Opportunities will keep coming up, but will you have the free capital to take them?

Thanks lightning and rumum for flushing out more questions and answers to my earlier post (this may have been indirect, but were the issues that I also thought were interesting/worth considering - as well as others).

Yeah! You guys have been really helpful. I am leaning toward leaving the money in the condo. BUT I retain the option to HELOC it if that one big opportunity comes along! :smxB:

 

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[randallg99]

equity is a very important element of my net worth and while i concur that utilizing that very equity is important for building net worth, it must be done with prudence. If anyone here has read another thread in the paper assets category, they will understand my philosophy about averting risk as much as possible.

my philosophy (which is nothing new to any of you): I pay down my debt as fast as I can and only within a few years all of my real estate attained at 40% equity positions at minimum.

my justification is simple after weighing the pros vs cons:

1. keeping the bank happy so if I find a deal, the bank will lend against this property as collateral without having to do a refi or heloc
2. increases net worth
3. once debt payments are eliminated, pure cash flow is created from the real estate
4. overextending can jeopardize cash flow

some people in the real estate investing arena are being nailed to the wall right about now because they became over leveraged and while this may have been the way to accumulating a lot of property, it creates the most risk while my way undoubtedly eliminates much of the risk in real estate investing.

 

[Eric]

Explain that one to me: I can write off my mortgage payment?

:

You can write off the interest that you are paying. Since you just bought the property, the first few years you will be paying mostly interest, so the write off is larger. Obviously as time goes by, and the less interest you pay, the lower this tax deduction is going to be, but by that time you should (hopefully) have a positive cash flow.

As of this year I think you can also write off PMI too.. double check that with your tax person though!

 

[PEERless]

^ Oh, right. That's true. My interest write-off is WAY more than my -$165 cash loss. Thanks.

 

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[I85]

You can write off the interest that you are paying. Since you just bought the property, the first few years you will be paying mostly interest, so the write off is larger. Obviously as time goes by, and the less interest you pay, the lower this tax deduction is going to be, but by that time you should (hopefully) have a positive cash flow.

As of this year I think you can also write off PMI too.. double check that with your tax person though!

Does this mean that he can only deduct the interest as an expense, or that he can deduct his full mortgage and then, after figuring the negative cashflow, he can write off the mortgage interest a second time to see a gain? I assume it would be the former and not the latter, but just wanted to double check.

 

[Eric]

Does this mean that he can only deduct the interest as an expense, or that he can deduct his full mortgage and then, after figuring the negative cashflow, he can write off the mortgage interest a second time to see a gain? I assume it would be the former and not the latter, but just wanted to double check.

Im not a CPA, so check with your tax person on this. From my understanding, you can only deduct the interest. I highly doubt the IRS will let you take a double write off on the interest.

On a side note, you might be able to claim the loss each month as a added deduction, but again don't take this as advice. Contact your local tax agent.

 

[PEERless]

LOLZ! You guys are awesome! Thanks.

 

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