Explain the investment difference of leveraging equity versus cash for rentals

[onemorebike]

We are looking at our investment portfolio in the coming years and I need some of your wisdom.

We have found a place for the small amount of our post tax available cash in low-cost index funds. We put away a decent percentage pre-tax as well (also in low-cost index funds or target retirement date investments depending on options). I've been considering real estate investment (again, we were landlords a few years back but moved and I didn't want to manage a property remotely) but I'm hearing in a lot of places that it is much easier just to pour cash into index funds or REITs EXCEPT what I don't understand is why it wouldn't be beneficial to leverage the equity in my current home (I think I could fund the 20 percent down on 3 rentals over time with a HELOC) which is essentially cash that isn't really available to me in the index fund investment scenario.

What I can't wrap my head around is: 1) yes, index investing is great - when you have cash. 2) Why not leverage equity to put down 20 percent and borrow $$$ from the bank in order to make more money? Aren't you essentially creating cash flow in exchange for a low interest rate on a loan? I can't see why this wouldn't be a great approach.

Please. Tell me why I'm wrong, or what I should be cautious about.

Thanks for reading this far, looking forward to your expertise.

onemorebike

[Telecaster]

Never mind.  Didn't understand the question. 

[dandarc]

So you want to use the equity in your primary home to buy further-leveraged real estate. Assuming the real-estate cash-flows well, that is a decent enough plan - lots of people have done that.

But don't use a HELOC to do that - do a cash-out refinance on a 30 year fixed rate and get fixed rate mortgages on the rentals too if you go that route.

And it certainly is easier to just dump money into index funds or REITS compared to being a landlord. You'd have to decide where the cutoff is for you, but the level of effort is an order of magnitude or two higher with directly owning real estate, particularly at the beginning.

You could also do the refinance and put the money into REITS or mutual funds as well.

[Cwadda]

1) yes, index investing is great - when you have cash. 2) Why not leverage equity to put down 20 percent and borrow $$$ from the bank in order to make more money? Aren't you essentially creating cash flow in exchange for a low interest rate on a loan? I can't see why this wouldn't be a great approach.

A couple of things:

1) Investing in real estate still takes cash. It's not just 20% down, it's also closing costs + renovations. Also, the bank doesn't tend to give out a bunch of 20% mortgages for investment properties. They sometimes want 25% or 30% down.

2) This is true, but the caveat is that this only works if your cash-on-cash return provides a higher ROI than it would in an index fund. This means you annual rate of return, after factoring in all cash invested and expenses, should be 10% or higher.

• Cash invested includes your down payment, closing costs and short term repairs invested.
• Expenses include all Capital Expenditures, vacancies, property management fees (yes, this too), mortgage, taxes, insurance

If you're making over 10% annual ROI considering all of those, regardless of appreciation, it's worth it. Basically, it really boils down to the specific numbers.