Author Topic: how to use my home equity for real estate investment?  (Read 657 times)

mariettapeashoot

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how to use my home equity for real estate investment?
« on: March 02, 2021, 02:58:15 PM »
My husband and I are mid 40s, no debt other than our home mortgage, both making about $60k a year ($120k total) and saving about $40k annually. This is all to say, I feel like we have the basics of financial responsibility down. We are considered getting into real estate investing.

Our home is currently valued at $810 and we have a mortgage of about $275k so we have about $535k in equity (we live in Seattle where things have really boomed since we bought it 10 years ago). We are wondering if it would be smart to do something with all that home equity.

One option: Because of rezoning, we can build a second unit on our lot. I think that we could build a 1000sqft home for about $350k and rent it out for $3000/mo. I'm not sure how building a second unit would change the value of our home, but currently, similarly sized townhomes in our neighborhood are selling for about $700k. We are fine with having a smaller yard, having tenants nearby, etc. My main question is whether those numbers seem reasonable.

I'm specifically wondering if borrowing $300k against our primary residence is too risky. I know that we could buy a property in a less-expensive market as an alternative--if that seems like a better idea, I'm curious about advice for a more reasonable price point.

If the numbers do make sense, then any advice about how to best finance the construction? HELOC vs HEL?

I should also say that we are not really risk takers or looking to have a huge real estate portfolio. Mostly, we're just looking at all that equity in our home and wondering if there is a way to make it work for us.



uniwelder

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Re: how to use my home equity for real estate investment?
« Reply #1 on: March 02, 2021, 04:52:17 PM »
Regarding HELOC's, I can tell from personal experience, your credit score can take a significant hit until the loan is paid off.  It counts as 'revolving credit', like a credit card, rather than a mortgage or car loan.  Your credit utilization % would skyrocket if you used the full 300k line of credit, and that % makes up a big part of your credit score.  Supposedly going over 30% is bad, but resolves immediately once paid off.  I'm at about 45% right now and I saw a 50 point drop in my score once we got our heloc, but we'll be selling our house soon (paying it off) and moving into another house we already have a mortgage on.

On the other hand, getting a 300k HELOC and then using 100k for a down payment for a house might not affect your credit score at all, if I understand it correctly.

edited to add:  You had a posting 2 years ago, asking about finances.  In it, you mentioned your mortgage at 4.2% interest rate.  Have you refinanced since then?  If not, it could be worthwhile to do a cash out refinance, giving you a much lower rate (maybe saving 1.25%) and put that equity in your pocket.
« Last Edit: March 02, 2021, 04:59:46 PM by uniwelder »

waltworks

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Re: how to use my home equity for real estate investment?
« Reply #2 on: March 02, 2021, 08:19:43 PM »
If you are making $120k/year between the two of you, you probably can't qualify to extract that much equity given your existing mortgage. So step one would be to talk to a mortgage broker/your bank to see what you can actually get. I'd *guess* your max total loan balance would hover around $450k, so $175k more that your existing mortgage. That assumes no revolving debt/student loans/auto loans, etc and good credit.

-W

Paper Chaser

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Re: how to use my home equity for real estate investment?
« Reply #3 on: March 03, 2021, 04:18:16 AM »
$350k invested in the market with conservative 7% returns becomes $688k in 10 years and 1.34mil in 20 years. During that time, it requires no work, won't increase your property taxes or home owners insurance, won't increase the complexity of your income taxes, and requires no work. Also, it requires no work.

Personally, I don't know that I'd be pulling equity out of my primary residence for any investment while in my mid-40s. Having a paid off home is part of my retirement plan to keep my expenses low. That being said, if I were to pull out equity, I'd want it to result in the best performance possible and I'd have to really run the numbers on real estate to know for sure if that made more sense than simply putting it into the market and forgetting about it.
« Last Edit: March 03, 2021, 04:25:06 AM by Paper Chaser »

Dicey

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Re: how to use my home equity for real estate investment?
« Reply #4 on: March 03, 2021, 05:58:52 AM »
$350k invested in the market with conservative 7% returns becomes $688k in 10 years and 1.34mil in 20 years. During that time, it requires no work, won't increase your property taxes or home owners insurance, won't increase the complexity of your income taxes, and requires no work. Also, it requires no work.

... if I were to pull out equity, I'd want it to result in the best performance possible and I'd have to really run the numbers on real estate to know for sure if that made more sense than simply putting it into the market and forgetting about it.
100% this.

SndcxxJ

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Re: how to use my home equity for real estate investment?
« Reply #5 on: March 03, 2021, 07:28:40 AM »
Long before you need any money for construction you will need a set of plans and approval by the city or county.  If you like the idea of this you can always start by talking to a designer or even possibly an architect to draw a set of plans.  Generally speaking a from where you are now until when you might break ground is commonly a year, and you don't need big money until you start construction.  A set of plans might be in the $5,000-$10,000 range, and the costs by the city can be obtained by a quick phone call but you will probably find that only a small amount will be due upfront for them to review your plans and the balance is due when you actually pull the permit. 
You can always bail on the idea at any point.
All of these costs are tax deductible, and there will be tax benefits beyond the just rent for the second unit.  You probably shouldn't expect the second unit to garner as much as a condo, but look for two homes on one lot or possibly duplexes in your area as the best reference for after construction value of the property.
Ultimately my point being, it's far too early to even consider financing the project and you might find that when you actually need the money the interest rates are different than today.

ChpBstrd

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Re: how to use my home equity for real estate investment?
« Reply #6 on: March 03, 2021, 12:46:31 PM »
...I think that we could build a 1000sqft home for about $350k and rent it out for $3000/mo. I'm not sure how building a second unit would change the value of our home, but currently, similarly sized townhomes in our neighborhood are selling for about $700k. ...

The $3k/mo rental income is <1% of the $350k building expense, so as a rental it doesn't make sense per the 1% rule. You're close though, so maybe play around with those construction and rent estimates, and use the spreadsheet in a sticky post in the real estate and land lording section of this forum.

If you could borrow $350k and increase the value of your property by only, say, $550k because of the loss of yard, that would be the easiest tax-free $200k you ever let other people make for you. Do that, then immediately put your home on the market for 810+550= $1.36M. When it sells, pay off your 275+350= $625k debt, and take the $735k somewhere affordable. You could pay cash for about 5 houses in my area with that home equity. Or, if it works, repeat the process of adding an auxiliary housing unit on another Seattle property and walk away with another $200k profit.

In a LCOL area with a paid-for house, your cost of living would drop from $80k to $50k, at worst, so your 4% rule retirement number would become $1.25M. So you'd be 59% to FIRE based on home equity alone, with only about a half-million to go to FIRE. Check salary.com to see what your salaries would be (spoiler, they won't go down as much as the housing savings) and figure up a new savings rate and projected FIRE date.

mountainfamily

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Re: how to use my home equity for real estate investment?
« Reply #7 on: March 04, 2021, 12:16:57 AM »
In Seattle (not many other cities) you can actually build a 1000 square foot cottage, then use a "condo" designation to split the lot into A and B addresses, and sell the cottage separately! These little 1000 square foot houses go for 600-700k in some neighborhoods if they have good separation from the main house, i.e., a corner lot and their own yard/patio area. However, it costs about $300-400k to build if you have it done for you and the construction is usually paid for with a combination of cash and maybe a HELOC. I'm not sure about how easy it is to get construction loans for these. If you are a real DIY person you may be able to save money by using a service like U Build it and then managing your own project. My neighbor did this successfully with her primary residence (tear down and rebuild) but she is exceptionally organized/determined. The maximum HELOC you can get is $120k or so, I believe. In Seattle, plans/permits alone can take 6 months and cost over $25k. We've researched it for our Seattle property extensively, but aren't sure if it's worthwhile for our particular situation. Real estate is really high right now and there's not much buildable land left.

mariettapeashoot

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Re: how to use my home equity for real estate investment?
« Reply #8 on: March 04, 2021, 04:31:28 PM »
Thanks, everyone, for all the detailed feedback. (Extra points to uniwelder for cross referencing this question with my other posts!!). We actually recently refinanced our mortgage, so missed our option to do a cash-out refinance.

The questions you raised gave me some good next steps:
-I'm talking to a real estate agents to see how this would impact the value of our home/lot--and about whether we could subdivide the lot (thanks for mentioning that possibility, mountainfamily)
-I'm having someone come out to give me an estimate about building costs on our lot (part of what set this is motion is that there are now seattle-based companies that are doing backyard cottages with all steps included (you pick a model and they take care of the rest; for example, this one: https://mykabin.com/model/kenai-traditional/). My husband and I are happy to paint some walls or do some landscaping, but aren't interested in big complicated construction projects.

I did put some numbers into spreadsheet that chpbstrd referenced. Based on on some conservative numbers I put in, we could get an 8% cash ROI and, depending on what the value of the 2nd home would be, a 200% ROI (or more) when factoring in equity. (While we are staying in Seattle for the near future, moving to a LCOL area is part of our longer term plan).

If anyone has more advice or suggestions based on this additional information, I'm happy to hear it! Otherwise, I will come back with updates when I have more information from the real estate agent and builder.

Thanks everyone!

mountainfamily

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Re: how to use my home equity for real estate investment?
« Reply #9 on: March 04, 2021, 09:38:52 PM »
The MyKabin houses look interesting, and some are really cute. The set price is appealing. I've been talking with builders, architects, etc., and am unsure where I'd actually land with price, so it's a little hard to plan. Also, another consideration is that the two properties will share sewer --you need to see if your sewer line is big enough-- and there may be some excavating, tree work, etc. to prepare the site. So, it's hard to say whether the price would actually be accurate after all the other stuff.

If I were going to build a DADU to condo split sell to someone as their primary residence, I would probably pick a design with bike/tool storage or even a garage. These are not included in the city's 1000 square foot limit. I saw a cute one in Wedgwood with a two car garage. Those DADU cottages are as big as the uninsulated postwar cottages that are selling for 700k or more around here...

Dicey

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Re: how to use my home equity for real estate investment?
« Reply #10 on: March 04, 2021, 10:35:17 PM »
Thanks, everyone, for all the detailed feedback. (Extra points to uniwelder for cross referencing this question with my other posts!!). We actually recently refinanced our mortgage, so missed our option to do a cash-out refinance.

The questions you raised gave me some good next steps:
-I'm talking to a real estate agents to see how this would impact the value of our home/lot--and about whether we could subdivide the lot (thanks for mentioning that possibility, mountainfamily)
-I'm having someone come out to give me an estimate about building costs on our lot (part of what set this is motion is that there are now seattle-based companies that are doing backyard cottages with all steps included (you pick a model and they take care of the rest; for example, this one: https://mykabin.com/model/kenai-traditional/). My husband and I are happy to paint some walls or do some landscaping, but aren't interested in big complicated construction projects.

I did put some numbers into spreadsheet that chpbstrd referenced. Based on on some conservative numbers I put in, we could get an 8% cash ROI and, depending on what the value of the 2nd home would be, a 200% ROI (or more) when factoring in equity. (While we are staying in Seattle for the near future, moving to a LCOL area is part of our longer term plan).

If anyone has more advice or suggestions based on this additional information, I'm happy to hear it! Otherwise, I will come back with updates when I have more information from the real estate agent and builder.

Thanks everyone!
I only looked at that specific model. So much wasted space!  It looks designed to be built as cheaply as possible. In a small space, you want as much functionality as you can get.

PMJL34

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Re: how to use my home equity for real estate investment?
« Reply #11 on: March 05, 2021, 10:38:45 AM »
Dicey,

Curious, why do you think there's so much wasted space? I plan on doing an addition and that is almost the exact floorplan I will be doing at a slightly smaller footprint.

Dicey

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Re: how to use my home equity for real estate investment?
« Reply #12 on: March 05, 2021, 01:21:24 PM »
Dicey,

Curious, why do you think there's so much wasted space? I plan on doing an addition and that is almost the exact floorplan I will be doing at a slightly smaller footprint.
I'll give you more details later. I'm off for a birthday hike!

PMJL34

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Re: how to use my home equity for real estate investment?
« Reply #13 on: March 05, 2021, 07:38:59 PM »
Happy Birthday Dicey! Perfect weather today and hope your hike was too!