Author Topic: Cash out part of primary residence to pay in cash for a 2nd rental?  (Read 1409 times)

kevj1085

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Current situation...

Age 34
1 paid off rental valued at $265k bringing in $1250/mo
1 primary residence with $60k left to pay off valued at $370k

Goal-
Get 2 more rentals paid off with hopes of eventually getting $4500 in monthly income.

My friend suggested I take out the amount needed FROM our primary residence to pay cash for a 2nd rental property, and then be getting $1250 from 1st rental and (hypothetically) something like $1400 from 2nd rental. Once we get out of this pandemic, that could place me 2/3 of the way to my goal immediately.

Here's my only issue...I kind of have a "safety/pride" issue regarding really really wanting to pay off my primary residence. The idea of freeing up something like $1300 in what is now going towards our principal seems almost like an equal win as well, not to mention it greatly increases our safety of housing. However, it does mean another probably 1-2 years before even having just a decent 20-25% down payment on a 2nd rental.

So, I'm curious which one you all think sounds better?
« Last Edit: April 14, 2020, 07:47:55 AM by kevj1085 »

Jon Bon

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #1 on: April 14, 2020, 07:57:16 AM »
Well since you asked, I see quite a few things wrong with this plan.

First of all I would not follow your friends advice even a little bit.

Second, your rental. 1250 a month on a 265k house? Is that net or before expenses? If it is total revenue that is pretty poor performance. How much do you net after expense, insurance, taxes etc? $800 a month? That is a ~4% return with a ton of risk and likely a fair amount of work. Even if that is a net number you still are only getting 6% return.

Third, borrowing against your house why exactly? Just borrow against the new rental house. Why should you hold the debt for your business? Make the business hold its own debt. Just get a regular loan on the rental house. Then you can at least expense the interest that you paid.

This is a bad plan. You have way to much value locked up in that rental house getting a terrible return. Sell the rental house, get a bunch of cash then buy whatever (better) rentals you want.

For instance I have a ton of equity in my primary and my rental. I am going to pull some cash out of the rental for the tax benefit as well as the security of a mostly paid off primary residence. Money is so cheap right now its almost better to have a mortgage on a rental.


kevj1085

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #2 on: April 14, 2020, 08:09:57 AM »
$1250 is what we keep after everything. Also we bought the rental for $132k back in 2011 and it is now worth $270ish.

Also we go through a property management company that takes I think about $90/mo.
« Last Edit: April 14, 2020, 08:12:00 AM by kevj1085 »

rulesofacquisition

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #3 on: April 14, 2020, 09:09:25 AM »
Warning - rank amateur here - in the fall of 2018 I found a rental that looked good in a very low COL area for $40,000 ($550 rent) while I was visiting relatives (which meant they are in the area and are capable of most repairs) and bought it. The day after my offer was accepted and we got home I got a call from my local realtor about a $160,000 duplex ($1,645 in rent/month). I didn't have money for both the cash deal and a 25% down payment, so I pulled the money from my primary residence (which had about $80k owed on it before this). I will say that I have a paid off inherited house that I could live in that makes this a little less scary in case everything really went to shit.

sammybiker

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #4 on: April 14, 2020, 09:49:06 AM »
@kevj1085 I would probably also leverage the paid off rental home as @Jon Bon mentioned vs your primary residence but your primary residence will be a better rate...so it all depends on your risk tolerance.

I would also just make sure you're getting some equity in these rental homes by paying cash and taking advantage of the market conditions to scoop up some deals and then refi them into long term super low interest debt.

Just make sure you feel secure with your employment/cash reserves/everything right now.  I'm hoarding cash right now vs looking for deals, obviously your situation appears different, so that's good.  Just run the numbers and worst case scenarios, as I'm sure you will.

Jon Bon

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #5 on: April 14, 2020, 11:06:00 AM »
$1250 is what we keep after everything. Also we bought the rental for $132k back in 2011 and it is now worth $270ish.

Also we go through a property management company that takes I think about $90/mo.

Ok that makes a bit more sense. I would much rather have a paid of primary then a paid off rental. If nothing else for the tax benefit as well as the peace of mind.  I am sure you are familiar with the 1% rule, but with 100% appreciation on a rental it might be time for a 1031 exchange anyways?

Not to mention 1250*12/265k = 5.7% not a great return for that much risk.

I would not take money out against my house when you can do it against rentals. But that is just me. The ~.25% difference in rates is not worth it to me.

Dare2Dream

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #6 on: April 14, 2020, 12:28:11 PM »

The consensus thought among RE investors would be to take the cash out of your primary and invest in additional rental units.  In the end it would provide the highest ROI

That being said as much as I would love to cash out refi my primary and take the $100k for rentals I will not.  There is something soothing about having your primary paid off and being able to live on $4k a month instead of $6k a month if you "Aspire to FIRE"

kevj1085

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #7 on: April 14, 2020, 02:46:29 PM »
Let me ask you this though. If we only paid $132k for the rental and are making $1250/mo off it take home, is that not 11.3% return on our original investment? I'm still so new to all this despite being a landlord for 6 years lol.

dandarc

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #8 on: April 14, 2020, 02:56:12 PM »
Let me ask you this though. If we only paid $132k for the rental and are making $1250/mo off it take home, is that not 11.3% return on our original investment? I'm still so new to all this despite being a landlord for 6 years lol.
Your original investment doesn't mean shit today.

dandarc

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #9 on: April 14, 2020, 02:57:59 PM »
That was perhaps a little harsh. You've got $265K less possible transaction fees tied up in this investment. You're making $1250 per month in actual cash flow - 6% annually. You're betting on appreciation with this property because the cash flow is not good enough to have that much tied up in it.

What you paid 6 years ago is little more than trivia at this point in time. Were you making the $1250 since day 1? If so, seems you have not been increasing rent much - why not?

kevj1085

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #10 on: April 14, 2020, 03:02:15 PM »
Yeah, we haven't increased it on them in 5 years. They have been good, reliable, not much fuss about anything. I finally increased it $50 this year as the property management company fees went up some so I was essentially making a little less each year to accommodate them. I could realistically rent it out for about $16-1700 as that's what other comparatives are going for, but I just have enjoyed the steady consistent pay.

joleran

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #11 on: April 14, 2020, 03:06:15 PM »
Let me ask you this though. If we only paid $132k for the rental and are making $1250/mo off it take home, is that not 11.3% return on our original investment? I'm still so new to all this despite being a landlord for 6 years lol.

Lots of ways to calculate returns, but in this case you could theoretically sell the rental and purchase some other asset, so the current value of the asset makes the most sense when evaluating other potential investments.

You are still depreciating and deducting expenses such that the 5.7% is somewhat tax free.  It's not great returns for real estate, but for non-leveraged real estate it's at least lower risk than having the same house with a mortgage and may just be the economic environment of the local area (some just aren't very good for high returns).

If you mortgaged 75% of it at 4.5%, you'd have a bunch of deductible mortgage interest and have 200k to go invest elsewhere.  You'd have to do the rest of the math there to see what makes sense.

Yeah, we haven't increased it on them in 5 years. They have been good, reliable, not much fuss about anything. I finally increased it $50 this year as the property management company fees went up some so I was essentially making a little less each year to accommodate them. I could realistically rent it out for about $16-1700 as that's what other comparatives are going for, but I just have enjoyed the steady consistent pay.

Is this an investment or are you just playing landlord?  That doesn't even pass the fair market rent test if you rented to a relative. 

kevj1085

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #12 on: April 14, 2020, 03:21:48 PM »
The area of our rental is a VERY hot area. Booming and safe area. I just figure I'll start raising it slowly over the next few years to make it up to the local market and once or if the current renters ever move, I'll put it back up for what it is actually worth. And yes it is an investment, I've just felt good with the consistent income and haven't tried to become too stingy, knowing I could also easily make more off it if need be.

When I asked our property management company back in December if they thought it was okay for me to raise rent by $50 they said they were shocked I hadn't raised it by $400 or more lol.

dandarc

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #13 on: April 14, 2020, 03:28:07 PM »
Maybe I'm misreading your post, but how are you netting $1250 per month if the rent is not already at least $1600 / month?

Don't you have to pay for property taxes, insurance, maintenance and repairs out of that rent? And you're paying a property manager. Are you accounting for things like "probably need to replace all the carpet and paint whenever these people leave?" Or replace roof every 15 to 25 years?

There's a ton of irregular expenses when you own a house - we had one summer where we wound up spending $10,000 because the 60 year old sewer pipe and not nearly as old HVAC systems both reached the end of their life at almost the same time.

Maybe your market is very different than ours, but our house that we live in is worth $170K according to Zillow and we'd probably be able to rent for $1200 at most, we have more than $350 per month in expenses, even low-balling the irregular stuff. When rented out taxes and insurance alone are almost $250 per month. Living in the house taxes are quite a bit lower due to homestead exemption.

We did rent it out for 17 months recently - made little to no sense on financial terms, but we knew there was a high probability of moving back in 12-24 months. So for us, the benefit was "have house we know we like to move back into", not "making a good return".

I get the feeling you did not buy this house with the intention of renting it out - is that true?

kevj1085

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #14 on: April 14, 2020, 04:21:56 PM »
HOA and taxes are paid by my parents from a fund they have for us. The rent is something like $1350 and we keep $1250. So technically yes the repairs and such will come out of that $1250 or whatever we make from work. This past year we had zero repairs, and minimal before that. The house was built in 2007. I know things still happen but that's the picture thus far.

ketchup

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #15 on: April 14, 2020, 05:08:18 PM »
HOA and taxes are paid by my parents from a fund they have for us. The rent is something like $1350 and we keep $1250. So technically yes the repairs and such will come out of that $1250 or whatever we make from work. This past year we had zero repairs, and minimal before that. The house was built in 2007. I know things still happen but that's the picture thus far.

I know it's not what you want to hear, but you are not getting much of a return at all on this house.  I remember seeing a breakdown someone did that factored in replacing all big ticket items (hot water heater, roof, HVAC, etc.) and that landed at an average of $238/month/house minimum (and he was trying to make it a small number).  That's not including repairs or improvements.  Let's pretend that brings your monthly profit down to $1000.

What are your property taxes and HOA fees?  Those are eating out of your $1000/month that's left.  Same with insurance.  If we pretend by some miracle those and repairs combined are less than a long-term average of $500/mo ($6000/year), that puts you at only $500/mo ahead.  $6k/yr on a $265k asset means you're looking at a 2.2% real return.  Not good for real estate.

I know I hand-waved a lot of numbers.  Feel free to plug in your own.  But this doesn't look like a winning rental on the back of the envelope.  It "feels" like a winner because it's paid off and you don't have maintenance coming home to roost yet, so your present cashflow is high.  I'd say you need to either raise your rent substantially if your market bears it, or realize your appreciation gains and cash that sucker out soon.  I think you said you owned it six years?  $132k->$265k in six years is a 12.3% IRR on just appreciation.  You already won!

When I asked our property management company back in December if they thought it was okay for me to raise rent by $50 they said they were shocked I hadn't raised it by $400 or more lol.
There's a reason for that.  You're losing money by not renting it out at market rate.  Everywhere I've ever rented has raised the rent each year (as have I with rental properties).  The only exception is my current house (long story but it makes total sense, it's a 100+ year old farmhouse in bad condition that nobody wants to live in - not at all your situation).  It's what every investor does - price at market rates.  If you want to "be nice," donate to charity.  Would you hand your tenants $400/month cash?  You already are.  If you want to have a decent investment, rent at market rate.

2.2% on an illiquid higher-risk asset is not something I'd stick with.  That's inflation if you're lucky.  Juice that return somehow, or take your cards home and sell.

EDIT: If this comes off as super harsh, I apologize.  I'm a nice guy, I promise. :D

Papa bear

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #16 on: April 14, 2020, 05:27:00 PM »
Ok. You should post actual numbers on your rental and we can evaluate.  We’re making a lot of assumptions here on this, and I definitely think you are too.  You do have a lot of equity tied up in that rental and your return on equity (ROE) is pretty garbage compared to other real estate. 

That’s not to say that your initial return on investment (ROI) wasn’t fantastic - based on the appreciation, it likely was great!  That makes it a good candidate to either 1) sell and 1031 exchange into something better, or 2) borrow against the equity to buy something else.  Your return on equity increases with leverage, AND you can get another 1-2 rentals.  Careful about the “house of cards” with leverage though.

Anyway, I’m not a huge fan of borrowing against your primary for rentals.  From a tax perspective, I believe you can still expense the interest from the primary residence that was used for the rental.  Money is fungible, doesn’t matter where it came from.  But you would definitely need to talk with a tax expert on this.  So, straight math says borrow against your primary, but I think that takes on unnecessary risk on your living situation.  I have each rental with it’s own mortgage.

What are some rentals that are available in the area? Can you post some numbers of ones you’re looking at? We’ll nitpick the shit out of them for you.  Your overall plan is fine. Rentals are awesome. You just need to dig into the numbers a LOT more and start treating it like a business to maximize your money. 


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Dicey

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #17 on: April 24, 2020, 12:29:23 AM »
Age 34

Here's my only issue...I kind of have a "safety/pride" issue regarding really really wanting to pay off my primary residence.

HOA and taxes are paid by my parents from a fund they have for us.
I can't even...

FatFI2025

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #18 on: May 03, 2020, 09:29:08 AM »
I'd lever your rental property before tapping into your primary residence equity, especially if you value having your home paid off (I don't). I agree with other posters that your CoC return for your existing rental is probably not very good. But I also wouldn't sell it. I'm guessing its >=Class B property and if you have a rental with long-term tenants and decent management, hold on to it. To make it perform better for RoE, I'd refinance out 75% of the equity and use that to invest in rentals elsewhere. Also increase the rent a little bit every year, but make sure your tenants know that you're keeping it below market because they're great tenants. IMO taking up to 10% below market is reasonable to keep high quality, long term tenants, but unfortunately you've slipped past that point.

When people talk about target CoC returns of 10%+ that's coming from Class C properties. And those are just higher risk. Destructive tenants, rent delinquencies, and high turnover.

I'm happier with a low-maintenance B+ property kicking off 6% CoC / 12% IRR than I am with a C property doing 10% CoC / 20% IRR. So for that reason I'd keep your easy rental and just pull some cash out to buy more.

dandarc

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #19 on: May 03, 2020, 10:42:07 AM »
So for that reason I'd keep your easy rental and just pull some cash out to buy more.
Did you miss the part where the reason the rental is easy is "parents paying HOA and taxes?" I personally would feel even more responsibility to run this business better if it is largely financed by my parent's money.

Dicey

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #20 on: May 03, 2020, 11:15:22 AM »
So for that reason I'd keep your easy rental and just pull some cash out to buy more.
Did you miss the part where the reason the rental is easy is "parents paying HOA and taxes?" I personally would feel even more responsibility to run this business better if it is largely financed by my parent's money.
Yeah, the OP hasn't updated (or posted anything anywhere else on the forum) since April 14th...

SeaWA

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #21 on: May 03, 2020, 12:07:20 PM »
So for that reason I'd keep your easy rental and just pull some cash out to buy more.
Did you miss the part where the reason the rental is easy is "parents paying HOA and taxes?" I personally would feel even more responsibility to run this business better if it is largely financed by my parent's money.
Yeah, the OP hasn't updated (or posted anything anywhere else on the forum) since April 14th...

Replying to get notices on this thread. I'm interested.

This thread on pulling money from a primary to buy a rental hit the top of the Landlord forum at the same time as my own thread on pulling equity from a rental to buy a primary.

After reading these responses I wonder how much more I can optimize. I don't have parent paying for anything, but I am not near the 1% rule.

Dicey

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #22 on: May 03, 2020, 12:34:32 PM »
So for that reason I'd keep your easy rental and just pull some cash out to buy more.
Did you miss the part where the reason the rental is easy is "parents paying HOA and taxes?" I personally would feel even more responsibility to run this business better if it is largely financed by my parent's money.
Yeah, the OP hasn't updated (or posted anything anywhere else on the forum) since April 14th...

Replying to get notices on this thread. I'm interested.

This thread on pulling money from a primary to buy a rental hit the top of the Landlord forum at the same time as my own thread on pulling equity from a rental to buy a primary.

After reading these responses I wonder how much more I can optimize. I don't have parent paying for anything, but I am not near the 1% rule.
Generally, its considered bad form to post a question and then ghost your own thread.

There are a lot of super helpful people here. Start your own thread with your specifics and you will get a lot of help that's relevant to your exact situation.

SeaWA

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #23 on: May 03, 2020, 01:40:40 PM »
Replying to get notices on this thread. I'm interested.

This thread on pulling money from a primary to buy a rental hit the top of the Landlord forum at the same time as my own thread on pulling equity from a rental to buy a primary.

After reading these responses I wonder how much more I can optimize. I don't have parent paying for anything, but I am not near the 1% rule.

Generally, its considered bad form to post a question and then ghost your own thread.

Is this directed at me or OP? I haven't done that.

There are a lot of super helpful people here. Start your own thread with your specifics and you will get a lot of help that's relevant to your exact situation.

As per my comment, I'd already done that.

I'll stop replying on this thread, so it doesn't get off topic.

FatFI2025

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Re: Cash out part of primary residence to pay in cash for a 2nd rental?
« Reply #24 on: May 03, 2020, 02:44:01 PM »
So for that reason I'd keep your easy rental and just pull some cash out to buy more.
Did you miss the part where the reason the rental is easy is "parents paying HOA and taxes?" I personally would feel even more responsibility to run this business better if it is largely financed by my parent's money.

By "easy" I meant that s/he has  long-term tenants and low maintenance. Contrast that with a property cash-flowing 10% with two evictions in the past year and a $20K annual repair bill.

I don't think that OP's family "fund" contributions should be excluded from the financial analysis for the property, that's for certain, but I'm also not going to give OP shit about having family money. It's still a legit business financing question.