Posted by Mike on December 06, 2006 at 17:23:51:
Mike,
What a wisdom stream coming from you. I learned so much from this explanation.
Thank you and please keep up posting your input.
Collecting Equity - Posted by Bob Davis
Posted by Bob Davis on November 04, 2006 at 09:29:45:
I have had several rental properties for six or seven years and would like to know the easiest way to collect the equity they have generated and how often this should be done. I would like to do this without increasing my current mortgage amount. I’d like to know my different options before I confront my bank. Thanks
Re: Collecting Equity - Posted by Bill Jacobsen
Posted by Bill Jacobsen on November 04, 2006 at 13:47:31:
I think the easiest way is to get home equity loans but that increases the amount you owe. I am not sure I understand what you mean by, " I would like to do this without increasing my current mortgage amount." Does that refer to the amount being paid each month or the amount of total debt.
You could refi for greater amounts but extend the length of payment out to 30 years or more. You could do a combination of selling and refying to keep the mortgage amount the same.
I don’t know if there is a set rule for pulling equity out. I think it depends on what your long term plan is. I would pull equity out when it was enough to do what I wanted to do with the cash and the cost of doing so was not prohibitive.
Bill
Re: Collecting Equity - Posted by Bob Davis
Posted by Bob Davis on November 04, 2006 at 18:58:49:
Thanks for your response Bill. I am aware of equity loans, refinancing etc. I was just wondering how the guy in the Sheets infomercial who calls himself an “equity farmer” goes about doing this? He makes it sound simple, but then too, it is an infomercial. Thanks again Bill.
Re: Collecting Equity - Posted by Mike-BC
Posted by Mike-BC on November 12, 2006 at 19:28:27:
The equity farmer refinances the property on a regular basis. He keeps the mortgage principal constant.
He uses his apartment buildings for this. First, the property increases in value through mortgage pay-down. Typically, a 30 year mortgage pays down 2-3% per year. So if the property is mortgaged for $1,000,000, the mortgage would be paid down $40-60,000 over two years.
Secondly, apartments are valued using the income approach. By raising rents, the income increases and so does the value. Assume that the property is worth $1.2 million based on a net operating income of $100,000. This makes for a CAP rate of about 8.3%. By raising the rents each year, even by a minimal 3% per year, the NOI rises to $106,000 after two years. Based on 8.3% CAP rate, the property is now worth $1,277,000; an increase of $77,000 which can be taken out by refinancing keeping the principal amount of the mortgage at $1 million.
By combining the two increases, the owner can pull $97-117,000 out and keep the mortgage at $1,000,000.
He could go one step futher and mortgage the property for 80% LTV; 0.8 of $1.277 = $1.021 million, the extra $21,000 could also be added to the equity harvest.
Hope this helps.
Re: Collecting Equity - Posted by Ed
Posted by Ed on December 18, 2006 at 18:30:14:
Mike, thanks, I agree your post about "Equity Farming"is excellent. Is there any reasonable way that can be done with several smaller properties - say 5-6 rentals that together total 1 Million?
Thanks -
Re: Collecting Equity - Posted by Bob Davis
Posted by Bob Davis on November 14, 2006 at 19:34:34:
Thanks Mike. These farmers therefore have no wish to pay off mortgage, just take equity every few years. Is this right?? Do you think the equity growth will slow since the market has slowed and do you think this is a good way to invest, pros and cons?? Thanks again, Bob
Re: Collecting Equity - Posted by Mike-BC
Posted by Mike-BC on December 18, 2006 at 21:03:37:
Are your rentals in a single building or in one building? If rentals are one property, then this could be considered a commercial property and the income valuation would apply.
Let us suppose they are single family homes. Then each property would have to be considered individually. Many people take out home equity loans against their homes, and so can a landlord. If the property rises in value, the property can be refinanced and equity can be taken out.
Ex. Suppose a property rises, on average, in value 4% per year. If the property is worth $150,000 starting year one, then it would be worth $156k at the end of year 1 and $162+k at the end of year 2. If the property was financed for 120k (80% of $150k) at the the start of year 1 and the principal is paid down 3% per year, then the principal would be paid down to $116,400 at the end of year 1 and down to $112,800 at the end of year 2.
The property could be refinanced at the end of year 2 for 80% of $162k = $128k. The principal is $112,800, so you get to pull out $15k and use for your own purposes.
Wouldn’t it be wonderful if the RE market was that predictable! Many years, property values will appreciate more than 4%, and in some years property values will actually go backwards. When you own commercial properties, you can predict with a fair amount of accuracy, not so with SFH’s.
Re: Collecting Equity - Posted by mike-bc
Posted by mike-bc on November 15, 2006 at 13:01:50:
That is a correct observation…farmers are not as concerned with paying off mortgages as they would prefer to take out equity for buying more properties. Farmers are comfortable with debt, mostly because they have a proven and reliable income stream that will support it.
With respect to your question re: equity growth and slumping RE market - the RE market is not slumping in all areas, you are in the best position to determine your local market conditions. However, remember that commercial properties - those with 5 or more units, are valued using the income approach. If rents remain stable, then the income should remain stable hence, property value should remain stable.
Contrast this with single family residences which are valued on the comparable approach which is based on what a comparable house has sold for most recently. Prices are based on supply and demand. Thus SFH tend to be more volatile, prices will go up faster in times of high demand and will drop faster in times of low demand.
Which is better? I think you need to start with a plan, and part of that plan describes how you expect to make money on the deal. If you are starting out, I would recommend buying single family residences because these are probably what you are most familiar with. But remember to start with a plan on how you will make money with this property - do you plan rehabbing and reslling at a higher price? Buy, hold and rent, waiting for market conditions to improve and sell for a capital gain? Buy and rent for a monthly income stream?
Having recommended starting with SFH’s, don’t be afraid to buy a multi-family property if the revenue will justify the cost.
Mike-BC