Should Real Estate Investors Leave Equity in Their Properties?

If you are a real estate investor and have one or more rentals you’ve accumulated over time, there’s a good chance you have a good amount of equity in at least one of your properties – maybe even your primary residence. You might feel happy that you have a lot of equity but from an investment point of view, you could be making more money — potentially A LOT more — if you pull out some of that equity to re-invest it rather than leave it in the form of equity for an existing property. Compare the following two scenarios.

Scenario 1

Let’s say you have 3 properties. One is your primary residence which you live in and are not renting out. The other two are rentals.

Current ValueEquityRental Income
(monthly)
Primary Residence$1,000,000$600,000$0
Rental 1 (townhouse)$750,000$650,000$2,500
Rental 2 (triplex)$590,000$100,000$4,820

Appreciation

Now, let’s estimate the value + appreciation on each property per year over 10 years. The average annual appreciation rate in California is 6.77%. We can easily calculate the appreciation using the calculator at

https://www.ddginc-usa.com/cgi-bin/apprec.php

In the last row, we see the total appreciation over 10 years.

YearPrimary ResidenceRental 1Rental 2
1$1,067,700$800,775$629,943
2$1,139,983$854,987$672,590
3$1,217,160$912,870$718,124
4$1,299,562$974,671$766,742
5$1,387,542$1,040,657$818,650
6$1,481,479$1,111,109$874,073
7$1,581,775$1,186,331$933,247
8$1,688,861$1,266,646$996,428
9$1,803,197$1,352,398$1,063,886
10$1,925,273$1,443,955$1,135,911
Diff$925,273$693,955$545,911

Rental Income

Now, let’s estimate the annual gross rental income and per year over 10 years. For simplicity, and to be conservative, we’ll keep the monthly rent fixed (we’ll never increase the rent), although in reality, in California you can legally increase the rent by at least 5% per year. In the last row, we see the total gross rental income over 10 years. Of course, you’ll have expenses like debt service (paying your mortgage), taxes, operational costs, etc which will reduce this total rental income.

YearPrimary ResidenceRental 1Rental 2
100$0
20$30,000$57,840
30$30,000$57,840
40$30,000$57,840
50$30,000$57,840
60$30,000$57,840
70$30,000$57,840
80$30,000$57,840
90$30,000$57,840
100$30,000$57,840
Total0$270,000 $520,560

Total Return on Investment

Now, if we add the appreciation and rental income minus expenses over 10 years, we’d get our total return on investment (ROI). But, since expenses vary from one property to another, to be conservative and keep things simple, we’ll just look at the total appreciation.

Over 10 years, our investments will have appreciated by $2,165,140.

Now, let’s compare this to another scenario where we do cash-out refinance and reinvest the money in more rental properties.

Scenario 2

In this scenario, we decide whether to do cash-out refinance for each existing property.

Primary residence

For the primary residence, we won’t refinance it and take cash out because doing so would increase the mortgage and since it’s not a rental, you’d have to pay for that increase yourself. Of course, if you can afford it, you could also do a cash-out refinance on that property as well, but it’s not a good idea to spread yourself too thin.

Rental #1

For rental #1, we do a cash-out refinance to pull out 75% of the equity. In doing so, our monthly mortgage pay for that property will go up but if you plan it correctly, your income will cover your new expenses, especially if your previous loan would be paid off in, say, 10 years, and you refinance to 30 years which would lower your monthly payments despite having borrowed more money.

Rental #2

For rental #2, there isn’t enough equity in the property so we can’t refinance it.

Current ValueCurrent EquityCash-out refi
75% of value
New Equity
Primary Residence$1,000,000$600,000No refi$600,000
Rental 1$750,000$650,000$562,500$100,000
Rental 2$590,000$100,000No refi$100,000
Total$562,500

According to the table above, we’re able to pull out $562,500 from Rental #1 which we’ll use as a down payment to purchase more rental properties. Let’s say we buy 4 duplexes at $500,000 each and we put down 25% (standard for investment properties) which is $125,000 for each. That leaves us with $62,500 for closing costs and some home improvement. We’ll estimate the rental income for each duplex is $3500 per month.

Current ValueEquityRental Income
(monthly)
Rental 3 (duplex)$500,000$125,000$3,500
Rental 4 (duplex)$500,000$125,000$3,500
Rental 5 (duplex)$500,000$125,000$3,500
Rental 6 (duplex)$500,000$125,000$3,500

Appreciation

Now, like in scenario 1, let’s estimate the appreciation over 10 years.

YearRental 3Rental 4Rental 5Rental 6
1$533,850$533,850$533,850$533,850
2$569,992$569,992$569,992$569,992
3$608,580$608,580$608,580$608,580
4$649,781$649,781$649,781$649,781
5$693,771$693,771$693,771$693,771
6$740,739$740,739$740,739$740,739
7$790,887$790,887$790,887$790,887
8$844,431$844,431$844,431$844,431
9$901,599$901,599$901,599$901,599
10$962,637$962,637$962,637$962,637
Diff$428,787$428,787$428,787$428,787

Rental Income

Now, like in scenario 1, let’s estimate the annual gross rental income and per year over 10 years.

YearRental 3Rental 4Rental 5Rental 6
1$42,000$42,000$42,000$42,000
2$42,000$42,000$42,000$42,000
3$42,000$42,000$42,000$42,000
4$42,000$42,000$42,000$42,000
5$42,000$42,000$42,000$42,000
6$42,000$42,000$42,000$42,000
7$42,000$42,000$42,000$42,000
8$42,000$42,000$42,000$42,000
9$42,000$42,000$42,000$42,000
10$42,000$42,000$42,000$42,000
Total $420,000 $420,000 $420,000 $420,000

Total Return on Investment

Now, let’s calculate the total ROI. Again, to be conservative and for simplicity, we’ll just consider total appreciation even though we know the total ROI will be much more than that since every month for 10 years we’ll be paying down the mortgage using the rental income which increases our equity in each property.

The total appreciation over 10 years in scenarios 1 and 2 are

  • Scenario 1: $2,165,140.
  • Scenario 2: $2,165,140. + $1,715,147 = $3,880,287.

Therefore, using a very conservative estimate, we could make an additional $1,715,147 over 10 years if we refinanced and reinvested the equity in our existing properties.

What to do after 10 years

Let’s say you hold on to the properties for 10 years. You’ll most likely have a mortgage on all or some of properties. At that point, you could choose to sell some of the properties to pay off all of your mortgages and live mortgage free! You’ll still be getting rental income from the remaining rental properties which may even amount to as much or more as your work income from a day job in which case you could choose to just retire and travel the world.

Measuring Water Usage in a Multifamily Building

If you own a multifamily investment property which you are renting out to 2 or more tenants, you’ll probably be disappointed to find out that there’s only one water meter (provided by the city) to the entire building located underground under the sidewalk. Following are some scenarios on how water pipes reach each unit and how to possibly measure each unit’s water usage.

Separate cold water pipes

Even though there’s only one water meter under the sidewalk, it’s possible that the downstream water pipe after the meter branches into multiple pipes, one for each unit, thereby creating multiple cold water networks If this is the case, then you’re in luck and you can install a water meter, e.g. Badger Model 25 or Neptune T-10 at each branching water pipe.

Shared cold water pipes, separate hot water pipes

If the cold water pipes from the city’s water meter go to all units in a shared manner, then it would be very difficult to measure water usage by unit. However, if each unit has its own hot water pipes that are not shared with other units, which would be the case if each unit has its own hot water heater, then you can measure hot water usage by installing a water meter at the cold water inlet to or the hot water outlet from the water heater.

Billing each unit for water

Usually there will be one water bill for a multifamily property. Since there are multiple tenants, you’d need to fairly split the bill among them based on each unit’s water usage.

Based on headcount

If both hot and cold water are shared among all units, then one common method is to bill each unit proportionally based on headcount (number of occupants). If one unit has twice as many people living in it as another, then that unit would pay twice as much for water. Of course, headcount can change over time so this would need to be updated whenever there is a change.

Based on hot water usage

If cold water is shared but hot water is separate, then you can split the water bill proportionally based on hot water usage. This would be more accurate that going based on headcount.

Water meters

Following are some popular water meters for residential use.

Badger Model 25

This meter has plastic threads and costs about $100.

Buy online – RC Worst

Buy online – QC Supply

Neptune T-10

This meter has metal threads and costs about $100.

Buy online

Smart Water Meters

The water meters above are manual read meters. To measure water usage remotely and see usage over time, you can buy a smart water meter. One of the best ones is Flume 2.

Flume 2 Smart Home Water Monitor

This smart water meter does not require plumbing as it is just attached or strapped around a compatible water meter. It costs $200.

Buy online

The Flume water monitor just straps onto an inline water meter. It reads the magnetic field generated by your water meter, which the company says can detect any water usage all the way down to one one-hundredth of a gallon — i.e. a slowly dripping faucet.

Recessions, Home Prices, Unemployment and Inflation

When an economic recession occurs, one thing that happens for sure is the unemployment rate goes up. You can see a graph of the California unemployment rate since 1967 on the St. Louis Federal Reserve Bank’s website. Below is a copy of that graph until 2019-01-01.

The shaded areas indicate a recession. As you can see, the unemployment rate has jumped up during each recession. Logically, as unemployment goes up, incomes go down since fewer people are working. Following is the graph of real median household income in California over the years.

So how do you know when a recession will occur. It turns out that the best indicator of a recession is when the Treasury Yield Curve inverts.

Continue reading Recessions, Home Prices, Unemployment and Inflation

How to Price Work in Other Countries

I occasionally use Upwork (formerly eLance) to hire contract workers in other countries to work on some projects. Considering that I live in the San Francisco Bay Area, which happens to be one of the most expensive places to live, I have to constantly remind myself to price my projects according to the economy and cost-of-living where I hire workers overseas. Here’s an example cost analysis.

US Cost
Let’s say that, based on the type of work you need done, a fair US wage would be $10 per hour. Let’s also say that you expect the work should be done in no more than 17.5 hours. Therefore, the total project cost in the US would be $175.

Target Country
Let’s say you hire someone in Egypt to do the work. You’ll need a way to fairly and reasonably convert wages in the US to wages in Egypt. One way to do this is by comparing each countries GPD per capita, which is an estimate of the average salary in a particular country.

GDP Per Capita
According to the World Bank, as of July 6, 2018, the GDP per capitas of the US and Egypt are:

  • 2018 US GDP per capita = ~ $60,000
  • 2018 Egypt GDP per capita = ~ $3,000

https://goo.gl/wG6AAd

In other words, the average annual salary in the US and Egypt are $60k and $3K, respectively.

Continue reading How to Price Work in Other Countries

Invest in Real Estate or Stock Market

Average rate of return:

ROI based on own money or borrowed money:

  • If you invest $100,000 in stocks, with a 10% ROI, you’ll get $10,000 at the end of year 1.
  • If you invest $100,000 in real estate (20% of a $500,000 house), with a 10% ROI, you get $50,000. Your ROI is based on a lot of money you’ve borrowed from the bank, not just the initial deposit.

Of course, you can also borrow $500,000 and dump it all into buying stocks but

  1. no one will lend you $500,000 to invest in stocks
  2. stocks are volatile and investing in them is more risky
Continue reading Invest in Real Estate or Stock Market

How to Find and Research (Pre) Foreclosure Houses / Properties

This information applies to properties in California (specifically, Alameda County).

When a bank begins the foreclosure process, they must file a Notice of Default with the county clerk. You can search for all notices of default within a time period in a county by going the county clerk’s website. For Alameda county, that would be

http://www.co.alameda.ca.us/auditor/clerk/propertysearch.htm

clerk1
Continue reading How to Find and Research (Pre) Foreclosure Houses / Properties

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