Hello my friends. Welcome back to Passive Real Estate Investing where we dive into the world of real estate investing among other related topics. To help you with your real estate investing journey, today we’re doing something a little different. We’re going to take a trip down memory lane and showcase an important episode from the past on what we call our throwback Thursday episode. Now, whether you’ve been with us since the beginning, which goes back to 2015, or you’re tuning in for the first time, this episode is a must listen, we are revisiting one of our more popular episodes from the past, and believe me, what we discussed back then, whether it’s six months ago or six years ago, is just as relevant today. So sit back, relax, and let’s rewind the clock for this great episode. Enjoy.
Now today’s question comes from MJ and MJ says, hi, Marco, like many listeners. I recently came across your podcast and love the concise and to the point information, I even spoke to one of your advisors. Well, thank you for that, MJ. So your question is I’m looking to buy a second home slash vacation rental, and we have enough cash to put down 20%, but I’m wondering if it’s worth taking out home equity on our primary and put it to work and keep our cash in stocks and other investments. Thank you.
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Throwback Thursday Episode (The episode originally took place in the year 2020)
This episode is part of our Throwback Series and may include references to older content such as web classes, events, promotions, or links that are no longer active or available. While the conversation and insights still hold value, please note that some information may be outdated.
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All right, MJ, it’s a good question because I think whenever we have multiple options, we always sit back and think about which of those choices are the better, more prudent choice. In other words, which one is going to give us the greatest return and put our money or our equity to work the hardest for us. So at the end of the day, it’s a matter of just laying out your options, running the numbers, and considering what the short-term and long-term gains are from those choices. So before I kind of give you an overview of what I think, let me just, first of all, quickly comment on your choice for a second home and vacation rental. I’ve done a couple of podcast episodes, one actually not too long ago, I think in the last month or two about this. And I don’t remember the episode number, but I do remember talking about, first of all, second homes are not necessarily, and usually not investments because they’re really a place for you to go for a part of the year each and every year, and then ideally, and hopefully you can lease it out.
So I’m assuming what you mean here is that it’s a second home, but really it’s a vacation rental that you’re going to use from time to time as a second home. And if that’s the case, then you’re talking about something like a short-term rental, like an Airbnb. I went into a great amount of detail about that again, just a couple of weeks ago. So maybe listen to that episode, but just understand the pros and cons of having short-term vacation rentals, because it is a business. It is operation intensive. It is very much dependent upon great locations and it could be impacted by local politics, local regulations, as, as things like black swan events or global pandemics. So keep that stuff in mind.
Now, to your question, the answer is, it really depends. And it truly does because the first question is what are all your options? I mean, you’re looking at a vacation rental, or it could be any piece of real estate for that matter. That’s all well and fine. But if you’re looking at that as one option and then keeping your cash in the stock market or what you refer to as other investments, the question is what are those other investments? The general categories are essentially equities, which are stocks, any kind of stock on the stock market, and that could be public or private. And then you’ve got fixed income vehicles, which are essentially debt like promissory notes, something that we also have been offering quite extensively this year. You’ve got just plain old cash, which is not an investment. It’s just money in your pillow or cash equivalents, which could be just parking your money in a savings account, which is a losing proposition, or you’ve got real estate. And then you’ve got commodities.
Now, commodities don’t necessarily kick off income like real estate does. So ultimately real estate is probably arguably the best investment from this list because not only is it a hard asset, but it can generate income and it gives you equity growth and it gives you tremendous tax benefits. So these are generally speaking your options and you’ve got to look at all of them. So if you’ve got cash parked in the stock market and other investments, does it make more sense for you to deploy those monies into this second home or some other investment real estate? Or do you want to just keep it there because you’re getting a high enough return that it makes more sense for you to borrow from your principal residence, draw some money out through a home equity line of credit, and use that as your down payment, your 20% down payment towards that vacation rental.
This is mostly a numbers game. And you also have to ask yourself, how do you feel about it, even though you shouldn’t let emotion get in the way? So let me break that down a little bit more. Here’s the general things that you need to consider, because I don’t know how much cash you’ve gotten stock market. If it’s 10,000, that’s not enough for a down payment, but if you’ve got a hundred thousand or a million, there’s a lot you can do with that, especially today and especially considering the volatility of the market. So that’s the first thing. Are you comfortable with the volatility, but you need to ask that question about any investment or asset class am I comfortable with, or can I accept the volatility in that investment and in that asset class, that will help answer your question. Second, how much liquidity do you need?
Real estate obviously is not that liquid single-family homes are reasonably liquid, but it’s not like trading stocks where it’s highly liquid. So you’ve got to understand what you want from a liquidity perspective and a volatility perspective. And as a side question you have to ask is the stock market truly inflated and overpriced? I believe it is overpriced. I think it’s in a danger, but it will continue to rise and be strong. As long as the Fed is pumping currency into the system. As long as we have a lot of fake money, fiat money being printed by the federal reserve and pushed into the system, pushed into the economy and it’s reaching its way down to the consumer level, you’re going to see the stock market continue to be propped up like it is. Leverage is another consideration. How much leverage do you want? And do you want to use leverage?
Because if you’re borrowing from your principal residence, you’re obviously leveraging the equity in your property to use as a down payment on another property. And there’s nothing wrong with that. If the numbers make sense and you’ve got a game plan for the next three or five or even seven years for that, so you can slowly or quickly repay that home equity line of credit from a refinance, then you can benefit in the real estate market and those investments today instead of waiting down the road. And so you don’t miss out on whatever cash flows and gains you can have between now and then. So leverage used properly is an incredibly powerful tool. Then you got to ask yourself about risk tolerance. Do you have thick enough skin? Are you able to weather through and be able to manage extra leverage on your principal residence? That’s just a comfort level thing, but again, you can help answer that question by running the numbers and understanding exactly what you’re investing in, what you’re expecting to get, and stress test your, um, your investments consider kind of a best-case and a worst-case scenario.
Can you weather through a worst-case scenario, especially if it lasts for two or three years? That’s going to tell you what your risk tolerance is. Are you looking for tax benefits? Not all investments give you tax benefits. Real estate is very much tax-favored. And so it’s a great place to invest if you need those tax benefits, especially if you’re a high-income earner or you’ve got income, especially passive income that you need to defer or minimize then investing in real estate makes the most sense. And maybe you could double down because now you have the home equity line of credit that you can use as a down payment towards a property that makes sense financially and otherwise, as well as keep your existing cash in those stocks and other investments that you talk about.
And then here are kind of the two big ones, not necessarily the most important, but certainly two big ones. And that is your expected returns and your upside potential. At the end of the day, this is probably how you’re going to end up making your decision. What are the expected returns from what you could potentially invest in and compare that to what you already have today? What are you invested in now and what are your returns today and in the future, what is expected over the next 12 to 24 months, and compare the different scenarios. Maybe there’s only two options, but at least you can compare scenario one to scenario two and maybe three and four. So what are the expected returns from the investments you’re making or plan to make? And second, what is the upside potential? For example, if you’re investing in income-producing property or real estate, or maybe some new construction homes that we have in, let’s say Southwest Florida, the upside potential on those may be very high because there is a severe shortage of housing and strong demand, population growth and demand for household formations is really driving up property values.
So you can make out very well from an equity and appreciation perspective. So the upside potential is high and maybe that trumps everything else because that is your strategy. And that is what you’re looking for. And that’s what you’re going for. So again, look at the expected returns today, and going forward, this is what we call proforma. And I just did an episode on that yesterday. And what are the expected returns down the road in terms of its equity growth, the upside potential, and the answer could be both, you know, it could be that these are both equally important to you and you need both and you want both, and you’re going to look at investment opportunities that provide as much as possible of these two things, immediate yield, and future growth. All right. So it’s not a direct answer to your question about, you know, whether it’s better to use cash or home equity to invest in real estate.
Again like an attorney. The answer is, it depends. So this is more of an answer to be like a compass to point you in the right direction. So you know what the next step might be for you and making that decision, but it’s really not going to be a definitive answer, and nor could it be without knowing enough about what you have, what you’re looking at, what you’re comparing and what returns you are already receiving on your different investments. And I’m sure that makes sense to you and MJ, but thanks for the question.
I hope you enjoyed this week’s throwback Thursday episode. If you haven’t already, remember to subscribe so you don’t miss out on a single episode. If you have a question about real estate investing or finance, simply go to passiverealestateinvesting.com and click the Ask Marco button. Lastly, help us share the show with other like-minded people that you know who can benefit from it as well. Just visit us on your platform. Most of you are on iTunes and leave us a rating and review. I would greatly appreciate it. I read them all and I will thank you in advance. And that is it for today. Thanks for listening. I will see you on our next episode.
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