These days, the real estate market has already gone back up its feet. Using equity for refinancing has been one of the smartest solutions for real estate success. Aaron Chapman who is a 21-year veteran of the finance industry talks about how to use the equity that you have to buy more rentals. He discusses what HELOC is and why he doesn’t advocate using it for down payments on more properties. Aaron also shares his opinion as to when a refinancing rental portfolio does not make sense and gives some tips on how to make good rate of returns.
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Using Your Equity To Buy More Rentals
It’s my pleasure to welcome Aaron Chapman to the show. He is a 21-year veteran in the finance industry with a focus on the real estate investor. He has a great team of eleven staff members who help him finance investment loans all over the country. He’s been married for over 22 years, has four great children, and has been a volunteer with the local Sheriff’s Department Rescue Unit for many years. Aaron, welcome back to the show.
How are you doing, Marco?
I’m doing great. How about you?
I’m doing well. I retired from the Sheriff’s Office. I’m no longer participating in the day-to-day rescue stuff. My travel and all the business that has been going on is not a giving me the availability to be there as often as I could. I hated people having to rely on me to be there when I couldn’t. I have since retired from that. I have four more people assigned to me directly that are closers and underwriters. My team consists of people from the initial phone call with the real estate investor all the way to check it and cut, including all the processing and underwriting. All that is part of my whole group of people that work very closely together. It’s been an exciting couple of months.
I didn’t know you made those changes, congratulations. Let’s talk about using the equity that you have to buy more rentals. This is of interest to a lot of people and one of the reasons is this. Many of the clients that you and I work with, whether together or separately seem to come from these expensive states. They have properties. Often they have rentals that have a lot of equity in there and they don’t know how to tap into that equity. Many times these people, particularly from California, people I call equity-rich and cashflow-poor, have a lot of equity in their principal residence that they’re not utilizing. I often refer to that as dead equity or dormant equity. You could turn it into cashflow but it’s sitting there in your residence or in your properties and is generating a rate of return equal to zero. Let’s educate our audience a little bit here into the ways that they can do that. Let’s talk about the different options available to them in order to tap or strip that equity from their properties. Do you want to comment on that?
I’m going to back you up on one thing you said about the equity itself. Unused equity is useless equity and if you’re not putting it to work and doing anything. It’s a figment of your imagination until you access it and use it. As far as different ways, I’ve seen people strip that equity or put it to work mainly through refinance. There’s always the 1031. You can always sell, then use 1031 and deploy them into multiple properties. That is one strategy that’s commonly used. The other is doing the refinancing and many people get hung up. Sometimes they’re like, “If I’m refinancing it, the interest rates go up. I’m stretching out that timeframe and I’ll be holding onto this loan longer.”
It gets back to the thought process of a consumer. They need to pull their mind away from being a consumer to now a business owner. A business owner or a CEO of a real estate investment firm is going to take a deeper look at than just the surface information of, “My interest rate went up 0.5% or now it’s stretched out from 21 years to 30 years or now, I owe more in the form of debt.” It’s really not debt, it’s an additional asset to your business. A refinance and I always typically will look at the 30-year fixed. Anytime we can get a new loan, 30-year fixed that will fix that payment, you are sending yourself up for a much more stable platform. You take those funds and put that to work because now you know what that payment is going to be for 30 years. There’s not going to be any adjustments in that.
You’re not going to have to adapt to their cash needs for an adjusting interest rate. Additionally, because of inflation, it erodes that debt for you rapidly. When you look back on the statistics or at least the inflation data, they claim it at around a 2% target, but that is also a cooked number because it doesn’t add in all the cost of living. With inflation going between 5% and 6% on an annual basis and it’s eroding that payment for you because of that fixed payment, anything that you strip out and put to work is going to grow for you. While the payment requirement is diminishing because of the dollar’s value. I will always advocate a 30-year fixed.
Let’s look at the other options because this is not necessarily an option I like or advocate, but it is an option. That’s a HELOC, getting a Home Equity Line Of Credit. Do you think that’s a good option for some people, especially people who have a lot of equity in a principal residence as opposed to refinancing with a 30-year fixed?
The way I see a HELOC playing a good part in all of this is let’s say you have a significant amount of equity. You’re in California and you’ve got people with a ton of equity in their home. If they were able to take that equity and get a 30-year fixed up to say 80% of the value. Now you have like $100,000 or whatever available to you in fixed funds to be able to put to work and use as down payments. If you need down payment money, I always advocate using that 30-year fixed. Let’s say you have a bank that says, “We’ll go up to 90% of the value.” Let’s say you have another $50,000, $60,000, or $70,000 available to you in the form of a credit line. I would get that credit line but do not use that for down payments. I don’t agree with that. That’s very risky.
I only advocate the use of a HELOC for being able to use that BRRRR method to be able to pay cash for a property and then put the rehab costs into your closing. When the rehab is complete, then we’ll do that 30-year fixed delayed financing and pull the cash back out. Go up to 75% of the after repair value but you can’t exceed the amount you pay at closing. I always direct one to have their purchase price as a line item on the settlement statement when they pay cash plus take the bid from your contractor when you’re doing all your due diligence. Add that amount to the settlement statement as well as another line item, the rehab costs. That way they’re all together and you’re closing when you pay cash. The title company can then deploy those funds back to the contractor when the work is done. In some cases, the property appraiser signs up all that cash back to you in a new refinance on that property.
The reason I don’t advocate using a HELOC for your down payments on more properties is that now you have this variable item. A lot of people like the fact that it’s interest-only. It’s interest-only for ten years, after that they reamortize it to a twenty-year note. I have seen people do this. You think ten years is a long time, it’s not that long. All of a sudden, you’ve got all these properties that you’ve been using a HELOC for your down payments and the interest rates start to go up. It goes into a point where you cannot use it as a credit line anymore. It’s no longer interest only. Now you’re looking at that rate fixed in for that remaining twenty years at a higher point. You’re no longer cash-rolling. You’re going into your pocket to make that HELOC payment. Your business is not taking care of itself. You need to engineer it where your real estate investment business takes care of the real estate investment business and eventually takes care of you. If you had to go to your pocket because of using some method that was faulty from the beginning, you don’t have a business anymore. You have a liability coming from you.
HELOC is best to use as a hard money loan. It’s good for short-term money to buy, fix, refinance and hold. In other words, what they call the BRRRR method, which is Buy, Renovate, Rent, Refinance and Repeat. That’s an active approach to real estate investing. You would use hard money, private money or your HELOC to do something like that. It’s short-term but expensive money. It can be used as a down payment. I know people do use it that way. It’s not advised. The key here is you want to be able to pay that off as quickly as possible. It’s an interest only loan that doesn’t necessarily amortize. Thirdly, it doesn’t give you that 30-year benefit of having a fixed interest rate for a long period of time. You have two options. You have a HELOC and you have a refinance where you pull equity out. I assume when you refinance, they’re typically up to 80% loan-to-value still.
On single-family, on your owner-occupied. If you start getting into the investment property, you’re going to be capped at 75%. If you get into a multi-unit investment property, you’re looking at 70%.
On one to four-unit residential properties, you can refinance up to 75% loan-to-value. When you refinance, you can calculate how much equity you’re pulling out. You have to have more than 25% to 30% equity in that property in order for this to make sense in the first place. Otherwise, you’re not pulling anything out or very little. A key point to make here too is that it’s tax-free. When you refinance and you borrow that money, it’s a loan and that’s tax-free. You’re essentially borrowing equity out of your property on a tax-free basis in order to leverage it into more properties that you can add to your portfolio and increase your cashflow. When does it not make sense to refinance your rental portfolio? Rates probably play into this book. Does it make sense all the time or are there times when you shouldn’t be doing a refi?
I would say it depends. It does not make sense when you don’t have a deployment process. If you’re taking it to take it and you’re like, “Maybe I’ll find some property, maybe I won’t,” cash either way is making its way out of your account into something. People are good at letting their account act like a sieve and bleed money out. You need to have a deployment plan. We’re human beings and we’re frail in many ways. Sometimes it’s justifying to use those funds for something else. Get a plan in place for your deployment of those funds and work that plan. Make sure you have some method of calculating what you’re willing to deploy it towards. I had one individual who had made a goal, “I’m going to buy X amount of properties this year.”
He went over whatever means he had to buy those properties. Now he’s in a bad spot. He was using any method necessary to get any property necessary because he had a goal. Sometimes your goal has to have a little bit better plan than just a goal. I would advise getting those people around you, the people you trust, your representative with Norada, myself and my team. Let’s talk about your strategy before you pull that money out. The other thing is to be sure that whatever you buy has the ability to service that expense. Whether you call it good debt, bad debt or asset, whichever way you refer to the loan, it still has to be serviced by the business. Make sure that whatever you’re purchasing and whatever you’re putting your money into will be able to put enough return to service that expenses for you.
Don’t make the mistake of looking at your pro forma and thinking that, “All of a sudden, the cash-on-cash returns are minimal and I’m getting hosed.” Many times, people are forgetting that those are based upon an 80% loan-to-value or 75% loan-to-value and that you’re bringing the 25% or 20% from your personal assets. The second you take it from another property, you refinance that property, you’ve increased the expense of servicing that note, it will have an effect on that return when you calculate it on a cash-on-cash return model. I will always advocate somebody, if you are getting any cashflow at all, you have to determine what that minimum cashflow is. If you’re getting cashflow, that means you are servicing 100% of that asset and not a single dollar left your pocket to do it. You took it from another property’s equity and you inject it into another property and then you’ve got another loan to do that.
You refinanced 100% of that new asset. If that asset pays for itself and continues to pay down that note, your return is incalculable. If you invested 20% on $100,000 property and somebody else paid down the $80,000 note or the 80% note, your 20% increases by 13.33% per year as long as somebody else is paying down that note. That’s 13.33% of the original $20,000. If you’re financing 100% of it, it’s getting paid down and you’re making a cashflow, there’s no cash-on-cash return model on that. You have no cash invested. When you think about that, it’s impossible to calculate that because any dollar you’re making is free money coming to you. As long as you’re choosing the proper team to work with, choosing the proper properties to invest in that will stay rented or has a draw from rent as far as renters to go into that property, it’s paying for both the note that you refinance and the one you financed the 80% on the new loan that we did with my team, you’re creating money out of thin air. There’s no way you’re going to look at that negatively.
What you’re saying, Aaron, is that the rate of return is infinite. It’s not that it’s impossible to calculate. For readers to know and understand what we’re talking about, you’re borrowing equity that has a zero rate of return and turning it into instant cashflow. The rate of return is infinite because you didn’t put anything into it. All you’ve done is taken the equity that’s been created in another property, you turned it around and turned it into an infinite return. The other comment I want to make too is that, for those readers that didn’t catch that 13.3%, it is a calculation on the rate of return using the equity gain out of the amortization of the loan. Every month and every year the equity is growing in your property because the tenant is paying down that loan for you. If you look at how much equity you’ve gained over the course of one year and look at that as a return from your invested capital, it turns out to be, on average over 30-year calculation, 13.3%.
If you look at an amortization table, those first two years you are going to get 13.33% because it’s front loaded with interest, but then you get into the tax benefits on that and it’s still going to get you to a very close number.
You averaged that across the 30-year amortization if I’m not mistaken.
Correct, because if you take the $80,000 divided by 30 years, that is $2,666.66 per year average over 30 years, you divide that into the initial 20% or $20,000, that now puts you at 13.33% if you average over 30 years.
When it comes to pulling equity out and using that equity as a down payment towards building a portfolio, what are your feelings or thoughts about doing the refinances one at the time on those rental properties versus doing what is often referred to as a blanket mortgage? In other words, a refi on multiple properties at the same time where you have one mortgage loan collateralized by multiple properties and then pulling that equity out.
I like both options. If you’re in a situation where you’ve got one or two that has a significant amount of equity you can pull from and deploy that capital, it’s very situational but that’s a great idea. If you’ve got say ten properties and you’ve maxed out your 30-year fixed loans that you’ve been getting on the conventional world backed by Fannie and Freddie, there are outfits out there now that are getting more and more lenient with these blanket loans and then it makes sense to be able to do something like that on a large scale. I get a lot of people calling me saying, “I’ve got these three houses that are $60,000 apiece. I’d love to do one loan.” We can’t do that. It’s too expensive to do a blanket loan on three properties.
Cross-collateralization with legal fees gets so expensive. If you’ve got ten properties or eight or whatever it is with a significant amount of capital, I will advocate that all day long because it does two things. One, you’ve got one loan that blankets multiple properties. You’ve got a serious amount of capital and you need to deploy it. You paid off all those properties, taking them out of the Fannie-Freddie type of environment. I always advocate in that world since you’re using a commercial institution to finance it, put it in a commercial entity, an LLC or something to that effect that will now take it out of your name. You’ve got that cash that you can deploy. Now, you can redo those ten Fannie-Freddie loans. Use that as your acquisition engine. Use these blankets loans as your warehousing type of engine. You have an acquisition capable of your low down payments 30-year fixed, finding properties one at a time, but then, move them into a big warehousing type of instrument like a blanket loan.
Are these refinance options easier, more difficult or the same as the initial purchase money mortgage that people used to buy these properties in the beginning?
It’s the same. It’s still debt-to-income ratio, credit score, property value, loan size and loan-to-value. It’s all going to be the same. For some reason, the marketing that has been done by the banking industry has made it seem like that when you own it. All of a sudden, there’s this special opportunity to be able to get you a better and simpler process. It’s not, we still have the same rules to live by it. We’ve still got to prove the same thing. We have a whole new group of funds coming in to pay off the old loan. It’s still going to go to somebody else. Whoever is funding that loan is somebody different who funded it the first time, regardless of what bank you’re paying.
This is a strategy that we can employ time and time again. It’s a matter of how much equity do you have in your property or your properties and how quickly does that equity accumulate? Generally speaking, we know that properties double in value on average every ten to twelve years. It actually ranges from seven to twenty but we typically see a ten to twelve-year doubling. If you have an original mortgage of $80,000 on $100,000 property now and in ten years you have a $200,000 property, you still have that $80,000 mortgage. You could refinance that at let’s say 75%, that’s $150,000 loan. It gives you $60,000 in equity to put towards an additional one or two more properties.
Do you have to wait ten years? Not necessarily, it depends on how much equity you have, how many properties you have and how many properties you can tap that equity into. This is a strategy that works very well to grow your portfolio quickly and accelerate what you’re doing. You need to have a conversation with a guy like Aaron Chapman to strategize how you’re going to pull that equity out. Talking to your investment counselor to figure out what’s the best plan and have that next steps laid out for you. When you have that equity coming out, you’re already in a position to add those additional properties to your portfolio. Aaron, is the process something that can be cued up with you, create a file and then it’s ready to go each and every month, every six months or every year as needed? Is it a matter of refreshing the files or the statements that you have in the file?
It is pretty much. If we’ve already worked with that person in the past within our organization, we’re able to duplicate what we already have. We’ll get ahold of them. One of my team members will get in touch with them and update some of the data that’s in there that needs to be and we start a whole new file appointment so they do not have to go online and recreate all that. Once that’s recreated and we update it, it’s a matter of updating data from them as far as the income and asset information and we punch it through.
I don’t want to make this sound like it’s a complicated thing, but using your equity to buy more rentals is not a complicated thing. It’s something that a lot of people don’t even think about or even know about. It’s something that you should look into because it helps you get to wherever you want to go quicker in terms of your financial goals. What else do you want to share with our readers? This is an interesting topic but not one that’s overly complicated. It’s a matter of exposing it.
The main thing I want people to think about is what do they want to accomplish all the time? I will always be considering what it is they want tomorrow to be for them and take the time to give that a thought in those quiet moments. Reach out to those people who you trust, your investment counselor. Reach out to my team and me and let’s discuss it. The best thing you can possibly do is put good thought into what you want the future to be and then get to work creating it.
Tell our readers how they can find you or get more information about you and your company.
Run out to AaronBChapman.com. Get on out there, check that out and get in touch with me through that. My assistant, Samantha, if you connect with us, we’ll try and set up a time where we can block 30 minutes or 45 minutes so we can take a deep dive into your scenario. I’m not always that reachable but I always want to be able to set aside the time and park that detailed moment with you. If I don’t schedule it, I ended up getting caught up in other things. I’d rather block that time for you and turn my back to the rest of the world and focus on your particular conversation.
Aaron, thanks again for coming on. It’s always fun having to chat with you.
It’s always a pleasure.
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