198: Your Cash Flow, HELOCs | Real Estate Technology with Daren Blomquist

...about your cash flow, your total rate of return, and finally, Home Equity Lines Of Credit. Then we’re going to have one of the top real estate trend trackers in the nation join us here later.

Let’s get right into it. Ellis from Gastonia, North Carolina asks,

“Keith, Episode 188 had a great breakdown of how run you all of the numbers on an income property. The thing I’m wondering about is that your example only resulted in a positive cash flow of $150 on that property.

With the maximum of 10 conforming loans that we can get, that’s only $1,500 in monthly cash flow. How would that be enough for us to leave our job?” Thanks, Ellis.

And, of course, not everyone that listens here wants to have their passive real estate income replace their passive job income. Though many do.

...and it’s not a get rich quick thing...it’s about incrementally building up durable cash flow streams over years.

Well, Ellis, and I’m not sure how many shows you’ve listened to.

That example of the $150 cash flow was just for one SFH - and really for one of the lower-cost ones - the purchase price on that was 70-some thousand dollars. It was in Memphis.

So most of the income properties you buy will have a higher purchase price, higher figures, and often a higher cash flow.

Really, $1,500 with ten properties would be about as low as a projected number could possibly get.

So Ellis, if you’re married, both you and your spouse - you each qualify for 10 one-to-four unit properties...20 total and BTW…

...you want to put those in your individual names. If both you and your wife were on the loan, that would count as a strike against each of your limit of 10, so as you buy, alternate back-and-forth - you own the first one, she owns the second, you own the third, and so on, or something like that.

So that’s 20 doors minimum there - or I guess 19 since your primary residence is part of that formula, plus if you have some duplexes or four-plexes in there, that might be 25 or 30 or 40 doors.

So, there’s so many reasons why you would likely have substantially more than $1,500 in passive monthly cash flow.

Then there are financing programs beyond conventional ones, you might also have some 5+ unit apartment buildings, some agricultural parcels or a mobile home community, or maybe you even got a couple low-cost properties paid-off and don’t think it’s worth getting a loan for tiny amounts, so they produce cash flow although there’s no loan there…

...there are a ton of reasons why it would be way more than $1,500. Thank you for the question, Ellis.

...And another important thing to remember there is that we’re only talking about cash flow - which is only one of five simultaneous profit centers that you typically have.

But cash flow is a key profit center because it’s the most liquid one.

Jessy from Sacramento, CA says, I love your show. It’s flipped my financial mindset totally upside-down, changed my family’s life, and changed what I thought was possible for us.

Part of what I love hearing about is that 5 Ways You’re Paid in real estate. Ah - then he (or she?) shows me an example here in the question of 30% for leveraged appreciation + 6% cash flow , 5% loan paydown, 4% tax benefits, 3% inflation-hedging = a total return of 48%.

Yes, those are the five ways that real estate investors often have as profit centers.

The question Jessy asks about this is: “Though I get my properties from GREturnkey.com and these returns seem about right, I don’t think I’m invested in any one market that performs this way.”

OK, I love that question, Jessy. Few individual markets are going to perform just that way.

It’s a blended portfolio approach. For example, on your new purchase in Dallas-Fort Worth, you might not have any cash flow any more. It might be cash flow zero. That’s just the way DFW behaves now.

But it’s likely that you’ve been achieving better than 6% appreciation there in DFW (and I’m referencing that 6% appreciation at 5:1 leverage as the 30% Jessy gave in the example).

Then if you’ve also bought in Memphis, you’re likely achieving less-than-average appreciation - that’s just how many areas in Memphis behave, but you’re getting above-average cash flow.

So it’s the blended portfolio approach that can lead to “Year One” returns like what I’ve described with the “Five Ways That You’re Paid”. Multiple markets means you’re more diversified at the same time.

One market, however, that’s performed lately with a nearly equal measure of both appreciation and cash flow are some of the Orlando and Tampa Bay submarkets...so some markets will come close - most won’t - they’ll be weighted differently across your five profit centers.

Thanks for the question, Jessy.

The next question comes from Michael in Astoria, Oregon. Astoria is beautiful. One day, I went to the top of the Astoria column there - it’s a tower overlooking the mouth of the Columbia River.

Michael says, “There aren’t any cash flow markets out here on the west coast and we have substantial equity in our $1 million Astoria home.

We still owe $504,000 on the loan so it’s about half-paid off.

From listening to you and understanding that the Return From Home Equity is always zero, I also know that our leverage ratio has been cut to 2-to-1.

What’s the best way of removing our home equity to use for down payments on cash-flowing income property?”

Well, thanks for the question, Michael. First of all, you need to decide for yourself that that’s what you want to do with your home equity.

Understand that doing so means that none of your equity is lost - it is merely transferred into multiple properties - and it also can produce a cash flow for you now.

Of course, though the return from home equity is always zero, borrowing against your home equity incurs an interest rate expense that you need to beat.

I’ve removed equity from my property with a HELOC for buying more investment property...and let’s drill down and unpackage a HELOC here - H.e.l.o.c. - Home Equity Line Of Credit.

Let’s talk about why you would use one, how it works, and both your advantages and your risks here, Michael.

With a HELOC - if you understand how a CC works, you largely understand how a HELOC works, except your credit limit is based on how much equity you have in your home. You can usually borrow up to an 80% combined LTV ratio.

So what’s 80% combined LTV really mean?

Now with your home, let’s just round your million-dollar home’s mortgage loan balance to 500K. This means that you could potentially borrow up to $800K total - you’ve already got a $500K lien on the property, meaning you could get a HELOC for another $300K.

Yes, with $300K, you could potentially put $30K into ten low-cost income properties in the Midwest and South - down payment & closing costs. Now you’ve spread your risk around because you’re invested in multiple RE markets.

Now to qualify for a HELOC, you'll need to document your income and employment status just like you would if you were refinancing your home, Michael.

People often use HELOCs for home repairs, sometimes they’re used to pay down higher interest rate CCs. But you can use the funds for anything - a trip to France, a new fishing boat.

The HELOC is essentially a second mortgage for you.

Like a credit card, homeowners can borrow or draw money on multiple occasions, usually for a period of 5-10 years, and up to a maximum amount - it would be $300K for you in this case, Michael.

There are two time phases with a HELOC. The first one is your Draw Period, which typically lasts 5-10 years.

The second one is your Repayment Period - which can last about 10 years, maybe even up to 20 years.

Now the first one, your HELOC Draw Period is a really nice time. Now you’ve got access to $300K, and you only need to make interest-only payments on it - which means you have flexibility - you can make principal payments on it if you want, but you only need to pay the interest portion monthly.

And your HELOC balance can be very elastic - like a credit card - you could just borrow out $150K on your $300K line right away, make extra principal payments to get it down to $120K after a few months, then months later, run it all the way up to the limit of $300K, and years later pay it back down to “0” again.

It’s a pretty great time for you - you’re enjoying what feels like a windfall of cash and you only need to make the interest-only payments.

But after this 5-10 year Draw period, the second of your two HELOC time phases begins - your Repayment Period.

Now, this can be a real test of how responsible you’ve been with your HELOC funds during your Draw Period - because during this repayment period which can last 10 to 20 years, you must pay both the interest and the principal amount - so your required minimum payment will be higher over all these months until you pay the HELOC balance back down to zero.

Usually, the repayment amount is calculated by dividing the capital you’ve accessed - call it $300K here - by the number of months in your repayment period. Simple math here.

Now, before you originate your HELOC - beware - occasionally, a lender requires your capital to be fully repaid at the end of your 5-10 Drawdown period all in one lump sum - which is known as a balloon payment.

So before you take out a HELOC, just ask your mortgage loan officer about the duration of your Repayment Period once your Draw period ends, ensuring that there’s no balloon due.

Now, even if you do have a 10-20 year repayment period, some borrowers still get surprised at the higher payment during the repayment period - but you won’t be - you’ve got to pay both principal and interest there. Your required payment will increase then.

Now, here’s a great option for you. Of course once your 5-10 year Draw Period ends, maybe you want to keep your line of credit and extend the draw period.

Many lenders will do this for you, so long as your home still has enough equity and your financial health hasn’t tanked.

Typically, a lender will “pay off” your old line of credit by simply extending you a new one.

Now that you understand Draw Periods and Repayment Periods, let’s talk about your HELOC’s interest rate.

HELOCs have substantially lower interest rates than CCs. HELOC interest is often tax deductible - CCs are not.

Your interest rate floats. It’s not fixed. HELOC interest rates are tied to Prime Rate or LIBOR plus a margin above that which is based on your credit score.

Your upfront HELOC costs low, Michael. A $300K HELOC cost might only be a $1K upfront cost.

Now, let’s talk about some risks associated with using your primary residence’s equity for purchasing rental property.

If you have a habit of abusing credit, maybe avoid a HELOC altogether.

Since a HELOC is secured by your home equity, if you don't repay it, you could end up in foreclosure. The same of which can be said for most any mortgage.

Let me tell you about something bad and unforeseen that happened to me with a HELOC in about 2007 or 2008….and by the way, lending guidelines were so loose then that I actually had a 90% LTV HELOC on a non owner-occupied four-plex.

If you can believe that!

But it’s not like that today, so with your HELOC based on 80% LTV on your primary residence, say, Michael, that you’re in a place during your draw period a couple years down the road and say you’ve borrowed $150K of your $300K HELOC.

You’ve got half of it in use.

Here’s what happened to me, just using your numbers to stick with your example - I got a notice from the bank telling me, essentially that they froze my HELOC.

What did freezing my HELOC mean? It meant that even though I was still in my Draw Period, they wouldn’t let me draw further equity from my home - it was frozen at $150K.

Now, they didn’t call the note due or demand any principal payments.

I could still make interest-only payments on the $150K, but with no further drawdowns. There was another $150K that remained unutilized.

...and why was that? Well, a lot of unprecedented things happened during the Great Recession of 2007 to 2009.

Even though the property I owned didn’t fall in value all that much ten years ago, when housing values started turning down nationally 10-12 years ago, many banks said that you can’t make any further draws on your HELOC - we’re freezing it - essentially the banks were saying that we’re worried about the value of your collateral that secures this loan that we made to you.

Well, I was disappointed because I still had some open funds to use on my HELOC, but access was shut off for quite a while. That was the HELOC freeze.

Now, I could have avoided that had I just taken all the money out of the HELOC and put it in my own liquid bank account. Of course, I would have had to pay interest on a lump that I wasn’t investing too.

Let me just add here, that whomever you listen to for finance and real estate investing information and education, listen to someone that been through a downturn.

I’ve been successfully investing in real estate directly since 2002, and the housing crisis and mortgage meltdown of 2007 to 2009 was actually good for me - as I’ve discussed on other shows.

Now, for you to get a gain - your HELOC interest rate that you’re paying should be the same as, or lower than, the cash-on-cash return of the income property that you’re buying with the HELOC funds.

That’s because it’s cash that you service the I/O HELOC payments with - and you’re really keeping an eye on that when your Draw Period comes to an end.

Remember that HELOC rates have been rising and they’re poised to keep rising.

Now, I already know what you’re thinking. You’re excited about real estate investing and building your portfolio and if you have some equity in your home, you might even be thinking something like:

“Even if my income property’s CCR ends up lower than my home’s HELOC interest rate, it’s all going to work out for me because when I consider that the income property pays me 5 ways (of which the CCR is only one of those five), my Total Rate Of Return will dwarf the smaller HELOC interest rate.

I know you might be thinking that. And you know what, you might even end up being right and it will work out for you, but now you’re tilting into a riskier area.

And you’re going to do whatever you’re going to do….

...but the Mortgage Meltdown ten years ago proved to me that liquid cash flow is what services HELOC payments.

The other four ways you’re often paid - appreciation, loan paydown paid by the tenant, tax benefits, and inflation-hedging - none of those profit centers are liquid.

By the way, and thanks for the question Michael -

Now, I’ve had some detractors in the debt-free School Of Thought that won’t even entertain the notion of harvesting equity from their own home and buying rental property with it.

But I do it...and I’m not telling you to do it...I’m saying make your own decision. But some even say things like - I bet you won’t like your decision when we have another mortgage meltdown like we did ten years ago.

My response is - this way, I’m better positioned in a mortgage meltdown. During the Housing Crisis, some markets even lost 50, even 60% of their housing values.

In a meltdown, I’m going to be really happy that I didn’t have a lump of equity all in one property just in one market.

Plus, during all that time leading up to a potential future meltdown, I will have had positive cash flow the entire time.

I’ve even had a couple people - that just don’t ever seem to want to think abundantly say - well what if things go beyond a recession and we’re in an all-out depression and everyone loses their job and Americans are massively starved for food.

Then the person that rents your Kansas City property won’t have their medical job to pay your rent anymore, and the Fedex employee in Memphis that rents your place won’t have a job and your cash flow will dry up.

Sheesh, if we’re in an all-out Depression, and the economy breaks down, no one accepts the dollar, and there’s anarchy and mass starvation and looting and Americans don’t even have clean water and everyone’s defaulted on every loan they have, then the fact that you lost the cash flow on your St. Louis rental property is not even going to be one of your Top 20 problems.

So...I don’t know what these people are thinking. Now...

When you’re running your numbers on a single-family income property that you’re thinking about buying and you get a CCR greater than 10%, you know, these days. I want you to look at that CCR with a magnifying glass.

Many markets have prices rising faster than rents that can keep up proportionally. You can still get 10% on a SFH, but not as easily as before.

And I still don’t know of a better place to invest right now than SF income property.

And I don’t think we’re in any kind of housing “bubble” now.

A bubble is defined as a price level unsupported by fundamentals. Today, supply shortage is driving demand.

Therefore, it is very much still a fundamental price increase, not a bubble - in these stable inland markets where we buy homes a little below the median housing value.

So...know the pros and cons of strategic investment moves like a HELOC origination.

Your goal, as a successful investor, is to maximize your ROI throughout your investing lifetime.

I frequently sell or refinance properties due to that fact that equity-heavy properties decrease your ROE - your Return On Equity.

Financially-free beats debt-free. The debt-free person asks a question like “Where do I think I can be someday?”

The financially-free person instead asked themself a better question - what do I have right now to make my & my family’s life better now - what tool do I have that I didn’t even know I had.

What knowledge do I have now, what talent do I have now, what property equity do I have now, what relationships do I have now.

So...thanks for the listener questions today. I only got to three. There is such a backlog of questions that I’ve got.

I wanted to answer three that I felt would be most applicable to the greatest number of people.

Well, ATTOM Data’s Senior VP Daren Blomquist is back with us today.

We’re going to discuss how among homeowners - they’re staying in their homes longer than before - but renters are not included in this - so note that this isn’t a direct measure of transiency.

There are so many reasons for why homeowners are staying put longer

Low interest rates that they locked in years ago often means they don’t want to leave.
Mortgage underwriting standards are tougher than they were pre-recession.
The supply of replacement properties is low.
To a lesser degree - our population aging - the older one gets, the less they move.
The supply problem is getting so bad that people increasingly are using data sets of predictive analytics and Artificial Intelligence to tell if someone is about to sell their home.

All that’s next, plus where the more undervalued Midwest & South housing markets are for income property today. You’re listening to Get Rich Education.

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For those figures Daren was using in comparing various metro housing market prices to their pre-recession peaks, those numbers are not adjusted for inflation. Keep that in mind.

So if over the last decade we had a cumulative 30% inflation over all those years, then a housing price that’s 30% greater is essentially the same. Very important distinction there.

Thanks again to Daren Blomquist.

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Until next week, I’m your host, Keith Weinhold. Don’t Quit Your Day Dream!