Why Cash Is King

by FI Fighter on May 19, 2015

in Real Estate Thoughts, Stock Investing Thoughts

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There’s a common belief out there that cash on hand is money wasting away. The argument is that because interest rates are at historic lows, keeping money in the bank is a fruitless endeavor towards building wealth. In fact, not only is your cash sitting stagnant, but at worst, it’s losing value because the interest earned on it won’t even allow you to keep up with inflation! As such, as a shrewd investor, you need to be putting those funds to use at ALL TIMES. In other words, if your money isn’t working hard for you in the markets, you’re doing yourself and portfolio a huge disservice!

Rapid Asset Accumulation Phase

Not too long ago, I used to believe in the notion that sitting on too much cash was a detriment to my goal of achieving early financial independence. When I was investing between 2012-2014, pretty much at all times, I had my cash tied up in: stocks, real estate, index funds (401k and Roth IRA), etc. Sure, I kept around an emergency fund, but it only resembled a tiny pittance of my overall net worth…

My, how times have changed… After going full throttle and working so diligently in trying to build up a net worth of a $1MM, I’m very much over the phase of always thinking in terms of: accumulation, accumulation, and more accumulation… Sure, when you’re just starting out and working towards building a strong foundation, you absolutely have to be focused on the Rapid Asset Accumulation Phase of wealth building. How else are you going to compound your money and get to early FI?

Market Cycles

But as time marches on, you start to pay closer attention to market cycles and where exactly we are at any particular point in time.

I’ve reached an inflection point, if you will… These days, I’m very clearly seeing the value of hoarding extra cash, especially as we look ahead and realize that the markets are still sitting at all-time highs!

No, I don’t believe that it is possible to time the market… But at the same time, it doesn’t take a rocket scientist to realize that at this stage of the game, we are much closer to encroaching a top than we are a bottom… When I was investing back in 2012, the same applied then — I had no way of knowing that we were just at the beginning stages of a historic bull run, but even then, it didn’t take a genius to realize that we weren’t very far removed from the bottom…

Investing At All Times!

One important realization that I’ve made is this — As investors, it isn’t necessary for us to keep injecting fresh capital into the market at all times.

This runs very counter to the belief that “compound interest is your best friend”. But notice that I didn’t say to divest from the markets… I simply said, it isn’t necessary to keep pumping in new funds like clockwork to keep the compounding machine happy.

Once your seeds have been planted, it’s perfectly OK to stop working the fields for an extended period of time, and to go on a nice, relaxing vacation, instead. Whatever previous work you had put in will still be returned to you as fruit later, anyway…

It’s taking on unnecessary risks and compromising additional principal that you should be concerned with…

Buy Low, Sell High

Everyone believes in the notion of “buying low and selling high”. But how many people actually go through with it?

When I was closing Rental Property #2 back in 2013, on the day I closed escrow, a new comp had posted, selling for $50,000 higher than what I was about to pay… Before the ink had even dried, I had instant equity built into the deal.

That was the norm back then…

Can this still happen in today’s market? Possibly, but the odds are becoming increasingly more difficult. When I closed Rental Property SH #3 just this past January, it was right before the next wave of buyer onslaught arrived. Two months later, the next door neighbor sold their house for $130,000 more than what we paid for, emphatically demonstrating to me that the sheer madness that possesses people in a seller’s market is still alive and (un)well today.

Not long after declaring that I was “done with real estate investing”, I started buying stocks again… And because old habits die hard, I got wrapped up into the game as if the year was 2012 again, and I started buying stocks left and right, under the assumption that prices were cheap…

But I was wrong… Shortly after building up my portfolio to $100,000, I had a wake-up call… I’m not sure what triggered it, but my gut feeling was now completely opposed to what I was doing… There was huge dissonance between my actions and thoughts… I knew that I had to reconsider things.

  • This bull run had been going on for 6 years now.
  • The markets were at all-time highs.
  • I had over $1MM in debt.

Clearly, rebuilding and reconstructing a dividend stock portfolio at this point in time wasn’t the best idea I ever had!

So, I took the gas off the accelerator. After more time and contemplation, I came to the conclusion that it was in my own best interest to liquidate my stock portfolio.

Instead of letting myself get consumed by greed (and chasing very, very marginal returns at this point), I made the decision to actually “sell high” and take the chips off the table.

By doing so, I effectively profited more in short-term capital gains than what I would have earned as a dividend growth investor over one full year of investing.

Most importantly, I got to pull my principal back out of the market. Now, my principal has been converted to cash and I feel much better.

Risk and Reward

As I mentioned above, I used to view holding lots of cash as a sign of weakness; it meant that money wasn’t working hard for me and losing its value over time, instead.

But as a highly leveraged investor, I’m learning that having a ton of cash in the bank is exactly what the doctor ordered! For one, it gives me absolute peace of mind. Although cash doesn’t earn much interest, it doesn’t lose principal either, which is very important! Cash is also liquid, and whenever this market finally decides to turn, it’s true power will be fully revealed!

Yes, I realize that earning constant returns can be appealing, but looks can be deceiving! For instance, if a dividend growth stock pays a 3.0% annual dividend, but the principal gets shaved by 20%, are you still really coming out ahead? I believe the constant stream of passive income is psychologically reassuring, but it doesn’t tell the whole story…

Let’s use an example: My Theoretical $100,000 Portfolio

Starting Principal: $100,000
Annual Dividend Yield (3%): $3,000

Let’s say this bull run continues for 3 more years. Each year, the dividends grow and the yield-on-cost (YOC) increases one full percentage point (for simplicity sake).

Year 1 Dividends: $3,000
Year 2 Dividends: $4,000
Year 3 Dividends: $5,000

So, I would have earned $12,000 in passive income over 3 years. That’s awesome! That’s $333.33/month more towards my early FI fund!

On the surface, of course it feels like I’m making tremendous progress. But if after 3 full years, the market finally decides to turn, and I lose 20% of my principal, my portfolio will be valued at only $80,000. Even if you re-factor in the dividends, I would still be out $8,000.

Although the above scenario may never play out, I don’t believe that a 20% correction is unrealistic either, at this point in time… It could very well happen.

As such, I just wasn’t comfortable enough with the risks to keep moving forward with my stock portfolio. Don’t get me wrong, this isn’t a knock on dividend growth investing; it’s a reflection on how hot the market is at present day.

Cash Deserves a Break!

A majority of the cash that I am holding at the moment was acquired through refinancing two rental properties; I pulled out ~$200,000 in equity. So, it’s important to factor in where the source of the cash came from…

Yes, I would agree that if I was just saving pennies from my 9-5 for many years and building up a chest vault to ~$200,000, then you could easily argue that my returns could have been much greater had I chosen to invest that money, instead. Really, how long would it take a person to save $200,000 in cash, after taxes?

But in my case, that’s not how things happened… There was no lost opportunity to account for. In fact, I gained this newfound cash by earning massive returns on some leveraged deals:

Rental Property #2:

Purchase Price $290,000
Downpayment: $58,000
Original Loan: $232,000

Refinance: $440,000
Loan-to-Value (75%): $330,000
Cash Out: $98,000 ($330,000 – $232,000)

The above is simplified and doesn’t include any principal paydown, which would have increased returns even more, but you get the general idea…

I profited $208,000 ($440,000 – $232,000) in leveraged returns off of my downpayment of $58,000. This is a return of 258% in just over 2 year’s time.

Lather, rinse, and repeat for Rental Property #1. It’s about the same story.

So, clearly, my original cash downpayment worked very hard for me! I think that it deserves to take a break now… Again, it’s all too easy to be deceived into thinking that cash always has to be in the game hustling to earn its keep; it doesn’t.

Just like when I visited Rome last August, I quickly realized that the most successful restaurants were always closed during that time of year… The owners were doing so well that they decided to take a break and go on vacation holiday!

The reality is also this — If I want any semblance of a chance to win such deals again in the future, I will ONLY be able to do so if I have ample cash in the bank ready to deploy at a moment’s notice.

When your cash does well and performs admirably for you, I think that from time to time, it too deserves a break!

Cash IS Cash Flow

The last important point I would like to make is this — Cash IS cash flow! These days, I feel like way too much emphasis is being placed on earning passive or semi-passive income, at all costs.

Sure, you can build wealth using the time-tested and proven DRIP approach (earn cash flow and re-invest it). But who says you can’t pay the bills using cold hard cash?

Let’s say my monthly expenses are $1,500/month, or $18,000/year. With $200,000 in the bank, that’s over 11 years of living expenses. In my own case, that’ll take me into my 40’s, and I’ll still have my 401k and Roth IRA, and rental properties working hard for me along the way… Not much is lost if you’ve already got lots of investments in the game. But again, you shouldn’t have to feel like every dollar you earn has to be participating at all times!

Depleting principal is never the underlying goal, but let’s not forget that it’s nevertheless a very viable option.

And as always, life doesn’t have to be so binary… You could deplete principal for 1, 2 years, while you wait for the tide to turn… When it inevitably does, you’re back to winning high-margin deals again… Which over the long-run, may serve you much better than having to compromise and settle on mediocre investments (when times are good). Don’t invest just for the sake of “putting your money to hard work”.

It’s not always about hard work… Smart work is the best approach.

Summary

Cash in the bank gets a bad rap, which is unfortunate. In a downmarket (which is the only way for us to go at this point!), cash is indeed king, and those who don’t have it will be wishing that they did.

There was a point in time when I dismissed cash as well, thinking that it was a stagnant “investment”, but those times have quickly changed…

These days, cash gives me peace of mind and helps me support my leveraged real estate investments. Further, I appreciate the fact that my principal will be held intact and not have to face disappearing into the night when times get rough, like many other assets will.

Too much emphasis is placed on passive income “returns” and not enough on protecting principal. From my own experience, I know that if you can put cash to good use, you can score deals that will blow DRIP cash flow returns out of the stratosphere… Over many, many years.

These are the type of deals that I’m after… and these bargains can only be had in a bear market when fear is paramount. We are not operating in that environment at this time. So, I’m content with hanging out on the sidelines now…

But when the next opportunity arrives and it’s time to go hunting again, I’ll be most glad that I have cash on hand.

Cash is king in a bear market… and that’s how you make the most money!

{ 34 comments… read them below or add one }

1 Financial Samurai May 19, 2015 at 1:10 pm

I believe in having good cash cushion, but shouldn’t cash be generated through c cash flow?

In your refinance example, you took out cash but increased your mortgage debt by $98,000. You’ve got to pay more cash flow a month to service debt. Why not just raise the cash through income and savings instead?

S

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2 FI Fighter May 19, 2015 at 1:16 pm

Sam,

Yes, in an ideal scenario, cash flow would put out enough cash where it could completely cover all expenses and/or replace your current earned income… Unfortunately, getting there takes a lot of time and work, and not everyone succeeds in doing so.

The cash out refi only works if you have enough cash flow margin so that you can take on the additional debt service and still not go cash flow negative. Or you can raise rents, which is what I did.

I realize that saving/earning $100k in passive income is extremely trivial for many people, like yourself, but at this point in time, it’s still a huge, daunting task for someone like me. 🙁

Having $200k in the bank for me is a good place to be right now and it lets me prepare for the next round of buying… Not sure how many years it would take for me to get to that point through the traditional route of just earning and saving…

All the best!

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3 Financial Samurai May 19, 2015 at 1:58 pm

FI – Raising $100,000 in cash is definitely not trivial for me. To be able to do so would be a nice achievement.

I’m just giving you the perspective from a financial analyst who’s been running a business and analyzing public co investments for a while now. What you’re discussing is more financial engineering – moving money from one account to another in a different form.

Raising cash by taking on more debt is not really raising cash. Raising cash while maintaining the same debt profile is raising cash.

It may be wise to take out some of the paper money equity gained, but unless you sell the asset, nothing is really gained. It’s important to really not consider this cash raising in your mind.

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4 FI Fighter May 19, 2015 at 2:14 pm

Sam,

I hear your point, and with investing of course nothing is guaranteed. Yes, ultimately, it’s just moving money around…

However, we’ve all got to place our bets somewhere… So, I’m placing my bets on the Bay Area and banking (literally) on the area to do well and prosper over the next few decades.

In my mind, I’m rationalizing it as: I’ve got a cash flow positive property locked in with 25% equity on Day 1 (after taking money out). It will become more valuable over time…

If I didn’t have that confidence, I could simply sell all my properties and be done with it… Now that would be raising REAL cash. Time will tell, but right now all I see is massive development everywhere and a very robust, strong local economy.

If the Bay Area continues to do well, those properties can’t help but go up in value.

In any case, adding a tad bit more debt (manageable and 100% covered by cash flow) but having $200k in cash to me is a far better place to be than to have slightly less debt (albeit slightly more cash flow) and ~$0 in the bank.

All the best!

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5 Adam @ AdamChudy.com May 19, 2015 at 4:25 pm

So long as your property continues to cashflow, taking money out of the house that you can redeploy is typically the most intelligent move. I agree with you.

Though, if you plan to let it sit in the bank, that may be a different story.

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6 FI Fighter May 19, 2015 at 5:15 pm

Adam,

Sitting on cash for an extended period of time is probably just about incomprehensible for most in the investing game… 😉

I’m holding cash for now and bracing for a downturn… but even so, I’m using some funds to generate returns. I’ll discuss more about it in a future post.

All the best!

7 Even Steven May 19, 2015 at 1:39 pm

I agree with you on a couple points and like the article, so we got that going for us;)

I agree that having cash in the bank can certainly be a good think and like you mentioned it depends on the phase you are in and also the percentage of your financial world, for example to have 80% in cash in your early 30’s for example wouldn’t make much sense.

The only thing that I question and more of a question would I do it myself was the cash out refinance. For either of our real estate investments, refinancing to take out 100K to have the money sit in the bank wouldn’t make much sense to me for our financial situation. I should point out that we are almost doing the opposite by paying down the mortgage to eventually increase the rental income and thus have no debt.

On a side note I want to add your FI date to my site, I’ll try to ping you on Twitter as well. Thanks.

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8 FI Fighter May 19, 2015 at 1:48 pm

Even Steven,

Definitely, a lot of it will depend on what phase you are at in the investment game. For instance, if I was just fresh out of college and working my first job, then definitely I would be pouring in almost 100% of my earned income into the markets… You’ve got time on your side and essentially nothing to lose if the market crumbles.

Also, yes, if I park the cash in the bank for an indefinite period of time (and rates stay at 0%) then yes, the cash would be losing purchasing power. However, I don’t think either scenario will manifest. A) I’ll deploy the cash and invest again, it’ just a matter of when. B) Rates won’t stay at 0%.

Regardless, in my situation, it made sense to refi since the cash flow from the property (after increasing rents) more than covers the debt service. So, I’m still cash flow positive, I still own the property, and I’ve got a lot of cash ready and waiting for the next deal.

Also, because I have $1MM+ in debt, having $200k in the bank does wonders for peace of mind… This is something I never planned or accounted for when I was starting out, but I’ve accepted that investing is not unemotional (at least for me). I’ll give up some returns for that peace of mind.

In the long run, I will eventually look to do exactly what you’re doing — Pay down mortgages and increase rental income.

Again, it has to do with where you are at in your investing career. I bought a bunch of assets in one bear market… I’m proceeding with caution now, but would like the opportunity to buy up again in another bear market.

My own plan is to accumulate the bulk of my assets over the stretch of 2 bear markets. After that, I’ll probably go conservative and work towards eliminating debt.

No one said the path to early FI was simple and linear 😉

Cheers!

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9 Financial Samurai May 19, 2015 at 2:00 pm

Going from $900,000 in liabilities and minimal cash to $1 mil in liabilities and $200K does sound better.

The #1 way you can help yourself though is to find another ADDITIONAL income.

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10 FI Fighter May 19, 2015 at 2:19 pm

Sam,

Yup, I’ll take that deal any day of the week 🙂

I’ll need to buy you lunch or coffee sometime and you can teach me how to earn ADDITIONAL income… That is very much a work in progress. I could use a jedi master 🙂

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11 Even Steven May 21, 2015 at 11:33 am

I have thought about having cash ready for a bear market, so I can certainly see that side of it. I think we all have different ways of getting that cash, more than one path, certainly agreed.

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12 FI Fighter May 21, 2015 at 11:58 am

Even Steven,

Yes, there are many ways to get cash, but whatever means you decide to use, I think we will all agree that in a bear market, we will all be grateful that we have funds to invest with.

This was the easiest path for me and since cash flow covers the new mortgage,really a no brainer…

Take care!

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13 jon May 19, 2015 at 7:29 pm

I view your cash cushion as an inevitable capital cost associated with leveraged REI. It is not a bad thing, it just needs to be factored into your calculations when thinking of buying a property. A DGI investor who does not use debt and does not time the market cares only about consistently increasing cash flow because they have no expenses associated with their investing. It is really an apples/oranges situation.

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14 FI Fighter May 19, 2015 at 9:55 pm

Jon,

Definitely, it is an apples to orange comparison. As I mentioned, it’s my heavy debt load which is holding me back from freely diving into the market right now…

With that said, I also do feel like there are other strong merits to holding cash. It is possible to make tremendous gains in both an upmarket and a downmarket. Knowing what I know now, my preference is to most definitely invest more heavily in a downmarket. It’s anyone’s guess when that will be, but there will certainly be better opportunities when that time arrives.

I’m content with waiting patiently until the next round.

All the best!

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15 No Nonsense Landlord May 19, 2015 at 7:46 pm

“Really, how long would it take a person to save $200,000 in cash, after taxes?” Coincidentally, that is my goal for 2015… It does make for less stress having less mortgages and less debt.

The market is a bit frothy. It’s hard to tell where it goes from here. Maybe a small correction, maybe -10%. But likely not a bear. When you have cash flow, you can let the market run it’s course and continue to do dollar cost averaging. That is how you make it in a choppy or down market.

Cash is a good thing. I have made offers in the past that I would not have gotten if I could not pay cash. I had two cash deals that required $130K and $205K in recent years. I was able to turn that cash into a great investment.

While your cash is in the bank, you are paying ~4% interest, plus 2% inflation. If you pay off a loan, you get at least the interest rate on the loan.

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16 FI Fighter May 19, 2015 at 10:01 pm

Eric,

I should rephrase that — “how long would it take an (average) person to save $200,000 in cash…”

You’re obviously not in that camp and a person who could declare early FI anytime they want… I make a pretty good salary and even then it would take me a tremendously long time to save up $200,000 after taxes…

Even if my cash was to remain in the bank for a few years, I still think the move was the right one to make — having lots of cash is what is necessary to act quickly and close out deals, as you know. Also, if things go south, the cash on hand can be a huge safety net as well.

I will gladly sacrifice some returns for that extra margin of safety.

With that said, I do have strategies to help generate interest on that capital. Although it’s mostly sitting on the sidelines, i will be in and out of stock positions to earn probably more that what I would have made investing in divided stocks for a year… I’ll share more in a future post.

And you never know what opportunities will arise… When you have cash, opportunity tends to come knocking a lot more often than otherwise.

Take care!

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17 Jerry Harrison May 20, 2015 at 7:22 am

stopped all investing (401k,ira,taxable, etc) for three months to build cash, pay real estate taxes, get some maintenance work done on vehicle and house, buy a little physical silver, and actually spend money on myself ( I need new running shoes). Ill wait for a downturn before i start investing money again.

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18 FI Fighter May 20, 2015 at 7:45 am

Jerry,

Sounds good, we could all use a break every now and then.

I think I need some new running shoes as well 😉

All the best!

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19 carlos May 20, 2015 at 7:34 am

this is sheer madness. Let me get this straight, you refinanced your homes using them as ATMs. Presumably took out a higher interest rate than what you originally had, paying the fees associated with that so that you could get the money out and let it sit in the bank idle? incredible. You are forced to raise your rents to offset your new costs which means your income will be higher on paper and your principal repayment will be higher (which is not tax deductible) implicating much higher tax bill at the end of the year. So you are borrowing money paying interest on that money in exchange for money to sit in a bank account erroded by inflation and losing purchasing power.

If this looming bear market hits, your hand is forced and you will hemorrhage money because you will have to slash your rent prices if the demand does not exist and your renters lose their jobs. In fact that is in the cards anyways bear market or not. These over paid renters of yours are getting outsourced to countries with cheaper labor. That is not a glitch that is a trend. Its the fed’s cheap money that is causing the frenzy not economic growth. Don’t believe me? Why have interest rates not rised (because the fed is afraid it will send the weak economy to the pits). read their notes. I do not believe this bear market is in the near term horizon so you will have luck on your side once again.

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20 FI Fighter May 20, 2015 at 7:54 am

Carlos,

So, it doesn’t sound like my strategy is suitable for someone like you, which is fine, but I think you’re making too many assumptions there, so let me explain…

First off, the interest rates I took out are IDENTICAL as before, and I did not have to pay any fees for this. That alone made the refis worth doing.

Second, yes the mortgage is higher as well as the interest, but I am NOT the one paying down the principal. And mortgage interest is tax deductible. I really don’t see what the big deal is as these properties are still cash flow positive after rent increases and my rents are still WELL BELOW market rate.

If a downturn were to hit and landlords had to slash rents, and there was trouble in the air, do you seriously think a bank or lender would loan me money at that point? At that point, yes, I will feel very fortunate that I was able to pull out money when times were good and I was able to.

If the money sits in the bank and earns no interest, that’s perfectly fine by me… for NOW! As always, I don’t see the point in looking at something through a binary, myopic lens… Just because money is being set aside RIGHT NOW, does not mean I will never invest it ever again… I don’t even know why anyone would assume that…

If a bear market hits, EVERYONE will be hurting. Being cash strong is what will save you, not to mention give you an opportunity to load up on more discounted deals.

I can’t predict the future, so I’m electing to stay cash strong. If I have to sacrifice some returns in the process, so be it. There’s more to lose at this point…

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21 Tony @ Inequality Today May 20, 2015 at 8:50 am

I totally agree with you. Everyone knows “be greedy when others are fearful”. However, few people can do it because most people have no cash left at the bottom of bear markets. That’s why long term investors like Jeremy Grantham who always have cash on hand can buy at rock bottom prices.

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22 FI Fighter May 20, 2015 at 9:09 am

Tony,

Absolutely! It’s so easy to say one thing and do the complete opposite. When I analyze things from a risk/reward perspective, I see very limited reward left in this market. Sure, I could test my luck and try to squeeze out another few drops, but I doubt whatever returns are left would make any noticeable impact to the bottom line.

On the other hand, the two properties that I won and refinanced during the downturn have each gained over 200%+ in leveraged returns. Most people will say, yeah well you got lucky buying into a downmarket…

Which is precisely why I want to hoard cash now! My best deals were made in a bear market. Sure, it make take a lot of patience, but who says you have to invest like clockwork every day, or every week, or every year?

It doesn’t take that many deals to get to early FI… The challenge is winning the right deals at the right time.

I don’t know when opportunity will come knocking again, but I’m making plenty sure that I will have lots of ammo when the time comes.

If I’ve learned anything it’s that you make a ton more money investing in a time of fear.

All the best!

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23 Mr. Belevedere May 20, 2015 at 2:10 pm

Fi Fighter, I think you’re on the right side of it. You’re going against the grain, and the best investors always seem to do so. The news isn’t really talking about housing quite yet coming roaring back…they mention it, but not like they do a stock that is on fire. Usually once the news starts running with it, that’s the end.

Anyway, I love your method of refinancing. If you’ve ever been invested in a stock at say 50k investment with 10% return, and then the stock flops and cuts the divy, you’re now at 25k with a 5% dividend, that’s no fun. It only takes one or two of those to realize why real estate is great for minimizing risk. Once you pull all your investment out, your risk is minimized to a credit rating.

If you don’t sell, or refinance, equity is useless except for bragging rights.

Nice job. Fantastic!

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24 FI Fighter May 20, 2015 at 5:35 pm

Mr. Belvedere,

Yes, there’s nothing quite like experiencing paper gains, doing nothing, and then having to painfully watch them vanish into thin air…

The rise up is usually staggered, but the descent down is a straight plunge!

Bragging rights don’t do me any good and don’t help me on my journey to early FI, so I’m glad I completed the refis. Like you mentioned, I’ve got all my initial downpayment back out (and much more) so no complaints from me!

I think we’ve still got ways to go… Lending is still strict, so once that loosens up (maybe another 2-3 years) things will start to get more interesting.

I’ll have the popcorn ready…

Take care!

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25 Curtis@PayOffMyRentals May 21, 2015 at 12:44 pm

I also got my hands on $200k about the same time you did, but it only cost me about $1,400.00 one-time fee. I got a credit line from my bank. They used 5 of my houses as collateral. All I have to do is email my bank and the requested funds up to $200k are deposited within the hour. I pay 5.5% interest. I’ve requested funds 3 times now and tested the waters. No transaction fees and I only pay interest on the money when I borrow it.

I think that would have been a better way to accomplish what you’ve accomplished. It’s just as effective and a heck of a lot cheaper over the long run.

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26 FI Fighter May 21, 2015 at 3:51 pm

Curtis,

That’s awesome and congrats to you for figuring out a way to tap into that equity!

I did try very hard to get a HELOC, but unfortunately due to my situation, no lender was willing to give me one on favorable terms (LTV = 75% is what I wanted). Further, I have heard from other investors who have pulled out HELOCs in the past to only have the lender pull them when the economy headed south or there were significant headwinds being faced.

Although I have no direct experience with HELOCs, the message i got was clear — they are subject to termination at any time, at the sole discretion of the lender.

That’s a risky proposition to me and with the cash out refis, at least I am assured that those 30 year fixed rate mortgages will always stay the same for the life of the loan, regardless of what happens to the economy.

Worst case, I would hate to have to depend on a line of credit that is nowhere to be found when you need it most. But if you can find a lender that can assure it will always be there, then that’s a win, no doubt.

Take care!

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27 Midwestern Landlord May 21, 2015 at 4:34 pm

Curtis / FI Fighter,

My past career is in commercial banking so I can add a little insight into this. Banks definitely have the option of pulling an existing line of credit when economic times turn for the worse or the borrower credit score is compromised. Even if the LOC is fully drawn, the bank can decide to not renew the note and put pressure on the borrower to pay off the loan. There is also interest rate risk. If the Bank does not want this loan anymore, the rate is subject to increase substantially in a worst case scenario. Borrowing via a fixed interest rate loan over 30 years (which is then sold off to the secondary market) does not suffer from these problems. It is a long term guaranteed contract as long as payments are made as agreed.

Also, there is true power in borrowing money at a low fixed interest rate over 30 years. Rents will go up over time with inflation, but that payment and interest rate remains the same.

Said that, I still like the concept of getting access to equity via LOC’s, just not as much as being able to get access to equity via low rate 30 year fixed mortgages.

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28 FI Fighter May 21, 2015 at 4:47 pm

Midwestern Landlord,

Very good to know, thanks for sharing and you bring up some very good points, especially in regards to fluctuating rates.

When it comes to real estate investing, access to more credit is always a wonderful thing 😉

I do prefer 30 year fixed rate mortgages at historically low interest rates as well, and will agree that having a line of credit can be extremely useful too. It’s so versatile and like a credit card, you only need to pay interest on it when you use it.

I just gotta find a lender willing to give me one… They definitely aren’t giving them away for free like they used to… and the more properties you have, the trickier this gets. Much easier to get for an owner occupied property, I should add that point.

Cheers!

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29 Midwestern Landlord May 21, 2015 at 4:54 pm

I would think that you would be able to get a LOC on your Indy property that is paid for, albeit, probably at conservative terms. With the cash you already have from the refi’s, it may not be necessary depending on what your longer term goals are.

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30 FI Fighter May 21, 2015 at 10:29 pm

That’s worth an inquiry, for sure. I relaxed my efforts on that after the second refi since it no longer became a pressing need, but it never hurts to have more options available.

I’m very close to opening up a margin account as well. I don’t plan on ever using it, but you never know…

Yup, long-term, who really knows what opportunities the market will bring! 🙂

31 Midwestern Landlord May 21, 2015 at 3:32 pm

Fi Figher,

You have been on a roll lately with a lot of good content. So much in fact it has been a little hard for me to focus on what I want to comment on. I absolutely agree with you beefing up the cash reserves with the refi’s. Borrowing money at a low fixed interest rate over 30 years when tenants are paying for the monthly obligation is a GIFT. I wish I had the opportunity to do what you are doing, however, in my area I do not have anywhere close to the appreciation that you are seeing in the Bay area.

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32 FI Fighter May 21, 2015 at 4:07 pm

Midwestern Landlord,

Thanks! Glad you are enjoying the posts.

In regards to the refis, yes, at these low interest rates I do consider them a huge gift! I got to lock down a 30 year fixed on Rental Property #1 at 3.75% and Rental Property #2 at 4.375%. For investment properties, I’m more than happy with that…

Yes, I realize that the type of strategy I’m employing in the Bay Area will most likely differ from what you are utilizing in the Midwest, and that’s part of the mystique with real estate investing. As an investor who has dabbled a bit in both, I can see how both approaches work, but you have to adapt to your market accordingly.

I am quite envious of the low barrier to entry point for Midwest properties and the much better cash flow (rent to purchase price ratios) you guys have! There are also very crafty ways Midwestern investors utilize cash out refis, although it’s more to speed up the rate of acquisition and to earn more cash flow as opposed to locking in appreciation gains.

I’m going to write a post about that in the near future, comparing coastal and Midwest market strategies.

One size doesn’t fit all, but they both work!

Cheers!

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33 CashFlowDiaries May 28, 2015 at 3:00 pm

Hey FI,

Wow heck an of article. I must say that was a bold move on your part taking out that refi for the sole reason that you are assuming you know what is going to hit the fan. This is one of those moves where a lot of people are not going to agree with you, especially real estate investors. Mainly because as you said its just sitting in the sidelines right now. But if youre right and all of a sudden we are in the position where we need CASH, then you will be genius who saw it coming.

I know if I pulled out a refi on one of my properties, I would invest it right back into purchasing a new rental property but that is my plan to retire. Cash flow from rentals will be my FI. Im slowly working my way there. Im actually having a ton of luck in the midwest with rentals (indy). The appreciation isnt much, but it is super stable and the cash flow is amazing! Im averaging at 20% cash on cash returns on all my properties so far.

Look forward to future articles.

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34 UK June 24, 2015 at 7:50 am

Hi
you say you are not a market timer – but you actually describe market timing.
Since the last 100 years S&P was mostly at all time high – that’s why its always expending higher in average of 8% a year~.
Investor that cannot stomach 20 – 50% correction should not be in the market at all. Because it will always happen and you cannot time it. You can wait out while the market will take another 100% higher to avoid 20% – 30% correction.

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