If you are a real estate investor and have one or more rentals you’ve accumulated over time, there’s a good chance you have a good amount of equity in at least one of your properties – maybe even your primary residence. You might feel happy that you have a lot of equity but from an investment point of view, you could be making more money — potentially A LOT more — if you pull out some of that equity to re-invest it rather than leave it in the form of equity for an existing property. Compare the following two scenarios.
Scenario 1
Let’s say you have 3 properties. One is your primary residence which you live in and are not renting out. The other two are rentals.
| Current Value | Equity | Rental Income (monthly) | |
|---|---|---|---|
| Primary Residence | $1,000,000 | $600,000 | $0 |
| Rental 1 (townhouse) | $750,000 | $650,000 | $2,500 |
| Rental 2 (triplex) | $590,000 | $100,000 | $4,820 |
Appreciation
Now, let’s estimate the value + appreciation on each property per year over 10 years. The average annual appreciation rate in California is 6.77%. We can easily calculate the appreciation using the calculator at
https://www.ddginc-usa.com/cgi-bin/apprec.php
In the last row, we see the total appreciation over 10 years.
| Year | Primary Residence | Rental 1 | Rental 2 |
|---|---|---|---|
| 1 | $1,067,700 | $800,775 | $629,943 |
| 2 | $1,139,983 | $854,987 | $672,590 |
| 3 | $1,217,160 | $912,870 | $718,124 |
| 4 | $1,299,562 | $974,671 | $766,742 |
| 5 | $1,387,542 | $1,040,657 | $818,650 |
| 6 | $1,481,479 | $1,111,109 | $874,073 |
| 7 | $1,581,775 | $1,186,331 | $933,247 |
| 8 | $1,688,861 | $1,266,646 | $996,428 |
| 9 | $1,803,197 | $1,352,398 | $1,063,886 |
| 10 | $1,925,273 | $1,443,955 | $1,135,911 |
| Diff | $925,273 | $693,955 | $545,911 |
Rental Income
Now, let’s estimate the annual gross rental income and per year over 10 years. For simplicity, and to be conservative, we’ll keep the monthly rent fixed (we’ll never increase the rent), although in reality, in California you can legally increase the rent by at least 5% per year. In the last row, we see the total gross rental income over 10 years. Of course, you’ll have expenses like debt service (paying your mortgage), taxes, operational costs, etc which will reduce this total rental income.
| Year | Primary Residence | Rental 1 | Rental 2 |
|---|---|---|---|
| 1 | 0 | 0 | $0 |
| 2 | 0 | $30,000 | $57,840 |
| 3 | 0 | $30,000 | $57,840 |
| 4 | 0 | $30,000 | $57,840 |
| 5 | 0 | $30,000 | $57,840 |
| 6 | 0 | $30,000 | $57,840 |
| 7 | 0 | $30,000 | $57,840 |
| 8 | 0 | $30,000 | $57,840 |
| 9 | 0 | $30,000 | $57,840 |
| 10 | 0 | $30,000 | $57,840 |
| Total | 0 | $270,000 | $520,560 |
Total Return on Investment
Now, if we add the appreciation and rental income minus expenses over 10 years, we’d get our total return on investment (ROI). But, since expenses vary from one property to another, to be conservative and keep things simple, we’ll just look at the total appreciation.
Over 10 years, our investments will have appreciated by $2,165,140.
Now, let’s compare this to another scenario where we do cash-out refinance and reinvest the money in more rental properties.
Scenario 2
In this scenario, we decide whether to do cash-out refinance for each existing property.
Primary residence
For the primary residence, we won’t refinance it and take cash out because doing so would increase the mortgage and since it’s not a rental, you’d have to pay for that increase yourself. Of course, if you can afford it, you could also do a cash-out refinance on that property as well, but it’s not a good idea to spread yourself too thin.
Rental #1
For rental #1, we do a cash-out refinance to pull out 75% of the equity. In doing so, our monthly mortgage pay for that property will go up but if you plan it correctly, your income will cover your new expenses, especially if your previous loan would be paid off in, say, 10 years, and you refinance to 30 years which would lower your monthly payments despite having borrowed more money.
Rental #2
For rental #2, there isn’t enough equity in the property so we can’t refinance it.
| Current Value | Current Equity | Cash-out refi 75% of value | New Equity | |
|---|---|---|---|---|
| Primary Residence | $1,000,000 | $600,000 | No refi | $600,000 |
| Rental 1 | $750,000 | $650,000 | $562,500 | $100,000 |
| Rental 2 | $590,000 | $100,000 | No refi | $100,000 |
| Total | $562,500 |
According to the table above, we’re able to pull out $562,500 from Rental #1 which we’ll use as a down payment to purchase more rental properties. Let’s say we buy 4 duplexes at $500,000 each and we put down 25% (standard for investment properties) which is $125,000 for each. That leaves us with $62,500 for closing costs and some home improvement. We’ll estimate the rental income for each duplex is $3500 per month.
| Current Value | Equity | Rental Income (monthly) | |
|---|---|---|---|
| Rental 3 (duplex) | $500,000 | $125,000 | $3,500 |
| Rental 4 (duplex) | $500,000 | $125,000 | $3,500 |
| Rental 5 (duplex) | $500,000 | $125,000 | $3,500 |
| Rental 6 (duplex) | $500,000 | $125,000 | $3,500 |
Appreciation
Now, like in scenario 1, let’s estimate the appreciation over 10 years.
| Year | Rental 3 | Rental 4 | Rental 5 | Rental 6 |
|---|---|---|---|---|
| 1 | $533,850 | $533,850 | $533,850 | $533,850 |
| 2 | $569,992 | $569,992 | $569,992 | $569,992 |
| 3 | $608,580 | $608,580 | $608,580 | $608,580 |
| 4 | $649,781 | $649,781 | $649,781 | $649,781 |
| 5 | $693,771 | $693,771 | $693,771 | $693,771 |
| 6 | $740,739 | $740,739 | $740,739 | $740,739 |
| 7 | $790,887 | $790,887 | $790,887 | $790,887 |
| 8 | $844,431 | $844,431 | $844,431 | $844,431 |
| 9 | $901,599 | $901,599 | $901,599 | $901,599 |
| 10 | $962,637 | $962,637 | $962,637 | $962,637 |
| Diff | $428,787 | $428,787 | $428,787 | $428,787 |
Rental Income
Now, like in scenario 1, let’s estimate the annual gross rental income and per year over 10 years.
| Year | Rental 3 | Rental 4 | Rental 5 | Rental 6 |
|---|---|---|---|---|
| 1 | $42,000 | $42,000 | $42,000 | $42,000 |
| 2 | $42,000 | $42,000 | $42,000 | $42,000 |
| 3 | $42,000 | $42,000 | $42,000 | $42,000 |
| 4 | $42,000 | $42,000 | $42,000 | $42,000 |
| 5 | $42,000 | $42,000 | $42,000 | $42,000 |
| 6 | $42,000 | $42,000 | $42,000 | $42,000 |
| 7 | $42,000 | $42,000 | $42,000 | $42,000 |
| 8 | $42,000 | $42,000 | $42,000 | $42,000 |
| 9 | $42,000 | $42,000 | $42,000 | $42,000 |
| 10 | $42,000 | $42,000 | $42,000 | $42,000 |
| Total | $420,000 | $420,000 | $420,000 | $420,000 |
Total Return on Investment
Now, let’s calculate the total ROI. Again, to be conservative and for simplicity, we’ll just consider total appreciation even though we know the total ROI will be much more than that since every month for 10 years we’ll be paying down the mortgage using the rental income which increases our equity in each property.
The total appreciation over 10 years in scenarios 1 and 2 are
- Scenario 1: $2,165,140.
- Scenario 2: $2,165,140. + $1,715,147 = $3,880,287.
Therefore, using a very conservative estimate, we could make an additional $1,715,147 over 10 years if we refinanced and reinvested the equity in our existing properties.
What to do after 10 years
Let’s say you hold on to the properties for 10 years. You’ll most likely have a mortgage on all or some of properties. At that point, you could choose to sell some of the properties to pay off all of your mortgages and live mortgage free! You’ll still be getting rental income from the remaining rental properties which may even amount to as much or more as your work income from a day job in which case you could choose to just retire and travel the world.