Inflation is spiking and rates are staying put. (At historically low levels, nonetheless.) Additionally, even people on the moon know that real estate values here on Earth are at or near all-time highs in most markets, particularly in Michigan. Given the combination of cheap money and high values, borrowing from a conventional or hard-money lender is almost a no-brainer.
The decision to borrow should always be analyzed carefully, though, because along with improving your return, it also increases your risk. What if your tenants move out? Or can’t pay because of a COVID job loss? What if the market crashes and you’re underwater? Hello, 2008.
So caution is always a rule of thumb. Still, if you own a cash-flowing property and borrow with a relatively low loan-to-value ratio (say, 50 to 70%), you should be able to weather a storm. But just because a cash-out loan may not appear to involve much risk, you need to consider two things:
First, do you have an immediate use for the cash you’ll borrow?
Second, what will the debt do to your cash-flow?
If you’re thinking of cashing out and don’t have an immediate use for the funds, think again. “But money is SOOOO cheap!” I hear you yelling. True, but if you cash out $100,000 from one of your properties, you’re going to be paying interest on that cash, let’s say about $4250 per year (Our current long-term rates start at 4.25% per year, lower with high credit and low LTV). With inflation currently above 5% per year, you’ll lose over $9000 of buying power in one year holding that $100K.
$4250 + .05($100,000) = $9250
And the cash-flow? Well that $4250 per year of debt payments eats into your cash flow. If you’re making $1200 per month in rent, or $14,400 per year, with a 45% expense ratio, you’ll be cash-flowing $7920 per year. Now subtract that $4250 and your cash flow is $3670 per year. Still a decent sum, but you could be earning more than double ($3670 + $4250) if you weren’t paying for the opportunity cost of holding all this borrowed, depreciating cash.
The bottom line is: if you’re having no problem finding deals or have an opportunity to purchase a property now or very soon, it is a perfect time to cash-out another property. If you’re thinking of borrowing just in case, or to lock up some “cheap money” for yourself, it’s probably safer, smarter, and more profitable to sit tight.