Cash-out refinance to purchase another investment property versus selling and re-purchasing?

Cash-out refinance to purchase another investment property versus selling and re-purchasing?
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#1

I recently purchased a duplex (for ~$200k and will be renting each unit to cover all payments/expenses and (according to my projections) have some cash left over each month (~$200). After 2-5 years I plan to sell the duplex and use the proceeds to purchase a larger/more expensive rental property (possibly through a 1031 exchange to avoid taxes on the gains). My goal is to maximize the appreciation of my initial investment in the duplex by expanding to more/larger properties as the potential purchasing power of my investment(s) grows.

With respect this goal, what are some pros and cons (interest rates, equity requirements, closing costs) of a cash-out refinance as an alternative to an exchange? Recommended resources would also be appreciated.


#2

Your plan of investing sequentially - selling one property to buy the next, using a 1031 tax deferred exchange - is by far the more prudent of the two options you present.  Financing the current property (cash out) to purchase the second is the more adventurous for sure and should only be done after a very careful and realistic consideration of both properties’ appreciation and rental prospects.

With the financing option, you are leveraging your investment and, as such, both your potential upside and downside are magnified.  Specifically, I presume the modest positive cash flow you are earning now from property 1 would turn negative when new debt service is included.  Will the second property generate enough positive cash flow to cover this shortfall?  And if not, do you have sufficient cash on hand, or a positive personal cash flow, to support any resulting negative cash flow? 

Are you counting adequately in your income and expense projections for vacancies? Maintenance reserves?  What would happen if one or more of the rental units stayed vacant for 3 months, 6 months, or more?  These are not necessarily catastrophic when you own a property that is not indebted, but can become so if you have a monthly mortgage payment to cover out of pocket.

Leverage can be a great way to speed up wealth accumulation in real estate, when it is used intelligently.  However, it is also a blade that cuts both ways and many investors have found out the hard way that when rental income falls, so does the value of the property, meaning you may have to sell at just the wrong time if you cannot keep servicing the debt during a downturn.

Make sure you know what you are doing, and have done a thorough financial analysis, before proceeding.  Most commercial RE brokers should be able to assist with the latter.


#3

There is nothing wrong with your strategy. However, most of the truly successful people I have known in the RE world, buy and hold. They want to see the mortgages paid off and have cash flow with no loans or interest payments. So I would hang on to the duplex if it is in a good location and you have no problems keeping it rented. Then you can refi, as you suggested to get money out for another property. But be careful, you don't over leverage. Many people have lost their shirt in RE because they got too aggressive. The key is to hang on to what you got - and to not over leverage yourself to buy new properties. You sound quite smart. So I am guessing you will figure this out quickly.


#4

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