Grow Your Mindset to Grow Your Portfolio
As real estate investors, our goal is to constantly grow our portfolio of rental properties.Starting out, this process may seem relatively quick for some. You might buy your first property, and soon after another and another. Eventually, you’ll start running out of capital to invest.
As a real estate investor, if you haven’t already, you will eventually run out of your own money to invest in deals. That’s just the nature of the game. Those who understand this, are far better off, as they realize the importance of raising money for deals. This is why we have focused heavily on syndication and raising money on this show.
While raising money through syndication or crowdfunding are great ways to continue expanding your portfolio, there are a couple methods that are often overlooked.
What if I told you that you have the ability to unlock capital you didn’t know you had? Well, you do!
We’re going to review two methods that will allow you to expand your portfolio without having to raise money.
Now you may be wondering where this mysterious capital is coming from. It’s not under your mattress. Rather, it’s in the walls and floors of your existing property. Yes, this capital is equity! Equity is essentially cash trapped in your property.
There are very few benefits to having equity stored in your property. In fact, the benefits of removing equity far outweigh any advantages to keeping large stakes of equity in your property.
The first method of expanding your portfolio is doing what is called a cash-out refinance.
What is Cash-Out Refinance?
A mortgage refinancing transaction in which the new mortgage amount is greater than the existing mortgage amount, plus loan settlement costs. The purpose of a cash-out refinance is to extract equity from the borrower’s home. A cash-out refinance is an alternative to a home equity loan (Investopedia).
Let’s look at an example scenario. In this example, you bought an $100,000 property. After five years, the property has appreciated a total of 25%, to a value of $125,000. In that time, you’ve paid down the principal of you loan to $90,000.
Your equity is the value of the property minus what you owe. So in this case your equity is $125,000 – $90,000, which equals $35,000.
By doing a cash-out refinance, you can access this equity and invest it in another property. Cash-out refinances are a great alternative to selling a property, as you get to maintain ownership and profit from the appreciation.
If you do sell a property, be prepared to pay taxes on the profit you make. If you hold the property for greater than 1 year, you’ll have to pay Capital Gains tax. However, you can avoid paying the Capital Gains tax by using a 1031 exchange.
What is a 1031 Exchange?
A section of the U.S. Internal Revenue Service Code that allows investors to defer capital gains taxes on any exchange of like-kind properties for business or investment purposes. Taxes on capital gains are not charged on the sale of a property if the money is being used to purchase another property – the payment of tax is deferred until property is sold with no re-investment (Investopedia).
You might need to sell a property due to loan limits, moving markets, or a number of other reasons. By avoiding Capital Gains tax, you’ll save yourself 15% – 20%, depending on your tax bracket. This will allow you to keep more money in your pocket, so long as you reinvest it in a “like kind” property. By using a 1031 exchange, you can use your equity in your existing property to invest in a larger property, thus increasing the amount of real estate you control, and presumably increasing your cash flow.
Every investor hits a ceiling using their own money. The best investors, use creative strategies to maximize their ability to control more and more real estate. Don’t make the mistake of doing nothing. There are always solutions.
Invest wisely, seek out solutions, and never quit learning.