As you know, I will start to use lines of credit to grow my real estate portfolio. After I decided my early retirement portfolio would come essentially from a rental property portfolio, I decided to look at lines of credit from a different angle. Just so you know, big rental portfolios have been proven to be some of the fastest ways to reach long-term wealth.
In theory, you need some assets to ask for lines of credit, but you can also start this process with a personal line of credit or an unsecured line of credit if you don’t have any collateral to show. If you do use a line of credit to buy a rental property, I recommend you to choose a rental property with very good changes of being rented out. Otherwise, it is risky… very risky…
Yet, lines of credit can be a great tool to expand operating rental portfolios. Just to be clear, in this post, I am covering home equity lines of credit, which are typically called HELOCs.
Before I proceed with my own model, I want to first review the generic model behind HELOCs.
Say you want to retire early with real estate (just so you know, it is among the best ways to retire early). You have a real estate portfolio composed of, let’s say, 3 homes. Two homes were purchased all cash, and so you haven’t mortgaged them. This means that they can be provided as collateral for a new mortgage:
You’re bored with your growth and you think of using a line of credit for investing further. Note that this is yet another way to finance yourself – you’ve got several options. The cool thing about lines of credit is that you don’t really need to guess much because the collateral is already yours. Plus, should you need money, it will be on your account pretty soon (after it has been established, that is). You can simply have it appraised and ask for a credit line. If you use the line of credit merely for investment, this is typically called an investment line of credit.
Now, as your property no. 1 and no. 2 are free and clear, you can have them mortgaged as a collateral for a line of credit. For the sake of discussion, this gives you access to a line of credit of $100,000:
For the sake of discussion, it doesn’t matter whether you mortgage one or two homes to get access to a line of credit. Now, given that you have access to $100,000, you buy a new investment property:
The best thing about this is that that investment property is free of any mortgage. Therefore, you can replicate this process essentially forever. The only things that are required to replicate this on and on are 1) that you don’t default and 2) your appraisals are enough so that the bank lends you enough money to buy a new rental property. An interesting question is “can I still get a line of credit if my credit score is low?”. I am not an oracle, but I’d say you need a decent credit score, so get yourself a secured loan and build that thing up!
Keep in mind that lines of credit typically work on a 70% Loan To Value (LTV) basis. That means that is your homes are appraised for say $100k, the bank will lend you $70k. This is why I am only interested in homes whose appraisal is way higher than the acquisition cost.
A new LLC – my second holding
As I said before, I am establishing a line of credit of $180k, given that RP#3 was appraised at more than that. Plus, I have renovated it, so I can ask for a line of credit giving RP#3 as a collateral. I am creating a new LLC for that, although it is not simply to hold assets. I want to turn it into a big holding, but also a company to sell services, eventually. This new LLC will start with at least 150k of fresh capital. Essentially, I will have to build a rental property portfolio from scratch…
Within this new LLC, I hope to ask for a few lines of credit until the point I ask one or more every quarter. Eventually, I will simply be managing the ratio debt/income of the company. This company won’t be built just so that I build another real estate investment portfolio. My intention here is to leverage a lot and use HELOCs to build a very large rental property portfolio…
I believe that there will be a sweet spot of the income-to-debt ratio as time goes by. Here is a projection of what I want the company to make:
Worst case scenario: revenue = $8,000/yr ; costs = $0 ; equity built $0 ; profit = $5,600
I will start this company with 150k and 0 debt (the 150k will be obtained at the cost of mortgaging RP#3, which belongs to another LLC), and it will take me a while to get my first line of credit accepted. Therefore, I am projecting 8 months to be running at full capacity (meaning having bought all properties and be drawing cash from them), which will create a revenue of $8,000 for the year. This is not particularly good, but it will be a start. In this scenario, I assume that, because the LLC is new, the bank won’t lend me money, which means I can only buy €150,000 worth of real estate. This should be enough to buy and renovate about 6-8 units.
- Assets worth = $250,000 (remember that I will buy way undervalue)
- Costs = $0 (I only factor in big costs – general company expenses such an accountant are factored in the final profit)
- Equity built = $0 because I won’t have any debt
- Profit = $5,600 as I am using a 70% operating margin
In the math above, take into account that the debt on the 150k belongs to my other LLC that owns RP#3. That company will then have some debt on the balance sheets, but the rental income from RP#3 alone (projected to be more than €1,400 by February 2018) will be enough to pay for the installments of that line of credit.
Best case scenario: revenue = $16,000/yr ; costs = $6,400 ; debt = $120 ; equity built $4000 ; profit = $6,000
If the bank lends me money, I will assume I can get $120k in debt. This means a monthly payment of $1,000 which is roughly $666 principal and $333 interest, on a 13-year mortgage.
In this case, I could potentially hit 15 units, which would mean an annual revenue of $32,000. However, I’d need time to buy and renovate the properties. Projecting 6 months to find, buy and renovate some properties, I’d say I would hit about $16k in revenue and pay down $4,000 in principle. The profit would be 60% of ($16,000 – $6,000), which means $6,000. This means that I would create $10k in actual wealth, as I pay down $4k in principle.
I will assume I ended up with the worst case scenario in 2018…
Revenue = $37,000/yr ; costs >= $15,000 ; debt = $150-200k ; com. equity built $9,800 ; profit = $13,000
If the bank doesn’t lend me money in 2018, it will certainly lend me money in 2019.
In this case, I could get about $150k in debt, which, on a 13-year, 3% interest mortgage would mean about $1,200/mo and roughly $385/mo interest and $815 in principle. I would operate at 100% the entire year, thus making over $37,000 in revenue. With $15k in cost, I’d make over $13,000 in profit and build almost $10,000 in equity.
At the end of the year, I need to have at least 18 units, regardless of what happens in 2018.
- Assets worth = $550,000
- Costs = $15,000
- Equity built = $9,800
- Profit = $13,000
In 2020, I will definitely resort to lines of credit…
Revenue = $55,000/yr ; costs = $27,000 ; debt = around $300k ; com. equity built $26,000 ; profit = $16,000
Assuming I could create another $100k in debt during 2020, I will have 26 units in this LLC. This means that I would hit $55,000 in revenue for the year and have monthly payments of $2,300. This would roughly mean about $18,000 in equity, which builds up to $26,000. As for profit, we are talking about $16,000. With debt summing up to about $300,000, the company would hit $875,000 in assets and a net worth of more than half a million bucks.
- Assets worth = $875,000
- Costs = $27,000
- Equity built = $26,000 (includes $9,800 from 2019)
- Profit = $16,000
If everything goes well, I could retire at this point and live solely on the profit of this LLC, while making sure that there are no mistakes maken from this point on.
Any thoughts on this? Let me know in the comments down below!