“It takes money to make money.”
You’ve probably heard that quote if you understand the business world and are familiar with basic investing strategies.
Well, it’s very applicable and valid in the real estate world, too. Why?
Because to acquire rental property, regardless of whether it’s a single family home, small multifamily, or a 300-unit apartment complex, you’re probably going to have to pay a down payment and fork over some cash.
Hence, it takes money to make money.
In my personal experience in building a portfolio of properties in Indianapolis, I generally put 25% down on my investment properties, meaning I have a nice chunk of cash “tied up” in my assets. Since I’m constantly saving then re-investing on repeat, you could call me “asset rich, cash poor” -- which many investors can relate to, as well.
With money tied up to acquire property, that brings us to the questions, “Is real estate liquid?” and “Can I access my equity quickly, if needed?”
As a quick answer, I’d say no.
While real estate is an illiquid asset class compared to stocks, bonds, mutual funds, and ETFs, that doesn’t mean you should close this window or go on to the next article right away. No way! I’ve got a few important points to touch on that will help you better understand the power of investing in real estate, even if your invested cash isn’t quickly accessible.
What is “Liquidity”?
Financial liquidity refers to how easily assets can be converted into cash. Assets like stocks and bonds are considered very liquid because they can be converted into cash within days.
Rental properties on the other-hand, take more time to convert into cash. Think about the process of selling a house: first you must find a buyer, agree on a price, the buyer will have a period of time to perform due diligence, and then you can close and get your cash as a seller.
The process from start to finish generally takes weeks.
Know What You’re Getting Into
The first thing to grasp when deciding to invest in real estate is having a clear understanding of this particular investment strategy. You need to know what you’re getting into, as there are pros and cons to every investment strategy.
As alluded to earlier, real estate is not like the world of stocks and bonds. But, that’s fine. We know the benefits and challenges of real estate and that’s why we’re interested in it!
First Recommendation: Invest Money That You Won’t Need in a Pinch
Want to know how to feel at ease when it comes to the lack of liquidity in real estate investing? DON’T INVEST MONEY YOU’LL NEED IN THE SHORT-TERM.
Yeah, there’s your answer. If there’s any chance of a big life expense coming up soon, like a wedding, honeymoon, or a college tuition bill, you really need to evaluate your investing strategy in real estate. It may not be the strategy for you at this time.
If you do decide to move forward down the journey of real estate investing, I’d personally recommend that you still have an emergency fund in case something unexpected pops up. One of the worst things you can do in your investing career is to be pressured into liquidating real estate out of desperation.
You’ve Got Options! How to Tap Into Your Equity
Now that we covered the fact that real estate is not very liquid, don’t worry, not all hope is lost. Here’s the good news: there are a couple of ways to tap into the equity of your real estate investment.
This is a refinance option where a new mortgage is created that’s larger than the existing loan. This is done in order to convert home equity into cash, which basically pays you the difference between the loan balance and the home’s market value. Note: it’s always a much better option if your property has appreciated since the purchase!
Generally speaking, the maximum amount you can borrow is 80% of your loan-to-value (LTV). So for example, if you have a property worth $100,000, the most you can borrow is $80,000.
Cash out refinances typically carry a higher interest rate than a standard refinance and the rate will be even higher if there’s little or no equity remaining in the deal after the refinance.
A few last things you’ll need to understand: the property will have to get re-appraised, the whole process can take anywhere from 30-45 days (or longer), and you’re probably going to need a credit score of at least 620.
A Home Equity Line of Credit (HELOC) provides a way to tap into the value of your home for cash. You’re basically borrowing money from the bank, with your property being collateral. Similar to a credit card, you have access to a pool of money you can dip into as needed and pay back over time.
Not only can a HELOC be used to reinvest in real estate, but if you’re really in need of emergency cash, you can use it to pay for a variety of things like car repairs, credit card debt, and paying bills during a financial crisis. Obviously, you need to be calculated when it comes to utilizing your HELOC as you’ll be paying interest on everything you spend.
A few last things to understand: you’ll incur various fees when setting up a HELOC and the amount you can borrow is largely dictated by your equity in the property and your credit score. Also, many people think that a HELOC can only be arranged on a primary residence, but I’ve seen cases where people get one on a rental property (depending on the lender).
Speeding Up the Liquidity Process
Luckily, we live in the day and age of progressive thinking and innovation. What would seem impossible years ago has now become reality in the real estate world. Quicker and easier real estate transactions are actually a thing these days! Companies like Roofstock and an industry of iBuyers are leading the way in improving the real estate transaction process and are at the forefront of progress in a traditionally slow-adapting industry.
This platform has been around for a few years now and is changing the real estate industry. From a liquidity standpoint as someone looking to sell their property, Roofstock allows you to sell a rental property without having to wait or pay for your tenants to leave, and you don't have to do any staging or showings to sell your property.
This exponentially speeds up the closing process. Roofstock’s other huge advantage is that it markets your listing to a network of more than 100,000 investors across the country instead of just buyers in the local area.
Companies like Zillow and OfferPad are making it easier to buy and sell real estate and have created a new category of buyers, called iBuyers. Their goal is to make the traditionally slow and painful process of real estate transactions a much simpler, quicker, and more painless experience.
iBuyers use technology to make offers on your property instantly without the need of an agent. Because they have access to critical data points in the market, they can calculate an estimated value of your home quickly and submit an offer immediately.
If you agree on a price and the iBuyer purchases your home, they will take on all risks, all holding costs, and turn the property around and sell it to an end buyer at a slight markup. If you’re familiar with the term “wholesaler” (someone who gets a property under contract with a seller and uses their network to find an interested buyer to purchase it), iBuyers are essentially digital wholesalers.
In this case, iBuyers’ greatest advantage is their use of technology and ability to forgo an agent, which makes for a much quicker transaction.
Pros and Cons to Every Investing Strategy
Look, you have to remember there are pros and cons to every investment strategy. And you simply don’t get into the world of real estate because of its liquidity (or lack thereof). No way! The buying and selling process of real estate isn't necessarily quick, but there are great advantages that make up for that fact. At the end of the day, here are some reasons why investing in real estate is so powerful:
Ahhhh, one of my favorite benefits of real estate investing! Cash flow was my inspiration for jumping into the investment world and it’s the amount of cash you have left over each month from a rental property after paying all operating expenses.
Cash flow = gross rental income - expenses
Cash flow is the key to passive income. Passive income, for many of us, is the key to financial freedom. Get it!
This is a process that allows the owner of an investment property to defer capital gains tax. Yes, deferred taxes! This is done through an exchange when the owner sells their property and reinvests the proceeds into a like-kind property of equal or greater value within specific time limits.
The fact that you can defer capital gains taxes is an amazing benefit, as you’ll then have more cash freed up for reinvestment.
This is an income tax deduction that simply reduces your taxable income. The crazy thing is, this tax deduction is based on the perceived decrease in value of your property as it gets older and there’s more wear and tear on it.
But the reality is, your property should hopefully be appreciating year over year. Crazy, right?! Ultimately, depreciation saves you money on your taxes. There are even cases where you may cash flow for the year, but show a tax loss.
Additional Tax Benefits
In addition to depreciation and a 1031 exchange (as described above), there are plenty of other tax benefits that come along with investing in real estate. Deductions play a big part in real estate investing and you can deduct a wide range of things like mortgage interest, repairs, capital expenses, property taxes, and property insurance.
As always, remember to talk with a tax professional here.
So, Is Real Estate Liquid?
Again, I’d say NO. However, the biggest takeaway is that before you invest in real estate, you need to know what you’re getting into! You should be aware of the pros and cons of this investment strategy and understand that no one gets into this business because of its liquidity.
Fortunately, there are strategies you can implement (cash-out refi / HELOC) that help you tap into your equity. And through the advances of technology, the industry continues to evolve with platforms like Roofstock and the new iBuyer industry. Real estate transactions have never been quicker, more convenient, or more seamless.
Lastly, I believe the benefits of real estate investing largely outweigh the weakness of its illiquidity. Cash flow and the numerous tax advantages that come with real estate prove that this is one of the most powerful investing strategies out there.
So go ahead, take a look at what’s available right now, and build a strong financial future!