Investing? Or insanity??

An investor I know down my way, (south Florida), has a unique approach to investing in real estate. I personally think it is borderline crazy, and fraught with risk. I’d like some other opinions.
He’ll buy a SFR with, say, 20 to 25% equity. As an example, a property with a $525K appraisal, for $400K. He is strictly buy and hold. He will immediately refi for as close to appraisal price as he can get. If successful, he now puts $125K in his pocket. So far, so good.
The property is marketed aggressively and he places a tenant in it. The rent might be $2,200/mo. His monthly PITI would be around $4,500/mo. He is out of pocket $2,300/mo.
When I questioned him about this his reasoning is he just put $125K tax free dollars in his pocket. So over the course of a year his negative cash flow amounts to, (I’m going to use round figures here), $30K. So he is still up $95K after 12 months. He further says that since he is buy and hold he isn’t too concerned with the current buyers market, as eventually it will turn around.
He is presently doing three or four similar type deals each month. Prices range from $200K to $1M. On the $1M property, using the strategy above, he pulled out $250K, but eats $5K/mo in negative cash flow. He reasons that as long as he is buying three to four properties each month, he will continually have equity to pull out and keep the ball rolling.
I see this as a house of cards, and a dangerous path to follow. Your feedback is welcome.

I’ll concur on house of cards. At some point this has to all come crashing down…

He is absolutely nuts. Living on borrowed money always leads to bankruptcy.

I concur. But I see him pulling $50K, $150K out of a property each time and it does grab my attention. His argument is that as long as he continues to do deals and pull cash out, the cash will continue to flow his way. Then, when the market turns around, he’ll be sitting in the cat bird seat. :huh

Most of us do the same thing. We find a property that we can buy below the appraisal cost. We finance more than the purchase price and use that to fix up the property and then we put a tenant in there that can actually cover the note. In my case I hire subs to do the work so I get a hunk of cash after the make ready $2k to $5k. It is not $100k but the rents cover the operating expenses and give me positive cash flow. I get the rest of my money when I sell or cash out refi after 2 to 5 years. At the point of 2 to 5 years we are both standing there I have $100k in my pocket plus all the positive cash flow payments from the last 24 to 60 months and the house and your buddy has no more money and they are trying to foreclose on his property. The key is monthly cash flow, not hunks of money in your pocket. Hunks of money will never make you rich, cash flow will. I can spend any hunk of cash no matter how much in a few months, but cash flowing properties give you steady streams of money which allow you to afford any lifestyle you desire to have…That is what rich means.

What happens to this guy if it takes 10 yrs for the market to bounce back? He’s either going to be a genius or a fool, only time will tell I guess.

His thinking is it doesn’t matter. As long as he continues to buy below market, he will always be able to pull out cash and keep the pump going.

What happens when the financing runs dry?

The other issue is the no-seasoning refinances. The best I have seen is 90%. This still puts $72,500 in his pocket tax free minus closing costs which are probably in the area of 3% which now drops him to $56,750 in his pocket. After his negative cash flow he is at $29,150 in his pocket tax free. So while he is unconcerned about the market rebounding if he goes into year two now he is now eating into his $29,150. Not to mention when it sells he will be responsible for his portion of the taxes as well as any realtor fees that he may incur by selling the property. Lastly unless he is in a super hot area it is doubtful that he is going to get 100% of his asking price because renters tear up rental houses just like rental car drivers beat on rental cars. So the house will either need to be rehabbed or sold as is at a discount. This scenario is very similar to a ponzi scheme. It will only keep working as long as he keeps bringing properties into his portfolio. There is no way this guy can last 10 years with this much negative income. On that million dollar property if he hold that house for two years he will be out of pocket 120K before any expenses discussed above.



I see this continuing for about another year or so, maybe a tad less. Then one day…POOF!..this guy is gone, so is the cash, and the bank is holding the bag.

That is what I was thinking as well. He will just one day disappear with whatever cash he has left and start over using his wifes credit somewhere else.

I don’t think he’s a crook, or has any bad intentions. In fact, he’s quite an honorable guy. But I do think this is a dangerous approach to investing.

It will only keep working as long as he keeps bringing properties into his portfolio.
Chris W, that's exactly what he is doing at present. Three to four deals a month.

basically, this guy has bought into his own pyramid scheme…when this house of cards falls, (and it will), there will be quite a blood-bath


But as has been posted that financing will run out. No lender will keep doing no seasoning investment property cash-outs. All lenders have a cap on how many loans they will do for one borrower. Otherwise they have way too much exposure and if something happens they have to buy-back all of those defaulted loans. Why do you think so many lenders have gone out of business this year. Not because the business is not there, but because they have so many buy-backs on defaulted loans that they can’t afford to stay open. And from the scenarios you posted he ius do 100% LTV no seasoning cash-outs. You can count the number of lenders that will do those type of loans on two hands. Once those are gone your friend is totally screwed. Also, I did not mean to indicate that I thought he was a crook or up to something sneaky, but bad things do happen to good people as well. Negative cash flow cannot continue forever.

With all/most lenders tightening up their policies I see him running out of financing sooner rather than later.

Chris, and everyone else, it seems we all agree and you have confirmed my original concerns with this investing approach. I sure hope, somehow, it all works out for him. It’ll be interesting to watch from a distance.

Yes, it will be interesting to watch. It reminds of this kid I was friends with when I was younger. He always said he was going to be a rock star and was always a big screw-up. We all thought he was nuts. Now he is playing guitar for Robin Thicke. So you just never know.

If your buddy wants hunks of cash. I just had a lady refinance out of one of my houses. I paid $101k for the house last year. I fixed it up with a rehab loan and then got a permanent loan. The lady gave me $6.5k and paid me monthly $210 over the PITI. She refinanced out at $145k. That means that I got $6.5k (minus trust creation fees) $210 time 12 months of payments and after we paid off the mortgage I got the difference. I got a got $28k (the difference between the mortgage and what she refinanced at) last week. That is a total of $37000 over 12 months. It is not the $125k that your buddy got but it is not bad and it is sustainable. Now I have to get another house to replace this one.