Real estate arbitrage occurs when a real estate investor purchases an investment property and sells it simultaneously at a higher price. In this case, the profit the real estate investor will realize is the difference between the purchase and selling price. You can also use a HELOC to expand ones passive cashflow portfolio which is how arbitrage occurs.
By definition a home equity line of credit, or HELOC (pronounced he-lock), is a loan in which the lender agrees to lend a maximum amount within an agreed period (called a term), where the collateral is the borrower’s equity in their house also known as a 2nd mortgage.
For example, let’s say your home is worth $300,000, with a remaining mortgage balance of $100,000. In this situation, the bank would allow you to borrow against your $200,000 worth of equity.
In most cases, a bank will allow you to borrow up to 80% of the value of your equity. So, in this instance, 80% of $200,000 is $160,000! The bank will issue you a checkbook which you can use to make purchases.
You can use a HELOC for a lot of reasons, but we advise folks to look at real estate arbitrage and not go buy a boat:-)
Because of this, the HELOC is a remarkable tool for buying real estate investments. You can turn your home’s equity and place it into cash flowing rental properties. The loan is a revolving line of credit (like a credit card), thus this is a repeatable strategy that you can use to expand your passive portfolio. You could also use your HELOC line to complete a flip, thus the strategy is very versatile in nature.. I included both examples below.
- SFH (single family home) buy = 100k
- ARV (after rehab value) = 165k
- Renovation Cost = 30k
- Holding Costs = 15k
With the simple example above you could make close to 20k (before tax). This is an example where you use open equity to fund a flip opportunity. Now, flips are not for the faint of heart, so please ensure your rehab numbers and contingency percentages are correct as we have had many flips go sideways even with solid due diligence.
Another way to use HELOC funds is to invest in a cash flowing asset. Basically, if your HELOC rate is 4.5% and you can deliver a CAP rate (NOI divided into Purchase Price) of 8.5% you essentially are 4% on the upside. In this case, you would utilize leverage capabilities (HELOC) or open equity to purchase passive cashflow. Always, side on the side of caution because HELOC rates can adjust with the market.
The numbers below are just examples as rents vary by region and there could be a lot of delayed maintenance needed…
PASSIVE CASHFLOW EXAMPLE:
- Purchase Price = 85k
- Money in the Deal (20% HELOC funds) = 17k
- Rent = $1,100
- Taxes = $150
- Insurance = $65
- Management (10%) = $110
- Maintenance (8%) = $88
- Vacancy (8%) = $88
- Yearly Rents (1,100 * 12) = $13,200
- Total Expenses Above (150+65+110+88+88) = $6,012
- Rents (13,200) – Total Expenses (6,012) = $7,188 (NOI; Net Operating Income)
- NOI (7,188) / Purchase Price (85k) = 8.5% (cap rate
Note: It’s good to keep a HELOC liquid as possible and use it as a short-term investment vehicle since the rate can vary. You could always refinance your primary mortgage and second mortgage to lock in the rate, but you’ll lose any amortization periods you would have gained on your primary mortgage, so keep that in mind.
Financial Arbitrage – https://www.investopedia.com/terms/a/arbitrage.asp