The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: flyersman on May 20, 2016, 08:23:29 AM
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I am looking to purchase a single family cottage that I would rent out in an area that has experienced tremendous growth.
The place I am looking at is well under market/appraises value and on a huge lot. Builders in this area have been buying up tare downs just for the lots and building gorgeous 3-4 bedroom places. The place I am looking it is that is nice as is and could be a perfect rental (Rental market is big in this area too).
I will just hold onto this place, have land appreciate and then sell it for the land value. Rent would be used to pay the mortgage. Not looking to make money on it.
Putting $50K down on the place, my monthly mortgage+tax+insurance = ~1600-1700.
Could rent the place for about $1800-1900.
I know its slim margin on the rent vs net expenses but in the long run I think the land appreciation outweighs everything.
I guess my question is, would you ever buy a place thats under market/appraisal in an area that land appropriates quickly in and rent it with thin margins?
I do understand that if things need to be fixed or if there are not renters, its on me. The Land value however I feel is worth it.
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I don't own any rental properties or anything so I can't contribute to much to this,
My question would be lets say you don't get any renters for 6 months straight, are you in a financial position to keep making payments without rental income?
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Once you factor in vacancy, repairs, management (either company or your time) that's not thin margins, it's negative margins. So you better be really sure that it's going to appreciate enough to cover your losses during holding and still provide a worthwhile return.
But why are you so sure that it's below market? Does it need some minor fixups? Are the current sellers just idiots? And if you're that sure that it could sell for more, why not immediately re-sell it at market price?
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You are siting the best case scenario.
Consider the worst case scenario: You are unable to consistently rent the place out and you lose your job and the place goes down in value.
What would you do in the worst case? Are you "financially thick" enough to handle it?
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I wouldn't. Renting a place has a lot of expenses, and if you manage it yourself with thin margins, you are basically taking a job with little to no pay. Generally speaking, you'll have to back out about 50% of your income for expenses of operating the rental, which leaves you at a pretty low cap rate. Opportunity costs on that 50K should be considered. And you are banking on land appreciation, which I think is kinda crystal ball stuff... Of course, you know the area and I don't. But still, real estate appreciation historically isn't great, so I personally wouldn't do it.
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I would walk away. That's definitely negative (not thin) cashflow once you account for all expenses. Relying solely on appreciation to bail you out is quite a risky move. If I had a very good reason to think a property would appreciate (not a hunch), I would probably be willing to go cashflow-neutral, but not cashflow negative.
As a real estate investor, I've learned that you absolutely 100% need to have multiple exit strategies planned when buying a property. If your property doesn't appreciate like you hope, what then?
I would walk away.
An "area that has experiences tremendous growth" does not necessarily mean it will continue to experience tremendous growth. Or worse, prices could already be inflated by speculators like yourself. Tread lightly.
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As a real estate investor, I've learned that you absolutely 100% need to have multiple exit strategies planned when buying a property. If your property doesn't appreciate like you hope, what then?
Can you talk a little more about what you mean by multiple exit strategies? We are also considering a purchase with thin (although not negative, and with vacancy, taxes and expenses factored in) margins -- not as a vacation rental, as a primary home for house hacking and peace of mind as expats -- and I haven't considered the issue of exit strategies. I thought we'd hold it until the kids were done with college and then consider. What other options should I investigate?
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As a real estate investor, I've learned that you absolutely 100% need to have multiple exit strategies planned when buying a property. If your property doesn't appreciate like you hope, what then?
Can you talk a little more about what you mean by multiple exit strategies? We are also considering a purchase with thin (although not negative, and with vacancy, taxes and expenses factored in) margins -- not as a vacation rental, as a primary home for house hacking and peace of mind as expats -- and I haven't considered the issue of exit strategies. I thought we'd hold it until the kids were done with college and then consider. What other options should I investigate?
Maybe "exit strategies" isn't the best way of putting what I'm talking about, but give yourself options. My current house I live in (bought a year ago) is a good example. When buying it, we gave ourselves three options for the future: staying in the house, moving out within a few years and selling (slow live-in flip), and moving out within a few years and renting it out.
So:
Option 1: We continue living in this house for the foreseeable future. Reasoning: We like the house, it's a reasonable size, reasonable taxes, good location, and I'm content with the cashflow needed to live here and the holding cost of the asset.
Option 2: Within a couple years, we move out and sell. Reasoning: We bought under market value as a "cosmetic fixer-upper" (everything works but is dated) to the point where we'd net a decent amount after we're done doing everything we want to it. IRR wouldn't be amazing but we would definitely come out substantially ahead.
Option 3: Within a couple years, we move out and make it a rental. Reasoning: The numbers pencil out that I'd net a reasonable return based on local rental rates and expected expenses.
This builds a few contingency plans into everything. If we decide we want to do option 2, and the market tanks so we wouldn't get what we want from a sale, we could do option 3. If we get into a situation where we definitely don't want to move, we're "stuck" in a reasonable house that we like. Etc. You have to paint yourself worst case scenarios and be able to bail yourself out from them. If you have one plan and one plan only, and things go south, you don't want to be left holding the bag.
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What you are looking at doing is not investing, but speculating.
If you are speculating with 50k, hopefully that is <5% of your NW (i.e. you have at least 1MM liquid). If that's the case, and you're okay gambling on appreciation, that's cool. I certainly wouldn't but it's your money. If it's not the case that you're in that position, no. Run.
:)
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As a real estate investor, I've learned that you absolutely 100% need to have multiple exit strategies planned when buying a property. If your property doesn't appreciate like you hope, what then?
Can you talk a little more about what you mean by multiple exit strategies? We are also considering a purchase with thin (although not negative, and with vacancy, taxes and expenses factored in) margins -- not as a vacation rental, as a primary home for house hacking and peace of mind as expats -- and I haven't considered the issue of exit strategies. I thought we'd hold it until the kids were done with college and then consider. What other options should I investigate?
Maybe "exit strategies" isn't the best way of putting what I'm talking about, but give yourself options. My current house I live in (bought a year ago) is a good example. When buying it, we gave ourselves three options for the future: staying in the house, moving out within a few years and selling (slow live-in flip), and moving out within a few years and renting it out.
So:
Option 1: We continue living in this house for the foreseeable future. Reasoning: We like the house, it's a reasonable size, reasonable taxes, good location, and I'm content with the cashflow needed to live here and the holding cost of the asset.
Option 2: Within a couple years, we move out and sell. Reasoning: We bought under market value as a "cosmetic fixer-upper" (everything works but is dated) to the point where we'd net a decent amount after we're done doing everything we want to it. IRR wouldn't be amazing but we would definitely come out substantially ahead.
Option 3: Within a couple years, we move out and make it a rental. Reasoning: The numbers pencil out that I'd net a reasonable return based on local rental rates and expected expenses.
This builds a few contingency plans into everything. If we decide we want to do option 2, and the market tanks so we wouldn't get what we want from a sale, we could do option 3. If we get into a situation where we definitely don't want to move, we're "stuck" in a reasonable house that we like. Etc. You have to paint yourself worst case scenarios and be able to bail yourself out from them. If you have one plan and one plan only, and things go south, you don't want to be left holding the bag.
Thanks, that helps. I think we were already there. Although we'd basically always rent out the bottom half, we could keep the top half available for us and pay part of the mortgage, rent it out as a long term furnished rental when we're not there, rent it unfurnished and store our things, or let one of the kids use it if they go to college in the area. We could always use one as a permanent base home in retirement, sell the whole thing, or de-duplex it into a permanent home, if needed.
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Once you factor in vacancy, repairs, management (either company or your time) that's not thin margins, it's negative margins. So you better be really sure that it's going to appreciate enough to cover your losses during holding and still provide a worthwhile return.
But why are you so sure that it's below market? Does it need some minor fixups? Are the current sellers just idiots? And if you're that sure that it could sell for more, why not immediately re-sell it at market price?
+1
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If you have the option to live in it or rent it out furnished at a higher value this is good.
One thing you are not accounting for, and which is rarely accounted for by landlords starting out, is the tax burden.
In Canada you will pay tax at your highest marginal tax rate on the profits, if any - I'm guessing it is the same in the US although maybe not if you are buying through a corporation which seems to be more common there for liability reasons.
You might think that you are only covering your expenses, however, you are paying down equity in your mortgage and this will be counted towards your net profit even though you won't see a cent of this in your hands.
I'd run the numbers carefully as this scenario could result in you paying hundreds a month extra in personal income taxes from what you currently take home even if significant repairs are not needed. If you can afford that and really believe it is a good long term bet maybe it is worth it to you. It appears that there are better opportunities available in the US though?