Too early to own a rental?

[mjmphx]

Hello Mustachians,

I got turned on to the blog by my realtor, and have soaked up a good deal in the last two weeks or so.  This was good timing for me and mine, as we are currently facing a (good) dilemma.  Is it too early in our Mustachian journey to own a rental property?

Here's the lay of the land: We live in a 2br condo, with ~$89k left on a 5% note.  We have a 16-month-old, a baby on the way, and an adoption in process (special-needs, so we'll be driving our 2006 Sienna, no loan).  I just completed my PhD and have a cushy job as a research engineer at the university, $95k/year.  Due to the family size increasing, we're looking at houses in the area (all within bike distance of work).  We've got savings for either a down payment or investment, depending on what we do. 

The dilemma is whether or not to keep the condo as a rental property (I already manage some units in the same complex for a family member, so I know the gig).  It's just that the condo debt is at 5%, and we'd like to get rid of our mortgage (and any on a new house) ASAP.

So, Mustachians, what are your thoughts?  Should we be further down the road to Mustachianism before venturing into the landlord gig, or would I be a Sukka for not using the opportunity to tap a rental income stream?

Thanks,
Phlummoxed in Phoenix

[Another Reader]

The problem in general with Phoenix is how much the market has moved up in the last 18 months....

What is the condo worth?  How much will it rent for?  How much will you spend on your new house?  How much down payment do you have saved?  How much in operating cash reserves would you have after the down payment?

One thing you might consider is refinancing the condo as an owner-occupied property if you have enough equity and a high enough credit score to get a good interest rate.  If that drops your payment to the point the condo is truly cash flow positive if rented and you have a substantial downpayment, the idea of moving into a new home might make sense at that point.

Real estate investing is a numbers game, and you have not provided enough numbers to determine if this investment makes sense.  If you are not knowledgeable about real estate investing, you should read up on it and get to know some successful investors before you make any decision that involves writing a check.

[Freda]

Ditto on exploring a refi before you move out. 

[mjmphx]

Thanks folks, your comments were helpful.  I have contacted the bank about the costs/benefits of a refi to see how long it would take to pay back.  If we kept the condo as a rental, I believe that we could be about $150 positive in cashflow per month, including mortgage ($600/mo, taxes incl.), HOA fee ($130/mo), and the big & little maintenance items I've run into on the other condos I manage (~$115\mo., assuming I do the labor, which I'm happy to do).    We do NOT meet the 50% rule, unfortunately, but we're also not buying into a property with unknown problems.  The other upshot is that we have good prospective renters.

The  prices in the area are recovering, but the comps say we'd just about break even if we sold right now.  If we were cash-positive on the sale, I'd do it in a heartbeat, just to avoid having two mortgages at this stage of our life.

I'll keep reading on BiggerPockets, but it seems like hanging on for another year or two before selling might be the best way to go.

Thanks for your thoughts.
Phlummoxed in Phoenix

[sdp]

Hey there, I live up the hill in Flagstaff and own several rentals.  It makes sense if you are going to get a decent yield on your investment.  how much is the condo worth?  how much cash would you walk away with if you sold it , after commissions and fees and paying off the mortgage?  If you invested that money into something else would you beat the yield you would be receiving from the rental (cash-on-cash)?  I typically try to reach a yield of 8-10% on each new rental property when I buy it.  You should strive for a better yield than you would get from a passive investment because there is extra work involved and the investment is illiquid. I factor that one month's rent will go to repairs and maintenance. so I get eleven months rental income. I discount the appreciation of the property as I buy each rental with a 'forever' hold timeline-- any equity I build in the property is just gravy. Of course, every several years I re-run my formula to see if it makes sense to keep it or not.
here are the numbers on my most recent purchase:
3 bed house in Flagstaff:
243,000 purchase price
down payment 25%  = $60,750
$5,780 in Settlement charges to buy house including 450 dollars in home inspection and repairs before renting
Total investment= $66,530
HOA is 225 per year
Mortgage P/I/Tax/Ins = 1023.85
Total expenses per year = $12,511.20
Rent is 1685/mo X 11 months = $18,535
Net income = $6,023.80
Yield on this Property = just over 9% (net income of 6,023.80 divided by total investment of 66,530)
and of course I will be building equity in the property as the mortgage gets payed down and the property value increases, but the property values are a variable that I eliminate from my equation--I can't predict them so I eliminate them, let's assume they never change or at the very least keep pace with inflation, any more than that, then sweet!  Too many people have been burned in the past hoping to time the market and sell high, I am not a wizard, so I am concerned only with cashflow...
Hope this helps!
Scott

[Another Reader]

It sounds like you both self-manage your properties and do not consider vacancy and collection loss in your calculations. 

Including those two items, Scott would be cash flow negative on the Flagstaff property. 

Mjmphx seems to be assuming $995 rent, no vacancy and collection loss, self management, and around $1,380 a year in repairs, maintenance, and capital improvements.  Given your original description, I assume the condo is in biking distance to ASU.  That increases demand, but not tenant quality.  As long as there are no special assessments for replacement of roofs or common improvements by the HOA, you might break even once you account for vacancy and collection loss but not management. 

[el_beardo]

Another Reader:

Isn't Scott from Flagstaff assuming rent payments x 11 months a year? Is that enough of a vacancy/maintenance estimate?

[Another Reader]

1/12=.083, or 8.3 percent.  OP is assigning this to repairs and maintenance.  When you consider paint and carpet have 5 to 7 year lives, water heaters 8 to 10, and A/C units 10 to 12, plus all the regular maintenace items, that's not far off.   He has not allowed for vacancy and collection loss. 

[sdp]

El_Beardo:  That estimate is more than enough in Flagstaff.  It is a little conservative for here actually, but every rental market will differ.
I manage my own properties. I am fortunate to be a small-time landlord that manages just a couple of properties so I have the privilege of getting close to my tenants and knowing them very well, therefore we have a healthy and long term relationship. I manage 4 properties and spend about 10 hours per month total.  And my expenses very rarely reach one month's rent like my conservative estimate in the example. vacancies and collection loss in Flagstaff is,on average, less than 5%.  I personally haven't seen anything as high as 5% for my own properties.  I have long term, multi year, rentals- no students- and when their leases end, I have them rented immediately, with a waitlist.  Flagstaff is lucky that way.  Housing shortage means expensive realestate, but it also means large and active rental market.  My house for 243 in my example would be aprox 120 in Phx.  I used to factor in a conservative average ten month/year occupancy, but it has always been alot closer to 12months.  The downside I guess, is that I don't readjust rents until a changeover in tenants or 5 years, whichever comes first.  I guess I am losing a little there as rents have gone up considerably over the last several years due to the housing crisis and growth of the local university. But then again I try not to mess with a good thing and am still making money from my investment and ten hours per month.