Author Topic: Reader Case Study - First Real Estate Deal  (Read 1687 times)

rotsknoll

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Reader Case Study - First Real Estate Deal
« on: April 17, 2019, 09:32:03 AM »
Hello,

LIfe Situation:
IRS The compulsory from my country's government.
Dependents Me 35, Wife 33, Kid 1

Salary
Gross 50.3K

Pre tax deductions 3.5K
Govt. Housing 1.6K
Govt. Insurance 1.3K
Govt. Retire 0.6K

Other Income
Bonuses and Profit Sharing 6.3K

Adjusted Gross Income 53.1K

Taxes 5.7K

Expenses 46.7K (Annual; the amount below is monthly)
Rent + Minor Maintenance   484   12.4%
Groceries   562   14.4%
Car credit   464   11.9%
House help   400   10.3%
Loan interests (no principal)   342   8.8%
Health Insurance   219   5.6%
Life insurance   193   5.0%
Car Gasoline + Insurance + Maintenance + Licences + Cleaning   417   10.7%
Fun   136   3.5%
Utilities + Internet and phone   177   4.5%
Personal and Miscelaneous   137   3.5%
Gifts   114   2.9%
Clothing + Dry cleaning   87   2.2%
Medicines, Doctors, Dentist   84   2.2%
Family Club Membership   79   2.0%

Assets - 214.1K
Cash on hand 15.5K
Other assets 198.6K
Car 13.1K
Gold 3K
Short term investments 6K
Land 134.2K
Long term investments 25.5K
IRS Account 16.8

Liabilities 73.7K
Short term cash debt (no interest) 2.7K
Car loan 7.47K (6.8K p + 0.67K i) (16 months to go)
Cash (no interest) 63.2K

I want to start investing in Real Estate to achieve FI but I'm hesitant on my options.

I'm not in the U.S.. About a year ago I purchased land in which I was planning to build my house. I was completely sold on the idea that renting was a waste of resources and that having my own home was the way to go. I'm not that convinced about that these days, since I've been learning more about FI and the advantages of not owning a home.

The lot of land cost me US$53,000 that I paid with savings (about 19,000) and a loan I took from my parents (about 34,000 they had in an investment that paid 1% monthly; a burden that I transferred to myself). Also, I bought it because it was in a great neighborhood and it was undervalued (not so much that I could expect to make a lot from appreciation). I could, very likely, take the deal that my parents had back and get rid of that rather expensive financing, but I'd have to come up with the capital from some other asset because I do not wish to sell this lot of land, because I'm sure it is a great piece of land, it is very marketable. The neighborhood is inside the city, near everything, but very secluded and strictly residential. It's in the part of the city where high-value growth was happening about two decades ago. So rather than getting rid of it I'd like to extract some rents off it.

I've explored several options for this:

1. Build with cash reserves a 970sqf 2 bedroom apartment and rent it for about 450/mo. I'd have to wait since I don't have enough now for this option, which would be the less risky. The rent would allow me to pay the interest to my parents (340) and still keep some, but not taking into account maintenance and vacancy.

2. Take a mortgage loan for an amount that would allow me to have monthly payments equal to what I'm paying in rent now (475), and build a duplex where I could generate enough revenue for paying the mortgage and pay my parents. I would do this by going to live there, and have the other, smaller unit rented at about 350/mo. Mortgage loans where I live are very expensive. They're in the order of 10.5% rate when cheap. So I'm not entirely excited about this. At this rate, I would be able to build the small rental unit (about 540sqf - which is right for the rental price of 350/mo) and build the apartment where I would live (about 1,075sqf - which could actually be rented for about 600/mo, more than the 475 I'm budgeting to equal my current rent and/or pay the mortgage), but this means that we'd have to live on a house about 30% smaller from where I live now, although with the added value that we'd have a garden, which is something we value, and we'd be living in the city, which has some perks, like shorter commute to work and for regular shopping, services, kid's kinder, etc. Summing up, I pay with my rent the mortgage, the tenant pays with their rent the interest of my parents loan, luckily I get a bit of cash-flow, I keep the property and I pay for the building. I'm just so very scared of contracting a mortgage. It feels like I'm giving away my freedom. Perhaps it's just a mental barrier to overcome.

3. Sell another lot of land I own, outside the city, in a rural area, that has appreciated around 150%, at a rate of about 25%+ yearly. Selling at this price would allow me to not need any mortgage loan. This is not a hard appraisal of value, though, but rather what brokers have told me it could sell for now. I don't think I could expect this lot to keep appreciating at this rate from now on. Although, to be honest, is not like the zone it is in is booming or anything, so even the current appraisal could be off. That being said, I could sell it for less than appraised and still have made a good deal that left me earning at more than 15% a year. In this scenario I would be short about 25% of what's needed for doing the duplex, but I could compensate with cash reserves, and I wouldn't have to contract the burden of the mortgage. The thing here is that I'm co-owner with a friend (his share is not taken into account) and he's convinced that the land will still go up in price, and keep this annual rate of return, or perhaps lower, but higher than 20%; also, he'd either have to sell with me or divide the lot which he argues makes his part less attractive. With this I wouldn't have the burden of having a mortgage, and I could decide whether I'd like to waive the additional rent (from 475 to 600, which due to vacancies and maintenance perhaps is not that much) and live there or have it strictly as a rental property and instead of it becoming a duplex of one large and one small unit, make 3 small ones of about 350/mo for a total of 1,050/mo, which would allow me to pay the 340/mo interest to my parents.

4. Sell the rural land, invest in just one unit to test the waters, invest the rest in an All Market ETF (there are no all market MFS where I live) or my country's treasury bonds (which are yielding about 8%). If I invest in the ETF, I'm not certain I could continue with the real estate project for a few years, because of volatility.

5. Sell the good neighborhood land, renegotiate the deal with the company that gave my parents the 1% /mo to get rid of that burden, sell the rural land, invest all the money in a long term portfolio of an All Market ETF and the 8% bonds.

About that interest. If my other option is at best 10.5%, with a bank, I guess the 12% with my parents is not that bad, isn't it? Plus, we all have the certainty that the money is in the family, instead of with a company that may or may not go under (it's a friends and family financing kind of deal).

Well, this has served up well for me to clarify where I'm at, and I was hoping some of you would chime in to point out any errors in my logic, or give recommendations, or perhaps make me aware of an option I may not be seeing, or whatever tip or comment would be greatly appreciated since I've been stuck here trying to decide what to do for a while now.

Thanks in advance!

EDIT: To comply with the recommended Case Study format.
« Last Edit: April 17, 2019, 12:34:48 PM by rotsknoll »

waltworks

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Re: Reader Case Study - First Real Estate Deal
« Reply #1 on: April 17, 2019, 05:19:43 PM »
It does not look to me like you'd be able to qualify for a construction loan (in the US).

-W

rotsknoll

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Re: Reader Case Study - First Real Estate Deal
« Reply #2 on: April 19, 2019, 08:29:04 AM »
Thanks. I've already checked around and I do qualify for a construction loan here where I live. I've been further doing projections and I now realize that the way to go is to earn more and take the real estate route, investing in rental properties to generate cash flow. The thing is that I have a savings rate of around 5-7% only and I'm the sole income earner (my wife does earn some from time to time but it is sporadic and I can't count on it, and not that significant to move the needle).

I don't think I can spend much less than I do now. At this income, the most I think I can achieve is a 15-20% savings rate. So my conclusion is that I need to earn more (duh).

If I get to a savings rate of about 50%+ my projections tell me I can FIRE in 5 years. So I'm willing to grind at a much  better paying job for five years in order to do this, even if it means relocating with the family.


leighb

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Re: Reader Case Study - First Real Estate Deal
« Reply #3 on: April 20, 2019, 09:39:50 AM »
Regarding going down the rental route. You need to get a better understanding of all of the expenses. The mortgage is just one of those expenses. Is there a local real estate investors' group in your area?
I'll speak from my personal experience. I have rentals that I bought at the bottom of the market and some of them have work out nicely. Others lose money and are hard to get rid of. This is with an initial investment of $10,000. On paper they should earn money but in reality there's a lot that goes wrong, especially with a duplex. I know I couldn't build for cheaper.
Best of luck!