At a Crossroad. Buying Another House, What to do with the First?

[atribecalledquest]

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[honeybbq]

Can you use a heloc to purchase a new house? That seems odd, collateral for one house is another house...?

[nereo]

Alright, let's evaluate your current home / future rental on it's own.  As I understand it, you've...

Purchased the home for $170k and put in $55k in improvements ($225k).  You claim you could sell it in a day for $255k.

So you could sell it for $255k or rent it out for $1600/mo.
Some quick math shows that your monthly rent would be 0.6% of what you could sell it for.  Not great.

Let's look at it another way:  $1600/mo x 12 months = $19,200/year gross.  Using ballpark assumptions that, over time, 50% of your rent will go to vacancies and rent.  That knocks it down to $9,600, or about $2,400 less than you anticipate in your calculations.  Also not great.

What's your opportunity cost?  Well, you say you could sell it "in a day" and have $160k equity in that house.  But you're counting on that to fund the purchase price of your new home, which, if I understand you correctly, means you're going to have notes on both homes?  That increass your leverage (which can be fine at today's rates) but means you'll have the bulk of your NW tied up in these homes for many years.

[nereo]

Correct nereo. One item to clarify, we currently do not have a mortgage on our house right now, but do owe $95k from the HELOC.

With the purchase of a second house, we could have the first house completely paid off in under 3 years. From there, the first house would pay the mortgage of the second house.

Beyond that, I guess we would have a few options. Aggressively attack the remaining mortgage balance on the second house (our primary) or invest our work related incomes into the stock market (non tax sheltered).

Side note, we also intend regardless of any decision we make to completely max out our 401k's for about 5 more years. Once they are around $500k (combined), we will stop investing in them and focus the funds either in real estate or taxable accounts.

Ok, thanks for the clarification.  Based on what you've said I"m not crazy about your numbers.  Two things I think you should take into account is the opportunity cost and the % of your NW that will be tied up in just the two homes (particularly for the first several years).  Your cash-flow from this property isn't great based on what you say you can sell it for.  Then you want to plow 3 years ($95k?) worth of earnings toward paying off that home.

You also say that from year 4 on the mortgage on home 1 will pay for home 2.  Problem here; ballpark cash flow from that house will about $800/mo, but your mortgage on a $400k home will be considerably larger (admittedly I'm still a bit lost about how much you plan on using for a downpayment on new home, but assuming a 350k mortgatge you'll still have to pay ~$550/mo for PI, not including TI.  So 100% of the rent will go towards house #2, plus some of your paycheck, meanwhile the only savings you have is in your 401(k)s.

[boarder42]

Nereo a 350k mortgage at current rates is 1550 a month not 550.

What I'd do. Sell the house use 80k for your 20% down and invest the rest. This house isn't a good asset if you want to get into real estate go to bigger pockets and find something better to invest in. You could buy 4 100k homes to rent out with 20% down with your 80k you have left and your higher end finishes will just get destroyed by renters.

[waltworks]

A high-end-finishes house that only rents for $1600?

Sell it, dude. That is a rental disaster waiting to happen, and even if disaster doesn't strike, you're not going to make much/any money renting it out.

-W

[englishteacheralex]

I'm intrigued by real estate too--I just finished a book called Getting Rich One House at a Time. The author outlines the best houses to buy as rentals, how best to finance them, and no-nos to avoid.

Yeah, high-end furnishings seem to get the best ROI in a hot market when you SELL, not rent. For a rental you want something functional and basic, preferably bought at a bargain price because somebody needed to sell in a hurry.

I have no experience in this area and probably won't for a long time, since I live in a real estate market that has a barrier to entry that's too high for us (Honolulu). But it's fascinating to me and I've been doing a lot of reading on the subject. To do well with rentals it sounds like you have to have different criteria than most people do with their personal residence.

For us, we bought a condo that would work really well as a rental and we live in it, building equity until we can move on and rent it out. But we bought the place with that strategy in mind. It's not high-end, that's for sure. And we are not putting money into renovations.

[nereo]

Nereo a 350k mortgage at current rates is 1550 a month not 550.

Yeah, but he said the rental income from house #1 would go towards house #2.  So: $1350 mortgage  - $800 rent income = $550/mo for the next 30 years at 3.0%, plus taxes and insurance.

OP - can you do this?  Sure.  Is it a great financial move... no.
One other thing that concerns me is that renters damaging a high finish house is a 'major concern' for you.  That's a red flag; if you're emotionally worried about what renters might do to the place it will just cause you stress.

Personal recommendation:  Sell home #1 and reap the $160k in equity.  Buy home #2 with 20% down (roughly $80k) and our historically low rates on a 30 year term.  Then start saving as much as you possibly can for the next 3-5 years while paying just hte minimum on the mortgage. Revisit buying real estate in a few years, but search for duplexes that will generate about the same income but will cost you half as much.

[aschmidt2930]

I concur with many of the above comments, sell.

[Dicey]

Before I made a decision, I'd do some more calculations. First, make sure your rental income estimate is accurate. Second, look at what a low- or no-cost owner occupied 30 year mortgage at 75-80% LTV would cost on a monthly basis. (You can use the cash you're pulling out for a DP on your next property*). Then run the numbers again and see if you like the results better. Rushing to pay off a 3.5% mortgage on a rental property could be a bone head move in your situation . Plus, the cheapest loan rates are for owner occupied properties. Once it closes, you can move out, but not before. No, the bank will not care, just as long as you keep sending them timely checks.

Possible better options: Refi as above, rent the house for about 2 years, then sell it. The IRS will let a married couple keep up to 500k profit from the sale of their primary home TAX FREE, provided they lived in the house for two of the last five years. Then move that money into other investments. Yeah baby, that's making the house work for you! Tax free monet is amazing!

I understand pride of ownership and fear of renters who trash. You're going to avoid those problems by cherry picking your tenant. Begin with refusing to rent to anyone with pets and thoroughly checking all references,  including credit. Then do your due diligence as a landlord, including collecting the largest deposit the law allows, doing regular inspections and maintenance. You should be fine.

*Technically, no you cannot borrow money for your DP. Typically, the bank will want to see where the money came from. What they usually want for documentation is two months of bank statements. If you time your deposits well, you should only have to have the money in your account for a little over thirty days to fulfill the seasoning requirement. BTW, if the bank asks why you want to do a cash-out refi, you can say you want to do more home improvements or pay cash for a car. Because you're not a consumer sukka, that's not actually what you'll do with the money, but as long as the payments keep rolling in, the bank won't care.

[hoping2retire35]

Sell.

even using optimal numbers your cap rate is awful. remember, 'if you wouldn't buy it, sell it.'