The Money Mustache Community

Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: SaraB on March 06, 2019, 10:45:07 PM

Title: Buy a new property or decrease debt/living expenses?
Post by: SaraB on March 06, 2019, 10:45:07 PM
Hello Everyone! I need some advice. I'll try to make this short.....
I'm trying to decide whether to refi a current rental to purchase another rental(which is kind of a unique situation), or do nothing and try to pay off my debt. Here are the deets:
We currently live an expensive (all things being relative but average home price is over 400k) housing market and we purchased a townhouse before the boom and have a decent aount of equity in it. It was a primary and then we moved to a new primary and are currently renting the townhouse. It is currently cash-flowing $500 a month. However, we are within the window for a major tax break, if we were to sell it by September of this year we would pay NO TAXES. We could probably walk with 120k. However, I happen to love the property and had actually hoped to retire there someday when renter had paid it off. HOWEVER, we have just been offered the opportunity to purchase a fixer-upper in downtown (which is really untouchable otherwise for us at this point) that is also zoned for an business/airBNB. It has to potential to cash flow very nicely ($1000-$3000 a month) and I think it could be an important step toward FI. I'm just very nervous about taking on this much real estate debt. I would have to refi the townhouse for the repairs on the downtown house but I would still have at least 25% equity in both. That being said I have a 16k car loan and a 20K student loan. I'm feeling very  torn between wanting to be debt free and knowing that having two assets that are appreciating and that someone else is paying off is a good thing! I guess you can say I'm stuck between the bigger pockets and dave ramsey philosophies. They both make sense but I don't know which one makes the most sense for US. Also, I am 42 and my spouse and I earn a very good income but have only about 70K in retirement. Here are my options.......

1. Do nothing. Keeping cash-flowing the rental and work towards paying off debt and stockpiling cash. Keep current mortgages which are 167k(rental) and 340(primary)
2.Sell rental, take 120k and pay off debt and buy the another rental with what's left
3.Refi rental (will still pay for itself but not as much cashflow) and buy the downtown property for air bnb. This option has the potential to generate $1000-3000 per month and is a very desirable location.

I would love to hear people's thoughts. Thanks so much in advvance!
Title: Re: Buy a new property or decrease debt/living expenses?
Post by: Linea_Norway on March 07, 2019, 03:05:05 AM
Is the house for sale for a good price? Have you calculated how much your total debt is costing you, compared to what the renters will pay? If their rent is higher than your total of mortgage costs and your car/study debt, then it might be a good idea to buy it. If you both have an independent good income, you are safe, as long as you can pay your debts and your rentals are generating profit.

I personally don't think you should buy a house if you cannot afford it, just because it seems like a once in a lifetime chance. I think other chances will come along later.
Title: Re: Buy a new property or decrease debt/living expenses?
Post by: MrThatsDifferent on March 07, 2019, 03:42:00 AM
I would get advice in the case study section to address debt and living expenses, do a case study. And, get advice in the real estate section. But also consider the option of selling the townhouse and paying of the debts if youíre following the investment order. Youíre 42, married with very little savings in retirement. You should focus on a 13 year plan to get your finances to the point that you could retire at 55 or not, however you like.
Title: Re: Buy a new property or decrease debt/living expenses?
Post by: Jon Bon on March 07, 2019, 07:24:48 AM
Drop it like its hot!

Sell the rental, like yesterday. You can make $120k WITHOUT PAYING TAX!! I dont even care about buying the next house with the proceeds, buy stocks, bonds, savings account, whatever. You are gonna make 120k tax free, do you know of a lot of other ways to do that?!

You probably should dump the entire 120 directly into your retirement accounts (live off the 120, put both of your salary's into 401k, Roth etc) But that is more of a case study question. More information is needed about the house and the rents.

Also cash flow of $500 a month is a TERRIBLE return! Now ill take you at your word, but rookie landlords tend to way under-count expenses (myself included) Your cash flow is not rent - mortgage interest and taxes. There is way more that goes into that, but I wont get into it here. Back to the return on this rental.  So if you are getting 500 a month that means your return is 6000/400000 = 1.5% That is terrible! A savings account could do better than that.  You could put your 120k gain in the stock market and be getting $9600 a year with none of the risk and PITA that comes with being a landlord.

To me it sounds like you don't have a ton of experience in residential rentals, so I think jumping into the commercial space would be a mistake. You said "potential" cash flow in your post. Which means its not there now, and you will have to spend money to get it there. Sell the rental, count your cash, add to retirement accounts, take the win.

Title: Re: Buy a new property or decrease debt/living expenses?
Post by: SaraB on March 07, 2019, 07:01:03 PM
@Jon Bon  not exactly sure where youíre getting 6000/400000, can you explain?  I bought the house in 2013 and have a 167k mortgage, so I think $500 (and do understand cap ex:)) is pretty decent. Terrible? I would disagree but maybe thatís subjective!

I appreciate your input but there are a lot of assumptions in your response about my experience that are a little off base:). Using the word ďpotentialĒ is accurate and appropriate because this home has never been a short-term rental. I know this short-term and long-term rental market well but nothing is a given. I do think you are right about the tax break being very attractive! Thank so much for your response!
Title: Re: Buy a new property or decrease debt/living expenses?
Post by: SaraB on March 07, 2019, 07:09:00 PM
@Linda_Norway thanks so much for you response! Yes, the house is a very good deal. We know the seller and she is being very generous.  We are in a market in Colorado that at this time has very few homes with instant equity and the mortgages have caught up with rent prices. Even after the necessary repairs we would have a lot of equity in the home and it would cash flow well as either a short or long-term rental.  The fact that it is allowable for an Airbnb in a town that has very Restrictive short term rental zoning also makes it attractive. I agree that itís not a once-in-a-lifetime chance, but itís certainly a good opportunity! My husband and I do you have a very good income(again itís all relative)and both work in stable job markets. That being said, sometimes I just want to pay it off and move back in rather than refinance!
Title: Re: Buy a new property or decrease debt/living expenses?
Post by: Dicey on March 07, 2019, 07:31:08 PM
If you ask a mod to move this to the Real Estate and Landlording section, I think you will get more hits from experienced landlords.
Title: Re: Buy a new property or decrease debt/living expenses?
Post by: SaraB on March 07, 2019, 07:46:22 PM
@Dicey thank you! I will just cut and paste. Good idea.
Title: Re: Buy a new property or decrease debt/living expenses?
Post by: waltworks on March 07, 2019, 08:59:09 PM
What's the place worth? If you can get $120k out of selling it, then your return is $6k/120k or roughly 5%. That's extremely mediocre for a risky/illiquid asset like a townhome (what happens when the HOA assesses $15k to fix the driveways?)

Figure out your expenses, first:

-Mortgage, taxes, insurance. That should be easy, it's on your mortgage statement every month.

-HOA, if any. Since it's a townhouse, I assume that you have one. Have you looked at the reserve study lately? If you don't know what that is or the HOA doesn't have one, run now to the hardware store to get a for sale sign.

-Management. Most property managers charge in the ballpark of 10%. "But I manage it myself!" you say. That's great, but that's something you need to expense as well, because managing the place is a job and it will cost you time and effort to do. So for the sake of analysis, use 10% of your gross rent for this expense.

-Vacancy. Sooner or later you'll have tenants move out before others are ready to move in, or have to evict someone who doesn't pay. It happens. You *might* never have a problem or a vacancy, but you should still assume 5% of gross rents will be lost to this expense.

-Maintenance. If your HOA maintains the outside of the property, use 5% of gross rents. If not, use 10%.  Carpet, paint, clogged toilets, etc, etc.

-CapEx. If HOA maintains outside, use 5% of gross rents. Otherwise 10%. This is money you set aside for anticipated costs (new furnace, new roof, new dishwasher) that are infrequent but expensive.

Are you still cashflowing? If so, awesome. You have a halfway decent rental - *if* you don't have a ton of capital tied up in it. If you have $120 sitting around earning a couple hundred bucks a month, on the other hand, you're shooting yourself in the foot holding onto the place.

Title: Re: Buy a new property or decrease debt/living expenses?
Post by: SaraB on March 07, 2019, 10:22:32 PM
@waltworks Great questions....
We are in the process of getting an appraisal but comps put it at 300-320, but in this market there are bidding wars so maybe more?
The HOA is $40 a month and does have a substantial reserve including land that can be sold. One other thing to consider when calculating the return is the fact that this is an appreciating asset on top of the 5%. No market/area is recession-proof but we are fairly insulated. In fact, that 120k in equity is all appreciation in the last 5 years. The town we live in is pretty land locked, very low vacancy and there is somewhat of a housing crisis at the moment. The furnace, a/c, and roof are newer (roof and a/c were paid from hail claim, luckily). Everything that you mentioned is definitely worth considering and reflects the true cost of rental ownership. However, given the fact that I only invested 8k in it 5 years ago I believe it has been a good investment. I also believe based on projections for the area that it will continue to appreciate more than other areas. There is also the fact that I love this property, it has a everything we would need in retirement. I think even with all the points that you mention, it is still a good investment.
Title: Re: Buy a new property or decrease debt/living expenses?
Post by: Freedomin5 on March 08, 2019, 05:53:34 AM
The 6000/400000 comes from your cash flow of $500/month ($6000 per year) over your initial postís statement that average house prices in your neighborhood is $400k, which you corrected in a later post saying that your particular unit may be worth $300-$320k.

The idea is, if you sold the unit, took your $320k or $400k or whatever  and stuck it in an index fund, would the average return over the years be more than $6000 per year?

However, not all decisions are financial. It really sounds like you love your unit and want to retire there, in which case selling may not be the best Emotional decision for you.

In any case, do get rid of that car debt and student loan as soon as possible. Youíll feel psychologically more comfortable when you do so.

In the end, itís really about how much risk you can comfortably handle. If you refi your current place to buy the new place, your new place will be entirely debt financed. That means there is a risk that you could lose both places if you are unable to make payments for whatever reason (not rented out as quickly or for as much as you projected, losing your job, etc.). Some people are okay with that risk. Others are more conservative. Just be aware of the risks and what youíre getting yourself into.
Title: Re: Buy a new property or decrease debt/living expenses?
Post by: Jon Bon on March 08, 2019, 08:05:17 AM

OK lets say its worth 300,000 for arguments sake. I am going to ignore the potential commercial property because I dont know that as well and you need to share a lot more information for folks on here to help you out. I also am going to ignore the emotional side because you cant really value it and I am not sure it has a place in big investing decisions. But back to your former primary residence.

You have 120,000 in appreciation and I assume 20% (180,000*.2=36,000) down when you purchased so you have $156,000 or so in the house? So your cash on cash return is 6000/156000 ~ 4% that is not so good is it not? That is cash you have locked into your house that could be earning at a higher rate nearly anywhere else. Stocks, Bonds, etc. You also get to be a landlord take on risk, repair the property, deal with tenants, vacancy etc. It is not a risk free, and it comes with work.  My target rate for rentals in cash on cash return is ~20%.

You house is probably just not a good rental, and that is ok! Not all houses work in a rental market, right now many houses suck as rentals. I also don't think the tax effect can be understated here either. You are going to take a bath in taxes in you hang on a few more years, You will pay tax on the entire gain and whatever deprecation that you have taken on the house.

We could use a little more information (price paid, rent, mortgage terms, vacancy. repairs etc) to get a complete picture but I gave you my best with what I had. My somewhat informed opinion is the return on this house does not justify the carrying and opportunity costs.

Good luck.
Title: Re: Buy a new property or decrease debt/living expenses?
Post by: waltworks on March 08, 2019, 01:10:22 PM
However, given the fact that I only invested 8k in it 5 years ago I believe it has been a good investment.

Look, I agree with you - but that has *nothing* to do with whether it's a good investment *now*.

Would you buy this property, today, to use as a rental? If so, why aren't you buying more of them at full market rate to rent out? If not, why do you want to hang onto it?

Note that I'm speaking purely financially here. If you have strong emotional attachments to the house, that can obviously trump any monetary considerations.