Purchasing another rental

[GoatStache]

Be gentle, it's my first time.

I've noticed a common theme amongst early retirees and it's cash flowing rentals. I'm sure there's exceptions but for my specific situation I am very interested in acquiring additional cash flowing properties. I'm 32

Wife and I have:
No student loans
no cc debt
no car payment
Primary residence have about 20k of equity, 440k mortgage @3.375% 26 years left
Investment property with negative equity(~-20k) 158k mortgage @4.5% 26 years left currently occupied long term tenant.

I lose around 1500 a year on the investment property with EVERYTHING considered. I bought it in 2006 at the very top of the market and I began renting it out in 2009. 

I refinanced both properties in 2012, loses used to be far worse at investment property.

I have 75K in 401k, wife has around 25k in a 401k.

We each have 35k in our roth ira.

(~15k cash reserves)

I want to transition from the cube life (I have a VERY stable govt job (~100k) , wife is a county employee (~55k))

I would like to acquire a positive cash flowing rental property and then another... and then another but I need to start with property 1 (I suppose it's 2 in my case) first.

So, my question is... any advice for what I'm doing wrong? I've considered opening a HELOC on my primary to pay down the investment property so it's no longer underwater for the tax advantages on the HELOC and aggressively pay down the HELOC. I suspect the answer is coming to the table with cash borrowed from my 401 so I have more skin in the game.

I'm not intimidated by the prospect of being a landlord or managing a rental.


Thanks in advance for replies.

Goat

[ooeei]

Can you elaborate on the numbers for the rental?  What it's worth, what it's renting for, repair costs, management costs, etc.

[GoatStache]

Apologies, I should have been more clear..

I'm wondering how I can be more attractive to a mortgage broker for an investment mortgage.

I don't have a particular property in mind just yet, my concerns are that my DTI is in the high 30's low 40's.

[ooeei]

Apologies, I should have been more clear..

I'm wondering how I can be more attractive to a mortgage broker for an investment mortgage.

I don't have a particular property in mind just yet, my concerns are that my DTI is in the high 30's low 40's.

So you currently have one property that's losing you money, and you want advice on how to purchase another property to add to the collection?  Why not get rid of the one that's losing money?

[GoatStache]

I'm losing 1500 a year on the property that is a write off. I don't consider this a significant loss.

Do you think it's the best approach to sell an asset and have to write a check for around 20k plus realtor fees? (sounds glib, but genuine question. It's 4 hours away so FSBO is out of the question.)

I think I'd rather hold it longer term and eventually get it to cashflow (likely 3-5 years)

I want to add a second rental property that is bought as an investment, place with negative equity was purchased as a primary home so I didn't do any cash flow analysis... also I didn't have a crystal ball in 2006.

[Another Reader]

Your earned income is approximately $155k.  You own a primary residence worth $460k, with only $20k in equity.  The loan on your primary is almost three times your income.  You are losing money on a rental, and not all of the rental income would be counted in a mortgage application anyway, so the rental will not help you.  You are also underwater on that property.  You have $15k in cash, and all your other money is tied up in retirement accounts.  Your net worth, not including retirement accounts, is close to zero.  Your DTI is near the maximum permitted under most guidelines.  You might qualify for a small HELOC, depending on the lender.

I think you need to meet with a couple of lenders that can explain to you very clearly what the rules are and how the numbers are calculated.  Hearing the news from them will be more helpful than hearing it from this forum.  Once you understand your situation, pick up a couple of real estate investing books that are focused on the numbers side of the business, not the glamour.  I think Sword Guy mentioned Gallinelli's book in a recent post.  That's a good place to start. If there is a decent real estate investors association in your area, attend a few meetings and chat up some of the more knowledgeable attendees.

Once you know what constitutes a good investment and how you are viewed by lenders, then you can make a reasoned decision about whether real estate investing is for you, and what sacrifices you would have to make to get started.

[Papa bear]

What are your total debt payments compared to your income?  You have a big primary residence mortgage compared to income and a mortgage on a property that has net losses. 

Just noticed your DTI in low 40's. You have 3 options.  Raise your income, reduce your debt, or pay cash. 


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[GoatStache]

Your earned income is approximately $155k.  You own a primary residence worth $460k, with only $20k in equity.  The loan on your primary is almost three times your income.  You are losing money on a rental, and not all of the rental income would be counted in a mortgage application anyway, so the rental will not help you.  You are also underwater on that property.  You have $15k in cash, and all your other money is tied up in retirement accounts.  Your net worth, not including retirement accounts, is close to zero.  Your DTI is near the maximum permitted under most guidelines.  You might qualify for a small HELOC, depending on the lender.

I think you need to meet with a couple of lenders that can explain to you very clearly what the rules are and how the numbers are calculated.  Hearing the news from them will be more helpful than hearing it from this forum.  Once you understand your situation, pick up a couple of real estate investing books that are focused on the numbers side of the business, not the glamour.  I think Sword Guy mentioned Gallinelli's book in a recent post.  That's a good place to start. If there is a decent real estate investors association in your area, attend a few meetings and chat up some of the more knowledgeable attendees.

Once you know what constitutes a good investment and how you are viewed by lenders, then you can make a reasoned decision about whether real estate investing is for you, and what sacrifices you would have to make to get started.

I will check out Gallinelli's book, I have been reading up on Real Estate investing and how to price a property for cash flowing etc. Agree with your assessment of my net worth on how a lender would see me, my primary mortgage is a VA loan and I'm fairly certain Navy Fed would extend me a HELOC, but I agree it would be a small one... I just don't know if that's the answer in this case. I am planning on talking to a mortgage broker to see the specifics on my situation and what I can do to make myself more attractive.

[GoatStache]

What are your total debt payments compared to your income?  You have a big primary residence mortgage compared to income and a mortgage on a property that has net losses. 

Just noticed your DTI in low 40's. You have 3 options.  Raise your income, reduce your debt, or pay cash. 


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I don't have this at the ready, the vast majority of my debt is mortgage debt.  I came to that same conclusion with raising my income/pay down debt or bring enough cash to the table/pay cash. The problem as I see it, if I pay down mortgage debt.. the monthly payments don't reduce. So if I aggressively pay down a mortgage my DTI won't adjust until it's cleared. Is this accurate?

[Another Reader]

I'm losing 1500 a year on the property that is a write off. I don't consider this a significant loss.

Do you think it's the best approach to sell an asset and have to write a check for around 20k plus realtor fees? (sounds glib, but genuine question. It's 4 hours away so FSBO is out of the question.)

I think I'd rather hold it longer term and eventually get it to cashflow (likely 3-5 years)

I want to add a second rental property that is bought as an investment, place with negative equity was purchased as a primary home so I didn't do any cash flow analysis... also I didn't have a crystal ball in 2006.

Your largest problem is that you have used up all of your borrowing capacity on an expensive primary residence and a money-losing rental.  You have sort of recognized that indirectly by looking to your 401k as a source of borrowed funds.  In your situation, I would step back and look at the big real estate picture. Dumping the rental and if feasible selling the primary might eventually put you in a position to buy more and better performing rentals.

[GoatStache]

I would say at this point selling the rental isn't going to happen. Id likely have to come up with 28k to dump it and I'm sure I'm missing someone in there that I'd have to pay.

If I aggressively paid it down in the next year(s), is there a way to restructure the payments with the lender (Wells) so my DTI looks better? If I pay the principle down, does that impact my dti? (Im assuming no because my monthly payments wouldn't change.)

I know another option is to pay it down enough to refi, but at 4.5% on an investment property I don't think i'll get better terms on another 30... and a 15 year would seemingly make my cashflow problem far worse.

[Another Reader]

Once you understand financing requirements better, you will see how deep a hole you have dug with your two properties.  You are grasping at straws.  You can either let your current leverage be a long term drag on your investing, or you can reduce your leverage to free up borrowing capacity for the future.  Like Papa bear said:  "Raise your income, reduce your debt, or pay cash."

 

[GoatStache]

Grasping at straws? I'm asking specifically about the part of "reducing my debt." I understood coming in to the question that I had a lot of mortgage debt. As mortgage debt is the only type of debt I have... How does one effectively reduce that so it impacts your dti? Is it only via a sale or completely paying off the mortgage? I would rather not "pay down debt" if it causes me to apply for financing and they see my dti is identical because my monthly debt obligations haven't changed.

[GoatStache]

Also, thanks for taking the time to respond...

[Elk]

I would wait till you have more cash.  Real estate is not a game you want to play cash poor.  The loan on your primary is huge.  I would focus on paying off the PMI on your primary first.  I would keep the rental mainly because it has low interest rate locked in.  Leave the money in the retirement accounts otherwise you won't be diversified enough.

[GoatStache]

There is no PMI on either property. Primary is a VA loan and the investment there is no PMI.  The investment was purchased as a primary via an FHA loan. Does this change your advice at all?

[Another Reader]

Debt to income is based on payments.  Reduce your payments or increase your income is a more accurate statement.

I'm not trying to be mean or flippant.  I want you to understand why you cannot gain any investment traction with the loans you have outstanding.  Both of these properties are huge drags on your ability to make additional investments.  Because DTI is a payment to income ratio, you have to reduce the numerator or increase the denominator.  As you now understand, paying down debt without paying it off does not help your DTI.  You pay off the loan or sell the property to reduce DTI.

If you want to be a real estate investor starting from your current position, you are going to have to restructure or get rid of the debt, increase your income, or save up and pay cash.  Based on the value of your primary residence, inexpensive rentals are probably difficult to find in your area, so paying cash locally is likely not an option.  My guess is that if you sold both properties and moved into a cheap rental, you could save up some cash quickly and start buying cash flow positive properties.  Yes, you would have to recognize losses and come out of pocket to do so, but the boat anchors would be gone.  If you and your wife are not willing to do that, you might be better off dumping money into paper assets now and waiting for the market to improve or the debts to be paid down to look at real estate investing.

[GoatStache]

Got it, thanks. With it locked in at 4.5 I think I'd like to keep the rental and try to pay it down enough via rent increase and other methods to try to refi or restructure.

I didn't think you were being flippant, I just wasn't following.

Thanks for the counsel, it's a different perspective than mine.

[zephyr911]

I second the advice about talking to lenders directly. Loan officers and mortgage brokers can explain the ins and outs better, and possibly help you identify a get-well plan for your credit profile and DTI.

If you explicitly pursue investment financing for this, your rate may be higher but the emphasis will be more on identifying a profitable property than on your other financials. Either way, suggest you focus on small, affordable options with high cap rates.

You might also look for owner-financed options if you're convinced your finances are strong enough to support this endeavor and the underwriters just aren't giving you a fair shake. Most offers are bullshit, but I'm looking at a big portfolio right now in my area that the guy just wants to unload; he's offering better-than-market terms and I may bite on 2-3 of them if we can work out a phased package deal that works for me.

[frugaldrummer]

One other way to reduce your payments-to-income ratio is to pay down some of one of your mortgages, then refinance it to get a lower monthly payment.  (For instance, if you paid down half your home mortgage, then refinanced the remaining half to a 30 year loan at the same interest rate you currently have, your monthly loan payment would be half as much.) However, beware that higher interest rates and/or loan fees may make this a less attractive option.

I agree with most here that your current ratio of mortgage debt to cash is too high for you to be considering buying another rental property.  About the only reasonable way to do that now that I can see would be to sell your house and buy an equivalently priced property that has a rental unit included (like a basement apartment or granny flat).

[GoatStache]

I second the advice about talking to lenders directly. Loan officers and mortgage brokers can explain the ins and outs better, and possibly help you identify a get-well plan for your credit profile and DTI.

If you explicitly pursue investment financing for this, your rate may be higher but the emphasis will be more on identifying a profitable property than on your other financials. Either way, suggest you focus on small, affordable options with high cap rates.

You might also look for owner-financed options if you're convinced your finances are strong enough to support this endeavor and the underwriters just aren't giving you a fair shake. Most offers are bullshit, but I'm looking at a big portfolio right now in my area that the guy just wants to unload; he's offering better-than-market terms and I may bite on 2-3 of them if we can work out a phased package deal that works for me.

Yeah I was looking in to owner financing, as you know they're tough to find. I am going to ask if loan recasting is available on my investment if I apply enough towards the principle. I can borrow a bit from my 401k at 2% and aggressively pay it off. One will advise the other, if I can't recast then I won't bother doing it. I think I'm going to seek out a mortgage broker and see what my options are.

[GoatStache]

One other way to reduce your payments-to-income ratio is to pay down some of one of your mortgages, then refinance it to get a lower monthly payment.  (For instance, if you paid down half your home mortgage, then refinanced the remaining half to a 30 year loan at the same interest rate you currently have, your monthly loan payment would be half as much.) However, beware that higher interest rates and/or loan fees may make this a less attractive option.

I agree with most here that your current ratio of mortgage debt to cash is too high for you to be considering buying another rental property.  About the only reasonable way to do that now that I can see would be to sell your house and buy an equivalently priced property that has a rental unit included (like a basement apartment or granny flat).


So I should throw 220k at my primary mortgage or 75k towards my investment?

[frugaldrummer]

You would have to look at the tax ramifications of one or the other to decide which was the better approach.  And you would have to pay off the entire mortgage on the rental property to get the same reduction in mortgage payment that you would get from paying half your home mortgage.

(Me personally, I like the idea of paying down the home mortgage, which lowers that payment and makes it less likely you could lose your home to foreclosure in another downturn or a personal crisis. But you have to look at all the tax ramifications to see which would be better dollar-wise).

[GoatStache]

I think I'm just going to aggressively pay down the rental and try to refi it. I'm going to speak to a broker to find out how I'll be assessed and go from there.

[Another Reader]

If you eliminated the rental from your calculation (only debt being your house), what is your DTI?  If you paid off the rental and used 75 percent of the net rental income in the calculation, what is your DTI?   Calculations like these will give you a feel of how much various actions will improve the DTI.

Most investors starting out are going to use conventional financing.  Most of the standards for owner-occupied mortgages are applied to conventional investor loans.  Loans on commercial properties and portfolios are more based on the income of the properties in my experience.   Again, it would be helpful to talk to a couple of lenders that do investment property loans to get a solid idea of what they are looking for.

[icemodeled]

My husband and I have 6 rentals, use to be 8. I would really make sure you do the numbers thoroughly of cost to buy, maintain and profit. We thankfully saved and paid cash for the first one in 2010. Then saved until we could buy another. WIth your salary and your wifes, I would imagine you could reach FI long before you could with rentals (from numbers I read). If you're just truely interested and enjoy being a landlord, then thats fine to. I just would consider other investment ideas to as it may be a better return elsewhere.

[GoatStache]

My husband and I have 6 rentals, use to be 8. I would really make sure you do the numbers thoroughly of cost to buy, maintain and profit. We thankfully saved and paid cash for the first one in 2010. Then saved until we could buy another. WIth your salary and your wifes, I would imagine you could reach FI long before you could with rentals (from numbers I read). If you're just truely interested and enjoy being a landlord, then thats fine to. I just would consider other investment ideas to as it may be a better return elsewhere.

I've considered other investments and I think rentals are the ideal passive income mechanism. Other investments just aren't yielding right now, oil is the only area I think has significant upside.

[GrowingTheGreen]

Well-diversified, low cost index funds will return a heck of a lot better than what your % return in real estate has been. They also have a practically non-existent barrier to entry. It really doesn't get much more passive, either.

Trying to time oil seems like a symptom of a greater condition: chasing high returns.  Consistently investing in boring mutual funds is the way to go.

I'm not saying real estate investments are bad, but they do involve careful number crunching and skill.  I think a good exercise for you would be to calculate your cash-on-cash return on your existing and future rental portfolio. It may be eye-opening.


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[Wile E. Coyote]

Any chance you could sell the rental to the long term tenant to save the commission?  I don't see the point in continuing to keep your money in a losing property in hopes of it turning cash flow positive in the future by putting more money into it. It is either a good investment property or it isn't. You would be better if biting the bullet and finding a good investment property.

[Mazzinator]

I'd buy another rental with cash before i'd pay down the mortgage and refi. Not sure where you are, but i'd look within a few hours drive and something that's 30-50k range that rents at 2%. It would help your income part of your dti (after 2tax years) plus it gets you positive cash flow.

Or...move. Sell or rent your primary house and buy and live in a multifamily or cheaper primary house. I think you can get another va loan after you've lived in your primary at least one year.

Either way, good luck!

[GoatStache]

Well-diversified, low cost index funds will return a heck of a lot better than what your % return in real estate has been. They also have a practically non-existent barrier to entry. It really doesn't get much more passive, either.

Trying to time oil seems like a symptom of a greater condition: chasing high returns.  Consistently investing in boring mutual funds is the way to go.

I'm not saying real estate investments are bad, but they do involve careful number crunching and skill.  I think a good exercise for you would be to calculate your cash-on-cash return on your existing and future rental portfolio. It may be eye-opening.


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Trying to time oil? How did me saying oil is at an attractive level turn in to me buying oil options suddenly? I currently only have low cost index funds for all of my investments, I was giving a "for instance."

[GoatStache]

Any chance you could sell the rental to the long term tenant to save the commission?  I don't see the point in continuing to keep your money in a losing property in hopes of it turning cash flow positive in the future by putting more money into it. It is either a good investment property or it isn't. You would be better if biting the bullet and finding a good investment property.

Tenant is elderly and not interested in buying the property, I've tried to setup a rent to own situation. Only option I have there is to raise the rent slightly over time. They're a great tenant, so no complaints there.

One way or the other I'm cutting a check.... If I cut the check to my equity... And I can refi it.. I have cash flow. If I cut the check and sell the property (which I admit is a loser, but remember it wasn't purchased as an investment.) I'm out the cash and the property... My dti plummets but I can lower it and strengthen my portfolio by paying it down.

[GoatStache]

I'd buy another rental with cash before i'd pay down the mortgage and refi. Not sure where you are, but i'd look within a few hours drive and something that's 30-50k range that rents at 2%. It would help your income part of your dti (after 2tax years) plus it gets you positive cash flow.

Or...move. Sell or rent your primary house and buy and live in a multifamily or cheaper primary house. I think you can get another va loan after you've lived in your primary at least one year.

Either way, good luck!

I'm outside of Baltimore so I could afford a rental in the right neighborhood. I agree completely with this strategy but moving forward I think I'd like to have the other rental sorted as I'm not certain I could pull the 2% without any renovations (especially in Baltimore... Where I think there's some opportunity right now)

Thanks for all of the responses, really got the juices flowing.

[frugaliknowit]

Echo "Another Reader".

[GoatStache]

Echo "Another Reader".

Yeah, sadly for me their advice was the most real world. I'm fairly certain if I found the right property and was able to raise enough cash (realistic amount) I could get around the DTI issues. I respect the rental property game enough to know, that 35-50k house is going to have some stuff that needs to get fixed prior to putting someone in there.

I suppose i'll just win powerball and sort it all out that way.