Buy an Expensive Local House - or Cheaper Remote House - or Just Invest?

[Frugal Philosopher]

Some general information -
I live in Orange County CA. Houses are expensive here.
I am 24. I have a good job. I live with my parents. I have very few expenses.
My math is a little approximate - but I think I save on average about 71% of my income (after taxes and maxing out 401K contributions).

Sometime next year I should have enough to put 20% down on a 500k home. I already went through loan pre-qualification a few months ago and qualified to take out a 460K loan with 10% down. I would rather put a full 20% down on anything I buy though. (In my area the cheapest homes are in the mid 400k's) I would end up renting out the home for probably more than my mortgage payment would be - at the very least the rent payment would cover all but a few hundred dollars a month of the mortgage. Owning locally gives me a place to move to in a few years - or to at least sell and move to a different place. I also get to write my interest off. Renting the place out should get me around 2500 a month in rental income.

I could also buy out of state and rent it out. This keeps the benefits of buying in a relatively down market and gives me interest to write off. I lose the benefit of having a place to move into and buying in Orange County at a "down" period. I could afford to buy a cheaper house, or even a few cheaper houses. The rental income would be less than Orange County rent though I am sure.

Or I could invest my savings and hope to get a decent return - I don't really see getting anywhere near 2500 a month in returns though...

Thoughts? Suggestions? Am I missing anything obvious? How about anything subtle?

[gooki]

Or I could invest my savings and hope to get a decent return - I don't really see getting anywhere near 2500 a month in returns.

Just be aware the return on investment of your "rental property" isn't $2500 a month. You have to subtract all expenses, interest, insurance, taxes, maintenance and make allowances for vacancies to get the actual ROI.

[arebelspy]

Search on here and BiggerPockets.com for the 50% rule.  You should be getting about double in rent what your mortgage payment (principal and interest part, not counting taxes and insurance, which are likely part of the payment) is to be break even.  Anything more than that is profit.

That's with 0% down.  If you're putting money down (which is a good thing) you should be getting even more profit.  That is, if you have to put down 50% to force it to break even, you're forcing cash flow and not actually getting a good return.

This makes me think it's quite a bad deal:

I would end up renting out the home for probably more than my mortgage payment would be - at the very least the rent payment would cover all but a few hundred dollars a month of the mortgage.

You may just be in a place where owning doesn't make sense based on price to rent ratios.  Fitghting it is just asking to lose money (or way underperform wherever that money could be invested).

Or I could invest my savings and hope to get a decent return - I don't really see getting anywhere near 2500 a month in returns though...

I don't see you getting anywhere near 2500 in returns on this either.. Unless (hypothetical numbers) you're renting out a mansion for 10,000 per month and the mortgage is 2500. (10k rent - 5k  expenses/vacancies/capital repairs/etc - 2.5k mortgage = 2500 profit).  That's an exaggeration in this case (you likely won't see 5k/mo, however a vacancy at the 10k/mo range hurts you bad when it's empty and is a lot harder to fill, so it likely isn't that far off).

This deal sounds more like you'd eek out a break even (if not negative return). If it was break even, then you could come out ahead via mortgage interest deduction, depreciation, equity paydown, and potential appreciation.  Otherwise, you'll likely be losing money, and I can tell you a few places where you can beat that return.

Bottom line: there are places that just don't make sense to invest in real estate.  You likely live in one.  If you want to invest in RE, you'll probably have to go out of state.

/disclaimer: I wouldn't invest in most of CA, but I am involved in a few REO deals there currently, that will likely be rehab / flips, although buy and hold is one potential exit strategy, not plan A.  I am involved in these due to bank contacts, and would not be normally investing in houses on the MLS in CA.

[Frugal Philosopher]

Good information, thanks.

So if you guys had 100k to invest in something, didn't have to buy a home now, and probably want to buy a home in a few years...

Would you invest in RE out of state or stick to more of a portfolio type investment?

[arebelspy]

Good information, thanks.

So if you guys had 100k to invest in something, didn't have to buy a home now, and probably want to buy a home in a few years...

Would you invest in RE out of state or stick to more of a portfolio type investment?

Will you need any of that 100k for the home purchase in a few years?  Real estate is pretty illiquid.  Or would you invest all that and let it grow, and start saving separately for a house down payment?

Personally, I'm very bullish on real estate right now, with low prices and low interest rates.  I think the long term return on it will be good.

But the answer to your question will be highly dependent on the individual involved.. Their knowledge, risk tolerance levels, market philosophy, etc.  We'd have to know more about you to answer that question.

To answer it for myself, were I in a location that was not ideal to invest in real estate, I'd be investing out of state.  Though I likely wouldn't be buy and holding.. I'd be investing with local real estate investors in partner deals.  Boots on the ground experience can't be beat, and by joint venturing on deals or lending them private or hard money, I could get exposure to the real estate market without trying to be an out of state landlord.  That is based on my real estate knowledge, however, and my belief in being able to find solid real estate investors to invest my money with.  Again, that will depend greatly on the person.

[Frugal Philosopher]

Will you need any of that 100k for the home purchase in a few years?  Real estate is pretty illiquid.  Or would you invest all that and let it grow, and start saving separately for a house down payment?

I will probably want to buy a house at some point. I could start saving all over again for a house down payment if I thought I was getting a good enough return on allocating this money elsewhere.

Personally, I'm very bullish on real estate right now, with low prices and low interest rates.  I think the long term return on it will be good.

I tend to agree - the prices of local real estate is what is kind of leaving me unsure...and thus my question to the smarter people than me. ;)

But the answer to your question will be highly dependent on the individual involved.. Their knowledge, risk tolerance levels, market philosophy, etc.  We'd have to know more about you to answer that question.

I know a bit about all financial markets but I am still developing my own views on most of it. What kind of information would help the advice on the real estate side of things?

[ShavinItForLater]

If you need the money in a few years as a down payment on a home, I would not want to take significant equity risk with it.  Real estate would be unlikely to make a lot of profit in only a few years, and as stated could be difficult to sell when you need it.  Stocks would be more liquid, but how would you feel if we had a bear market over the next few years and were 20-30% down from the current levels?

I generally use 5 years as the threshold--at that point inflation risk starts to be the bigger worry than equity risk.  If you think you'll need the money shorter term than that, I'd be looking at very conservative choices, like money markets or high yield savings accounts or CDs.  That's just my opinion, but that's what I'd do in your shoes.

If you are sure you won't need the money for at least 5 years, then I'd say you could look at either a cheaper rental (much,  much lower price than your $500K example--I'd be looking at about 1/4 of that if I were you), or some index ETFs/mutual funds.  I would also add that I would never, ever become an out-of-state landlord by choice.  If I own a property as a landlord, I want to be able to bike or drive by it without having a significant burden of cost and time to do so.

[MooreBonds]

***IF*** you are damn sure you will be in the same area 5-10 years from now, it could make sense to buy now, if prices are stabilized and aren't still overvalued. The reason is that 30 year mortgage rates aren't likely to go any lower - and could very well rise a bit 5 years from now.

$400,000 @ 3.5% (current rates) would be about $1,800/month.
$400,000 @ 5% is $2,150/month, or $350/month more.

Of course, the above rates would be if you bought the house as an owner-occupier. If you financed the house telling the mortgage company you're using it as a rental, the rate will be a bit higher.

Getting to take depreciation for your rental is a plus, if you are certain you will be living in it down the road. But think about potential wear and tear on the house (unless your long-term plan is to remodel it after you're done w/ the rental activity).

Work up your true out-of-pocket expenses (interest, taxes, utilities, insurance, projected upkeep), your net tax benefit, and then look around at what comparable rentals are going for.

[arebelspy]

But the answer to your question will be highly dependent on the individual involved.. Their knowledge, risk tolerance levels, market philosophy, etc.  We'd have to know more about you to answer that question.

I know a bit about all financial markets but I am still developing my own views on most of it. What kind of information would help the advice on the real estate side of things?

Knowing about real estate investing.  Finding a particular niche and learning all about it.

Barring that, I'm of the opinion that the best out of state investing is owning notes - i.e. being the bank and lending the money on property.  Find a good local investor and invest with them.  Your money is secured by real estate, and you get a strong, reliable return.

I buy locally and do my own investments, but I also own a note on a house in Mississippi and am working deals in CA and AZ.  I don't plan to long distance landlord.  Too many pitfalls for me.