2 properties in same community - bad idea?

[Megma]

Hello,

I am considering buying my first investment property, something I've been looking at for a while, watching what was available in my area and at what price.

My current home is in a community governed by an HOA, I know that some on the forums are anti-HOA and I can understand why but the reality is that almost all neighborhoods in my city have one. Even the SFH neighborhoods.

There is a foreclosure in my community at a good price. It is slightly larger than my home and listed for ~25k less than I paid for my home a year ago (property values have held steady/increased), which is less than a block away. It has been listed since November, price steadily decreasing and just recently had a contract fall through (I would need to find out why) so I would expect I can maybe get it for a little less even.

It appears to be in rent ready condition (from photos/walking past the outside).

Since it is so close to where I live it would be very easy to keep an eye on the property and the tenants but I am wondering if it is a bad idea to buy into my same community/HOA? I do go to the board meetings, no special assessments are planned now (down the road who knows); we did not have an HOA fee increase this year but if there was an increase or a special assessment I would get hit with it twice.

What do you think? Good idea? Bad idea?

[Ricky]

You already know the answer to this question.

You've lived in this community, know the type of tenants it attracts, know your HOA's financial situation, know exactly what level of rent to expect, etc. You also have a good idea of where the neighborhood is headed overall.

Being diversified doesn't really matter at this point since you already know so much. It wouldn't make sense for a newbie going in to buy 2 properties at once, but this isn't that scenario.

[LiveLean]

+1.

If you know the market, by all means. Our weekly beach rental is a 1,300 square foot small home in a community where homes are getting torn down and replaced with 8-bedroom monsters. The house next door to ours is identical and we'd buy it if it became available just as a preemptive strike to keep it from being torn down and replaced with something that would literally cast a shadow over our future FIRE home.

[Bob W]

Buy it --- just make sure it will be cash flow positive.

In general,  it makes sense to own properties in close proximity for a number of reasons as long as the market is good and the price is right.

Without cash flow positive --- I would keep my money elsewhere and avoid the headaches and potential losses. 

[Megma]

Ok good, I was nervous that there would be a special assessment or some such nonsense. Thank you for the reassurance!

Based on the math I've done, there should be positive cash flow. It's listed for 122k, my target price is 110k (max 115k).

Based on getting it for 110k, I need to rent it for at least 975 to do slightly better than break even (before any tax benefits), my target rent price would be 1050-1150 based on what other properties in the community are getting that are of similar size.

#s
purchase price: 110k (approximate value 148k)
down payment: 16,500 (15%, as indicated by my conversation with my lender)
Interest rate: 5.125 (lender said I would be between 5 and 5.125)
Payment: 509/mo
HOA/Maintenance: 230 (HOA ~208 based on what I pay and a little extra maintenance fund)
Insurance: 625 (again based on what I pay for my house that is almost the same)
yearly taxes: 2,100 (again based on what I pay for my house that is almost the same)

I would self manage from around the block.

First year scenarios:
Renting for 975 would net me only 112/yr (719 after tax benefits)
Renting for 1,050 would net me 1,012/yr (1,367 after tax benefits)
Renting for 1,150 would net me 2,212 (2,231 after tax benefits)

There is a strong rental market in my area as we are between two very large universities, on the free bus line for one of them, and both have very large graduate/professional schools (medical, dental and law). I would be looking to rent to either a young professional couple or some grad/professionals. There is also a large hospital, affiliated with the university, on the bus line that charges employees a small fortune for parking. Finally, there is a plan to connect us to the other university with a light rail project that is supposed to break ground soon.

Due to these factors, I feel it is reasonably certain the rental market will remain strong/improve and I can likely over time increase the rent and earn more income from the property in exchange for the work I will put in being a landlord. Though I'm sure someone will say I would do better with an index fund :-)

Any additional thoughts?

[waltworks]

Gah. This is a terrible idea. With NO provision for management costs (yes, I know, you're going to do it - but you should be paying yourself something and planning for the contingency that you move away/can't manage it and have to hire that out), vacancy, or maintenance (oh, wait, you budgeted $22 a month...), you are basically just barely breaking even. Including even a little vacancy or a broken appliance, you're negative. Special assessment? Tenant lawsuit/eviction? Say goodbye to lots and lots of money.

I might consider this deal for, say, $50k. At the price you are paying, it makes no sense. Do something else.

-W

[Megma]

First, I made a mistake on the insurance it's actually $290/year (not 625).

Based on my mid-range scenario (probably the most likely), I could pay myself $25 per hour and spend 40hrs a year on management. Though it's true this might not be enough hours, only ~3/month.

Plus I get the added tax benefits and the tenant to pay off the property as the return on my down payment.

I will concede that I don't have enough built in for maintenance but HOA does cover the entire exterior of the property. I will increase that in my calculations and see if it still looks good to me.

For now, I am also talking to other landlords in the community to see what their experience with finding tenants and how accurate my rent projections are.

[waltworks]

I will say this one more time: little bits of improvement around the edges are not nearly enough to make this property interesting as an investment. You need to look elsewhere. If you want 1 or 2 percent returns, just buy some bonds (or a CD) and sit back and relax with your safe, liquid investment. RE carries lots of risk and is pretty illiquid. You need to compensate yourself for that with lots of return/upside, or else not do it at all.

-W

[dsmexpat]

Y'all seem to be treating this as if the 590/month payment on the mortgage is an absolute loss as if you'd account for tiny profits for the first 19 years and then suddenly +$200k (or whatever the house will be worth then) on the 20th year out of nowhere. Over half of the expenses on this property are spent building equity which has value that ought to be included in any calculation of returns.

[waltworks]

Go look at a 30 year amortization schedule, dude. And remember it's going to cost you ~6-10% to sell in fees/commissions/closing to realize that equity gain. AND the IRS will take capital gains PLUS your depreciation back, unless you want to do a 1031, which also costs money upfront, plus closing/fees on whatever you're 1031'ing into...

It is very expensive to extract the equity from a rental property, and thus most RE investors ignore principal paydown for the purposes of analyzing a deal.

-W

Y'all seem to be treating this as if the 590/month payment on the mortgage is an absolute loss as if you'd account for tiny profits for the first 19 years and then suddenly +$200k (or whatever the house will be worth then) on the 20th year out of nowhere. Over half of the expenses on this property are spent building equity which has value that ought to be included in any calculation of returns.

[Beaker]

Over half of the expenses on this property are spent building equity

Uh, what? I'm counting ~429/mo of taxes, insurance and HOA fees.

At the beginning the mortgage payment is going to be $109.78 of principal per month, and $399.32 of interest. So $110 of equity vs $630 of expenses. Not exactly half. The principal payments don't even come close to the expenses + interest until the very end of the mortgage.

waltworks is right - this thing doesn't pencil out as a rental.

[Ricky]

You're at ~$1k in expenses, maybe more.

Minimum rent would have to be $1,100. I'd want probably more like $1,200 in that situation though. $200 * 12 in profit would be a return of 15% on the $16,500 down payment. Not bad, but if you don't foresee getting that amount in rent consistently then I would move along. You shouldn't factor tax benefits into your cash flow.

Y'all seem to be treating this as if the 590/month payment on the mortgage is an absolute loss as if you'd account for tiny profits for the first 19 years and then suddenly +$200k (or whatever the house will be worth then) on the 20th year out of nowhere. Over half of the expenses on this property are spent building equity which has value that ought to be included in any calculation of returns.

Generally, RE investors don't care if the rental is still breaking even (building equity). Not only is most of that mortgage payment going towards interest initially, it's a fairly illiquid investment and there are high transaction costs.

Say after 30 years it was paid off, and you otherwise broke even, and the property kept up with inflation and slightly appreciated. After everything, you get $100k. That's $3,333 per year / $16,500 (down payment). That's a 20% return on your money, yes, but you had to wait thirty years for that, or nearly. That's also not compounded. Compounded, it's only about a 6% return. Also, this is assuming everything goes right and a tenant is in place for that long and there aren't any major repairs, special assessments, etc. So many IF's to lock down to one place for 30 years. That's why any equity built doesn't really matter (and doesn't matter at all in the beginning of the mortgage).

[Another Reader]

The return on the investment is comprised of the net cash flow and net equity returned to you at sale.  If you do a full discounted cash flow analysis, that $200k or whatever it is at the end of 20 years does not have a lot of value today. 

This is apparently a condo or townhouse with an HOA.  The HOA is responsible for some of the property upkeep, but the owner still has to replace paint, carpet and appliances over time.  Best case on paint and carpet is 7 years.  There will be vacancies at turnover even in a strong market and you may get a tenant that deteriorates and does not pay.  You may lose rent and have to pay for the eviction.  You pay property taxes, and you pay for a landlord insurance policy that covers whatever the HOA policy does not.  You may pay utilities when the unit is vacant.  At some point there may be special assessments to cover roofs, parking lots, or other common improvements if the cash is not sitting in the HOA account. 

If you purchase this property with the mortgage suggested, over time you would probably break even on cash flow.  Maybe a little better at the higher end of the rent range and a constant P&I payment, but not much.  Unless you can get better leverage terms, I would pass.  For example, could you put 20 percent down, move into it for a year and rent yours out, and finance the new unit as owner occupied at 3.75 percent?  That gives you another $100 a month in reduced mortgage payment. 

Overall, in your shoes, I would probably pass and look for something that cash flows more.  There is just not enough there to make the purchase worthwhile.

[Mrs. PoP]

I don't know about where you live, but another thing to consider is whether or not using your values for things like insurance and property taxes is really a good proxy for a rental.  If there's flood insurance, FNIP just announced a $250/year surcharge for non-primary residences and our taxes on our rental place are not subject to the same homestead exemption and cap on increases that our home is.  In general, it seems like if an entity can charge more for a rental or non-primary home, they do.  And you should build in plenty of allowance for that. 

[theoverlook]

You would probably make more money putting that $16,500 into VTSAX for 20 years.

[Jesstache]

FWIW we are purchasing a house 1/2 a block from us as an investment/rental and will be actually floating about $200/month between the mortgage and what it can rent for.  My husband wants a garage and our current lot has absolutely no room for building and this is our solution for not moving from the location we love and do not want to leave and getting him his garage (also 6% realtor fees on our current house are about $33,000).  The investment house is immediately rentable (and in fact, is currently rented) on 1.5 city lots with room to add a garage and a rental unit above it and that's what we plan to do.  Also, they are building a 4 year university only 4 blocks from us that will undoubtedly make the current 0.5% rental vacancy in the city even worse (our neighborhood is closer to 0% because it is so desirable).  We also have another rental house about 0.5 miles away that we self manage so this isn't a new endeavor to us. 

We are looking at the deal as we are basically subsidizing the garage with a property that we can have two rental units on (a very rare empty lot in the neighborhood would be $260k at least).  We also have huge incomes so we can easily absorb these and any unexpected costs (plus a 1.3M net worth doesn't hurt).  This is a very long term investment for us.  We have no plans to sell. 

As long as you know the numbers and the risks, you can decide what you are comfortable with.

[waltworks]

Jessstache - What you are describing is really just buying yourself access (very expensive access!) to a garage, though, not an investment. And it's going to suck up a bunch of your time, too, which, if I were worth $1.3 million, I would value pretty highly.

Just rent a garage if DH wants to tinker.

-W

[bruce88]

Regarding your original question.....

Two in the same community may not be a bad idea, since you know the area.  (Congrats on asking local landlords for their take on rents, getting renters.  Good idea.)

My only concern with your question is the whole HOA thing.  We have had two experiences (with rentals) in the last couple of years of HOA's getting "tough" with (evil) landlords.  They poisoned the neighborhood with tales of bad rentals and held a vote to either eliminate rentals (by non- occ owners), or in one case, made mandatory "interviews" for all tenants, plus credit checks, plus criminal back ground checks-paid by the renters/landlords. 

Personally, I will never buy another "rental" with an HOA board.  Instead, look for homes over 25 years old, most of those older neighborhoods don't enforce their covenants and don't have active HOA boards.

[TheGrimSqueaker]

A slipping price is often a sign of a distressed seller or a property that's got something wrong with it.  Have a high quality inspection done, and make the offer contingent on clean results from the following:

- Termite check
- Stachybotrys (toxic mold) check
- Meth check

Have the seller assume the costs for these tests.  You do NOT want a former meth lab as an investment property.  The remediation can be very expensive as you have to rip everything out right down to the sheetrock.