Author Topic: Acceptable amount of debt??  (Read 3455 times)

Markywalberg

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Acceptable amount of debt??
« on: July 28, 2015, 04:51:17 AM »
Alright so here is the situation. I just bought half a townhome with my brother we are renting it out soon. Together we established and llc and we own 50 percent of property and uncle owns other half. Between us we own the house. No mortgage no debt even in personal finances. So townhome was 120k and we put up 60k. If renting it goes as planned we should have say 20-30k saved jn 6-12 minths and then I would like to take out a mortgage on anither townhome for around the same price the loan amount would be 75k( smallest loan I could get from bank) and we would put down 80 for townhome and pay back the other 35k from the loan owing only 40k on mortgage @ 5% interest costing about 2k a year in interest. So here is the math      Townhome 120k-60k(uncle will own half) = 60k left (what we owe) - 20k what we pay right away= 40k left which we have a 5% interest on. Rent is about 1300-300 a month expenses which gives us 500 after we split rent so 500x12=6000 minus 2k mortgage giving us 4k left over . My question is does it seem like im throwing added risk at it or does it seem pretty reasonable with only a 400 a month mortgage less than half being interest and collecting 1000 a month from rent that we can easily handle a 40k loan

nereo

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Re: Acceptable amount of debt??
« Reply #1 on: July 28, 2015, 06:16:25 AM »
Alright so here is the situation. I just bought half a townhome with my brother we are renting it out soon. Together we established and llc and we own 50 percent of property and uncle owns other half. Between us we own the house. No mortgage no debt even in personal finances. So townhome was 120k and we put up 60k. If renting it goes as planned we should have say 20-30k saved jn 6-12 minths and then I would like to take out a mortgage on anither townhome for around the same price the loan amount would be 75k( smallest loan I could get from bank) and we would put down 80 for townhome and pay back the other 35k from the loan owing only 40k on mortgage @ 5% interest costing about 2k a year in interest. So here is the math      Townhome 120k-60k(uncle will own half) = 60k left (what we owe) - 20k what we pay right away= 40k left which we have a 5% interest on. Rent is about 1300-300 a month expenses which gives us 500 after we split rent so 500x12=6000 minus 2k mortgage giving us 4k left over . My question is does it seem like im throwing added risk at it or does it seem pretty reasonable with only a 400 a month mortgage less than half being interest and collecting 1000 a month from rent that we can easily handle a 40k loan

Your math is a bit hard to follow the way that you've written it all out in-paragraph.  Next time try writing it out in a list form ;-)
From what I understand, my main concerns are that 1) you do not seem to be factoring in vacancies in your calculations, and 2) you do not have any sort of maintenance/repairs factored into your calculations.  Both will happen.

On the surface your rental seems cash-flow positive, which is good.  But your real risk here is what will happen if either the current or future properties need an expensive repair like replacing the roof - a repair that might require you to pay for your tenants to live somewhere else for several days.  Do you have savings enough to cover such a scenario?  In your "real-life" (non landlord) do you have a surplus of cash each month, or are you already stretched pretty thin?   If you are on solid financial footing, have at least several thousand$ to cover repairs/vacancies then I see no problems.  But if you're already stretched to buy the first house, I'd wait before buying a second unit.

Markywalberg

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Re: Acceptable amount of debt??
« Reply #2 on: July 29, 2015, 05:19:13 PM »
well there are some expensive repairs that could come up but th ebig thing like siding and driveway and roof is all covered by the 150 association fee and next place would be a townhouse as well. As far as financially once i get a place or 2 i think this buisness will run seperately of my own finances and i wont need to contributew but at the momnt i have enough finances to cover the first place not sure what a ideal amount would be for covering emergency expenses?

nereo

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Re: Acceptable amount of debt??
« Reply #3 on: July 29, 2015, 07:22:25 PM »
well there are some expensive repairs that could come up but th ebig thing like siding and driveway and roof is all covered by the 150 association fee and next place would be a townhouse as well. As far as financially once i get a place or 2 i think this buisness will run seperately of my own finances and i wont need to contributew but at the momnt i have enough finances to cover the first place not sure what a ideal amount would be for covering emergency expenses?

The big thing  I'm getting at here is whether taking on a second property will make you over-leveraged.  Yes, after several years any well group of well run properties should be able to generate the cash-flow to provide for all maintenance, but it's during the first few years, when you are just starting to collect rent payments that an emergency (or even a misevaluation of the market) can destroy you.

Different people will use different numbers, but I'd like to know I can cover a sudden $20,000 expense on each property without it forcing me into bankruptcy.  I'd also plan on 3-5% maintenance costs per year (depending on the age of the building, the newness of things like the boiler, roof, plumbing etc) and vacancy rates of at least 1/12 (many will use 2/12 to be conservative).

I can't give you more specific advice without knowing a lot more about your personal finances and the kinds of properties and market you are working with, but at least run some pessimistic numbers yourself and ask "could I survive this".  Instead of first looking at a rental property as having the potential to generate lots of wealth (which it certainly can), I would begin by making sure it isn't going to ruin me.

PS  - really loved The Departed :-)

Markywalberg

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Re: Acceptable amount of debt??
« Reply #4 on: July 29, 2015, 11:54:09 PM »
Alright thanks for the 3-5 percent estimate i am hoping it should be lower since the bigger stuff is covered by association but i think maybe instead of jumping on another property after renting the first one for 6 months ill just wait for a year of renting the other property so that i can get a better estimate of the cost on the my first place since the second place is almost a duplicate

deborah

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Re: Acceptable amount of debt??
« Reply #5 on: July 30, 2015, 01:27:21 AM »
As nereo says, some people go under in the first few years of landlording (actually MORE than some - and usually because they are moving too quickly). It is much better to wait 3 or 4 years after getting your first property, and see how you go than it is to jump in to another property after only six months or a year.

During the time when properties were very depressed there was some reason to move quickly, because the prices were not going to last very long, but there isn't now.

It would be good for you to have a few emergency calls from your tenant before you start on the next one.
It would be good for you to have eighteen months of the place not needing too much maintenance before you start on the next one.
It would be good for you to have had a couple of different tenants before you start on the next one (have some experience of getting a second tenant).
It would be good for the relationship between you, your brother and your uncle in this lease to have withstood the test of time before you get into the next one - especially if this is the first time the three of you have jointly owned something.

clarkfan1979

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Re: Acceptable amount of debt??
« Reply #6 on: August 01, 2015, 07:13:51 PM »
I'm currently at 57% equity and 43% mortgage with 2 rentals. In two years, I should be around 60%-65% equity and will consider buying a 3rd property would should put me back to 50/50. I don't like being less than 50% equity, but that is just a personal choice. 

Markywalberg

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Re: Acceptable amount of debt??
« Reply #7 on: August 02, 2015, 07:28:40 PM »
I like the points everyones making my only argument would be that for this first property there is no loan we own the property 100%. I would like to wait to have more experience before gong for a 2nd property but are uncle is the one who is "teaching us the ropes" of landlording and buying and fixing/renting properties. So I have already accepted the work that is involved in this as i have been with him while going to house calls to fix problems and while he screened tenants and etc.... so im confortable with the amount of work required. Also a point I would like to make is that for a 2nd property it would cost around 120k and he would put up 60k and we would put up 60k (20k is cash saved up and 40k a loan from the bank). So as far as bank is concerned we owe 40k on a 12ok house so 2/3 equity and 1/3 mortgage and its reasonable to think that we easily pay off that mortgage in 2 years. So with that information what does everyone think sorry i didnt inlcude al lthe details in first post and might have been sloppy while posting numbers but i think this sums it up

nereo

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Re: Acceptable amount of debt??
« Reply #8 on: August 03, 2015, 06:31:25 AM »
I like the points everyones making my only argument would be that for this first property there is no loan we own the property 100%. I would like to wait to have more experience before gong for a 2nd property but are uncle is the one who is "teaching us the ropes" of landlording and buying and fixing/renting properties. So I have already accepted the work that is involved in this as i have been with him while going to house calls to fix problems and while he screened tenants and etc.... so im confortable with the amount of work required. Also a point I would like to make is that for a 2nd property it would cost around 120k and he would put up 60k and we would put up 60k (20k is cash saved up and 40k a loan from the bank). So as far as bank is concerned we owe 40k on a 12ok house so 2/3 equity and 1/3 mortgage and its reasonable to think that we easily pay off that mortgage in 2 years. So with that information what does everyone think sorry i didnt inlcude al lthe details in first post and might have been sloppy while posting numbers but i think this sums it up
It is indeed very good that your first rental property is paid off in full.
From your posts, I have two concerns:

1) this property is co-owned by you, your uncle, and your brother.  I strongly advise that you have a written contract detailing all ownership aspects.  This is to protect all three of you from the unexpected.  I'm not a lawyer but it shuold include things like what will happen if one partner leaves the partnership (e.g. one of you moves, gets injured or dies), how expenses and paid for and profits split (including large unexpected expenses like a new roof or a tenant-lawsuit) and what happens when you ultimately sell the property (which might be decades in the future).  How do you vote on issues?  What happens if one person winds up doing the majority of the repairs because the other two are unavailable?  Are you protected if one of your partners declairs bankruptcy?

2) Can you afford a large unexpected expense or a prolonged vacancy?  It's great that you will have 66% equity in the home, but that says nothing about your personal finances (and the finances of your partners).  Can your finances handle a short-term, ~$20k loss?  Can your brother and uncle?

zephyr911

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Re: Acceptable amount of debt??
« Reply #9 on: August 03, 2015, 01:41:36 PM »
40% of gross rents for debt service is quite acceptable, assuming decent cash reserves. My rental business runs at around 50%.

Markywalberg

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Re: Acceptable amount of debt??
« Reply #10 on: August 03, 2015, 03:14:45 PM »
Well yes we have a contract currently stating the ownership of this property. I dont think ill need it but we do have it. As far as a 20k loss idk how we would have that all the sudden considering the roof and driveway and siding is all covered by HOA and townhome was originally builtin 2001. also with the 120k invested that included all repairs like plumbing and water heater so i should be good for awhile but ill keep the 20k mark in mind i thinkin a year it will be resonable to think we could have the 20k down and 20k for unforseen expenses. Id say right now for this first place we got 10k-15k inreserve for unforseen expense. Also is 20k for unforseen expenses is that for both places or 20k each place?

nereo

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Re: Acceptable amount of debt??
« Reply #11 on: August 03, 2015, 04:53:16 PM »
Well yes we have a contract currently stating the ownership of this property. I dont think ill need it but we do have it.

Good to know you have a contract.  No one enters a partnership thinking it won't work out, but sometimes circumstances change.  Hopefully it is comprehensive and details how one partner might exit the arrangement as well as profit/loss sharing, etc.

Quote
Id say right now for this first place we got 10k-15k inreserve for unforseen expense. Also is 20k for unforseen expenses is that for both places or 20k each place?
$20k is a ballpark number I use - others may have higher or lower amounts.  It's based on being able to cover an expensive repair and get renters back into the unit and paying rent.  I know you think there's nothing major that could go wrong, but there's always something.  Two examples: Sub-contractor didn't glue a pipe correctly behind a wall and it bursts over the weekend when no one is home.  Floors, walls, appliances all need to be replaced pronto, before any homeowners insurance comes through (which might not even happen if there's a coverage gap).  Or; one of your partners suffers bad economic circumstances (medical, legal, divorce, etc) and needs to sell out immediately, cashing out all of his equity.  There's an almost endless list of very unlikely things that might happen  You can't predict or prevent them all, so you just have to know you can weather them financially if they happen.

From what you've said you seem like you are in a good position.  My only concern is that you might be looking at this through rose colored glasses.  Like great investors, all the successful landlords I know are fearful first - when you're prepared for the worst and have conservative projections you do very well.