Author Topic: Buy small now and rent later, or buy big and rent half?  (Read 1649 times)

jdaws

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Buy small now and rent later, or buy big and rent half?
« on: May 29, 2016, 07:38:16 AM »
Hey everyone. I've been a reader of the site for a little over a year now, but new to the forum. I've been weighing pros and cons of the situation my wife and I are in right now, and I'm interested to see what other insights and considerations the community has that we overlooked.

I'll be 33 this year and my wife will be 30. Our baby boy is 6 weeks old and we are planning to have 1 or 2 more kids over the next few years. Between my job and her maternity leave EI benefits, our net monthly income is a few bucks over $5,100. While she hopes to get a job next spring when her benefits run out so that she can work a year before we plan for our next child, it's no guarantee. She has the ability to work contract jobs for her old company though which allows for stay at home part time work and possibly saving us on many child care expenses too. Based on the contract work she's done for them earlier this year while on leave, and my job at a bank, it's reasonable for us to expect the same amount of net income.

Now to the fun stuff. We both have TFSAs and RRSPs, and have automatic saving setup for an emergency fund and investing. We are not concerned about investing for our financial independence. We've set it up to always pay ourselves first, and now have included automatic RESP saving for our boy.

But what's the problem here? Well we've typically been renters, but now want to build real assets and buy a home. We hope to buy around October or November-ish and really we have two options.

Option 1 is to buy one of many 2 bedroom, 2 bathroom condos in the city within a few minutes walk of downtown for about $250,000-$300,000. Many condos are listed for less but would need some repairs, so our total dollar figure includes cosmetic improvements. The plan would be to live there for a few years on a 10 year mortgage with our tiny humans with tiny mustaches before buying another primary residence for the family, and keeping the condo, close to if not already mortgage-free, as a rental to generate cash flow.

Option 2 is to buy a house with an income suite in the basement or side for about $550,000-$600,000. This doesn't allow us to do much in terms of immediate repairs or improvements, but enough to make the income suite nice enough to attract quality renters. The plan here is that we get a huge (by our own definition) house with 3-4 bedrooms for our growing family AND have a renter in the suite helping pay off this 20-ish year mortgage. The suite at one such home we are looking at is apparently being rented for $1,300/month which is reasonable and right in line with current market rates for the area.

So I figure why not reach out to the network and see if anyone was in a similar position and what ideas others have. Option 1 lets us ease into things with less debt, but we would still need to buy another property eventually one day to use the condo as income. Option 2 gets us to the end game immediately in terms of having a large house forever for us to live in as log as we want, all the while having income helping pay the longer mortgage and eventually providing cash flow.

We can't tell if this is a win-win situation where there really are no wrong answers and just personal preference, but honestly, the debt and longer mortgage of option 2 scares me.

Any ideas?

nereo

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Re: Buy small now and rent later, or buy big and rent half?
« Reply #1 on: May 29, 2016, 08:35:39 AM »
Welcome jdaws

To be frank, I don't like either of the two options you presented
Option 1: (2 bd/2ba @ ~$300k) strikes me as a bad move since you plan on being there only "for a few years".  Given your $62k/yr salary this will eat up a substantial portion of your monthly take home pay - roughly $2700/mo).  Transaction fees will likely kill any profit to be made holding a home for such a short amount of time, and the oppotunity cost of devoting that much cash to your primary residence is huge.

Option 2: For starters, I don't see how you can afford to pay for something costing $600k on your income.  I understand you hope to make money by having renters, but taking into consideration vacancies, repairs, etc. how much do you expect from rental income over an annual basis? Would you take out a loan for $500k+, and do you have 20% ($110k+) on hand to avoid PMI?  Your mortgage payment would likely exceed 60% of your take-home pay ($3k-3.5k/mo assuming a 25yr note with a 3.25% rate).  What will you do when your term resets, how much 'wiggle' room do you have?

I'm also concerned when you make statements like we "went to build real assets"... bonds, index funds, REITs are all very much 'real' assets. Why the urge to put a substantial portion of your net worth into your home?
Run this calculator.  What does it say is the tipping point in your area between buying and renting?

ender

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Re: Buy small now and rent later, or buy big and rent half?
« Reply #2 on: May 29, 2016, 08:52:53 AM »
Welcome jdaws

To be frank, I don't like either of the two options you presented
Option 1: (2 bd/2ba @ ~$300k) strikes me as a bad move since you plan on being there only "for a few years".  Given your $62k/yr salary this will eat up a substantial portion of your monthly take home pay - roughly $2700/mo).  Transaction fees will likely kill any profit to be made holding a home for such a short amount of time, and the oppotunity cost of devoting that much cash to your primary residence is huge.

Option 2: For starters, I don't see how you can afford to pay for something costing $600k on your income.  I understand you hope to make money by having renters, but taking into consideration vacancies, repairs, etc. how much do you expect from rental income over an annual basis? Would you take out a loan for $500k+, and do you have 20% ($110k+) on hand to avoid PMI?  Your mortgage payment would likely exceed 60% of your take-home pay ($3k-3.5k/mo assuming a 25yr note with a 3.25% rate).  What will you do when your term resets, how much 'wiggle' room do you have?

I'm also concerned when you make statements like we "went to build real assets"... bonds, index funds, REITs are all very much 'real' assets. Why the urge to put a substantial portion of your net worth into your home?
Run this calculator.  What does it say is the tipping point in your area between buying and renting?

It's even worse than that too, because the current income includes the wife's EI benefits which might disappear.

I'm curious to see more about the actual financials of this. Do you have a ton of cash right now? I'm also not sure how this makes any sense at all financially (either option). It seems you must have some numbers somewhere that are not present.

Even if your $5100 is net of taxes (so a salary more like 70k or 80k) a house that is 250k+ is going to be very tight, especially if you have no downpayment. A 550k place is straight up CRAZY for that income though.

SwordGuy

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Re: Buy small now and rent later, or buy big and rent half?
« Reply #3 on: May 29, 2016, 11:20:14 AM »
Agreed with the other commenters!

No way should you be considering a 500k+ house on your income.  Period.   If you have trouble finding a renter you'll be really hurting.

There are 4 ways to make money on rental property.   Condos appreciate much worse than regular single family homes, so that's 1 out of 4 that likely won't happen.   HOA fees on a condo and paying full retail price for the condo mean that it won't cash flow as well as a better rental property.
That's 2 down.   You don't have the income to benefit from depreciation without good cash flow.  That's 3.
Find a cheap rental to live in if that's possible and wait until you find a really inexpensive fixer-upper that you can mostly fix up using sweat equity.

I would go the stock route.

Or find a different market to buy rental property in.   Unless, of course, rental prices at 2% of your purchase price are commonplace, in which case, it might be a great deal.

Do you actually know how to run the rental property numbers?

leherself

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Re: Buy small now and rent later, or buy big and rent half?
« Reply #4 on: June 02, 2016, 02:38:04 PM »
I'd pick option 3.  I'd buy a larger home in your smaller price range.  It's what I did (I bought a "3 bedroom, 1 bath, 1100 square foot" single family home that was in the bottom 10% of the market for my city.  Trick was, it also had an 1100 square foot unfinished full height basement.  I rented out the recently remodeled finished portion on airbnb while renovating the basement with the cash I was bringing in, and now I own a 5 bedroom, 2 bath house, with a mother-in-law basement suite.  And now that the remodel is done, the rental income will pay for the mortgage, utilities, and maintenance instead.  The year of awkwardness living in a construction zone was a small price to pay - especially considering the godawful apartment I used to live in).

You may have to make some compromises - buy in an older neighborhood, put in sweat equity, etc.  You may also have to wait a while before you buy, looking for the right bargain.  Also look for market circumstances that are in flux - for instance, the value of my neighborhood is currently depressed quite a bit because of the proximity of an absolute cesspool of a mobile home park.  However, because there's a land crunch in my city, mobile home parks are being bought up all over the place and being replaced with new developments - I'd honestly be shocked if it was still there in five years (it helps that the city put a moratorium on new mobile homes - existing parks are not able to replace old or demolished homes with new ones, so as units age out, more and more of the existing parks are simply left empty.  The neighboring park already has something like 25% of its spaces vacant).

I definitely agree with other posters that a $500k mortgage is completely unrealistic on your current income.  But I think you're selling yourself short if you go with a small condo.  Do some more research, and get creative.  Make sure you're genuinely considering all of your options.

hucktard

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Re: Buy small now and rent later, or buy big and rent half?
« Reply #5 on: June 03, 2016, 09:53:55 AM »
How would you get approved for a $500K mortgage with your income? Could you buy a cheaper single family home and rent out a room or something. House hacking is an amazing strategy for building wealth, but just buy something that you can afford to pay the mortgage on with or without renters helping you.