Author Topic: Considering purchase of investment property from family member  (Read 1690 times)

yoyalia

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Hi All,

My husband and I are considering purchasing a single family unit from my father in law. We're a bit unsure whether the financials make sense and I'd love to gather feedback from y'all and anyone who might have similar situations.

Here are some of the details:
  • My husband's father is willing to sell the property for $600k, where it's current estimated value is $690k (redfin), but he estimates its market value more around $640k
  • We'd purchase it as an investment property as we won't be living in the area (so we'll need a property manager)
  • It is currently being rented at $2.3k, but I think we can raise that to $2.5k fairly easily
  • It would be our first mortgage and would be $480k (estimated ~$2.3k / month)
  • The location is in San Diego, three blocks from the beach
  • We live in SF (and maybe NYC shortly) so we're not entertaining the idea of buying in either city for the forseeable future. For this reason, we're thinking this might be a good opportunity to invest in real estate.  I.e. hold on to it for a couple of years and sell when we're ready to purchase a home for us to live in in a more reasonable housing market
  • Our current combined gross income is ~$270k

Happy to provide more info or context if needed. I think our biggest uncertainty is how to understand the tax implications in our basic calculations of: mortgage + property tax + property management + etc - rental income.

Additionally, we're a bit in the dark as far as financial pros/cons of buying from a family member, any insight there would be much appreciated!

Thanks!
« Last Edit: April 16, 2017, 05:50:41 PM by yoyalia »

Another Reader

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Re: Considering purchase of investment property from family member
« Reply #1 on: April 16, 2017, 06:00:24 PM »
Do you like to lose money?  Because this is an alligator of a negative cash flow property.  The only reason anyone would buy this is appreciation and the real estate up-cycle is getting very long in the tooth.

Suggest you read some of the books cited in the post pinned to the top of the thread.  In particular, the Gallinelli book Sword Guy recommends, which explains the financials of investment properties.

Another Reader

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Re: Considering purchase of investment property from family member
« Reply #2 on: April 16, 2017, 06:45:47 PM »
As an investment property, you may have to put 25 percent down.  You will also pay a higher interest rate for a non-owner occupied property.  At 20 percent down and a 5 percent interest rate, the principal and interest payment on a 30 year mortgage is $2,577.  Taxes, based on 1.1 percent of fair market value, will be $7,040.  The property may qualify for the parent to child exclusion from revaluation, which would reduce the property tax bill.  Insurance will probably be around $1,000.

You also need to allow for vacancy and collection loss, repairs and maintenance, capital improvements, and property management.  See where this is going? 

Your objective is to sell in a couple of years.  What if property values stagnate or, worse, decline? 

In your shoes, I would pass.

jinga nation

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Re: Considering purchase of investment property from family member
« Reply #3 on: April 18, 2017, 11:24:25 AM »
You're mixing family and business. You can ruin it all in one fell swoop.

bryan995

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Re: Considering purchase of investment property from family member
« Reply #4 on: April 19, 2017, 08:34:17 AM »
If it was close to breaking even cash flow wise, and then you also could take the tax deductions (this is possible, no?) then I don't see how this is a horrible horrible deal. At a high income the tax deductions are worth sig. more, no?

Yes mixing family and business can be dangereous, but this sounds like an honest effort to ease you in the RE Rental space?  I don't think the father-in-law is trying to unload a horrible property to you, correct?

I just so happen to be in SD, is the rental in PB? OB? Or further south? Currently pay 2.4k for a 1 bed 3miles from the beach (UTC area).  Housing prices and rents are on the rise ... for now!
« Last Edit: April 19, 2017, 08:46:21 AM by bryan995 »

Goldielocks

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Re: Considering purchase of investment property from family member
« Reply #5 on: April 19, 2017, 10:52:33 AM »
Walk away.  Not enough rent for your investment, (1% rule is the target, or at least higher than 0.5% if you manage yourself and are playing the capital gains game and don't need that cash right now) and not enough opportunity to immediately turn it for a profit, if you need to.

Relative is getting all the benefit, because he can take the cash and use it for a better investment elsewhere, and does not pay the hefty realtor fees. If this was a better deal for you, the relative would likely keep it themselves.

The only times this may make sense would be if you wanted to live there in a couple of years and could inherit a very low tax rate as a relative (such as some properties in California), or if it was being sold at a steeper discount that guaranteed no lose for you.

yoyalia

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Re: Considering purchase of investment property from family member
« Reply #6 on: April 19, 2017, 08:57:11 PM »
If it was close to breaking even cash flow wise, and then you also could take the tax deductions (this is possible, no?) then I don't see how this is a horrible horrible deal. At a high income the tax deductions are worth sig. more, no?

Yes mixing family and business can be dangereous, but this sounds like an honest effort to ease you in the RE Rental space?  I don't think the father-in-law is trying to unload a horrible property to you, correct?

I just so happen to be in SD, is the rental in PB? OB? Or further south? Currently pay 2.4k for a 1 bed 3miles from the beach (UTC area).  Housing prices and rents are on the rise ... for now!

It's a 2br in Ocean Beach, 3 blocks from the beach.

You bring up a point that I guess I'm confused about.  While this would be cash flow negative month to month, that is ignoring the tax implications.  Shouldn't these be part of the discussion?

yoyalia

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Re: Considering purchase of investment property from family member
« Reply #7 on: April 19, 2017, 09:02:37 PM »
As an investment property, you may have to put 25 percent down.  You will also pay a higher interest rate for a non-owner occupied property.  At 20 percent down and a 5 percent interest rate, the principal and interest payment on a 30 year mortgage is $2,577.  Taxes, based on 1.1 percent of fair market value, will be $7,040.  The property may qualify for the parent to child exclusion from revaluation, which would reduce the property tax bill.  Insurance will probably be around $1,000.

You also need to allow for vacancy and collection loss, repairs and maintenance, capital improvements, and property management.  See where this is going? 

Your objective is to sell in a couple of years.  What if property values stagnate or, worse, decline? 

In your shoes, I would pass.

Fair points and I think it's a long shot we move forward.  I am curious, however, if the tax implications and the +50k of equity off the bat should be wrapped into these calculations as well?

Another Reader

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Re: Considering purchase of investment property from family member
« Reply #8 on: April 19, 2017, 09:08:11 PM »
Depreciation is recaptured when you sell, so there really is not any tax benefit, unless you hold until the basis is stepped up through inheritance.

What's the point of your investment?  Aren't you trying to make money on the investment?   You make money through net cash flow and/or appreciation.  Implicit in your approach is that you expect appreciation over your holding period.  You want to sell in two years?  Your buying and selling costs are likely to be more than any appreciation over that time.

Another Reader

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Re: Considering purchase of investment property from family member
« Reply #9 on: April 19, 2017, 09:10:15 PM »
The $50k is your profit if everything else works out and your market continues to appreciate.  It may all go up in transaction costs if it does not.

Dicey

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Re: Considering purchase of investment property from family member
« Reply #10 on: April 20, 2017, 04:23:38 AM »
I'm a landlord and am very pro Real Estate as a wealth-building tool. Nothing from the info you've provided would compel me to do this deal from a stranger, much less family.

aj485

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Re: Considering purchase of investment property from family member
« Reply #11 on: April 20, 2017, 05:55:19 PM »
If it was close to breaking even cash flow wise, and then you also could take the tax deductions (this is possible, no?) then I don't see how this is a horrible horrible deal. At a high income the tax deductions are worth sig. more, no?

Yes mixing family and business can be dangereous, but this sounds like an honest effort to ease you in the RE Rental space?  I don't think the father-in-law is trying to unload a horrible property to you, correct?

I just so happen to be in SD, is the rental in PB? OB? Or further south? Currently pay 2.4k for a 1 bed 3miles from the beach (UTC area).  Housing prices and rents are on the rise ... for now!

It's a 2br in Ocean Beach, 3 blocks from the beach.

You bring up a point that I guess I'm confused about.  While this would be cash flow negative month to month, that is ignoring the tax implications.  Shouldn't these be part of the discussion?

@yoyalia - With an AGI of $270k, you won't get to claim any losses, unless you have other passive income to offset.  The AGI for deducting passive losses (rental real estate is considered passive unless you are a real estate professional) starts to phase out at $100k and tops out at $150k.  See IRS Pub 527 https://www.irs.gov/pub/irs-pdf/p527.pdf