Author Topic: Should we buy this rental?  (Read 2749 times)

Lalo2

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Should we buy this rental?
« on: May 14, 2014, 11:15:55 AM »
My husband and I purchased a duplex with another couple in 2003 in Oakland CA. After living in it a couple of years we both move on but have kept it as a rental. Fast forward 10 years and they are ready to get out. I am tempted to dig up enough money to buy out their share, and keep it as a long term investment. It would be great to have the property fully paid off when I am 60 and live on the income. But would love some feedback about the choice.

Pros:
We've rented for about 5 years now. We are basically breaking even and getting some tax write-offs.
We have had good luck keeping the place rented to young professionals. Rents are climbing steadily.
We aren't investment savvy so can't think of a similarly solid investment for the cash we'd get by selling now (we'd probably walk away with $80K post taxes if we sold now). We'd probably just use the money to pay off a short term loan.
This is a hot real estate and rental market (Oakland CA), so long term prospects are good for appreciation and rental income.

Cons:
The house is 100 years old and in earthquake country.
We self-manage but live far away and have to pay for major and minor repairs.

Financing options I've looked into several ways to finance a buy out of our partners.

*20 year loan on property and 10 year 2nd loan on our primary home. This would optimize interest rates (keeping the rental loan at $417K) but require us to liquidate our short-term savings ($40K) and take out a second loan on our primary home. We'd have the rental paid off when we turn 60.

*30 year loan on rental property - We'd pay a slightly higher mortgage interest rate if we exceeded $417K cutpoint. We could probably pay a bit extra to the principle on years we don't have major repairs, and as rents increase. My husband would be less stressed if we didn't assume a loan on our primary house, and kept our rainy day fund intact. It seems like there are probably tax benefits to keeping the rental debt associated with the rental itself.

Option 3 - Cashing out and finding some other investment for part of the money.

Fishingmn

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Re: Should we buy this rental?
« Reply #1 on: May 14, 2014, 11:57:33 AM »
You say that you are just breaking even right now but don't give projected numbers of cash flows after buying out partner and adding in extra debt payment.

I think many real estate investors will tell you to invest for the current return, not for appreciation or tax purposes. Therefore, with no current cash return it already sounds like a deal I wouldn't want.

I always look at the current return potential as compared with the alternatives. In other words, does the cash flow return on the rental property look better than the return on alternatives like stocks, bonds or other investment options? While it's really hard to get a guaranteed return in other areas you should use long-term return outlooks for those alternatives.

Lalo2

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Re: Should we buy this rental?
« Reply #2 on: May 14, 2014, 12:15:45 PM »
Thanks for your response! We are talking about a property that would appraise for about $600-650K, brings in $4000 monthly rent, and are 20 years from paying off the loan. We've been able to increase rents by 42% since 2007, or 6% per year.

We could probably continue to break even if we refi'd with a 30 year loan but would extend the payoff period by another 10 years. If we tried a more aggressive loan structure to keep on the 20 year timeframe we'd take out about $66K loan on our primary home or use a combination of savings and HELOC to pay off our partners. 

In general we could handle a negative cashflow of $600-1000/month for the next 5-10 years. We've been setting aside this much money for savings, so I think about it as redirecting our savings into a rental property with significant benefits in our golden years. A local realtor friend told me there isn't a similarly profitable rental scenario in my local market.

I've never made more than 7% in the stock market and was figuring that it would be great to keep a portion of our retirement savings invested elsewhere. (I not an expert here by any stretch).

Another Reader

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Re: Should we buy this rental?
« Reply #3 on: May 14, 2014, 12:25:53 PM »
Since you have owned since 2003, you have already seen the value drop and recover once.  Rents have climbed because of where we are in the jobs/real estate cycle and the rate of increase is not sustainable indefinitely.  Oakland is the last of the inner ring suburbs to rise in value, and the first to go down.  I have seen periods of high vacancy and declining rents in Oakland over the years.  Oakland rules and regulations are not landlord friendly.  Your cash flow with the proposed financing (buying the other half out at current market value) will likely be negative over time if you are breaking even now.

In your shoes, I would consider doing a 1031 exchange into better performing property elsewhere.  Just because your realtor friend told you there is not a similarly profitable scenario in your local market does not mean there isn't a much more profitable scenario elsewhere.

Fishingmn

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Re: Should we buy this rental?
« Reply #4 on: May 14, 2014, 01:05:22 PM »
I agree that it's good to diversify but you should also consider that another alternative is to cash out of the negative cash flow spot that you are managing remotely and into a positive cash flow property in another market that would be a much better investment.

Negative cash flow may have worked in the 1980's when you could write off unlimited losses against your high income but these days you can't do that unless you are a full-time real estate professional so the standard thinking is that cash flow is what drives good investments in real estate.

GrayGhost

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Re: Should we buy this rental?
« Reply #5 on: May 14, 2014, 03:02:52 PM »
I agree, cashflow is king. Also, if you have never see 7% returns on the stock market, I think you're doing something very wrong. Last year the stock market jumped by about 30%, so unless you've tried (and failed) to pick stocks, you would definitely enjoy a strong year.

AccidentalMiser

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Re: Should we buy this rental?
« Reply #6 on: May 14, 2014, 07:19:26 PM »
In general we could handle a negative cashflow of $600-1000/month for the next 5-10 years.

This is the most important sentence you wrote. 

If you're projecting that you will lose money month after month, SELL!! (or find a 1031 exchange as Another Reader suggested.)

Good luck!
« Last Edit: May 15, 2014, 01:38:40 PM by Accidental Miser »

Lalo2

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Re: Should we buy this rental?
« Reply #7 on: May 14, 2014, 07:59:11 PM »
I am getting very consistent advice here, thanks! I guess it is hard to fight the lure of another $600 k asset in my 60s. I'll investigate other options.

And yes, i did get good returns on mutual funds last year, but in general dont have the time, the skill or the optimism to get too heavy into playing the market.

GrayGhost

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Re: Should we buy this rental?
« Reply #8 on: May 14, 2014, 10:24:12 PM »
And yes, i did get good returns on mutual funds last year, but in general dont have the time, the skill or the optimism to get too heavy into playing the market.

Don't! You'll probably lose in the long run. MMM has written a few brief articles about the futility of trying to beat the market. If you divide up your assets in the manner he suggests (which is entirely reasonable) or something similar to it, you'll do well enough in the long run. At your age, you probably don't want to try to beat the market at all.