Author Topic: Good Predicament? Seeking guidance - paying down mortgage vs long term rental  (Read 517 times)

wlangshaw

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Hello All,

First time poster - Long time lurker.

I have an interesting decision to make. This decision has long term financial repercussions that my brain is too small to figure out.

Situation: I just bought a $1.1m house with a large separate 2 and 1 granny unit. Essentially two houses on one large property. My mortgage balance is roughly $465k. My monthly PITI is about $3750/month. The rental income brings in $1800/month.

I have two options.

Option 1. Live in the main house, and continue to rent the granny. Over time and as I fix it up it will continue to rise in rental value.  I can see with considerable upgrades it renting for $2,500 within 5 years, and continue to go up in the years beyond. Everything I have is basically in this house and with my retirement situation I will heavily depend on this being a money maker that gives me max payback. 

Pros and cons for option 1. Pros: Rental value goes up, my monthly cost goes down. Over time my rental will do more and more work in paying off my mortgage, and my monthly out of pocket will go down. Cons. I will have to take care of the granny unit and be a landlord.


Option 2. More complicated. My parents have decided they want to move to california and live near me. They are retired and can not afford the rent of granny now. Their current house is paid off and they are considering selling it and using the cash to pay down my mortgage considerably (possible pay down $300k) until the new monthly PITI matches my current out of pocket after my rental income.

Pros and cons for option 2. Pros: Parents pay down mortgage, less interest expense over life of the loan. $185k saved in interest, by my rough math. Parents make improvements and maintain the property. Free childcare.  Cons: I can never charge them rent as long as they live there, thus my out of pocket will be the same for 30 years. Until the loan is paid off or they move into a home or something. Other con is I will be responsible for their home situation. Essentially, if they sell their house and put their money into my house then they put themsleves in a vulnerable situation.  For example if I get a divorce. Or realize I need to sell.  They would not have enough cash to buy another house in the area.

Overall, I am not sure what is best for all of us. The primary goal is for them to be able to move to the most expensive state in the world. But I want this property to work for me and become increasingly more affordable for to live in and eventual make money for me.   All thoughts are welcomed. Thanks
« Last Edit: August 26, 2019, 10:56:36 PM by wlangshaw »

ecchastang

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I personally would not want the responsibility of option 2 unless it was the only option.

Jon Bon

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I need more info.

So you put down 700k?! Why? is my first question.

Option 2 sounds uber complicated and generally a bad idea. Sounds like trouble with uncle sam and any other potential heirs? Why not have them sell their house, and just pay your mortgage out of the proceeds. That makes so much more sense. You are right that this would put you in an unwinnable situation if anything bad happened.

Option 3: Split the lots and sell them the granny?

Lastly what is your goal? Why did you buy such an expensive house, and why did you put so much down? whats your financial picture look like?

Renting this place for you sounds like its more trouble than its worth. If you can afford a 1.1 million dollar house why are you messing around with a few thousand in rental income per year? What are each of the houses roughly worth separately?




wlangshaw

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I took the cash of the last house I flipped and put a significant amount of it as a downpayment into the new property. I put so much down so I could keep my monthly PITI + rental income comparable to my last situation. $1900/month is what I am comfortable paying, and the big downpayment helped me get to that number.

I would be the sole heir to whatever they leave behind. Part of the logic is to give me their money now and let them live with me.

Splitting the lot is not an option with my zoning. Although these houses feel very separate on a 2.5 acre lot. They need to remain singularly owned.

My financial picture is not on the course of a traditional mustachian. We have a family income of about 150k/annually, and just over 125k in savings. Some in 401k most in cash which I am planning to use to fix up this property. My ultimate goal is to pay off this property someday, potentially build another very small rental on it. When I am older, supplement my modest retirement off the rental income. Or move into the smaller house and rent the main house out as a vacation home or rental. The house has sweeping views in a desirable North SF Bay wine country.  The other longer term option is to sell the whole property in 20 years and retire in another state.

I bought such an expensive house because I flipped my last house and did better than expected. I found a property which a ton of potential, and essentially two houses.  So I put most of the cash/profit from my last sale into it, I would be able to afford it and still pay what I was used to paying on the last house.

The rental house rents for more than a few thousand per year. It rents for $1800/month.   Separately these houses would likely be worth a combined $1.6m. But the lot can not be divided. 

Look, I understand the numbers here are wild for most of the world's sensibilities. The economy and real estate is just different in California. But this is where i live, work and have family. So I have to aspire to stash the best I can while living in this reality.

Thanks for helping me think through this.



ecchastang

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The opportunity cost of putting 700k down to keep the PITI low enough is HUGE!

Jon Bon

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Oh I am not jumping on you for buying a 7 figure house. I get its not cheap. Just is very unconventional and im trying to get to the WHY. My point is on this that after expenses the rental does pretty poorly if it stands on its own.

So the main house say is 800k? Rental is 300k? Lets just go with 70/30 for simplicity shall we?

                    Price     Equity     PIIT          Rent     Rental Expenses   Rental Income   Rental Return
Main House   7700000   490000   31500            
Rental House   3300000   210000   13500   21600     2400                     5700               0.03
Total             11000000  700000   45000   21600

Now these numbers are back of the napkin, and sorry if they are jumbled I done feel like there is a good way to put excel sheets in this thing. Also let me know if I got any of your facts wrong. We can change the numbers some, but I guess my point is the rental return on the equity you put down is not very good.

Perhaps all this is not important, but I think getting that rent up ASAP is the right way to go. Just my .02 Just a lot of eggs to have in one basket. You have a good salary and other assets you should be fine, but I dont think you should depend on this property to fund your retirement or anything. Get the rents up and get it out there at market rent. If your parents want to take you up at 1800 or 2500 that is up to them. But I wont not mess with them paying into your mortgage. They will probably need that money at some point.           

wlangshaw

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Thanks for breaking it down. Where did you come up with $2400, 5700, and .03?

Jon Bon

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Thanks for breaking it down. Where did you come up with $2400, 5700, and .03?

Sure can.

So assuming the 70/30 split I split your into PIIT buckets of  2625/1125. I picked out $200 a month for rental expense, repairs, vacancy, etc.  So in an average month you are going to have (Rent-PIIT-Expense=profit) 1800-1125-200 = 475 OR yearly numbers 21,600-13,500-2,400=5,700.

I then took your yearly profit and took it over your cash you have put into the rental house. So the yearly return is: 5,700/210,000=.03

So my point is earning so little on your investment is not ideal especially since your investment comes with risk and other work not induced in this calculation. This all might be a moot point, maybe you love the house and the granny suite is just a bonus. This is just one way to look at it.