Author Topic: Help? - buy or not buy?  (Read 4897 times)

Dillydally

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Help? - buy or not buy?
« on: April 10, 2016, 12:25:29 PM »
I have a property purchasing question that I have not been able to resolve. I could keep the description short and stick to just the numbers, but there are some non math factors that are part of the value. I will try to keep this as succinct as possible.

1. I currently run my business from my home. Live/work space. I own my place. Expenses are low. If i move away or retire, rentable for $3,000ish a month. Any future rental not possible if business is located at current location.

2. A second property one block away has become available. Purchase price would be about $425,000, rent could be about $3,000ish. This could be a rental (especially to one of my most important employees, which would in turn make it much more likely that I could retain this employee indefinitely  and eventually sell the company off to him as I transition to retirement). I could also potentially use it as a business location to run my business from, or both rent it to my employee and have him run the business from the second property...

Although I am in a very expensive area of the country and the price is probably about fair market value and on the rise, $425,000 purchase seems like a premium price, considering the rental amount it would get (the other forums suggest the 1% rental-purchase rule).
The value of keeping the employee is immeasurable, as he would be a fantastic person to transition into partnership and allow me to:
Years 1-4 not work as much (several months off per year),
Years 4-8 then not much (check in on things, semi - retire?),
Years 8-12 and eventually, not at all (hands off, passive business  income)...

Any ideas about balancing cost / value / risk, or even completely new suggestions about how to sell a company vs bring in a partner are welcome.
« Last Edit: April 12, 2016, 10:43:35 AM by Dillydally »

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Re: Help? - buy or not buy?
« Reply #1 on: April 13, 2016, 01:34:53 PM »
I dont see how you can make any profit from a 425k house and a 3k rent.  You would be negative cash flow.

I would not do this.  The 1% theory is really just a market that indicates it may be a good rental property after running numbers.  So you have have to buy that house for 300k and rent it for 3k, then it might be a decent deal.

PadAdventure

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Re: Help? - buy or not buy?
« Reply #2 on: April 13, 2016, 01:55:31 PM »
I dont see how you can make any profit from a 425k house and a 3k rent.  You would be negative cash flow.

I would not do this.  The 1% theory is really just a market that indicates it may be a good rental property after running numbers.  So you have have to buy that house for 300k and rent it for 3k, then it might be a decent deal.

I have to agree, I can't see making that work. 

Dillydally

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Re: Help? - buy or not buy?
« Reply #3 on: April 13, 2016, 02:08:27 PM »
The purchase doesn't need to be profitable, just not too costly. Keep in mind that the property allows for me to expand into an off site work facility if needed in the future, as well as secure a long term employee that would perpetuate a profit making business .

onlykelsey

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Re: Help? - buy or not buy?
« Reply #4 on: April 13, 2016, 02:11:57 PM »
I think you may be overlooking tax and regulatory issues.  If you're giving him below-market rent to keep him, that's reportable, no?  Insurance and zoning also gets dicey if you want to change the use of a property, as well.  If you think it's independently a good investment (clearly it's cash flow negative so you'd have to think it will skyrocket in value), then fine.  Otherwise I see nothing going for it.

Dillydally

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Re: Help? - buy or not buy?
« Reply #5 on: April 13, 2016, 02:17:52 PM »
The zoning does allow for business use so there would not be a conflict with zoning law. A landlord can charge any amount of rent he sees fit. I would probably charge a fair market rate for the space, it just wouldn't be high enough to meet with the 1% rental rule of property purchase. The value is likely to continue to appreciate but as we all know, real estate is speculative because no one knows for sure... my business however would definitely generate more income than the option of closing down the business after a certain number of years when I decide to retire.

onlykelsey

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Re: Help? - buy or not buy?
« Reply #6 on: April 13, 2016, 02:24:48 PM »
The zoning does allow for business use so there would not be a conflict with zoning law. A landlord can charge any amount of rent he sees fit. I would probably charge a fair market rate for the space, it just wouldn't be high enough to meet with the 1% rental rule of property purchase. The value is likely to continue to appreciate but as we all know, real estate is speculative because no one knows for sure... my business however would definitely generate more income than the option of closing down the business after a certain number of years when I decide to retire.

I ran really quick numbers on this, and it looks if you brought in rent of 3000, paid 5000 in property taxes, and had expenses/sinking fund of another 3000 a year (assuming it needs no work now), you'd be short more than a grand in cash flow.  Maybe I'm missing something.  If you want to retain him, can't you just pay him more? Maybe you have a unique relationship, but there is no way I'd accept housing from my employer unless I was being relocated abroad or something. Has he brought up housing as a concern?

Also, a landlord can ask whatever rent they see fit, but you are subject to local landlord tenant laws, which are worth looking in to.  HCOL areas often have pretty extensive regs (NYC, California, Chicago), so I'd look in to how those would affect you, if at all. 

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Re: Help? - buy or not buy?
« Reply #7 on: April 13, 2016, 03:57:20 PM »
The thing which I would value as sole proprietor of a business is a reliable worker who can run the business while I take long holidays - one of the big problems with running a business is the need to always be "on", and if you've got that sorted you've got a valuable asset.  Also, having someone to sell the business to rather than just closing it or having to spend time and energy trying to find a buyer is a benefit.  I'm not sure however how buying this other property fits into your employee's wishes: you would need to be pretty sure that you and he are on the same page before buying.

If the property is a live-work space and you are using the work space for the business and renting out the live space to your employee that does change the financials: the $3k rent only relates to the "live" part of the investment which will make it more financially viable.  And in any case, I don't think you are looking at needing the same level of return as with an arms-length rental: provided you and your employee are sure about where this arrangement is going, you are not looking at potential voids, for instance.

FrugalFan

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Re: Help? - buy or not buy?
« Reply #8 on: April 13, 2016, 06:16:48 PM »
We need to know more about the costs of the property. Would you be getting a mortgage? How much would that be? And property taxes? Utilities? Insurance? Maintenance? Would you need snow removal or lawn care? If all these expenses are less than you would be making in rent, and you only have a bit of money tied down in the down payment, it might not be a terrible idea for the reasons you propose. It might not be a super-profitable rental but it doesn't sound like that's what you are after.

I'm not sure how this would help you keep this valuable employee though. Is it because housing is hard to find in your area?

brightblade81

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Re: Help? - buy or not buy?
« Reply #9 on: April 14, 2016, 05:13:41 PM »
I hope you and your employee have great communication, otherwise are you sure they employee would even be interested in living there?

One idea that comes to mind is present your employee a offer to help provide a down payment if they purchase this house in return for a contract stating if they leave the company within 5 years they have to return the down payment or the company could help subsidize the mortgage's monthly payment.  Then you've effectively got the house, secured the employee and given them a financial incentive to stick around...seems less risky for the company while also helping reduce the risk for the employee.


Dillydally

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Re: Help? - buy or not buy?
« Reply #10 on: April 14, 2016, 10:13:33 PM »
Im not seeing why its such a huge drain, Maybe you could all help out with the math?

Purchase $425,000 - about $80,000 down
$345,000 @ 25 year fixed at 4.5%
Property tax 1.44%
Insurance about $100 month
Utilities are payed by renter
Rent approx  $3,000






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Dillydally

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Re: Help? - buy or not buy?
« Reply #11 on: April 14, 2016, 10:23:38 PM »
We need to know more about the costs of the property. Would you be getting a mortgage? How much would that be? And property taxes? Utilities? Insurance? Maintenance? Would you need snow removal or lawn care? If all these expenses are less than you would be making in rent, and you only have a bit of money tied down in the down payment, it might not be a terrible idea for the reasons you propose. It might not be a super-profitable rental but it doesn't sound like that's what you are after.

I'm not sure how this would help you keep this valuable employee though. Is it because housing is hard to find in your area?
Yes, pure profit from rental is not the motive. As long as it is not too expensive for me to own the building, it would provide a space that would otherwise be unattainable for the employee. Cost of living here is quite high, so it helps offset his living situation. Maintenance is likely to be quite low. Long term, it could become the primary business space, which would allow me to rent/sell my primary residence in the future...
The business could potentially be more valuable to sell, if it had a building to go with it...
The business needs to have some physical location, either in my primary residence, or in the new building. I either need to run the business from a $600,000 building (my place, while I'm working) or a $425,000 building (the new building, when I am retiredish).


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adamcollin

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Re: Help? - buy or not buy?
« Reply #12 on: April 15, 2016, 04:06:23 AM »
I donít think it is profitable to buy a house. Renting may be a good option.

Frs1661

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Re: Help? - buy or not buy?
« Reply #13 on: April 15, 2016, 05:24:32 AM »
OP, I will try to help on the math. From the information you provide, PITI is about $2530 per month. This leaves you with $470 per month to pay:
-General maintenance & repairs (clogged drains, broken appliances, yard upkeep, snow & leaf removal, gutter repair and cleaning, etc...)
-Saving for capital expenditures (roof replacement, HVAC replacement, etc...)
-Management costs (even if you self manage you should separate the money you make managing the property and the money you earn on your investment, so you can compare directly with other investments)
-Vacancy costs (what if your employee quits or has a family emergency and can't stay in the area? What will it cost to replace him and how long will it take?)

Even though you won't see these expenses every month, they are a part of your average cash flow and must be considered. One simple estimate of these costs is to roll then together into the "50% rule" which assumes 50% of your gross rent will be consumed by expenses not including your mortgage P&I. This leaves you with an average of  $1500 per month to pay the P&I of your mortgage ($1920). Are you prepared to subsidize this employees housing with an average of $420 per month of negative cash flow?

 This may be too conservative, or not conservative enough depending on the property. Still through, this is why you are getting lukewarm/negative comments in the viability of this investment.

Even in a world where you have ZERO expenses above PITI (a complete fantasy), you're only making a 7% return on your 80k investment. Why not just invest in the stock market for similar returns with much less work? Perhaps the new location for your business makes the negative cash flow 'worth it' but from the info you've presented it seems unlikely.


 Edit:typos

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« Last Edit: April 15, 2016, 05:27:18 AM by Frs1661 »

Frs1661

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Re: Help? - buy or not buy?
« Reply #14 on: April 15, 2016, 05:33:05 AM »


We need to know more about the costs of the property. Would you be getting a mortgage? How much would that be? And property taxes? Utilities? Insurance? Maintenance? Would you need snow removal or lawn care? If all these expenses are less than you would be making in rent, and you only have a bit of money tied down in the down payment, it might not be a terrible idea for the reasons you propose. It might not be a super-profitable rental but it doesn't sound like that's what you are after.

I'm not sure how this would help you keep this valuable employee though. Is it because housing is hard to find in your area?
Yes, pure profit from rental is not the motive. As long as it is not too expensive for me to own the building, it would provide a space that would otherwise be unattainable for the employee. Cost of living here is quite high, so it helps offset his living situation. Maintenance is likely to be quite low. Long term, it could become the primary business space, which would allow me to rent/sell my primary residence in the future...
The business could potentially be more valuable to sell, if it had a building to go with it...
The business needs to have some physical location, either in my primary residence, or in the new building. I either need to run the business from a $600,000 building (my place, while I'm working) or a $425,000 building (the new building, when I am retiredish).


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On the one hand, you say you are charging market rent, and on the other say renting in this area would be unattainable for the employee unless you offest his living situation. This seems to be a contradiction to me.

Also, I'm not sure why a negative cash flow rental would make a business more valuable when/if you sell.

Perhaps there is something special about your business you have not disclosed but with the info we have  it seems like a bad idea to me all around.

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ender

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Re: Help? - buy or not buy?
« Reply #15 on: April 15, 2016, 06:16:21 AM »
Im not seeing why its such a huge drain, Maybe you could all help out with the math?

Purchase $425,000 - about $80,000 down
$345,000 @ 25 year fixed at 4.5%
Property tax 1.44%
Insurance about $100 month
Utilities are payed by renter
Rent approx  $3,000






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You should post how much it's actually going to cost you instead of just what you'll get for rent.

Dillydally

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Re: Help? - buy or not buy?
« Reply #16 on: April 15, 2016, 09:50:39 PM »
OP, I will try to help on the math. From the information you provide, PITI is about $2530 per month. This leaves you with $470 per month to pay:
-General maintenance & repairs (clogged drains, broken appliances, yard upkeep, snow & leaf removal, gutter repair and cleaning, etc...)
-Saving for capital expenditures (roof replacement, HVAC replacement, etc...)
-Management costs (even if you self manage you should separate the money you make managing the property and the money you earn on your investment, so you can compare directly with other investments)
-Vacancy costs (what if your employee quits or has a family emergency and can't stay in the area? What will it cost to replace him and how long will it take?)

Even though you won't see these expenses every month, they are a part of your average cash flow and must be considered. One simple estimate of these costs is to roll then together into the "50% rule" which assumes 50% of your gross rent will be consumed by expenses not including your mortgage P&I. This leaves you with an average of  $1500 per month to pay the P&I of your mortgage ($1920). Are you prepared to subsidize this employees housing with an average of $420 per month of negative cash flow?

 This may be too conservative, or not conservative enough depending on the property. Still through, this is why you are getting lukewarm/negative comments in the viability of this investment.

Even in a world where you have ZERO expenses above PITI (a complete fantasy), you're only making a 7% return on your 80k investment. Why not just invest in the stock market for similar returns with much less work? Perhaps the new location for your business makes the negative cash flow 'worth it' but from the info you've presented it seems unlikely.


 Edit:typos

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This is super helpful. I understand you are making estimates, but it gives me a rough idea of how to go about evaluating the different scenarious. I don't have exact numbers to use either, which is why my description is a little vague. The part of the equation that complicates the scenario is the relationship between the property being used as a rental vs a business space , so I can try to explain that a little better.
As a rental space, it might not generate the income recommended for good rental investments. I might rent it out for 5 years. After five years, I might need to move my business into it, at which point the business would pay the rent. If I continue to own the business, then no problem, it eats up a small amount of the business profits. If I sell the business, I then collect rent from the business. If the business moves elsewhere, I can rent or sell the building. I don't have an exact plan, but the building provides options for me.

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Dillydally

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Re: Help? - buy or not buy?
« Reply #17 on: April 17, 2016, 11:54:39 AM »
The zoning does allow for business use so there would not be a conflict with zoning law. A landlord can charge any amount of rent he sees fit. I would probably charge a fair market rate for the space, it just wouldn't be high enough to meet with the 1% rental rule of property purchase. The value is likely to continue to appreciate but as we all know, real estate is speculative because no one knows for sure... my business however would definitely generate more income than the option of closing down the business after a certain number of years when I decide to retire.

I ran really quick numbers on this, and it looks if you brought in rent of 3000, paid 5000 in property taxes, and had expenses/sinking fund of another 3000 a year (assuming it needs no work now), you'd be short more than a grand in cash flow.  Maybe I'm missing something.  If you want to retain him, can't you just pay him more? Maybe you have a unique relationship, but there is no way I'd accept housing from my employer unless I was being relocated abroad or something. Has he brought up housing as a concern?

Also, a landlord can ask whatever rent they see fit, but you are subject to local landlord tenant laws, which are worth looking in to.  HCOL areas often have pretty extensive regs (NYC, California, Chicago), so I'd look in to how those would affect you, if at all.
Is your calculation of $1,000 negative cash flow per month or per year?

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FrugalFan

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Re: Help? - buy or not buy?
« Reply #18 on: April 17, 2016, 12:46:03 PM »
OP, I will try to help on the math. From the information you provide, PITI is about $2530 per month. This leaves you with $470 per month to pay:
-General maintenance & repairs (clogged drains, broken appliances, yard upkeep, snow & leaf removal, gutter repair and cleaning, etc...)
-Saving for capital expenditures (roof replacement, HVAC replacement, etc...)
-Management costs (even if you self manage you should separate the money you make managing the property and the money you earn on your investment, so you can compare directly with other investments)
-Vacancy costs (what if your employee quits or has a family emergency and can't stay in the area? What will it cost to replace him and how long will it take?)

Even though you won't see these expenses every month, they are a part of your average cash flow and must be considered. One simple estimate of these costs is to roll then together into the "50% rule" which assumes 50% of your gross rent will be consumed by expenses not including your mortgage P&I. This leaves you with an average of  $1500 per month to pay the P&I of your mortgage ($1920). Are you prepared to subsidize this employees housing with an average of $420 per month of negative cash flow?

 This may be too conservative, or not conservative enough depending on the property. Still through, this is why you are getting lukewarm/negative comments in the viability of this investment.

Even in a world where you have ZERO expenses above PITI (a complete fantasy), you're only making a 7% return on your 80k investment. Why not just invest in the stock market for similar returns with much less work? Perhaps the new location for your business makes the negative cash flow 'worth it' but from the info you've presented it seems unlikely.


 Edit:typos

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This is super helpful. I understand you are making estimates, but it gives me a rough idea of how to go about evaluating the different scenarious. I don't have exact numbers to use either, which is why my description is a little vague. The part of the equation that complicates the scenario is the relationship between the property being used as a rental vs a business space , so I can try to explain that a little better.
As a rental space, it might not generate the income recommended for good rental investments. I might rent it out for 5 years. After five years, I might need to move my business into it, at which point the business would pay the rent. If I continue to own the business, then no problem, it eats up a small amount of the business profits. If I sell the business, I then collect rent from the business. If the business moves elsewhere, I can rent or sell the building. I don't have an exact plan, but the building provides options for me.

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Those are similar numbers to what I would use for assessing a rental, but I think it's different in your situation. If you are willing to do all maintenance, and the costs listed are truly your only costs, you would be roughly breaking even on the rental if you put all the surplus away for maintenance and repairs (roughly $480 per month). You would be making the assumption that the vacancy rate would be very low or zero. Your cost would be the opportunity cost of not having that 80k downpayment invested and generating a 4% SWR per year (3200 per year). But that might be balanced out by the principal being paid down each year. If it is in a good area and you think it would be easy to rent for at least 3000 or sell for the same price or more (i.e. prices in your area do not seem inflated), the risk seems pretty low. So, it does not work as an investment, but if it is serving an important function for your business, I think it is a reasonable low-cost option. Is 4.5% the best rate you can get for the mortgage?

Dillydally

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Re: Help? - buy or not buy?
« Reply #19 on: April 17, 2016, 12:50:51 PM »
I was quoted 3% refinance mortgage - cash out on my primary residence, or high 4% business loan 17% downpayment, no collateral. I like the low interest rate, but I think I like my primary residence mortgage free even better. If I refinance primary house, interest is tax deductible...

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Frs1661

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Re: Help? - buy or not buy?
« Reply #20 on: April 17, 2016, 04:42:06 PM »
Is this house an ideal location for your business, apart from the option to rent some of it to your employee? Would it be less risky to provide a flat housing stipend to the employee to live somewhere closer to the business?

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Dillydally

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Re: Help? - buy or not buy?
« Reply #21 on: April 17, 2016, 05:04:59 PM »
Ideal