Author Topic: Looking to invest in real estate as a hedge against rising home prices  (Read 5032 times)

BoulderTC

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About a year ago, my hubs (30) and I (26) bought a great house in one of Denver’s “hottest” neighborhoods. We bought the fully renovated house for $382k (3br/2ba), which we knew was overpriced, but we justified that it was worth it and we could afford it. We realize it was not a mustachian move, but we don’t regret it at all because our quality of life is great, it is exactly what we wanted and we have really enjoyed living there (I know, face punch). Lately, though, we have been thinking about our next step. We are not ready to move, but we anticipate that our current house will not fit our needs/lifestyle forever. We want to stay in the great Denver neighborhoods, but we can’t stomach that getting a house that’s fit for a family in 5-8 years from now would certainly cost over $500k in ANY Denver neighborhood. So, our plan is to buy a fixer-upper in an up-and-coming neighborhood now (~$200k-250k), rent it out, renovate it over time to be our dream house, and when we’re ready for more space, move into it and sell our current house. We don’t think a fixer upper will be hard to rent out because the neighborhood we are eyeing is right next to a small university. In our plan, by the time we’re ready to move into this house, the neighborhood we buy in will also be one of Denver’s “hottest” neighborhoods, but we will have gotten in early to avoid getting priced out and spending way too much on it, plus not needing it to be "move in ready" as we would if we waited until the last minute. This will also hopefully help us avoid lifestyle inflation by having a second house already secured.

We realize our plan requires us to become landlords, but we are not necessarily looking to get into rental property as a long term side gig, except for this one house. Our main motivation is to make a smart choice that eventually pays off and increases our happiness, not necessarily maximize rental income. It’s definitely a bonus that we’d add some cash flow to our existing incomes in the next few years as well. Our lender approved us for a mortgage, and we’re starting to save up our pennies for a 25% down payment.

The advantages of our plan as we see them are:
•   We could secure our future dream house now, while we’re young DINKs (engineers). We would then have plenty of time to renovate it into exactly the house we want over the years.
•   We would take advantage of good interest rates available now.
•   We would get into a “hot” neighborhood ahead of the curve, allowing us to stay in the city when we otherwise would probably be priced out.
•   We have time right now to be picky and find the exact house we want, rather than later when we NEED a new house before x happens (baby arrives, I decide to stop working, we don’t like our neighborhood anymore, etc).
•   All the advantages of owning rental property (someone else paying for our equity).

The disadvantages of our plan as we see them are:
•   All the disadvantages of owning rental property (wear and tear, taking on the side job of being a landlord, repairs/maintenance, etc).
•   Risk associated with trying to anticipate what the future holds.

The specific questions I have for you experienced landlords and homeowners are these:
•   Is our plan a good one? Are we being ridiculous to try to find something cheap that will greatly appreciate over time? Is it asinine to assume there will even be something that will serve as a good rental now that would be a good family house later?
•   One option we have is to open a HELOC from our existing mortgage for up to ~$42,000. Is this something you would advise? Our lender said it can be a really great tool with tons of flexibility, and a way for us to still beat the interest rate increase before we save up 20-25% down payment. He said the adjustable rate isn’t that big of a deal because it’s a small sum of money (compared to an entire mortgage). What do you guys know that my lender isn’t telling me?
•   I read about the 50%/2% rule on MMM and elsewhere. Do any of you have rental properties in Denver or similar cities, and can you speak to which rules of thumb I should be making an effort to uphold?
•      Do I deserve a facepunch for even thinking about having two mortgages?

Thanks in advance for your time and I'd really appreciate any feedback, positive or negative about if this is a solid plan.

BoulderTC

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Re: Looking to invest in real estate as a hedge against rising home prices
« Reply #1 on: November 04, 2013, 06:13:53 PM »
Good question! One of the bedrooms is not actually big enough to be a real bedroom. It would be a good home office, at best. I am not even sure it would fit a twin bed. We're planning for 3 or 4 kids. So yeah, we'd need something more in the 4 bedroom range... and they'd need to be actual bedrooms.

Recently got a quote to dig out and finish our basement in our existing house to see if we could make it work and it was prohibitive. Something like $100k for an extra 450 square feet. So that's why we're looking at other neighborhoods.

KingCoin

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Re: Looking to invest in real estate as a hedge against rising home prices
« Reply #2 on: November 04, 2013, 06:28:11 PM »
I would say that if the fixer-upper constitutes a good investment in it's own right (making no assumptions about future appreciation), then it might be a good plan.

Otherwise, the success of this plan is predicated on numerous conditionals:
1) That you actually end up having a family of sufficient size to warrant moving (maybe you decide one or two kids are enough).
2) That you still want to move to the fixer-upper neighborhood when said family materializes (maybe the schools aren't up to your standards or any number of other factors).
3) That the neighborhood actually appreciates in value and becomes "hot", making it a sensible investment.
4) That the fixer-upper doesn't cause you more headaches than it's worth both in terms of tenant management and the actual fixing-up.
5) That you still want to live in Denver (who knows what opportunities present themselves elsewhere).

While each of these items may be ~85% likely individually, the chance that they all come to pass dwindles.

Basically, humans are notoriously bad at predicting their future needs and wants (I'd highly recommend the book Stumbling on Happiness) so all this projecting is likely an exercise in folly.  You'll probably come out ahead by just investing in equities, putting together a kick-ass stache over the next 5-8 years, and then having your options wide up when the time comes to make a real estate decision. The fact that you already own one Denver property is a largely sufficient hedge. I don't think there's a compelling reason to get ahead of yourself and double down.
« Last Edit: November 04, 2013, 08:22:22 PM by KingCoin »

BoulderTC

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Re: Looking to invest in real estate as a hedge against rising home prices
« Reply #3 on: November 04, 2013, 06:28:55 PM »
We've pretty much thought of everything as far as keeping the current house and adapting it to a growing family lifestyle. Our house is in a pretty urban area, which means no way to expand in any direction except up. Our realtor friend has told us that we wouldn't get returns on any major work we do to our current house and advised us to not attempt it. In addition to more bedrooms, I'd want a garage, and a family room (we only have one public living space now), and just a more flexible setup (i.e. a home office today becomes a bedroom tomorrow becomes a playroom later). Our dining room can't be closed off because it's essentially like an eat-in kitchen, in a way.

Any thoughts on our plan to buy a house now which will meet our needs down the line and play landlord in the meantime?

Another Reader

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Re: Looking to invest in real estate as a hedge against rising home prices
« Reply #4 on: November 04, 2013, 06:49:34 PM »
It sounds like you got a fixed up but functionally obsolete house for your $382k.  You fell for the eye candy, as this house does not really meet your needs.  It was probably not a wise purchase for you. 

You have not yet demonstrated any really sound thinking about property based on what you have said and done, owner occupied or rental.  You are not interested in being a landlord except as a means to an end.   You need to learn a lot more about rentals, what the risk is in picking the next "hot" neighborhood, and what leverage can do to help or hurt you.

Your current house is your hedge.  As long as your neighborhood continues to be as "hot" as the one you want to move into, the appreciation should be similar in percentage,  Meanwhile, save and invest those nice engineer salaries.  You will have the equity in your house and savings for the additional down payment if needed for a house that does a better job of meeting your needs at that time.


BoulderTC

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Re: Looking to invest in real estate as a hedge against rising home prices
« Reply #5 on: November 05, 2013, 08:56:37 AM »
It sounds like you got a fixed up but functionally obsolete house for your $382k.  You fell for the eye candy, as this house does not really meet your needs.  It was probably not a wise purchase for you.

Yes this is absoutely true! And our realization of this is why we want to be smarter the next time around, but not have to give up our area of town... leading to this 'plan' of ours. I guess what we are really trying to hedge against is getting priced out of our area altogether, having to move to the suburbs and then have to give up walking and biking everywhere and add a lot of inconvenience (i.e. suburbia) to our lives because we didn't plan ahead. Plus, we know that the people who do the fixing up (rather than buy fixed up houses) are the ones that get the better end of the deal. So we want to attempt to be those people.

Thanks for all the feedback! We will think hard about the likelihood of our predictions coming true and separately analyze whether we want to take on investment property (making sure it is a solid investment first). Of course, everyone's situation is different, and without knowing us, you can't give a perfect answer ... so it's up to us to decide now.

I will say that I'm 99% sure that the neighborhoods surrounding my current one will be "hot" in a few years. So buying a house now for ~$200k that will be worth the higher prices of my neighborhood in a few years would be very satisfying. But probably not a good way to undo the first short-sighted decision. Thanks again for the food for thought! Any other feedback welcome...

SnackDog

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Re: Looking to invest in real estate as a hedge against rising home prices
« Reply #6 on: November 05, 2013, 10:17:34 AM »
Interest rates have only one way to go: up.  This means mortgage approval amounts have only one way to go: down.

You  may be better off renting your dream house and investing the rest since the stock market outpaces home appreciation, long term.  Rent out your current house if it doesn't fit your needs, or sell it.  Have you checked rental prices in your desired locations?  Often in "hot" markets the price of owning and maintaining a home is a great deal more than renting it.

Eric

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Re: Looking to invest in real estate as a hedge against rising home prices
« Reply #7 on: November 05, 2013, 11:58:44 AM »
Maybe I'm not reading this right, but if you're certain that you'll need a bigger house in the future, and you can afford it now, why wouldn't you just make the move right now?  Then you can renovate at your own pace without having to worry about tenants and you don't have to become a landlord.  I'm assuming the other neighborhood must be a desirable place to live too, otherwise, why would this even be an issue?

KingCoin

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Re: Looking to invest in real estate as a hedge against rising home prices
« Reply #8 on: November 05, 2013, 12:58:12 PM »
Maybe I'm not reading this right, but if you're certain that you'll need a bigger house in the future, and you can afford it now, why wouldn't you just make the move right now?  Then you can renovate at your own pace without having to worry about tenants and you don't have to become a landlord.  I'm assuming the other neighborhood must be a desirable place to live too, otherwise, why would this even be an issue?

Yes. The true mustachian move is to sell the $382k house and move into the big $200-250k fixer-upper.

I will say that I'm 99% sure that the neighborhoods surrounding my current one will be "hot" in a few years.

99%? This tells me you're not thinking about probabilities correctly. If it was that likely, the change would already be largely priced in. What if there's another recession in the next 5 years? What if there's a major economic meltdown? What it mortgage rates go to 9%? What if the neighborhood just turns for the worse as neighborhoods occasionally do? None of these are trivial probabilities and all will adversely affect real estate.  That's not to say I'm bearish, but if you're using a 99% probability in your thinking about this situation, you're making a large mistake.

BoulderTC

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Re: Looking to invest in real estate as a hedge against rising home prices
« Reply #9 on: November 05, 2013, 04:19:34 PM »
I like that you all are challenging me to think about this differently.

I don't think that it's equally desirable to live in a neighborhood that is just starting to get turned around as it is to live in a great, lively, exciting neighborhood with lots of great nightlife. Or maybe I'm just not willing to give up our lifestyle right now of having everything we need within walking distance. Are you trying to say that the more mustachian thing to do would be to sacrifice some of our preferred lifestyle (now) for a cheaper house where it will pay off (later)? I think I agree with that, but not sure I'm ready to jump ship quite yet. I know it probably sounds like I live a crazy lifestyle, but that's not it. We're quite frugal, but want to enjoy our surroundings while we're still young and kidless.

illy5603

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Re: Looking to invest in real estate as a hedge against rising home prices
« Reply #10 on: December 02, 2013, 03:47:14 PM »
Sooooo... Do you want a great nightlife or 4 or 5 kids? Sounds like the answers to your questions depend on the answers to a lot of other questions.
 
You could also do what I did. Invest out of state. Two of my rentals are in Memphis and perform better than anything where I live (Northern California) ever would.

meadow lark

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Re: Looking to invest in real estate as a hedge against rising home prices
« Reply #11 on: December 02, 2013, 05:24:34 PM »
I disagree with the idea it is always better to buy a fixer-upper.  We have done it multiple times, and I would say half the time we have made good appreciation on it, and half the times we sold them with no increase over the costs  of materials.   We have made a pact to stop doing it.  Also, if you are doing things yourself it always takes longer, and that is money you won't be making in rent.

_JT

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Re: Looking to invest in real estate as a hedge against rising home prices
« Reply #12 on: December 02, 2013, 05:57:00 PM »
There are lots of people here and elsewhere who know a lot more about this than I do, but one of the most common refrains in real estate investing is 'Don't bet on appreciation!' Make your money on the rent/flip/rehab, and let any appreciation that does happen be a happy bonus. You're betting on appreciation, using a confidence interval that scares me.

willn

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Re: Looking to invest in real estate as a hedge against rising home prices
« Reply #13 on: December 05, 2013, 11:34:03 AM »
Yeah this is facepunch-worthy.  Two mortgages, one on a place you want to move to in an unknown time frame, in a risky neighborhood (I've watched the Denver market over a couple of decades and seen a few up and coming neighborhoods which don't come up).  Fixer uppers have a way of costing a lot more and taking a lot longer to fix up than expected--if its even a modest underestimation, you'll lose any of the hedged advantage.  Landlording is no picnic and vacancies can ruin your cash flow.

Better would be too really crank down and knock down your existing mortgage so you have lots of freedom to sell it easily and have a ton of cash to put down on the next home---for which, your requirements will probably change over a few years time anyway. 

One way to think of your situation is that you are already hedged by having locked in the price of your current housing, while inflation is rising around you.  You'll benefit from the inflation or appreciation when you sell.  Introducing risk in the form of another mortgage negates the advantage.

My opinion is there's often an aspect of "bubble mentality" thinking around real estate--sometimes it seems as if everyone is making money on it or being smart about their purchases--often though they are introducing long term risk and overestimating the real costs.  Don't let fear or greed guide you in this--instead think of the long, steady, proven strategy: save early, save often, avoid leverage that depends on speculation.  Lots of deals look good when everything goes right, but a great deal works even when things go bad--the neighborhood declines, the job is lost, the health fails, the partner gets addicted, the contractor stops showing up, etc.