Author Topic: RE Investing Questions - Help w/ the Numbers  (Read 3117 times)

cbr shadow

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RE Investing Questions - Help w/ the Numbers
« on: April 20, 2015, 06:02:01 PM »
1. If I want to purchase a house for $100k as an investment property to be rented out, and I have the cash to buy it outright, is it not the best idea to purchase it outright? My other option is to put 20% down and get a 30-year loan for $80k while investing the $80k cash that I didn't put into the house.

I guess this sorta comes down to the "Pay off mortgage or invest" argument, right? Is this different considering it's a rental property?

2. I have a house in Chicago that I eventually want to move back into. I'm overseas for another year, but for the last year I've been renting it out successfully.

(15yr)Mortgage+Insurance+taxes = -$1840

Rent = +$2050

Prop. Management = -$205

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I basically break even and it covers my 15yr mortgage. This pays off about $800 of principal every month, so I see it as a big win. I understand that a lot of people in my situation wouldn't be happy with this, but I'm unsure why. The above numbers don't include maintenance from things breaking (furnace would cost a lot, damaged items, etc) but I can't imagine it would be more than $800/month. What's the counter argument?

3. I'll be coming back from overseas with a large amount of cash (likely ~$150k) and was planning on putting it all towards VTSAX in my taxable account through Vanguard. Since my current house is renting well, I'm considering when I get back to the states purchasing a cheap (~$80k) single family house in the less expensive neighboring town (a few miles from my other home) and living there with my wife while we fix it up (while continuing to rent out our original home and covering that mortgage). The goal would be after 6 months renting it out through our PM again and possibly repeating the process. I could do most of the DIY projects and she can paint and do some of the smaller projects. Any flaws in this plan? It seem that in the area we're looking there are a lot of opportunities that pass the 1% test.

I'm just starting to read articles/forums on investment properties at BiggerPockets, but I've been a mustachian for a long time and thought I'd post my initial questions here.

-Ryan

Calimandc

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Re: RE Investing Questions - Help w/ the Numbers
« Reply #1 on: April 20, 2015, 07:33:35 PM »
I doubt you are breaking even.  Are there any costs associated with the place?  Any upkeep, maintenance, anything like that?

To answer your first question, paying outright is your better option unless you can guarantee that you can earn above your interest rate in your investments.  No offense, but you probably cannot guarantee that.  Therefore, avoid the debt, own outright, and enjoy the income stream. 

Also, look up the 1% rule, if you have not already.  It does not sound like the property you mentioned satisfies this, so it may not be a good investment for you.

Jeremy

3okirb

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Re: RE Investing Questions - Help w/ the Numbers
« Reply #2 on: April 20, 2015, 07:52:12 PM »
^^^exactly right.

cbr shadow

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Re: RE Investing Questions - Help w/ the Numbers
« Reply #3 on: April 20, 2015, 07:58:21 PM »
Calimandc, I appreciate your response.  I think I am doing much better than breaking even with the current rental house.  I'm breaking even with the 15-yr mortgage, but paying off $800 principal with each month being rented.  Just over $9600 principal payoff per year.  I think the only argument against this is that at some point things may start to break.  I can't imagine those would be more than the $800/month though.  Is there something else I'm not counting? 
I may be missing vacancy losses, but our area seems pretty hot right now for rentals.  Yesterday morning we signed a new tenant for another year lease.

I don't think anyone can guarantee any kind of interest rate on their investments, but based on history there's a high likelyhood of 7-8% returns on VTSAX right?

As for the 1% rule, our current property doesn't quite satisfy the requirement.  Home value = $213k, rent = $2050.  Very close though. 

waltworks

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Re: RE Investing Questions - Help w/ the Numbers
« Reply #4 on: April 20, 2015, 09:25:59 PM »
Yes, yes they will. Google up the 50% rule. Or just find some threads on it here.

-W
I think the only argument against this is that at some point things may start to break. 

Calimandc

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Re: RE Investing Questions - Help w/ the Numbers
« Reply #5 on: April 21, 2015, 07:34:50 AM »
I'm not sure how long you've owned this house, but can tell you from my as well as many other people's experience that there are a lot of unforeseen costs associated. Things break all of the time, lawns need to be cared for (since you're not there someone has to do it), and lots of others.  We owned a home, and it looked great on paper when we bought it.  150K extra later, we realized the thing was sucking us dry and sold it, bidding good riddance.  Yes, I'm jaded from home ownership, but I can tell you, they are far more expensive than we expect them to be!

J-

cbr shadow

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Re: RE Investing Questions - Help w/ the Numbers
« Reply #6 on: April 21, 2015, 11:24:26 PM »
Point taken about the expenses adding up quickly.  We've been in the house for about 5 years.
$150k in unforeseen expenses?!  I'm 90% sure I could burn down the house and rebuild it for $150k lol.  I'm curious more than anything, what were the big expenses that added to that $150k expense, and how much was the house actually worth?

Thanks for the responses so far.

iamlindoro

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Re: RE Investing Questions - Help w/ the Numbers
« Reply #7 on: April 22, 2015, 12:04:48 AM »
The major flaw in your analysis is that merely covering your mortgage is the absolute worst possible metric of a successful real estate investment.  Remember that when most of us evaluate a rental, we're looking for expenses to be ~50% of collected rents (which can vary somewhat, but over long time horizons tends to be approximately true), then to cover mortgage, and to cash flow beyond that a few hundred bucks per unit.  That would be the rough definition of a "acceptable" deal, which excellent deals available that go far beyond that (2% or more of purchase price every month in rent would be a pretty great deal). 

Think about when we evaluate someone's investments in funds-- If they said "but I've averaged 4-5% annually for the past 20 years!  I've beaten inflation!" We would shake our heads and point to the fact that with a low expense ratio fund, they would have averaged 8-11% over that same time period.  In the absolute ideal scenario of your rental, where absolutely, miraculously, nothing breaks, you get the mortgage paid for you.  But is that objectively a good investment when the same amount of equity could be built, a healthy margin for repairs, vacancy, and property management if you decided to move could build up, and you could pocket a few hundred bucks a month on top of all that?  Your current rental is a poor use of resources when evaluated against other rentals.

cbr shadow

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Re: RE Investing Questions - Help w/ the Numbers
« Reply #8 on: April 22, 2015, 08:39:57 PM »
iamlindoro thanks for the response.  Between your response and what I read on BiggerPockets I now understand that our current house isn't as good of an investment as I thought originally.
I think in this case it's still the best option for us since we want to move back in there when we return to the states within a year or so.  I spoke to our realtor when we were deciding to rent or sell the home.. she explained that we'd probably break even if we sold (+ or - a couple thousand depending on the sell price) since the value fell quite a bit since we purchased the home.
Anyways, it's good to understand the math now.  I still have trouble understanding how someone would be able to satisfy the 50% rule in my area though!  Maybe this is generally satisfied in low income areas where there's more risk and reward?

waltworks

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Re: RE Investing Questions - Help w/ the Numbers
« Reply #9 on: April 22, 2015, 08:58:14 PM »
There are many areas where owning rental properties doesn't work out due to high prices. Invest elsewhere, or in other things.

-W