Investment Property

[swanson719]

So maybe a stupid question... We're almost done with our emergency fund, ans have no other debt than our mortgage. Traditional wisdom would say to finish out the emergency fund and save for a down payment on an investment property, if not pay cash entirely. However, we've found a 3BR, 1 Bath, 900 sq ft, in good shape, that is an REO for $29,500. Rentals in the area go for $600 a month. With mortgage and insurance, it would cost us $300 a month on a 15 yr note. On a rental, the mortgage payment and insurance and everything else is all tax deductable as well, which lowers our personal tax bill while at the same time raising our personal income. My question is why would it not be a good idea to purchase this house as a rental if 6 months from now we'll get our downpayment back via a tax refund? The downpayment would be $5900, plus a $300 inspection before we buy it, and we have $7,200 in our emergency fund. So we wouldn't be completely whiped out, but there wouldn't be a lot left either. I'm wondering if I'm looking at this a little prematurely since we'd be depleting our EF so much, or if the fact that we'd be making an extra $7K a year after taxes, plus hedging against inflation with real estate, would be a good idea.

Financially, we can afford the payments on the house even if there aren't tenants. I have first hand experience of rental properties and know the hassles they can be.

I really don't see the immediate downside to this. We have the insurance paid for the house and cars through January, and have money set aside for vacation. We wouldn't have PMI because we'd put 20% down. Other than the use of the EF as a downpayment, I don't see the issue. It's appraised value is $45,000 which is what other houses in the area sell for right now. So we'd have an instant 50% equity considering the down payment. To me, there isn't much risk involved and it's a good, stable, income generating investment.

[tifnglen]

Well...I dont have much experience in this area. I will tell you that most people here would want to know your income, age, how much $ you have in retirement (or what % you put towards retirement)

[swanson719]

We make about $60,000 a year right now net, our mortgage is $140,000. I'm active military - age 22. So they will pay retirement, plus we have funded Roth IRA's, so as far as I'm concerned, that covers retirement. We have roughly $1,000 a month left after all the bills are paid, Roth funded, etc.

[tmvijai]

hey swanson

I should say your idea to invest in rental property is a good one. I also should acolode you for funding your emergency fund first before thinking about investing. Not many people do that. I have seen many people come to real estate seminar don't even know what is emergency fund. You are atleast good planner.

Being a student of financial planning, I should say you are in the right track but how close are you to achieve victory is the true question. You got $7k of emergency fund. You annual income $60k - $5K net/month and $1000 pending after paying bills which is a solid earning. I would say you have to atleast $4k * 3-6 months of emergency fund = $12k - 24k in the higher end before even start thinking about any money for investing. That would your safest bet.

I was in your same situation 3 years ago. I had good emergency fund savings and invested in my 1st rental property with $20 down including closing cost. My EF reduced to just $5k which was a mistake. I lost my job and I was in a panic mode. Luckily I got job in a month otherwise I would have been a mess. THats a tough lesson learned. For you, you don't have to worry about job loss but still disability and other factors still valid for you.

After saying all that, I am still kinda of attracted by the deal $30k investment property with just $6k down. Good deal but rental amount doesn't seems to be really attractive. You have to calculate vacany rate, maintenance into account not just insurance and mortgage and decide on the cash flow. That would be around $100/month which is still not bad. Also you need to see 3-6months out. How can you manage without tenant? You said, you can pay mortgage out of your pocket which is actually loss for you.

So taking all into consideration, I would sit out and wait until you build atleast $15k of EF. Real estate market is going nowhere.

[Ima saver]

I owned 3 rentals and it was the worst time in my life! My renters trashed the houses, we had to repair constantly and we sold all three houses for far less than we paid. It was a definate money losing deal and I would never do it again.

[boosami]

I own a bunch of rental properties. They have been a good investment and I haven't had any major problems with them or renters. However, I have always been very careful with selecting tenants and keeping everything official and legal and documented. Eventually, all my properties will be managed by a management company and I will no longer have to work directly with them (except for making executive decisions). I am currently trying this out on some of my properties and if all goes well, I will do it for all of them.

If you decide to do it, initially keep all the rent income in a separate account (or carefully accounted for) and do not use it to supplement your income at all. That will you'll have a pool of money to draw from for expenses. After your first tenant, you'll have a better idea of the profit margin and you can start supplementing your income. Be sure to always keep a rental property emergency fund! I wouldn't feel comfortable with less than a year's worth of rent as a backup for any of my properties.

On another note: Wow, under $30k! My cheapest rental is $150k.

[tmvijai]

I do the same. I have seperate saving account for my rentals in ING and I just move the money from the bank it get deposited by the tenant every month. I only spend anything from that account. I also have a seperate credit card to use for any expenses. So I know how it was spent on repair fromthe credit card statement.

I also have to agree with screening the tenant properly. It is very important. I use few tenant screening services to make the decision faster and easier. You can collect that fee from the tenant so you don't have to dig from your pocket.

I know you are confused now but as I said EF is very important and comes first then your investing.

[PennySaved]

The numbers seem to work, but the bigger question is "do you want to be a landlord?" Seems like you do, but that is just as big a deal as the numbers.

Also, I may assume some vacancy rate, perhaps 15% or so.

[creditcardfree]

Won't it be harder to be a landlord when you move? Active military, right? I expect you won't be staying in one place for more than 3-5 years at a time. Just something to think about. Good luck.

[swanson719]

Generally, you're right about moving every 3 to 5 yrs. My job is the exception. I work at Leavenworth. We don't move much, and when we do, it's for a year to a small podunk prison before we move back here. One of the guys just retired having done 16 of his 20yrs working in Leavenworth.

[wincrasher]

Sounds like a sentance instead of a job!

EF funds are not for investing. This is not an emergency.

Also, the down payment requirements and interest rates are higher for investment properties. The profits may be slimmer than your are projecting. Look at investments objectively - it's not just total ROI. Return has to be commensurate with risk. To me, this investment has a high risk and your potential reward needs to be in line with that.

So let's put it another way. Let's suppose you can clear $200 a month profit on this investment - that is an 8% return on your money. That's after the interest you'll pay on the loan, expenses, the tax benefits, etc.
Sounds pretty good - better than CD's certainly, better that mutual funds.

Now what are the risks? Occupancy, destruction, repairs, expense increases (like property taxes), litigation. All these things you may need to hold reserve funds to cover. These come out of your 8% return. Also, not only is your investment ($29,500) at risk, but your liability is not capped at your invested amount. Still sound good? If you can get a CD for 3.5% with no downside risk, is that a better investment? What about some conservative stocks or ETF's that may yeild 5% but you risk the entire principal, but no more than that.

Things to think about.

[creditcardfree]

Originally Posted by swanson719

Generally, you're right about moving every 3 to 5 yrs. My job is the exception. I work at Leavenworth. We don't move much, and when we do, it's for a year to a small podunk prison before we move back here. One of the guys just retired having done 16 of his 20yrs working in Leavenworth.

I think you told me that before. Sorry!!

Sounds like a great investment plan, especially if you want to be a landlord. Best wishes.

[swanson719]

We aren't getting the property for two reasons - primarily DW's peace of mind because she doesn't want to be a land-lord, and secondly, because DW feels the same way as wincrasher about the EF. She'd rather wait until we can buy it outright in another few years. As far as liability, it would be capped at the amount invested because if/when we do get into investment properties, we'd do it via an LLC. It's not worth risking our own house.

[am_vanquish]

Sounds to me like you made the right decision. Perhaps in the future you can re-consider with a more stable financial foundation and a better understanding of your risk tolerance.

[wincrasher]

Swanson -

While you are waiting to invest, investigate fully your potential liabilities of an LLC. It is not blanket immunity, nor is it total anonymity either. You have to be set up right, and follow all the rules to the letter - there are some pitfalls.

Many financial gurus recommend putting 1 - 3 rentals in a single LLC, and then starting another to help mitigate risk and keep a liability from bringing down your entire portfolio.

Liability insurance is a must. No only for property, but for personal liability, even if you are shielded by LLCs. You can get a blanket policy for yourself fairly inexpensively.

Good luck to you!

[swanson719]

There are a lot of problems with having several different LLC's as well. Lawsuits over a single property have been successful against all of the LLC's in owned by a single individual because the proceeds were all placed in the same bank account and the LLC's were run rather as one large LLC than several seperate. Tax records and such were different, but the simple fact that the bank accounts were the same made them fair game according to the court.

Umbrella insurance would be a must as well. Dave Ramsey talks about this all the time for business owners. No amount of profit is worth losing the roof over your family.

The biggest problem with doing things as an LLC is that you almost have to have an accountant in order for it to be pretty much shielded from lawsuits, and even then it's not immune. It's better than nothing, but you're right, it's no where near total anonymity. It's an effectual liability shield, and great for taxes, and little more.

Thanks.

[Troyrb]

I'm in contract for my first rental investment property. It is a duplex two blocks from my home. The duplex needs some work but is in pretty good shape. One side in currently being rented by a elderly man who has been there for 20 yrs and says he doesn't want to move till he dies. The other side is also rented by a younger family. The price of the property was only 61k and we are putting 20% down on it. The rent from one side covers all but about $75 of the entire mortgage, property tax, and insurance payments. I did use my EF to pay for the DP but it only totaled about 20% of my fund.

I'm also in a unique situation of being self employed so I have some free time each month to address any issues that may come up. I also have past carpentry experience. So most all repairs I can do myself and save money that way. I have always wanted to own investment property so I'm keeping my fingers crossed that it all works out. If it does then I may buy more properties. I don't have a LLC but do plain to look into it.

[Alex_Adviser]

Originally Posted by swanson719

Generally, you're right about moving every 3 to 5 yrs. My job is the exception. I work at Leavenworth. We don't move much, and when we do, it's for a year to a small podunk prison before we move back here. One of the guys just retired having done 16 of his 20yrs working in Leavenworth.

Now that sounds like everything is in your favor. You also have a very good planning for the Investment in a Rental property. I dont see any hurdles in the investment plan that you are having.

All the best....