Cash positive rental properties or leveraged debt ?

[secretlyrich]

So I have $200K liquid in the bank (I have my own company) and I earn about $260K a year (before taxes).

By my calculations, if I buy a $250K condo in a well sought after part of the city, and pay it off COMPLETELY in 2 months, then rent out the condo (which is in a city I live near) , the cash flow I should have each month should be about ~$1600/month (after the HOA fee).

If I then buy a second condo worth $250K and use the rental income from the first & 2nd condo to pay for 2nd condo's mortgage in addition to paying down the 2nd condo within a year, I should have a ~$3400 cash flow when the 2nd condo is paid off and $500K in equity that I can borrow against if I want.

Do you see any downsides to this strategy ? Its aggressive and all hinges on buying the right condo in a well sought after area of the city, but once I have the $3400 a month, I can then use that to buy bigger places or commercial real estate.

I think my strategy is good because the $3400 would be passive income for life (since the condo is in a well sought after part of the city, which is easy to rent), and then I can use that passive income to not work anymore (if I chose to do so), and the rate of return on it (plus the historical appreciation of real estate (~14%)) would net me about ~20% on each condo I bought.

My end goal: I prefer having real estate that I own free and clear that generates cash monthly. Monthly cash flow would allow me to retire in 3 yrs (if I wanted to) after I have 4 properties generating ~$6800 a month. I prefer a monthly cash flow much more than increased debt with a more expensive property(s) that bring in little cash (and increased risk).

Do you think there is a better strategy as far as using the $200K in the bank (ie: buying more houses at once) ?

My main concern is that I am under utilizing my assets (eg: the $200K cash), and that I could be using it better. I dont own any 401K, stocks, etc. I do have a personal home worth over $600K currently.


Thoughts ?

[noppenbd]

A few things to think about:

-Going this route will put a lot (100%?) of your net worth in real estate. You will be very undiversified in that sense, and future downturns in the real estate market would hit you particularly hard.
-I think your number for the historical appreciation of real estate is quite high. The number I have heard is 5-6% a year, which ekes out only a few percent over inflation.
-Are you considering maintenance on the condos in your estimates?
-Are you including 2-3 months a year vacancy in your estimates?
-Are you including property taxes in your estimates?

[jIM_Ohio]

This is leverage working in theory. I would make sure you do the following:
a) include the HOA fee in rent
b) make sure you have 12 months rent in the bank cash
c) this works better if properties are close to 80% leveraged, not 50% leveraged.

b)- if you have a period where a tenant leaves or trashes the place, you need enough cash to fix place up and rent it out again.

c) if you do as you describe, you have $250k of your own money on the line. If you can just put 20% down on each property (100k) and invest the other 150k with modest growth (6-7%), you will come out much further ahead with much less risk and much more liquidity if something goes wrong.

Keep in mind if you cannot make a payment the worst case is a property is foreclosed with a ding on your credit score. In addition, in your case you would lose the 250k you put down. In my case you lost the 50k down payment on one property.

Risk vs reward. Think about it.

[secretlyrich]

Thanks for the replies.

noppenbd:

True, I will be very undiversified, but the area I would buy in would be an upscale area that has never have negative growth (expensive part of Wash DC) and is in high demand from renters and students that go to expensive schools.

I ask you this though, if I have the two places paid off, get a months rent from the renter then it would seem the biggest risk would be during the period that I am paying off the 2 condos. As soon as I pay them both off (within 1 yr), I could easily and quickly build up a sizeable savings again using both condos rent and my salary.

You are correct though, I did not include property taxes in my estimate, and I did not include 3 months vacancy because the place I'd buy would be in a upscale sought after area with limited housing. I also will include in the rental agreement, that the renter is responsible for the first $250 in repairs, but all the condos I'm looking at are 1 bedroom 600-900 sq ft.

Jim_Ohio:

"In addition, in your case you would lose the 250k you put down."
How would I ever lose the $250K if I own the property outright ? There is no loan.

"Keep in mind if you cannot make a payment the worst case is a property is foreclosed with a ding on your credit score."
Thats why I like the idea of paying for the place completely. No risk of foreclosure ever.

I'm young (just turned 30), so this would be a very aggressive, but if I buy in a very upscale area, that has a steady pool of ppl with money (Ivy League students, etc), I should never have any vacancies and steady cash flow.

[noppenbd]

If it were me, I would do a lot of investigating. See if you can check out some existing rentals on the market that are at the price point you are targeting (pretend you want to rent them), walk through the units and compare with what you are buying. $1600 a month sounds like a lot for a 1 BR, even for a college student using the Bank of Mom & Dad, so I would be sure you can get it.

I still doubt that you can get 100% occupancy, especially for college students. You would likely have 2-3 summer months vacancy, and you should budget for this. If you end up with a really hot property and you don't have the vacancy then that is just gravy.

[simpleyme]

;-0..................

[maat55]

the only real down fall I can see is
being a landlord is not quite as passive as you might think it is ;-)

You might run this question at Biggerpockets.com. It's a real estate forum with some savy REI's.

[maat55]

Thanks for the replies.

noppenbd:

True, I will be very undiversified, but the area I would buy in would be an upscale area that has never have negative growth (expensive part of Wash DC) and is in high demand from renters and students that go to expensive schools.

I ask you this though, if I have the two places paid off, get a months rent from the renter then it would seem the biggest risk would be during the period that I am paying off the 2 condos. As soon as I pay them both off (within 1 yr), I could easily and quickly build up a sizeable savings again using both condos rent and my salary.

You are correct though, I did not include property taxes in my estimate, and I did not include 3 months vacancy because the place I'd buy would be in a upscale sought after area with limited housing. I also will include in the rental agreement, that the renter is responsible for the first $250 in repairs, but all the condos I'm looking at are 1 bedroom 600-900 sq ft.

Jim_Ohio:

"In addition, in your case you would lose the 250k you put down."
How would I ever lose the $250K if I own the property outright ? There is no loan.

"Keep in mind if you cannot make a payment the worst case is a property is foreclosed with a ding on your credit score."
Thats why I like the idea of paying for the place completely. No risk of foreclosure ever.

I'm young (just turned 30), so this would be a very aggressive, but if I buy in a very upscale area, that has a steady pool of ppl with money (Ivy League students, etc), I should never have any vacancies and steady cash flow.

I would ask this question at Biggerpockets.com, it's a real estate forum with good advice also.

[ScrimpAndSave]

Yes that is an awesome forum.

[tripods68]

The problem I see in your investment is all of it comes from Real Estate. A true leveraged is not about putting your egg in one basket (referring to $200K liquid to buy one property). Your cash is better serve to use as cash reserve, repairs, down payment, and some invested mutual funds that will provide a nice return.

2nd - The real estate properties tend can be complex with tenants living on your property with rules/laws etc.

3rd - It would better serve your money by only putting small amount required say 20% for each property. Being a landlords comes with annual maintenance, property tax, repairs cost and often with big cost (unknown sometimes).

4th - A smart investor in general should establish a self directed retirement accounts especially for business owners which help reduce income tax.

5th - The house market could further reduced the value you will pay for condo. You could already be a lost once you rent it out.

6th - Another option would be invest $200K aggressively into the stock market, or by buying index fund. Also, I'll even consider hiring a financial advisor to manage your account.

I'm rambling here so pick and choose. Just a thought...good luck!

[jIM_Ohio]

You are correct though, I did not include property taxes in my estimate, and I did not include 3 months vacancy because the place I'd buy would be in a upscale sought after area with limited housing. I also will include in the rental agreement, that the renter is responsible for the first $250 in repairs, but all the condos I'm looking at are 1 bedroom 600-900 sq ft.

What if the tenant chooses not to pay the $250 and walks away? Tenents might do that. $250 might be a lot extra for a college student or renter. Why not just charge an extra $20/month and add this $20 to a cash account each month?

Jim_Ohio:

"In addition, in your case you would lose the 250k you put down."
How would I ever lose the $250K if I own the property outright ? There is no loan.

"Keep in mind if you cannot make a payment the worst case is a property is foreclosed with a ding on your credit score."
Thats why I like the idea of paying for the place completely. No risk of foreclosure ever.

I'm young (just turned 30), so this would be a very aggressive, but if I buy in a very upscale area, that has a steady pool of ppl with money (Ivy League students, etc), I should never have any vacancies and steady cash flow.

If the properties are paid off, your worst case is that you lose the money you paid for the properties. Hurricane, Tornado, drug dealer living there, your own bankruptcy, property goes down in value, whatever- you need to think worst case. You are liabel for the actions of your tenants and your tenants could TRASH the place to where more than $250k of repairs is needed.

If you have a loan, you are only out the down payment if you walk away. If you pay off the property, you are out everything you put in.

In addition the rental income is taxed as ordinary income come tax time. If you have a loan, you can offset that income with the cost of the mortgage payment/ mortgage interest AND depreciate the property. Most land lords like renting because of the tax advantages of the leverage, not the passive income.

I think you should talk to some landlords. This is not easy money like you think or everyone would be doing it.

[simpleyme]

;-).............

[jIM_Ohio]

NO

I have looked into it, but decided to use free cash for other more profitable investments.

[LuxLiving]

I'd keep my cash out of the houses and in the bank. If you want to or need to later you could do a payoff.

a relevant site:
Real Estate Investor, The Home of Real Estate Investing - real estate investment education, networking & tools

[maat55]

After reading a few books on REI, I think it is good for your portfolio. Paying cash for properties is a good plan, but leveraging say half, would leave you with more cash on hand for other opportunities that arise. The trick is to pick properties that will cash flow themselves with a mortgage.

I would also suggest that the properties be managed by an management co. There are good tax benefits in real estate, along with stability of value, due to the fact that RE is a real asset, as apposed to stocks where companies can loose complete value.

I'm new to REI. But I have spent some time learning the ins and outs of knowing what is a reasonable investment. You certainly want to find properties with a good NOI & appreciation potential.

Your desire to invest in RE is a good decission, but make sure you run the numbers with someone who is knowledgable on good cashflow. Good luck.