Cash flow or pull out more cash and buy another rental?

[cologero]

Hello SA friends,

So, long story short, after 7 years of renting, I bit the bullet and decided to relocate for my employer (bought a condo) to get closer to our corp office (after getting their blessing). 3 months after moving (and after dedicating 7 years to this employer and being told I was one of the key leaders of the future) I was laid off.

Never again will I rely on an employer for my future job security, because at the end of the day, you can bust your ass and surpass performance goals and it still doesn't matter. Fast forward to now. I have a new job (paying less), but I've also studied a lot about RE and and actually self funded my first deal! I'm trying to figure out what is a better option for me now. Here's the situation:

I purchased a SFH in my personal name with cash and rehabbed it from top-to-bottom ($50K all-in). It's currently renting for $1,025/mo.

I was thinking of purchasing it (from myself) through an LLC I just set up. It appraised for $99,900 so that's what I would buy it for (I already have a lender in place too). So I would get $99,900 in cash minus paying back the 20% downpayment from my LLC, $4K in short-term debt, and closing costs of $6K...and probably $15K in capital gains (I'm assuming). Regardless, that still would net me $55K. So basically all said and done, I'd be able to have a fully renovated property with tenants with no real out of pockets cost.

Where I'm torn is, right now I have $1,025 in cash flow each month. If I pull the cash back out, I will have a $700-$750 mortgage (incl taxes & insurance), which basically kills my cash flow once I back out money for repairs, capex, vacancies.

Which route do I go? If I don't pull my money out, I'm pretty much out of cash with the exception of my Roth IRA and 401K which is about $90K total. My goal is to get up to $2K+ per month in rental cash flow that way it covers all of my basic expenses in the event I'm ever jobless again. My real estate friend reccomends I pull as much cash out as possible so I can fund my next deal.

Thought? Thank you in advance.

[TexasHusker]

Using leverage is the key when building wealth through real estate, and by doing so, you also will likely build wealth quickly.

Using leverage means borrowing the equity from the property and using those funds to buy more property.

I am going to use my mother's situation as a comparsion tool for you to see the difference. I care after all of her finances. Being elderly, she isn't interested in building further wealth - she just needs income. So, she paid cash for five single family residences that are worth a sum total of around $1 million. All of these are rentals. Then net income to her is around $85,000 per year.

Let's say in 10 years she dies and I settle the estate. The houses might be worth $1.3 million then, meaning her wealth grew $300,000. Of course, she also had income over that 10 years of $850,000, so her profit from these houses over 10 years is $1,150,000.


Now, if her goal was to build wealth instead of income, we would have done this very differently: I would have taken her $1 million in cash and used it to finance the purchase of 25 houses ($200K houses, 20 percent down). So she's buying $5 million in property, using $1 million as leverage.

Right off the bat, she's not paying any income tax whatsoever any more, as the deprecation value of these properties offsets all of her income.

Financing all of them for 30 years @ 5.5% APR, after figuring in vacancy, repairs, maintenance, taxes, and insurance, she would still have positive cash flow of around $275 per unit per month, equating to $6875 ($82,500 per year).

So with the tremendous depreciation benefit and the rental income, her income is actually more than she has when she purchased 5 houses in cash!

Fast forward 10 years and it's time to cash in the chips: Her total income has been $825,000 (assuming she never went up a dime on rents). The $5 million worth of properties are now 30% higher than they were when we bought them, so that's another $1.5 million in profit.

Total profit from the $1 million investment is $2.35 million. And paying zero income tax on the rental income of $6875 per month for 10 years!

Your annual total return on this is in the range of 15%.



Now, let's say after 10 years you take all of your $3.35 million in CASH and start all over. This time, you use the money to buy 84 houses. .

In 10 more years, you cash out again...this time taking out close to $12 million in cash.


The power of real estate.

[Jluke]

I am going to use my mother's situation as a comparsion tool for you to see the difference. I care after all of her finances. Being elderly, she isn't interested in building further wealth - she just needs income. So, she paid cash for five single family residences that are worth a sum total of around $1 million. All of these are rentals. Then net income to her is around $85,000 per year.

Let's say in 10 years she dies and I settle the estate. The houses might be worth $1.3 million then, meaning her wealth grew $300,000. Of course, she also had income over that 10 years of $850,000, so her profit from these houses over 10 years is $1,150,000.

So a 200k home will appreciate 60k in 10 years? 5 homes x 60k is 300k. where is the 6% realtor fees? closing costs?

Each home would need to be rented for 1400/month (appx) just to meet the 85k net. So how much more is rent to account for property taxes and other utilities, upgrades, fixes, etc that the renter doesn't cover?

These questions are not an attack - I am interested in the math.

ETA: Are these weekly/monthly vacation rentals?

[TexasHusker]

So a 200k home will appreciate 60k in 10 years? 5 homes x 60k is 300k. where is the 6% realtor fees? closing costs?

Each home would need to be rented for 1400/month (appx) just to meet the 85k net. So how much more is rent to account for property taxes and other utilities, upgrades, fixes, etc that the renter doesn't cover?

These questions are not an attack - I am interested in the math.

If a home appreciates 3% a year, then yes, it will have appreciated about $60K in 10 years. The most conservative studies show 3.4% average annual appreciation throughout the U.S. since the 1960s, and the more liberal studies suggest over 5%. If you figure 3% you're quite safe, unless you are investing in an area that is definitely headed south (pun intended).

In my neck of the woods, a home that doesn't rent for at least 1 percent of the value isn't worth buying.

I don't use realtors, so I don't pay 6%. Certainly you have a few closing costs when you sell a property.

Here is a site that might be helpful: https://michaelbluejay.com/house/appreciation.html

[TexasHusker]

ETA: Are these weekly/monthly vacation rentals?

No, single family residences. The returns on my vacation rentals are going to be in the 18-22% APR range. But the places in the U.S. that I would buy a vacation rental as an income property are very few. Most resort areas can't deliver a return that is acceptable to me.

[corn18]

You need to account for the depreciation recapture tax somewhere in your math.

[TexasHusker]

You need to account for the depreciation recapture tax somewhere in your math.

Aside from tax free bonds, an investor is going to ultimately pay the appropriate income and/or capital gains taxes on his profits regardless of the investment, whether you earn 1% or 15% APR. The bigger the tax bill, the more you made.

[corn18]

[QUOTE=TexasHusker;474049]Aside from tax free bonds, an investor is going to ultimately pay the appropriate income and/or capital gains taxes on his profits regardless of the investment, whether you earn 1% or 15% APR. The bigger the tax bill, the more you made

So why not include it in your analysis? You tout the rental income as tax free when in reality it is tax deferred.


You say you don’t pay taxes on the $850k income as it comes in because it is offset by deprecaution. All well and good, but you will pay tax on that $850k plus any appreciation in value when you sell. That is a non trivial amount of money.

So the income generated is not tax free. It is tax deferred.

[TexasHusker]

[QUOTE=corn18;474051]

Aside from tax free bonds, an investor is going to ultimately pay the appropriate income and/or capital gains taxes on his profits regardless of the investment, whether you earn 1% or 15% APR. The bigger the tax bill, the more you made

So why not include it in your analysis? You tout the rental income as tax free when in reality it is tax deferred.


You say you don’t pay taxes on the $850k income as it comes in because it is offset by deprecaution. All well and good, but you will pay tax on that $850k plus any appreciation in value when you sell. That is a non trivial amount of money.

So the income generated is not tax free. It is tax deferred.

It is impossible to include any sort of accurate tax analysis, because everyone's tax situation is different. You are correct, any income derived from tax savings due to utilizing depreciation is in fact tax deferred.

But you are deferring capital gains tax - either 10 percent or 15 percent depending on your marginal bracket, not income tax. Big difference.

One of the advantages of this strategy is that you are effectively eliminating a 25-30-35% income tax and replacing it with a 10 to 15% capital gains tax.

[corn18]

[QUOTE=TexasHusker;474052]

It is impossible to include any sort of accurate tax analysis, because everyone's tax situation is different. You are correct, any income derived from tax savings due to utilizing depreciation is in fact tax deferred.

But you are deferring capital gains tax - either 10 percent or 15 percent depending on your marginal bracket, not income tax. Big difference.

One of the advantages of this strategy is that you are effectively eliminating a 25-30-35% income tax and replacing it with a 10 to 15% capital gains tax.

@ $85,000 income you are in the 12% tax bracket. If that is your only income, then you have some options. If you run it through an LLC, then the passthrough tax exemption makes it even better to pay income tax vs. capital gains tax.

The best scenario is the real estate stays in the estate until death and then gets passed on to the heirs. They will get a stepped up basis and all taxes will be avoided.

[TexasHusker]

[QUOTE=corn18;474055]

@ $85,000 income you are in the 12% tax bracket. If that is your only income, then you have some options. If you run it through an LLC, then the passthrough tax exemption makes it even better to pay income tax vs. capital gains tax.

The best scenario is the real estate stays in the estate until death and then gets passed on to the heirs. They will get a stepped up basis and all taxes will be avoided.

and you're asking me for tax analysis?

[LivingAlmostLarge]

What's the risk TH in the leverage scenario? The cash homes isn't risky. You have cash for the repairs. You have cash to pay taxes. Only risk is that you have to have cash to buy the homes and rent generation.

But for someone else? Leveraging 5x the amount invested in RE seems risky. There has to be a catch or everyone would do it.

Question - how do you qualify? I was told my DH and I wouldn't qualify with our income buying rental property. Let's say we have $200k on $1m in properties to leverage (and this is real because we're looking into it) I was told we wouldn't qualify from B of A. Even with our assets backing the rest.

They want to see us be able to carry the investment and we could but they deemed it too much risk. How do these hypothetical situations all happen?

I don't get how people keep qualifying for mortgage after mortgage after mortgage on rental properties with far less assets and far less income. I'm not joking but I don't know where you find these lenders.

[TexasHusker]

What's the risk TH in the leverage scenario? The cash homes isn't risky. You have cash for the repairs. You have cash to pay taxes. Only risk is that you have to have cash to buy the homes and rent generation.

But for someone else? Leveraging 5x the amount invested in RE seems risky. There has to be a catch or everyone would do it.

Question - how do you qualify? I was told my DH and I wouldn't qualify with our income buying rental property. Let's say we have $200k on $1m in properties to leverage (and this is real because we're looking into it) I was told we wouldn't qualify from B of A. Even with our assets backing the rest.

They want to see us be able to carry the investment and we could but they deemed it too much risk. How do these hypothetical situations all happen?

I don't get how people keep qualifying for mortgage after mortgage after mortgage on rental properties with far less assets and far less income. I'm not joking but I don't know where you find these lenders.

Leveraging 5X is actually quite conservative to me: You have 20% equity in every home right off the bat. That gives you a LOT of downside cushion in the event of a downturn. Bank of America isn't the place to go for local investing. They are in the consumer loan and banking business, as well as Fortune 500 banking. That includes the other nationals...Citi, Wells, etc. The local officers in your hometown barely have authority to issue you a $500 cashier's check, much less finance local investment real estate.

You need a relationship with a LOCAL bank for local investing.

[prosper]

Hello SA friends,

3 months after moving (and after dedicating 7 years to this employer and being told I was one of the key leaders of the future) I was laid off.

I understand this all too well. It sucks, but it really pushes you in the direction of controlling your own destiny.

[TexasHusker]

I understand this all too well. It sucks, but it really pushes you in the direction of controlling your own destiny.

Something my granddad told me once:

"You'll never be worth more to a company than you are to yourself."

Five years from now, you may well be sending your former company a dozen roses for setting you afloat...