Duplex as a rental property.

So, I'm sure this has been covered ad infinitum but I'm considering spending a largish amount of money and want someone to hold my hand and tell me if it's a good idea or not.

Duplex two doors up the street from me is about to go on sale.  The owner will give me first shot at buying it.  It's an all brick, nicely renovated 1960's ranch on a walk-out basement above the flood plane for about 150K.  One tenant who will stay paying $700 rent and I have a solid guy lined up to rent the unit currently occupied by the owner.  Owner is selling out due to personal issues requiring him to move back to California.  

So what is my best way to buy it (and should I)?  I have a mortgage on my house with roughly 60K in equity.  But when I bought 8 years ago, rates were as good as ever in history and I'm locked in at 2.5% and I'd hate to refinance to pull cash out and screw my interest rate (currently not a terrible 3.5 but still...)

Rental property mortagages require 20% down and I don't have 30K laying around.  I could give myself a loan from my retirement account at no interest if necessary but it's not my favorite thing to do.  Tiger Mom is not on my mortgage and could potentially get the loan under her name qualifying it for more traditional terms and only require 5% down but that would mean carrying mortgage insurance.

What would the hive do?  I like the idea of setting up something that is a positive cash flow and $400 a month on the side would be nice (properly banking it for a year against repairs and emergencies) but what is the smartest way to finance such a thing?

In general, now is not a great time to be buying rental property. Home values are so high that the rents don't often equal enough to make it worth the hassle of landlording.

The 2 biggest "quick and dirty" rules in real estate math are the 1% rule and the 50% rule. Educate yourself on both. The general idea is that your rental should pay for itself, including it's own maintenance and upkeep and on top of that you should make a little money for your effort too. What you'll find is that simply covering the mortgage plus a little extra might not actually math out to be a money maker over the long term. A property that meets the 1% rule usually works out to a profit of about $100 per month per unit after all expenses. That means that paying $150k for a place that generates $1400/mo in rent might actually cost you money long term. That might be ok if you were confident that the property would really appreciate in value, but I'm not sure how likely that is in your location, and hedging your bets and hoping for the property to magically be worth more one day is a recipe for losing money on an asset that you've invested a lot in. You don't want this to underperform is what I'm saying.

If the plan is long term ownership, you're going to have to spend money at some point on expensive things like a roof, flooring, a water heater, etc. A $10k roof can offset a lot of monthly rental profit. A $700 water heater or new fridge can too. And then there's the more frequent little things like electrical/plumbing fixtures or paint. You need to be saving a portion of the rent each month to put into it's own account earmarked for these things. If anything big will need money soon, then you'll want to have those funds in addition to your downpayment because it will take awhile for the rental funds to build up any significant money in your maintenance account.

Here's a decent rental property calculator.

I plugged in your numbers: $150k purchase price/30k down + 5k closing/1400 rent

I guessed on taxes and insurance of 1500 and 1000 annually

Conservative estimates of 8% for vacancy, 10% for management, and 10% towards maintenance (I also eliminated the $350 annual rent insurance that defaults in the calculator) got me a monthly profit of...$1.31 for a rate of return of...0.04% on your $35k up front investment.

You'll have a better idea of cost for things like taxes, insurance, and closing costs specific to that exact property but those would have to be really low to make it a decent investment. Get the price down as low as you can, or raise the rent if it's currently below market and the numbers might get a little better. Play around with the calculator to see what kind of impact downpayment, interest rate, or slightly higher rents can have and it might be an eye opener.

But keep in mind that same cash that you'd be using for the downpayment here could sit in an index fund and probably get about 8% of a 30 year time frame (same length as a typical mortgage) and it takes no work.

In reply to STM317 :

I spoke with a mortgage guy yesterday about what I could expect and If I did 20% down my MEI payment would be $750.  Paying myself back $250 a month makes it $1000.  I'd manage it myself and as a professional handyman maintenance costs should be pretty darned low.

It isn't a fantastic deal I do know that, and rents would be going up over the next few years (maybe write the lease so that rent increases $50 a year) 

Chiming in to say "Do the math."  The situation sounds ideal as you'd have the units rented going in.  Figure your mortgage payment and see if it's less than the sum of the rents, plus some extra money for repairs/upkeep/surprises. 

KyAllroad (Jeremy) said:

Tiger Mom is not on my mortgage and could potentially get the loan under her name qualifying it for more traditional terms and only require 5% down but that would mean carrying mortgage insurance.

She could...But she would also likely be engaging in fraud if she did.

The more legal option would be a home equity loan or home equity line of credit on your current home. Although you'd want to find out the actual interest rates for your situation, as total loan-to-value can impact what the banks will actually do for you vs what they're advertising, and then do the math to see how this compares to a cashout refi.

I'm only a small-time landlord but I'm hoping to grow that.

One piece of advice a friend who is also a landlord gave me about multi-unit rentals: "The bad renters tend to drive away the good ones" You've got to ensure that you have decent tenants for both units and not be afraid to get rid of questionable ones.

KyAllroad (Jeremy) said:

In reply to STM317 :

I spoke with a mortgage guy yesterday about what I could expect and If I did 20% down my MEI payment would be $750.  Paying myself back $250 a month makes it $1000.  I'd manage it myself and as a professional handyman maintenance costs should be pretty darned low.

It isn't a fantastic deal I do know that, and rents would be going up over the next few years (maybe write the lease so that rent increases $50 a year) 

Nothing wrong with self managing, and Im sure you've got the skills to do just that. Just be aware that not accounting for any management fee in your math assigns no value to your time spent managing, and doesn't account for the costs associated with things like driving to/from the property or making trips to the hardware store for supplies, etc. Self managing is work, and by not accounting for a management fee, you're basically agreeing to do that work for free; to deal with the late night phone calls, or have your vacation interrupted, for free. Most serious real estate investors will include that in their math even if they self manage, and they can then choose to either pay themselves that 10% for dealing with the hassles of landlording, or pay somebody else to deal with the hassles. 

Youre talking about a 20-30k investment that you're likely planning on being tied to for decades. It  can have serious negative ramifications for you if it goes poorly. I'd suggest you be cautious when doing the calculations rather than risk being overly optimistic. You might miss out on some marginal deals by being conservative with your math, but It keeps you from getting burned. And if it takes self managing for free, and having really low maintenance costs for the math to barely squeak by, is that really what you want to do with your fairly large pile of money?

KyAllroad (Jeremy) said:

It isn't a fantastic deal I do know that, and rents would be going up over the next few years (maybe write the lease so that rent increases $50 a year) 

Are rents going to go up if the market flattens out and we have a recession? If enough people lose their jobs will you be able to find enough renters? Will you have to lower your rent to get them back? 

That's what I would be worried about. Just seems like you'd be cutting things super close and stressing about money would be an even bigger drag on your mind.

I had typed something and it dissapeared. 
 

Just some thoughts:

• Based on the numbers you mentioned I dont see you clearing $400/month anytime soon. 
   
• $50 increase on a $750/month rent is close to 7%. It will be difficult to find a tenant willing to go through that and stay year after year. If they leave, one month without a tenant will mess up your numbers big time.
   

I don't think this is one of those once in a lifetime opportunities. I would personally pass. 

My back of the napkin numbers don't make this work unless you're planning on moving into one of the units within a year or two.

If you move in to the unit the current owner lives in, I could see this working.

Beyond that, it's stretching the feasibility of it all.

The hard thing about rental property math is choosing what to include. ie - do you include the principal portion of the mortgage as an expense? It's certainly a cash flow need, but technically that is paying yourself so it may or may not be a real 'expense'. Similarly do you account for any taxes in the math? Both annual income (and therefore the depreciation you may be able to claim on the house) and also on any capital gains if the house appreciates and then you sell?

Do you count the REALLY high transactional fees of real estate? (ie its very cheap to buy and sell stock, but not so with property). 

I flop back and forth on owning rental property. But I do think some real diversification never hurt anyone. 

The best rentals are ones where you're either

A) making damn good money (50% rule)  or appreciation is super high or

B) the renter is helping pay for, but not a burden on, land or property you want to utilize yourself (a $2000 mortgage on a beautiful property with a renter in a MIL Suite paying $1000).

If someone were offering me a good deal on a duplex I'd be looking around at the going rate for similar properties. If I was offered such a deal that I could potentially immediately flip the house for profit, I would consider it. At market rate? Forget it. 

Two things:

1) With risk comes reward.

2) A lot of really wealthy people made a lot of money buying real estate.

STM317 said:

But keep in mind that same cash that you'd be using for the downpayment here could sit in an index fund and probably get about 8% of a 30 year time frame (same length as a typical mortgage) and it takes no work.

I dabble in looking at property and have a rental unit with a friend. If the basic capitalization rate doesn’t work out to 12% or higher we don’t even bother thinking about taking the risk of property ownership. 

Why make all this effort to barely do better than an index fund? Buying and selling property isn’t cheap or easy. 

Quick and dirty numbers for value on just about anything that is supposed to generate positive cash flow.

Take your annual gross rents and subtract 41%. That magic number does a good job covering all your expenses from taxes and ins to vacancy and management.

Divide the 59% that is left by the capitalization rate for your area and you have a really good idea what an MAI appraiser is going to come back with for a value.

Ex ample

100K gross

59K left after subtracting the 41%

Divide 59000 by  .12 (12% cap rate)

Building is worth $491,666

Lower the Cap rate, the higher the value.

The issue is knowing the Cap rate.  It is very local. Find out what things are selling for and back into the number or see what people in the market claim they are seeing.

Example from above, Andy Neuman works with 12%, that is a dream number where I am in St Pete/Clw, Fl. People will accept a lower return(lower Cap rate) the more desirable or secure the investment. I have an 18 unit in St Pete Beach that I could offer with a 5.5% cap rate and sell it in a week.  The average cap rate that I've heard people aim for is 9%.  There are a lot of variables, the more of them you can lock down the better you deal.

I might let the guy try to sell it for a couple months and be ready to swoop in when it doesn't move.  If it gets away, you still learned something crunching the numbers.

This IS one of the best ways to buy property. Death, Divorce or Transfer.

In reply to jgrewe :

True 12% is a slumlord number. Most of the properties that work out to be high 10-20% need some type of major repair immediately reducing the actual rate. 

2 doors up the street? I think I'd pass unless it was a killer deal. I used to live on-site of the apt building I managed. Residents didn't seem to understand that 7PM on a Friday in my unit, is NOT my business hours and not my office. Do you really want your tenant to see when you leave and come home and what you buy etc? What happens when you need to evict a renter and they know your schedule and where you live and what cars you drive etc? 

At today's rates, mortgage is probably $900-1000 with 20% down. If borrowing down payment, probably more like $1,200. Only $1,400 in revenue, BEFORE vacancies, repairs, and capital expenses. 

From what I've seen, duplexes tend to be harder to sell, so if it doesn't work out, you may have it sitting empty for several months while trying to sell it.

House from 60s may have asbestos, lead paint, lead pipes, AL wiring, etc. And may also require updating to be able to keep leasing. Also has 2 units, so 2 furnaces to possibly die simultaneously, 2 stoves, fridges, HWT, etc.

Yeah, I wouldn't do it unless I could buy for 160 and then immediately flip it for 200 and take the 20k after taxes and fees and run.

Thanks all, I think I'm gonna pass on this one.  Just not enough juice for the squeeze.

On the other hand, a co-worker who recently repatriated to the states has been looking for an owner-occupied duplex so I'll point him in that direction.

One last comment. My friends father has a few rental properties and is a general contractor. He does all the repairs himself, but he outsourced rent collection and tenant control. The repairs he could handle, dealing with the actual tenants he could not. 

KyAllroad (Jeremy) said:

Thanks all, I think I'm gonna pass on this one.  Just not enough juice for the squeeze.

On the other hand, a co-worker who recently repatriated to the states has been looking for an owner-occupied duplex so I'll point him in that direction.

Yeah. I wish I would done that back in '09 when I bought my house in Sand Springs. Buy a duplex I can easily afford, rent out the other side, make double or triple payments on a 15 year note. Buy another duplex to live in, since the other is now paid for find another renter, now I can make quadruple or quintuple payments on a 15 year note. 

And now at 37, I'd probably have quite a few rental properties. 

But no desire to futz with any of that now.

Andy Neuman said:

The repairs he could handle, dealing with the actual tenants he could not. 

And that's pretty much the reason I paid a rental agency when I owned a rental property.

If you go ahead and execute this plan, in four years you will have gained an education on how it all works. Or did not work. You might have more money in the bank or you might have a bit less. I doubt it will ruin you. Education can be expensive and what you do with the education moving forward is the important bit.

Pete