Friday, May 7, 2010

Twenty Seventh Bag Of Mail: Buying Bigger

"Kelly,

I've got a question. Or more like... I'm seeking advice.

First let me give you some background. Jeremy and I currently own one rental property as well as our current home. Right now we're saving up to buy another rental property. Ideally we'd like to purchase a property every year or two until we've got a nice little rental empire.

We would like to invest in a property like Liz's house (that you just commented on). It is an ideal kind of investment property for us (little to no renovations needed, cosmetic work only) and we'll probably buy her home if she decides to sell in a year.

But I also have my eye on duplexes. There are some really cute historical duplexes around my neighborhood and one is for sale on my street for nearly twice the price of Liz's home. This is currently outside our budget, but I think we may get a higher return on investment by getting two properties in one. However, it would take longer to save.

So I guess I'm just curious about your thoughts on this. Would you recommend buying sooner to get things going, or saving up a little longer to get a duplex?

Thanks!

Kathleen, Jeremy & Kathleen"


There's no right answer, based on the information you provided, though I'm flattered that you'd be curious about my opinion. The most important question to ask yourself is, what is the cash flow?

In other words, how much is the rent versus what your mortgage payments will be? I never recommend purchasing something that's not at least a break even from the get go (including taxes, insurance, and maintenance). As long as you can afford to hold a property, though, it's really up to you how much risk you're comfortable with taking. It may seem that the duplex is higher risk in your scenario since it's a higher purchase price. However, having the option of two tenants gives you more security that you'll be able to cover your holding costs -- therefore resulting in less risk.

Right now we're in a once in a lifetime market with mortgage rates and purchase prices shockingly low. It seems to make the most sense to grab whatever you can afford at the moment (the FHA loans are ridiculous), but on the flip side you must be prepared to hold it for a significant amount of time. So it really has a lot to do with your personal agenda over the next decade or two.

Without having an understanding of your micro-market, I agree that Liz's home sounds like an excellent possibility as a rental for you. You're familiar with the neighborhood, it's convenient, and it's in great condition. Too often people assume that foreclosures covered in feces are the best deals around, and it's simply not always the case. Also, if there are no Realtors involved it should help save you both a good chunk of change in transactional fees.

In terms of comparing future profit from the sale of the properties, it's impossible to tell which might be the better investment. A lot of it is relative to the standards of your community so I'd research past comparable sales if I were you. I'd also take a look at what's currently for sale and how long those properties have been sitting on the market. Traditionally in recessions single family homes will retain their values longer and continue to sell faster than condominiums or multi-families. However, if Liz's home is surrounded by those types of properties, anyway, it might not make much of a difference.

Another idea to throw into the mix is the option of converting a duplex. Depending on the zoning of the properties that you're looking at, it may make sense for you to sell each unit separately down the road as a townhouse or condo. Obviously, this works better in times of economic growth, but it's an idea to keep in mind that, depending on your area, could significantly increase your return.

Also, I'm assuming that you will not be moving into the next rental property that you buy? You may have already experienced this with your first rental property, but keep in mind that this will limit your options in terms of financing and holding costs. It's always best to live in a new purchase for a period of time, if possible. I plan to delve further into this topic on the blog soon. Also, you'll eventually want to make sure that you have an accountant that specializes in real estate and familiarize yourself with tax laws and closing fees.

I hope my longwinded response offers at least a tad bit of insight?

Basically, if it were me, (assuming that all of the properties are located in or about the same neighborhood) the most important thing I'd be looking at is which property will make the most money at the closing table? In other words, which property is being sold farthest below the comps? And of course, secondly, what is the cash flow?

Also, not that you asked, but I want to add that I think that you're making a great move by taking advantage of the market and timing your purchases a year or two apart. You also have the added benefit of being located in a reasonably priced somewhat steady midwestern market (as opposed to the volatility of coastal regions), and you're planning long term. I think there are a lot of things that you're doing exactly right. Very exciting stuff, especially for those of us who regularly stalk your blog.


p.s. You might also find this and this post helpful.

2 comments:

J and K said...

Thanks again for such a thorough response. While I was considering the income advantages of renting a duplex I wasn't really considering the resale value in the long run.

I discussed it with Jeremy and we both agreed that we need to buy what we can afford (within our priorities - location and quality) as soon as we have 20% down in cash saved to put down on a place. This most likely means we would be investing in a single-family dwelling. But it also means we can start looking and investing sooner rather than later.

Mrs. D said...

I browsed through and your pics are gorgeous! I wish you'd come re-do our house, I need the help, lol.