Is it wise to turn my house into a rental property?

[MapsandMeanings]

So I blindly bought my first house in 2008 not doing any homework and just jumping into things. We live in an area/state that we don't necessarily want to stay in and since we want to learn how to invest in real estate and properties, we though about making our current house our first.

Now I'm totally new to this but I would imagine the equity we would pull from the house can then be used to duplicate and get another property etc.

Anyone every started with their own home as basically their first investment property?

Thanks for the advice.

 

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[Sauce]

A lot of folks do this, they call it "house hacking" (do a search on google or biggerpockets).

It could be a great thing or a terrible thing. It really depends on what your numbers are and if you have the personality to be a landlord.

If you can provide some additional information (I.E. Purchase Price, Expected Rent, Mortgage Pmt, etc) we can give you a better answer.

 

[MapsandMeanings]

A lot of folks do this, they call it "house hacking" (do a search on google or biggerpockets).

It could be a great thing or a terrible thing. It really depends on what your numbers are and if you have the personality to be a landlord.

If you can provide some additional information (I.E. Purchase Price, Expected Rent, Mortgage Pmt, etc) we can give you a better answer.

Thanks for the reply. So we purchased the house for 308,000. The expected rent from research could be anywhere between 2500-2700 and the mortgage payment would be roughly 2200.

Thanks for the advice.

 

[CareCPA]

I don't think the numbers will work out for you if you want it to be cash flow positive.
Let's assume worst-case scenario since I don't know your location:
$2,500 rent
-10 % management
-10% Capex reserve
-5% Vacancy (this is less than a month a year)
-2,200 Debt service

This would put you at $(325) each month, so you'd be paying out just under $4,000 a year.

Some people try to make the argument that even though you're losing money, you're gaining equity and appreciation. I don't bank on my houses appreciating (or even necessarily maintaining their value), I count on cash flow.

 

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[MapsandMeanings]

I don't think the numbers will work out for you if you want it to be cash flow positive.
Let's assume worst-case scenario since I don't know your location:
$2,500 rent
-10 % management
-10% Capex reserve
-5% Vacancy (this is less than a month a year)
-2,200 Debt service

This would put you at $(325) each month, so you'd be paying out just under $4,000 a year.

Some people try to make the argument that even though you're losing money, you're gaining equity and appreciation. I don't bank on my houses appreciating (or even necessarily maintaining their value), I count on cash flow.

Thanks for the reply. My location is South Florida.

So yes I have heard people that exact statement that your gaining equity and appreciation. I agree that the numbers don't amount to positive cash flow.

With that said and given I'm new to this, what is an example of cash flow positive? What does that look like and where is the best place to education myself?

Thank you for the advice.

 

[Jon L]

Thanks for the reply. My location is South Florida.

So yes I have heard people that exact statement that your gaining equity and appreciation. I agree that the numbers don't amount to positive cash flow.

With that said and given I'm new to this, what is an example of cash flow positive? What does that look like and where is the best place to education myself?

Thank you for the advice.

positive cash flow means that the money you pay out in a year is less than the money you take in during the same time period. (include the mortgage in that calculation)

If you plan on keeping the house for an extended period of time, you should include charges for long-term maintenance items like the roof, water heater, central air, etc. Perhaps tack on an additional $300/month for those items and put it in a separate account. That amount (whatever amount is reasonable for your house) would be on the 'expenses' side of the cash flow equation.

You should also include some calculation for vacancy - on average, it won't be rented for every month of the year.

 

[MapsandMeanings]

positive cash flow means that the money you pay out in a year is less than the money you take in during the same time period. (include the mortgage in that calculation)

If you plan on keeping the house for an extended period of time, you should include charges for long-term maintenance items like the roof, water heater, central air, etc. Perhaps tack on an additional $300/month for those items and put it in a separate account. That amount (whatever amount is reasonable for your house) would be on the 'expenses' side of the cash flow equation.

You should also include some calculation for vacancy - on average, it won't be rented for every month of the year.

Thanks Jon. So given this scenario, it's not really a benefit to be doing this on property that I currently own. With that said, to obtain positive cash flow, then I should search for smaller properties? Perhaps town homes/condos?

My co-worker invests in town homes in my area. However, she said some of them make her positive cash flow a month and others even out. But of course she then states that she is building equity etc.

Maybe 4 bedroom houses aren't the right type of properties for cash flow.

 

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[CareCPA]

Thanks Jon. So given this scenario, it's not really a benefit to be doing this on property that I currently own. With that said, to obtain positive cash flow, then I should search for smaller properties? Perhaps town homes/condos?

My co-worker invests in town homes in my area. However, she said some of them make her positive cash flow a month and others even out. But of course she then states that she is building equity etc.

Maybe 4 bedroom houses aren't the right type of properties for cash flow.

Check Biggerpockets.com for good real estate advice.
With townhouses and Condos, make sure the HOA fees don't kill your returns.

I'll try to pull together an example from my portfolio tonight, if no one else chimes in. Some general advice from Bigger Pockets is to start with the 1% rule and dig in further from there for actual numbers. For example, if your house is worth $300k, and you can get $3k a month in rent, then it would be worth digging into actual numbers (taxes, insurance, etc) to see if it makes financial sense.
I (naively?) assumed your $2,200 above include escrow amounts for taxes and insurance. If not, factor these in as well.

 

[Sauce]

My philosophy is invest for cashflow first, then if you get appreciation, it is like icing on the cake! Take a look at biggerpockets if you want to get some more education.

 

[Sauce]

Check Biggerpockets.com for good real estate advice.
With townhouses and Condos, make sure the HOA fees don't kill your returns.

I'll try to pull together an example from my portfolio tonight, if no one else chimes in. Some general advice from Bigger Pockets is to start with the 1% rule and dig in further from there for actual numbers. For example, if your house is worth $300k, and you can get $3k a month in rent, then it would be worth digging into actual numbers (taxes, insurance, etc) to see if it makes financial sense.
I (naively?) assumed your $2,200 above include escrow amounts for taxes and insurance. If not, factor these in as well.

I have a condo, the numbers are as follows:

Rent: $835
Mortgage $225
HOA: $175 (ouch!)

HOA's are a two edged sword. Mine covers everything from the sheetrock out, including plumbing, water heater, HVAC, landscaping, parking lots etc.

The downside is, they can give you a special assessment. For example, if you need to resurface the parking lot, and there aren't enough funds to cover it in the HOA reserves, they can assess all of the residents to get the money.

Additionally, they can raise the HOA fees at any point in time.

Mine is a $0 money down deal and has turned out to perform marginally. Lots of good food for thought.

 

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[MapsandMeanings]

Check Biggerpockets.com for good real estate advice.
With townhouses and Condos, make sure the HOA fees don't kill your returns.

I'll try to pull together an example from my portfolio tonight, if no one else chimes in. Some general advice from Bigger Pockets is to start with the 1% rule and dig in further from there for actual numbers. For example, if your house is worth $300k, and you can get $3k a month in rent, then it would be worth digging into actual numbers (taxes, insurance, etc) to see if it makes financial sense.
I (naively?) assumed your $2,200 above include escrow amounts for taxes and insurance. If not, factor these in as well.

Thanks for the tips. Yes I would love an example if you don't mind!

 

[Chazmania]

Also borrowing out is only an option if it's owner occupied. Used to be much easier to scale up real estate but that all changed after 2008.

 

[CareCPA]

Actual numbers:
I bought 2 houses for $60,000 total in 2014. Have about $5k into rehab on each. All numbers below are 2016 numbers for the two combined.

Rent: $1,425/ month
Prop Mgmt: (114.00)
Mortgage: (298.83)
Total: 1012.17/ month or $12,146.04/ year

12,146.04/ Year
( 800.00) Insurance (rounded)
(2,600.00) R/E Taxes (rounded)
(4,359.00) Repairs (heavy turnover repairs needed)
4,387.04 Cash flow - annual

I consider these ok. The reason being they are in a C class neighborhood, so repairs are higher, wear and tear are higher, and vacancy is longer. I lucked out in 2016 with no vacancy, but I've had 2 months between tenants before, I've had tenants not pay for three months and just pay enough to keep the eviction process from finalizing, etc. Tenant placement fee will also take a full month's rent every time a new tenant gets put in.

This is after having about $25k in cash invested in closing costs/downpayment/rehab. I do not consider this a short-term strategy (the long-term goal is to 1031 these into better properties once I have some equity).

Long story short, these satisfy the 2% rule, and I still don't consider them a good return when I look at the amount of stress they cause me (yes, even with property management).

 

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[Fortune5ive]

I'm sorta confused. I know we want a return on our investments but the idea of having someone else pay off your mortgage over time and not you seems like a great idea to me.

 

[MapsandMeanings]

I'm sorta confused. I know we want a return on our investments but the idea of having someone else pay off your mortgage over time and not you seems like a great idea to me.

Great question as I have always thought the same to be honest with you.

My Uncle in New York has invested in apartment buildings for years in Queens and the Bronx. He said he never had to put down his own money for it and is about to sell one for millions. Obviously, I'm going to be talking to him more about it. Just curious as to everyone's thoughts on that.

 

[Fortune5ive]

That's what I'm saying. To me...the return is me not having to use my money to pay off my property.

 

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[MapsandMeanings]

That's what I'm saying. To me...the return is me not having to use my money to pay off my property.

Can anyone give us some insight and advice on this please?

 

[MidwestLandlord]

I'm sorta confused. I know we want a return on our investments but the idea of having someone else pay off your mortgage over time and not you seems like a great idea to me.

Great question as I have always thought the same to be honest with you.

It is a great idea. Someone wakes up in the morning and goes to work so they can buy you a house. It's amazing.

However,

Counting on equity returns (the mortgage getting paid), instead of cash returns (positive cash flow), are bets where time is against you.

Will the property appreciate over time? Maybe.
Will the property depreciate over time? Maybe.

So what will the equity in the home look like in 15-30 years? No way to know.

Will you have major expenses over time that require cash outlays? YES.
Will you have vacancies over time that require you to foot the bill? YES.

Will you need cash over the next 15-30 years? YES.

Needing cash is guaranteed, an equity return is not.

Do you have the cash to buy a new furnace?
Meet your insurance deductible?
New roof?
New water main?
Foundation issue?
Siding?
Windows?
Long term vacancy?
Significant reduction in what you can rent it out for?
Tax increase?
Insurance rate increase?

I firmly believe that most landlords that get in trouble financially do so because they treat it like an investment (equity return), and not a business (cash return)

No business will last long with a negative cash flow.

Also,

With vacancy...it's been my experience that most vacancies happen at once.

Recent example: I went 5 years in a condo with no vacancy. Then, I had a 4 month vacancy. That was 4 months where I had to meet the property's obligations with no incoming cash flow. That's only a 6.7% average vacancy rate (good), but it happened all at once. Big expense!

 

[MapsandMeanings]

Counting on equity returns (the mortgage getting paid), instead of cash returns (positive cash flow), are bets where time is against you.

Great post. So at the end of the day it's switching the mindset from equity returns to cash returns. I'm starting to see that now.

 

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[MidwestLandlord]

Great post. So at the end of the day it's switching the mindset from equity returns to cash returns. I'm starting to see that now.

At the end of the day it's understanding that a rental is a business, and should be operated accordingly.

A rental is an income generating asset.

Let's say Coke buys a new bottling plant. That is an income producing asset. Likely it has a liability attached to it (bank note). Doubtful Coke would pay cash for it.

Do you think Coke would be OK with only producing enough income from that machine to pay the bank note, but not have a cash return?

 

[CareCPA]

Plus, no matter what the IRS thinks, rental real estate is not a passive activity. If I'm going to be active in something, I want true returns, not just a hope for a return after 30 years.

 

[MapsandMeanings]

At the end of the day it's understanding that a rental is a business, and should be operated accordingly.

Makes perfect sense. Like everyone else in the world I sell on Amazon and I must make sure that I'm not only getting sales but making healthy returns. You can have sales all day long and just even out. I get it now for sure!

Any advice on how to education myself on the leveraging of financials for when looking at real estate?

 

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[MidwestLandlord]

Plus, not matter what the IRS thinks, rental real estate is not a passive activity. If I'm going to be active in something, I want true returns, not just a hope for a return after 30 years.

It's super passive until you have 5 units or more on one property, then suddenly it's a business and not passive anymore lol (sarcasm obviously)

 

[MidwestLandlord]

Makes perfect sense. Like everyone else in the world I sell on Amazon and I must make sure that I'm not only getting sales but making healthy returns. You can have sales all day long and just even out. I get it now for sure!

Any advice on how to education myself on the leveraging of financials for when looking at real estate?

biggerpockets.com
Anything here written by @JScott (his flipping book is awesome)
Anything here written by @SteveO

 

[Thoelk]

I firmly believe that most landlords that get in trouble financially do so because they treat it like an investment (equity return), and not a business (cash return)

This whole post + thread is becoming gold!
Midwest you've summed up my recent dilemma perfectly!

I've investigated to see if I could keep my current house and rent it out. Looking at it from an investment point-of-view, it made totally sense... But luckily I also calculated it from a business point-of-view... And we decided to drop it & just take the cash... Even though the bank was pushing us to go for it...

I'll use my cash & stress on something else...

 

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[MidwestLandlord]

Makes perfect sense. Like everyone else in the world I sell on Amazon and I must make sure that I'm not only getting sales but making healthy returns. You can have sales all day long and just even out. I get it now for sure!

Any advice on how to education myself on the leveraging of financials for when looking at real estate?

Exactly.

And with a rental, your product is living space for a day/month/year/whatever.

That's a perishable product for sure. If you don't have someone paying you to sleep there TONIGHT, you can't go back in time and sell that night again. It's gone. (this is why hotel's damn near give away rooms later in the day...their product is about to go bad!)

But tonight's expenses are still there lol.

 

[Thoelk]

Exactly.

And with a rental, your product is living space for a day/month/year/whatever.

That's a perishable product for sure. If you don't have someone paying you to sleep there TONIGHT, you can't go back in time and sell that night again. It's gone. (this is why hotel's damn near give away rooms later in the day...their product is about to go bad!)

But tonight's expenses are still there lol.

Might be that I missed it, but this is a discussion that's always live on RE. Are you into/prefer houses/flats/commercial?
Recently I've heard someone talking about investing in woods and/or farm-grounds, because they are becoming scarse...

 

[MidwestLandlord]

Might be that I missed it, but this is a discussion that's always live on RE. Are you into/prefer houses/flats/commercial?
Recently I've heard someone talking about investing in woods and/or farm-grounds, because they are becoming scarse...

I own 4 single family homes, 1 condo ("flat" for you European's haha), and 3 commercial rentals (technically 20 commercial properties, but 17 of them we rent to my and my biz partner's B&M stores)

I have no idea about farm lands and such.

I made huge mistakes in the buying process on these rentals (@JScott set me straight on this when I first joined the forum cause he's awesome like that), so I'm not the best one to ask about what to buy lol.

When I talk about having proper cash flow, I speak from experience. I've made these mistakes many times.

 

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[CareCPA]

Might be that I missed it, but this is a discussion that's always live on RE. Are you into/prefer houses/flats/commercial?
Recently I've heard someone talking about investing in woods and/or farm-grounds, because they are becoming scarse...

What's your business plan?
1. Hope for appreciation? (i.e. gamble while paying property taxes)
2. Timber? (usually low returns)
3. Rent out the farmland to a farmer? (usually very low $/acre)

Don't get me wrong, you can make some great returns, but don't just go buy some land because people are saying it's scarce. You still have to do full due diligence.

 

[Thoelk]

What's your business plan?
1. Hope for appreciation? (i.e. gamble while paying property taxes)
2. Timber? (usually low returns)
3. Rent out the farmland to a farmer? (usually very low $/acre)

Don't get me wrong, you can make some great returns, but don't just go buy some land because people are saying it's scarce. You still have to do full due diligence.

I have no intention to just do that, but thanks for the warning! It's just that I got swamped lately in RL and on some FB-groups about these 'experts', saying that you should invest in them.

The house we own now was actually bought with renting it out in mind already... It's only now, when the time is there to decide, that the numbers don't add up the way we want it (investment vs. business). My perception nowadays is that you're better of with commercial properties. Rules (atleast here) are more in favor of both parties, compared to private properties.