Please Advise How Newbie Start Out Based on My Situation

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Please Advise How Newbie Start Out Based on My Situation

Emma Chen
Investor · San Diego, CA · Member since 2013 · 87 posts · 17 votes

Hello all,

This is Emma greeting from San Diego, California. I recently graduated from my MBA program and currently work on the acquisitions team in a real estate company. I have been listening to the Biggerpockets podcasts for a month and found it very very helpful.

My boyfriend and I are considering starting out real estate investment. We can a couple ideas, please advise based on our situation.

We bought our first property (townhouse 2br/2bth) for living in Nov. 2012 for $300k with 3.5% intereste rate and it has appreciated to be around $350k now.

We have $40k cash on hand and can withdraw $50k more from 401K account without penalty. We both have jobs with total monthly income of $6k after tax.

Here are options we have in mind (please don't laugh:)

Option 1. We can use all cash we have as down payment to buy a 2-3 bedroom single family and rent it out. Use the rent to pay off mortgage for the single family.

Option 2. We take out second loan on our current property to buy another small apartment/condo 1 br/bt to live in and rent out the current 2br/bt townhouse.

Option 3. We sell the property we have and make some money ($50k), and then put all our cash together as down payment to buy a duplex. We live one of it and rent out the other.

4. Use 1031 exchange, which I don’t know how it works, we "trade in" the current property plus our cash for a duplex. In this case, we can avoid some transaction tax I guess. I will do more research on 1031 exchange.

Please please let me know what you think. What you would if you were us.

All suggestions and critics will be highly appreciated.

Thank You

Emma Chen

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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
12y

Hi Emma,

Only a percentage of your property would qualify as property held for rental if you rented out the guest room. You would need to move out of the property and convert the entire property into a rental property if you want the entire property to qualify as held for rental. If it was me, because I'm more conservative, I would rent it for at least 18 months in order to demonstrate that you did in fact have the intent to hold for rental.

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  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    12y

    Hi Emma,

    Welcome to Bigger Pockets!

    I wanted to comment quickly on your 4th option. 1031 Exchanges only apply to properties held for rental, investment or use in a business. They do not apply to a primary residence, second home or vacation property used for personal vacations.

    You could convert the primary residence to rental property and after a seasoning period (holding period) you would qualify for 1031 Exchange treatment. Generally, advisors recommend a holding period of 12 to 24 months in order to demonstrate that you did in fact have the INTENT to hold for rental purposes. The key issue is that you must have the INTENT to HOLD for rental, investment or business use.

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  • Emma Chen
    OP
    Investor · San Diego, CA · Member since 2013 · 87 posts · 17 votes
    12y

    Thank you! Bill.

    We have held this property for 13 months. How can I demonstrate that I have the INTENT to hold this property for rental? Should I rent the guest room out? Or should I move to a condo and rent the whole townhouse out?

    0Reply
  • Dawn AnastasiPro Member
    Rental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votes
    12y

    Are you going to be investing in the area you live in?

    Will you be landlords yourself or will you hire a property manager?

    What are rents like in the area you live in?

    If you take $50k out of your 401(k), is that truly a withdrawal or are you going to do a loan? If you take an early withdrawal, you can be subject to taxes and penalties.

    Podcast Guest on Show #29
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  • Cuong Le
    Investor · Houston, TX · Member since 2013 · 228 posts · 30 votes
    12y

    Hi @Emma Chen and welcome to BP! One of the best reasons why real estate is so awesome is that ability to leverage money. While options 1-3 will get you in the game, it will take you a bit longer to obtain the next property. I'd save that money and look into private lenders (it could be friends and family) or hard money. Here's an article that you can start with relating to hard money from Brandon Turner.

    I think it also will be difficult to show intent on your first property as a rental so don't think you can go with option 4. Glad you guys joined and hope to see you around.

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  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    12y

    Hi Emma,

    Only a percentage of your property would qualify as property held for rental if you rented out the guest room. You would need to move out of the property and convert the entire property into a rental property if you want the entire property to qualify as held for rental. If it was me, because I'm more conservative, I would rent it for at least 18 months in order to demonstrate that you did in fact have the intent to hold for rental.

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
    WebsiteView Page
    1Reply
  • Emma Chen
    OP
    Investor · San Diego, CA · Member since 2013 · 87 posts · 17 votes
    12y

    @Bill Exeter

    0Reply
  • Emma Chen
    OP
    Investor · San Diego, CA · Member since 2013 · 87 posts · 17 votes
    12y

    @Cuong Le

    Good tips! Thanks. I will think about raising/borrowing money from family to get started.

    0Reply
  • Charles Morgan
    Investor · El Paso/Socorro, TX · Member since 2012 · 365 posts · 75 votes
    12y

    I like option 1+2. But that is my comfort zone. In fact what I have done to this point is buy a home, move into it and rent out the previous home. I then save for the next home. I am in my fourth home at this point and looking for my fifth. As I live in a home I try to improve it as if I were going to stay there, that way I can be pretty sure the future renters will also be comfortable there. (Don't over-improve though), remember it will become a rental.

    0Reply
  • Bret Lorenson
    Real Estate Investor · Lakeville, MN · Member since 2012 · 15 posts · 5 votes
    12y

    Emma, I think you need to look at 2 goals. Your long term goals and your short term goals. Long term it sounds like you are thinking buy and hold rental properties, which is a great idea. But what are the rental rates vs. cost of houses / duplexes in San Diego? San Diego is a pricey market so I think you will find it hard to get properties that will produce any cash flow. If you buy a SFR for 300k and rents are only $1500-$2000 you will end up in negative cash flow situation. For your short term goals I would try to leverage your current position at the Real Estate company into helping you get some deals going. Maybe you can partner with your company on a rehab, wholesale deal, rental, or whatever your company specializes in.

    0Reply
  • Ali Boone
    Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes
    12y

    Welcome! I'm north of you, up in LA. Congrats on the MBA (after I got my Master's in engineering, I wished I had done the MBA instead) and congrats for knowing some good options for RE :)

    It's hard to say, I think at least, which of those is the best option, not knowing the exact numbers... like what you could buy other stuff for, how much you could rent things out, etc. In general, I'm a huge fan of leveraging as much as possible in order to buy as many properties as possible. The more properties, the more the tax benefits and income.

    San Diego is tough for rental properties. LA too. Prices are ridiculously high compared to what rents come in, so just be sure that you are really up on the anticipated returns you should get from any property (whether your existing one or new ones). Make sure it shows that you should profit, not lose, on whatever property you are looking at.

    0Reply
  • Emma Chen
    OP
    Investor · San Diego, CA · Member since 2013 · 87 posts · 17 votes
    12y
    Originally posted by @Bret Lorenson:
    Emma, I think you need to look at 2 goals. Your long term goals and your short term goals. Long term it sounds like you are thinking buy and hold rental properties, which is a great idea. But what are the rental rates vs. cost of houses / duplexes in San Diego? San Diego is a pricey market so I think you will find it hard to get properties that will produce any cash flow. If you buy a SFR for 300k and rents are only $1500-$2000 you will end up in negative cash flow situation. For your short term goals I would try to leverage your current position at the Real Estate company into helping you get some deals going. Maybe you can partner with your company on a rehab, wholesale deal, rental, or whatever your company specializes in.

    Thank you! @Bret Lorenson: my long term goal is to buy and hold rental properties. My short term goal is to get into the game first, buying my first investment property. I agree with your opinion about San Diego market and I am actually thinking about other less expensive markets in southern California . Good idea about partnering with someone, but, unfortunately, my company is specializing in multifamily and hotels.

    0Reply
  • Emma Chen
    OP
    Investor · San Diego, CA · Member since 2013 · 87 posts · 17 votes
    12y

    @Ali Boone I enjoyed my MBA program very much, but I wish I could have taken some real estate classes :). I am trying to catch up with my colleagues who graduated with Real Estate Master degrees. I am still doing market analysis to figure out which market/area will be ideal to start with. "leverage as much as I could" will be considered in my plan as well. Thank you.

    0Reply
  • Ali Boone
    Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes
    12y

    Nah, you can learn everything you need outside of college classes :)

    With whatever market you analyze, just make sure you will get positive cash flow each month out of a property there!

    Good luck.

    0Reply
  • Jose RubioPro Member
    Investor · Groveland, FL · Member since 2013 · 38 posts · 6 votes
    12y

    Welcome to BiggerPockets @Emma Chen !

    In regards to option 4 , selling your primary residence and using the profit to purchase another property, there is no need to use a 1031. You can sell your primary residence and make up to $250,000 in profit if you're a single owner, twice that if you're married, and not owe any capital gains taxes. One of the requirements is that You must live in that principal residence for two of the five years before you sell it.

    Hope this helps.

    0Reply
  • Emma Chen
    OP
    Investor · San Diego, CA · Member since 2013 · 87 posts · 17 votes
    12y
    Originally posted by @Jose Rubio:
    Welcome to BiggerPockets @Emma Chen !
    In regards to option 4 , selling your primary residence and using the profit to purchase another property, there is no need to use a 1031. You can sell your primary residence and make up to $250,000 in profit if you're a single owner, twice that if you're married, and not owe any capital gains taxes. One of the requirements is that You must live in that principal residence for two of the five years before you sell it.

    Hope this helps.

    Thank you! @Jose Rubio it's good to know. Live in for two of the five years? Does it mean that I have to hold the property at least for 5 years and live in for 2 years? Can I hold and live in the property for only 2 years and then sell it without paying capital gains taxes? Thanks.

    0Reply
  • Karen MargraveBusiness Member
    Moderator
    Realtor, General Contractor, and Developer · Redding, CA · Member since 2009 · 7k+ posts · 4k+ votes
    12y

    @Emma Chen I personally like Option 1, as it doesn't encumber your other property. Make sure you do your homework on neighborhoods, pricing, etc. Look at what is selling what that includes, quality of finishes, etc. so that you are comparing apples to apples. HOA fees on condos, etc. Mello Roos fees, etc.

    0Reply
  • Emma Chen
    OP
    Investor · San Diego, CA · Member since 2013 · 87 posts · 17 votes
    12y
    Originally posted by @Dawn Anastasi:
    Are you going to be investing in the area you live in?
    Will you be landlords yourself or will you hire a property manager?
    What are rents like in the area you live in?
    If you take $50k out of your 401(k), is that truly a withdrawal or are you going to do a loan? If you take an early withdrawal, you can be subject to taxes and penalties.

    Thank you for your questions. I am working on figuring out which area to invest in, probably somewhere within 3-hour driving from San Diego. At the beginning, I will be landlord myself in order to lower the cost. The $50K is not gunna be loan. I am positive about it.

    0Reply
  • Emma Chen
    OP
    Investor · San Diego, CA · Member since 2013 · 87 posts · 17 votes
    12y

    @Karen Margrave

    I appreciate your personal opinion. Will find out what "Mello Roos fees" is :)

    0Reply
  • Jose RubioPro Member
    Investor · Groveland, FL · Member since 2013 · 38 posts · 6 votes
    12y

    Live in for two of the five years? Does it mean that I have to hold the property at least for 5 years and live in for 2 years? Can I hold and live in the property for only 2 years and then sell it without paying capital gains taxes?

    Yes , you could literraly do this every two years... you only have to have made this your primary residence for at least two years.... another scenario... you could buy a second home, live in the other one, and sell this one within the five year period and still qualify for this exemption.

    0Reply
  • Emma Chen
    OP
    Investor · San Diego, CA · Member since 2013 · 87 posts · 17 votes
    12y
    Originally posted by @Jose Rubio:
    Live in for two of the five years? Does it mean that I have to hold the property at least for 5 years and live in for 2 years? Can I hold and live in the property for only 2 years and then sell it without paying capital gains taxes?


    Yes , you could literraly do this every two years... you only have to have made this your primary residence for at least two years.... another scenario... you could buy a second home, live in the other one, and sell this one within the five year period and still qualify for this exemption.

    @Jose Rubio

    Great! Thank you so much for explaining to me. I will keep it in my mind when plan for next step.

    0Reply
  • Karen MargraveBusiness Member
    Moderator
    Realtor, General Contractor, and Developer · Redding, CA · Member since 2009 · 7k+ posts · 4k+ votes
    12y

    @Emma Chen Mello Roos is a tax that is charged by certain municipalities for various improvements. Not all neighborhoods are subject to it.

    The point I was making is that when you are doing comps on properties, and costs of ownership, make sure you are comparing all of the costs, etc., such as taxes, HOA fees, etc., as well as the benefits, such as special amenities in neighborhoods, etc.

    1Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    12y
    Originally posted by @Jose Rubio:
    Live in for two of the five years? Does it mean that I have to hold the property at least for 5 years and live in for 2 years? Can I hold and live in the property for only 2 years and then sell it without paying capital gains taxes?

    Yes , you could literraly do this every two years... you only have to have made this your primary residence for at least two years.... another scenario... you could buy a second home, live in the other one, and sell this one within the five year period and still qualify for this exemption.

    @Jose Rubio,

    I REALLY hope you are not advising that they say the lived in it when they didn't. They must actually live there for the 2 years or qualify under one of the exclusions to utilize the Section 121 exclusion(Home sale). To lie that they lived there could end up with you filing a fraudulent return, subject to a penalty of over 25% of the under reported income. Shall I go on?

    [email protected]224-381-2660
    0Reply
  • Jose RubioPro Member
    Investor · Groveland, FL · Member since 2013 · 38 posts · 6 votes
    12y

    @Steven Hamilton II . If you take the time to read Emma's first post, she states that they have lived in this home since they purchased it in November 2012 ... As long as they complete the remainder of the two years..you would agree that they' could qualify for the exclusion.. Correct?

    As far as the second scenario I was referencing, I was merely stating the fact that even if they purchased another home, as long as they lived in the primary for two years, they could still claim the exclusion as long as the home was sold within the five year limit.

    At no time was any implication of fraud or deceitful reporting suggested. Shall I go on?

    0Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    12y
    Originally posted by @Jose Rubio:
    @Steven Hamilton II . If you take the time to read Emma's first post, she states that they have lived in this home since they purchased it in November 2012 ... As long as they complete the remainder of the two years..you would agree that they' could qualify for the exclusion.. Correct?

    Jose,

    I did. I misread your post twice.

    "you could buy a second home, live in the other one, and sell this one within the five year period and still qualify for this exemption."

    I read it as, buy another one, move into it ..... etc.

    Sorry.

    [email protected]224-381-2660
    0Reply
  • Emma Chen
    OP
    Investor · San Diego, CA · Member since 2013 · 87 posts · 17 votes
    12y

    @Jose Rubio I really appreciate for your suggestion. I am happy to learn that I wont need to pay capital gains taxes after living in my house for another year(2 years in total).

    @Steven Hamilton II I understand your concern. I graduated from a Catholic school. Integrity is my core value in business. I will stay away from unethical things :) Thank You!

    0Reply
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