Did I upgrade my first house too much to rent it out?

19 Replies

I bought a 1400 sq ft 3 br 2 bath HUD home in late 2012 for ~$130k after closing costs in Puyallup WA on a 15 year fixed mortgage at 2.875% interest. (Why 15 year? Wife listens to Dave Ramsey and the difference was only like $300 or something). The loan balance is $113k.

Payment breakdown:

Principal & Interest~$850
Homeowner's Insurance(s)~$40
Mortgage Insurance~$35
County Tax~$210
Total Scheduled Payment~$1135

For a living I run various internet businesses and I feel I already take a lot of risks in my day to day "job" I'd like to have less than 5 mortgages at any one time. I simply want to buy a single family house or two every year with surplus cash I generate and use debt snowball approach to pay down their mortgages (I don't mind growing slower if it reduces the risk of the cards falling down).

Have I Upgrade My House Too Much To Rent It Out?

Our plan was to use this as our first rental when we bought our next house, but because we're living in it now while we upgraded we surely did things that we shouldn't have done had we bought this house initially as an investment (or maybe you think I'm ok?)

I do pretty well with my online businesses so we paid cash to redo all of this stuff and I could probably pay my house off this year (but I'm not so eager to pay off such cheap 2.875% money). 

Here's What We Did / Paid Other People To Do 

(I don't recall exact prices unless I go back through receipts):

1. New IKEA kitchen with granite counter tops, nice undermount sink etc ~$10k
2. Replaced carpets with laminate floor ~$5k installed (I assumed hard woods would be too nice for house price and we have a dog + new twin babies)

3. Removed walls in living room to make it more open concept ~$2.5k (we did demo)

4. Replaced deck $1,500 (we did this)

5. Replaced molding $1,500 (I think)

6. Replaced all duct work when we moved in $1k (we did this)

7. Had to pay to have insulation from under the house removed $2k (it was vacant for 18 months so rats were in there etc)

8. Replaced all the doors (happening this month)

9. Redo main bathroom ~$8k - $9k (happening this month)

10. Redo master bathroom ~$8k - $9k (happening before year end)

11. Replaced all appliances ~$4k (there were none)

12. Removed popcorn ceiling $2k

13. Repaint etc

14. Added external AC unit $3k (we did some of the install e.g. ran the lines etc)

So by the time we decide to move everything in the house will basically have been redone to our liking.

Rents In My Area:

I did a search through Craigslist to see what houses were renting for and found a rough estimate of around $1,250 to $1,400 a month for 3 BR 2 Bath. Only one of the houses I found had granite (that's not the only quality indicator of course I'm just trying to make comparisons) but at the $1,400 on up mark the houses have around 1,800 to 2,000 square feet.

Do you think it's better to buy another property strictly as an investment and do the appropriate upgrades for the price? Or do you think an upgraded first time buyer home is worth it in terms of better rents and (presumably) higher quality tenants?

I've listened to as many podcast episodes as I could. If I'm going to do this I know I just gotta do it. Just trying to decide if the first time I go forward I do it with this property or if I do it with something else bought specifically as an investment.

Thanks in advance sorry if post is long still new here. I'll figure it out.

EDIT: Perhaps some people would advise pulling the cash out of the house that we have from the increased value. Interested in any advice.

$1135 PITI and rent for $1250 To $1400? Not great for a rental from a positive cashflow perspective. You would have to consider vacancy, maintenance, capital expenses, and property management - even if you plan to do it yourself for now. Search the 50% rule. This one might work as a flip since prices have jumped up since 2012. Or, maybe you could continue to use this one as a primary residence. Sometimes it makes more sense to improve a rental property over time after it has been put into operation - from a tax writeoff perspective. Many things to consider. I wouldn't be in a hurry to kill that 15 year fixed 2.875% interest rate anytime soon. What a deal! For buy and hold, try to get as close to the 1% rule or better to at least break even - which is, - example - 150K house rents for $1500 per month. Seattle and surrounding areas are tough to find good buy and hold deals. More rural areas can get 2% and sometimes 3% of purchase price in rents per month. But sometimes it comes at a cost due to tough areas with bad tenants and lots of issues to deal with. Good luck.

I am sorry but this is a terrible idea and you will not make money on this house renting it. Did u actually do any calculations on return on investment?

Cash flow should be at least $100 and that's if u have a lot of appreciation in the area.  A good deal is if you have $500 per month cash flow.  With all these crazy updates... you are renting a 200k house for peanuts

Good luck.  I hope you can sell it to at least break even.  

Did you close the FHA loan back when they waived PMI for 15 year terms? If so, awesome! If I were in your shoes, I would be OK with little to no cash flow on that property in exchange for allowing a renter to pay off that loan. $6000+ per year in principal pay down is nothing to sneeze at.....so long as you aren't in need of the immediate cash.

Originally posted by @Gerald K.:

$1135 PITI and rent for $1250 To $1400? Not great for a rental from a positive cashflow perspective. You would have to consider vacancy, maintenance, capital expenses, and property management - even if you plan to do it yourself for now. Search the 50% rule. This one might work as a flip since prices have jumped up since 2012. Or, maybe you could continue to use this one as a primary residence. Sometimes it makes more sense to improve a rental property over time after it has been put into operation - from a tax writeoff perspective. Many things to consider. I wouldn't be in a hurry to kill that 15 year fixed 2.875% interest rate anytime soon. What a deal! For buy and hold, try to get as close to the 1% rule or better to at least break even - which is, - example - 150K house rents for $1500 per month. Seattle and surrounding areas are tough to find good buy and hold deals. More rural areas can get 2% and sometimes 3% of purchase price in rents per month. But sometimes it comes at a cost due to tough areas with bad tenants and lots of issues to deal with. Good luck.

Yah heard of the 50% rule I will do some more searching for it. 

My point was more along the lines that had I bought with a 30 year fixed at the like 3.2% something at the time we could have gotten (or maybe it was 3.7 - I don't recall) anyway the payment would have been around $750 or so. That would get it closer to 50% rule (if it rented for $1,500) and I didn't spend as much as I did but clearly I've put a lot of money into it as well so factoring that in again it's probably not doable.

Do you think that because of the local differences in real estate that perhaps picking a strategy that sounds interesting isn't a good plan but rather if I'm interested I should pick a strategy that works for my area?
Buy and hold seemed most appealing to me because I'm just looking for a place to shovel extra money towards that doesn't go back into my online businesses as I'd like to diversify.

Good point on improving the rental property over time. Since I've already done it I can't claim the costs etc

Originally posted by @George P.:

I am sorry but this is a terrible idea and you will not make money on this house renting it. Did u actually do any calculations on return on investment?

Cash flow should be at least $100 and that's if u have a lot of appreciation in the area.  A good deal is if you have $500 per month cash flow.  With all these crazy updates... you are renting a 200k house for peanuts

Good luck.  I hope you can sell it to at least break even.  

 Adding up the stuff we've put into the house and the purchase price it comes out to roughly $175,000. I've looked at the comps in my area and we should be able to sell for a profit. Not a huge one.

As I mentioned in the post I did buy the house to live in not and not as an investment. Only now after the fact have I been trying to research whether or not it would be alright as a rental. I sort of knew the answer would be bleak given that I went with a 15 year fixed but just wanted to ask here since I'm new.

Originally posted by @Dan Schwartz:

Did you close the FHA loan back when they waived PMI for 15 year terms? If so, awesome! If I were in your shoes, I would be OK with little to no cash flow on that property in exchange for allowing a renter to pay off that loan. $6000+ per year in principal pay down is nothing to sneeze at.....so long as you aren't in need of the immediate cash.

No we're paying the $40 in PMI but that comes off in like 8 or 9 months I think.

Don't really need the cash except for potentially in other business stuff I do but likely don't need it.

@Chris Guthrie  the market is the best it is going to get right now. 5yr Bull market with all time high rents and high price home sales.

I would sell and look for a better deal!

Hard to say. Yeah, it doesn't make for a great rental, so I think I would either stay in it or sell it. However, with a 15 year mortgage, you are actually paying quite a bit of principle down each month. It made your payment higher, but you can handle it -so maybe worst case, you rent it out and break even and in 14 years from now you have a free-and-clear home. That actually sounds kind of intriguing... thoughts @Chris Guthrie  ?

What you are describing is our model although we are all about leveraging as much as possible. I talk all about or model, goals and investing philosophy in my not.  Those upgrades while not producing more income will certainly allow you to appeal to a better tenant.

My husband has a very stable job for hopefully the next 15 years. Our goal is too invest in homes now that will have the cashflow to allow us to retire off of it and a military pension in 15 years. We have found that living in personal properties and renting them out has been a huge benefit to our model. It allows us to invest very little to nothing into them in the sense of downpayment. We get lower interest rates (as you found).  If I were you, I would continue to get 15% loans. While your cash flow is not huge and it affects you ability to invest in future houses, you have mentioned this nt being an issue. 15% give you more rights off, higher book loss more and more principle.

We certainly over improved our first house but it has allowed us to get a 3 year tenant at market rate. We have even been able to keep the rate increased. 

It really determines your goals. Our goal is when the house appreciates so will the cash flow. This will produce more returns. Once the market no longer makes sense at our business strategy, we will start to pay off the loans. We also like these nice properties because they let us manage long distance which is need because my husband has transient career.

You should do what comes naturally for you IMO. If 15 year notes make you feel good and you have plenty of disposable income and RE isn't your main source of income then it is all good.

I know a couple of guys (father-son) who buy just regular places like small plexes and take them to the next level with tile and granite and expensive flooring. They get an extra $450 or so rent and do all the work themselves. They are finding ex homeowners that like nice stuff but lost everything in foreclosure and/or BK.

Your cost for bathrooms sounds high to me.

BTW your project sounds a lot like one I just did. Took out a dividing wall to open it up. Spent around 60k including holding costs for a year (redemption period 6 months). Mine was going to be a rental then too nice so moved in.

Originally posted by @Elizabeth C.:

What you are describing is our model although we are all about leveraging as much as possible. I talk all about or model, goals and investing philosophy in my not.  Those upgrades while not producing more income will certainly allow you to appeal to a better tenant.

My husband has a very stable job for hopefully the next 15 years. Our goal is too invest in homes now that will have the cashflow to allow us to retire off of it and a military pension in 15 years. We have found that living in personal properties and renting them out has been a huge benefit to our model. It allows us to invest very little to nothing into them in the sense of downpayment. We get lower interest rates (as you found).  If I were you, I would continue to get 15% loans. While your cash flow is not huge and it affects you ability to invest in future houses, you have mentioned this nt being an issue. 15% give you more rights off, higher book loss more and more principle.

We certainly over improved our first house but it has allowed us to get a 3 year tenant at market rate. We have even been able to keep the rate increased. 

It really determines your goals. Our goal is when the house appreciates so will the cash flow. This will produce more returns. Once the market no longer makes sense at our business strategy, we will start to pay off the loans. We also like these nice properties because they let us manage long distance which is need because my husband has transient career.

 What do you mean by 15% loans?

Originally posted by @Brandon Turner:

Hard to say. Yeah, it doesn't make for a great rental, so I think I would either stay in it or sell it. However, with a 15 year mortgage, you are actually paying quite a bit of principle down each month. It made your payment higher, but you can handle it -so maybe worst case, you rent it out and break even and in 14 years from now you have a free-and-clear home. That actually sounds kind of intriguing... thoughts @Chris Guthrie ?

Yah I mean looking at numbers had I done a 30 year fixed my payment would fall close to the 50% rule. I'd still try to rent it for $1,500 or a bit more as the properties I was comparing to didn't have all new stuff either and none of them had AC (so if we were to move out next summer and showed it while it was really hot out people will be more aware of how awesome having AC is). Then again I assume the value of the house after the upgrades would mean that it again falls short of renting for the 1% rule though.

So many rules

Chris everyone has their own niche. We have 5 house 4 rentals and do very well. While we certainly couldn't retire off them. In our goal time period in 15 years we should be very well set up. We don't follow any of the rules. I use the rules as guidelines and truly look at my earning based in my downpayment.

I'm a new investor so I'm not sure if this is way off but could you do a lease option / rent to own.  This way you can get non refundable option consideration, slightly higher cash flow per month, and then sell it to the tenant/buyer in 3 years.  Just a thought; it may be off base.

I like the fact that you plan to invest slowly and debt snowball.  I've heard of one too many REIs who put too many eggs in one basket and have lost everything.  With a diversified portfolio, you'll be fine!

You could always list it for sale or rent and see who bites at what price.  If it rents high enough, then rent it.  If you'd rather sell at a certain price, sell it.  If it doesn't sell, live in it...etc.

Kudos to you all for choosing a 15 year term on your mortgage.  Once your mortgage principal is less than 80%, you can discontinue the mortgage insurance resulting in a small monthly savings. 

Long term, if you keep your investment and pay down/off your mortgage; you will have the entire value of this asset at your fingertips - to provide monthly Cashflow indefinitely, or to leverage (or exchange?) into another investment.

Short term, you can protect your investment somewhat by asking new tenants to pay a larger deposit (or make a greater % nonrefundable).  You can decrease your monthly expense by requiring that tenants pay all utilities.  If you decide to self-manage, you can eliminate the cost of a professional property manager (approximately 10% of gross rent). 

You might consider marketing the home as transitional housing to area employers for executives/hires moving into the area.  if you were to lease the home to a local employer for the purpose of providing transitional housing, you would receive revenue whether or not the home was in use.

When you look back on this investment experience at the end of the day, after the last transaction is complete, likely you will look at many variables to determine whether or not this was a "good" investment.  These variables may include:

  • -the price of the initial purchase,
  • -the cost of capital improvements,
  • -the terms of the mortgage and the total amount you actually repaid,
  • -the monthly positive or negative cashflow,
  • -the taxes you paid or didn't have to pay along the way,
  • -the time and energy this investment required from you all, and
  • -the proceeds you captured from the property's sale.   

I hope that you will also consider what you learned along the way and the joy of the journey as you consider this investment's value to you. 

Originally posted by @Daniella Ortiz:

I like the fact that you plan to invest slowly and debt snowball.  I've heard of one too many REIs who put too many eggs in one basket and have lost everything.  With a diversified portfolio, you'll be fine!

You could always list it for sale or rent and see who bites at what price.  If it rents high enough, then rent it.  If you'd rather sell at a certain price, sell it.  If it doesn't sell, live in it...etc.

 Yah good point thanks

If you are looking at 200K+ sale price, that would probably be the better option.  It may have started out with rental potential, but it has been turned into an owner-occupied home, so you are most likely going appeal more to those looking for a home vs. a place to live as rental.

The first choice is do you want to stay or do you want to move?  

If you do go the rental route, it potentially is a good appreciation play, but not much of an income property.  

Maybe the best approach is to find a similar property(although the purchase price may be higher) and do what needs to be done to make it a rental.  If you get something that rents a little higher say 1600, but only costs 160K, the numbers will look better.

If there are townhouses in your market those might be better income properties.  Condos often have the best price/rent ratios but also the have some potential complications - the condo fee being a big one.

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