A Path to choose

23 Replies

Hi All,

I’m new to the whole real estate game (down town Chicago). I found out that my rent was the same as a mortgage, so last year I made the switch. I purchased a fixer upper, moved in, and did the work myself. Now I rent out the second bedroom and my renter has cut all my cost by more than half. In addition the house was appraised and I discovered I made a nice chunk of change. I had a blast through the whole experience (with the exception of dealing the real estate agent, but that’s another story). The point is I’m eager and ready continue the process by adding more rentals to my portfolio.

Here’s my dilemma, I have 2 options with the $70k I have in cash.

2 bed 1 bath - Use $60k cash for a down payment and closing on a place that needs no fixing up and already has renter for the year. After all cost, I will gain a profit of $2,900 a year.

This means my mortgage +Tax +HOA is $1,500 per month

1 bed 1 bath - Use $30k cash for a down payment and closing on a place that needs $10k in fix up. ($40k total) This means, I will be out of pocket for 3 months fixing it up and finding a renter (-$6k). When it’s done, after expense I will be making $3,000 per year. In addition, in a 4-6 month period I could save up another $10k and buy another place doing the same thing.

This mean my mortgage +Tax +HOA is $1,000 per month for one place.

The question is:

Do I buy the 2 bed 1 bath already rented, then in 6 months refinance, take out 30K and then buy another place. Now have $50k cash

Or

Do I buy the 1 bed 1 bath that needs work and will cost me 3 months to fix and rent while paying a mortgage at losing rent. But I’ll have enough money to do it again in a 6 month time frame or refinance and do it sooner.

Now that I write this out, although the Mortgage is higher in the 2 bed 1 bath. I’ll have enough cash to get a second place in 6 months. Whereas if I buy the fixer-up and do it again regardless of a refinance, I loses $12,000 in mortgage payment + not getting rent. (6 months of fixing and loss of rent)

Nonetheless, your thoughts would be greatly appreciated!

@Phillip Faries IMO I think more research needs to be done on both of the subject properties in order for your path to become clearer. When you examine the properties during your due diligence, you may discover an issue that will ruin the entire investment, making it a bad deal. (Roof, Electrical, Special Assessment, ETC.) You have the right idea with both properties by refinancing your money out and making it work harder for you, but until you physically see what your dealing with you will not know for sure what your getting. The tenant in the 1st property may be the reason the LL is selling in the first place...  

Christopher M. | IL Agent # 475163570

Originally posted by Christopher M.:

@Phillip Faries IMO I think more research needs to be done on both of the subject properties in order for your path to become clearer. When you examine the properties during your due diligence, you may discover an issue that will ruin the entire investment, making it a bad deal. (Roof, Electrical, Special Assessment, ETC.) You have the right idea with both properties by refinancing your money out and making it work harder for you, but until you physically see what your dealing with you will not know for sure what your getting. The tenant in the 1st property may be the reason the LL is selling in the first place...  

Hey Chris, thanks so much for the response.

I’m the kind of guy that looks at every angle before making a decision, especially when it comes to my money! Lol

I've already had the 2 bed 1 bath (already rented) inspected, no issues what so ever. In addition, my RE broker has done a complete review of both HOA and both are in good shape. In regards to the tenants, I thought the exact same thing, but they just moved in last week. I am awaiting a response from the seller as to why he want to sell the property. I don't know if I will get an answer though….

On the flip side, I haven’t had an inspection on the cheaper 1 bed that needs work…….. so your right, who know what problems that one could have.

My gut is telling me that the 2 bed 1 bath is the way to go, I just wanted to get the communities thoughts on the situation to see if I was missing anything…..=

Thanks Again!

@Phillip Faries , Congrats on buying your first property! If I can ask, why are you looking at small condo units when you can buy a 3-4 flat with an FHA loan owner occupied? The down-payment will be 3.5-5% and the seller can pay the closing cost. You can have even more fun remodeling units, as there will be plenty of them, your networth will grow substantially, as your cash flow...

Lumi Ispas, Century 21 SGR | [email protected] | 773‑392‑2906 | IL Agent # 475.113981

what's your plan/goal?

We buy in higher end homes, so they have smaller margins but meet our life and investment goals. So I would say, make sure what you buys meets your goals.

Originally posted by @Lumi Ispas :

@Phillip Faries , Congrats on buying your first property! If I can ask, why are you looking at small condo units when you can buy a 3-4 flat with an FHA loan owner occupied? The down-payment will be 3.5-5% and the seller can pay the closing cost. You can have even more fun remodeling units, as there will be plenty of them, your networth will grow substantially, as your cash flow...

Good morning Lumi, thanks so much for your message. The reason why I'm looking at smaller units in the city is based on a few things. 

1) I have no car, ok.... maybe that not a good excuse as I can rent them... 

2) I know the city of Chicago, a biggerpocket podcast said you should invest where you know. That happens to be where prices are high, and the 3-4 flats that are affordable are in troubled areas. 

3) I would love to buy a 3-4 flat like you mentioned below. I asked my realtor about buying one and showed him the MLS post but he said the area was dangerous and I wouldn't want to live there.

Can you suggest how to get started or give me a little advise in regards to a location I should be looking? 

thanks again,

Phil

Originally posted by @Elizabeth Colegrove:

what's your plan/goal?

We buy in higher end homes, so they have smaller margins but meet our life and investment goals. So I would say, make sure what you buys meets your goals.

Hi Elizabeth, that's a great question, and one that I have been thinking about for the past few days. Originally it was to buy 1 property per year for 5 years and make a profit of $3,000 per unit after all expence and tax. However since join biggerpockets, my eyes have been opened to a bigger picture. I'm young and ambitious so Im conscious that I should that it slow and not bite off more than I can chew, but I am eager to learn. I guess now I'm beginning question/think about what my goals are. Buy higher end homes and meet my goals of 3k per year per condo, or think bigger......

Nonetheless, thanks for your post it really has me thinking!!

Phil

@Phillip Faries I assume you have W2 income.  If that's the case, w/ $70K available for a downpayment the opportunities for you to find a multifamily w/ a unit that you can live with positive cash flow on the remainder in a safe neighborhoods, are coming on the market all the time.   I have to agree w/ @Lumi Ispas  .  While you're looking @ the small condo units, expand you're horizon.  If you're current agent can't help you, hire another agent.

Do you have a little more details on the numbers?  Are you pricing in property management(even if you are doing it yourself).

If the 2 bedroom costs 50% more for the same profit and requires more cash, the 1 bedroom looks like a better investment.  

Are the condos in similar neighborhoods?  The 2 bedroom will probably be an easier resale, but if you are buy and hold that isn't the major consideration.  

Is there significant appreciation potential for these condos?

Originally posted by @Crystal Smith :

@Phillip Faries I assume you have W2 income.  If that's the case, w/ $70K available for a downpayment the opportunities for you to find a multifamily w/ a unit that you can live with positive cash flow on the remainder in a safe neighborhoods, are coming on the market all the time.   I have to agree w/ @Lumi Ispas  .  While you're looking @ the small condo units, expand you're horizon.  If you're current agent can't help you, hire another agent.

 Morning Crystal,

Yes I have a W2. Thanks for the tip. I'll have him start looking into that. In his defense, based on my old goals he has been looking for the places Within my search criteria.

Phil

Originally posted by @Jesse T. :

Do you have a little more details on the numbers?  Are you pricing in property management(even if you are doing it yourself).

If the 2 bedroom costs 50% more for the same profit and requires more cash, the 1 bedroom looks like a better investment.  

Are the condos in similar neighborhoods?  The 2 bedroom will probably be an easier resale, but if you are buy and hold that isn't the major consideration.  

Is there significant appreciation potential for these condos?

Morning Jesse, 

No I didn't price in property management. Another thing I've just learned since joining biggerpockets.

Yes they are in similar neighbors, and I do intend to buy and hold.

Yes there is significant appreciatetion, with the 2 bed ill get 40k in automatic appreciation and with the 1 bed its 10k appreciation as I am buying them at discount. I intend to refinance and use the cash to buy another place down the road.

Phil

I am with @Lumi Ispas  and @Crystal Smith I would do a FHA loan on a 3-4 unit, but I am personally against condos, so you will never find me suggesting that. There are plenty of very good neighborhoods near public transit that are a much better investment than a condo.

Medium second city real estate logo   white close upBrie Schmidt, Second City Real Estate | [email protected] | http://www.SecondCity-RE.com | IL Agent # 471.018287, WI Agent # 57846-90 | Podcast Guest on Show #132

Originally posted by @Brie Schmidt :

I am with @Lumi Ispas  and @Crystal Smith I would do a FHA loan on a 3-4 unit, but I am personally against condos, so you will never find me suggesting that. There are plenty of very good neighborhoods near public transit that are a much better investment than a condo.

 Morning Brie, 

Yeah I agree. I was really hoping not to move, I love my place. Guess the question is do I want to be comfortable where I live or do I want to get serous about investing in real estate and make the move.

Phil

Originally posted by @Brie Schmidt :

@Phillip Faries that is the question most newer investors need to answer for themselves.  

 Totally agree! My fear is moving too far out of the city and not getting the units rented..... Or having to lower the rent to get someone into the place. Maybe that's just my newbie fear.... 

Also when you deal with a condo you only have to deal with the inside of the unit. With a multi-unit, you have the outside to deal well as well. Another newbie fear I guess...

Phil

@Phillip Faries Everyone has to develop a strategy they feel comfortable w/.  If you love where you live & your strategy is working then stick to it.  But, don't let you're fear prevent you from learning about other profitable parts of the business.

@Phillip Faries  for me  a 2 bedroom is more marketable for renting and also for resale.

But like @Brie Schmidt  said pretty much the decision is really yours. These are the tough decisions us new investors have to make. I think it ultimately make us better.

@Phillip Faries I will need to understand more about your price point in order to advice you on the choice of neighborhoods. Also, you should look at properties that already have at least a few units rented, and when you move in you can start remodeling the units one by one, as they vacate, instead of having a vacant building to cover expenses for.

Call your lender and see what is the maximum amount you can get approved for, and of course you don't need to go all the way to the max you get approved for, you'll look at what makes sense.

1. Cash Flow

Let's say you are looking at two buildings for example:

Example 1: 3 flat with 2 bed/1bath units, building is for sale at $200,000 and the rents are $700. Your expenses will be approximately $1800/month self managed, and the income is $2100, so you get $400/month in cash flowafter a year if you move out and all the units are fully rented.

Example 2: 4 flat with 3 bed/1 bath units in a different area, $500,000 purchase price, and the rents are $1500 each. Expenses are about $4500 a month, while the income is $6000/month.  In this case, your cash flow is $1500/month.

2. Tax deductions Remember that in addition to this you get tax deductions for interest & property tax and also amortization. The bigger the purchase price, the more reduction in income tax you get. 

3. Amortization. You'll save $5000+ per year ( if you don't make at your job six figures) for 27.5 years

4. Because of the low interest rates ( in my opinion money is almost free these days), you get a lot of principal paid per month. For a 500K loan, your monthly principal paid starts around $600 in the first year and goes up, which means that you'll get over $7000 paid the first year.

After seeing all these benefits, which building will you buy? 

Lumi Ispas, Century 21 SGR | [email protected] | 773‑392‑2906 | IL Agent # 475.113981

Originally posted by @Lumi Ispas :

@Phillip Faries I will need to understand more about your price point in order to advice you on the choice of neighborhoods. Also, you should look at properties that already have at least a few units rented, and when you move in you can start remodeling the units one by one, as they vacate, instead of having a vacant building to cover expenses for.

Call your lender and see what is the maximum amount you can get approved for, and of course you don't need to go all the way to the max you get approved for, you'll look at what makes sense.

1. Cash Flow

Let's say you are looking at two buildings for example:

Example 1: 3 flat with 2 bed/1bath units, building is for sale at $200,000 and the rents are $700. Your expenses will be approximately $1800/month self managed, and the income is $2100, so you get $400/month in cash flowafter a year if you move out and all the units are fully rented.

Example 2: 4 flat with 3 bed/1 bath units in a different area, $500,000 purchase price, and the rents are $1500 each. Expenses are about $4500 a month, while the income is $6000/month.  In this case, your cash flow is $1500/month.

2. Tax deductions Remember that in addition to this you get tax deductions for interest & property tax and also amortization. The bigger the purchase price, the more reduction in income tax you get. 

3. Amortization. You'll save $5000+ per year ( if you don't make at your job six figures) for 27.5 years

4. Because of the low interest rates ( in my opinion money is almost free these days), you get a lot of principal paid per month. For a 500K loan, your monthly principal paid starts around $600 in the first year and goes up, which means that you'll get over $7000 paid the first year.

After seeing all these benefits, which building will you buy? 

 Hi Lumi, first off amazing post! When you think of it, the 4 flat is the better deal! From a rent, profit and a tax perspective it's much better. Don't know how I feel about accumulating a 450k mortgage this early in my real estate career. I suppose its all about your risk appetite but with a monthly expence of 4,500 per month, if one or two of the renters don't pay, I'll be completely screwed. I understand the above is just an example, and it definitely has changed my perspective! I'll give my mortgage broker a call.

@Phillip Faries , it's all put in perspective.  In my opinion, the higher the mortgages, the better, as in 20 years, I will have a half a million dollar building paid off entirely by tenants, while I get cash flow and tax benefits. In top of it, by the time the property is paid off, all the money that was going towards the mortgage payment becomes extra cash flow and my 500K building will be worth by then at least 750K if not $1,000,000.

In the same time, I also own condo units that I bought for less than 50K, those will be worth up to 150K each  in 20 years if I am luck, and even if I had a mtg on them, the cash flow will not increase a lot, as chances are the assm will increase also.

What you have to do, is increase your risk tolerance by increasing your reserves account. After buying the building, make sure all the cash flow goes into a reserve account, so this way, in case one or multiple tenants leave the building unexpectedly in the same time, you have the money in the bank. Same with repairs.

Let's not forget that tenants move out of condo units also, and then 100% of your expenses have to be covered by you!

And again, it's all how you are looking at it! You can see it as a possibility to use the bank's money & multiple tenants to become a millionaire quickly or less risk and lots and lots of condo units to get to the same finish line!

Lumi Ispas, Century 21 SGR | [email protected] | 773‑392‑2906 | IL Agent # 475.113981

Originally posted by @Lumi Ispas :

@Phillip Faries , it's all put in perspective.  In my opinion, the higher the mortgages, the better, as in 20 years, I will have a half a million dollar building paid off entirely by tenants, while I get cash flow and tax benefits. In top of it, by the time the property is paid off, all the money that was going towards the mortgage payment becomes extra cash flow and my 500K building will be worth by then at least 750K if not $1,000,000.

In the same time, I also own condo units that I bought for less than 50K, those will be worth up to 150K each  in 20 years if I am luck, and even if I had a mtg on them, the cash flow will not increase a lot, as chances are the assm will increase also.

What you have to do, is increase your risk tolerance by increasing your reserves account. After buying the building, make sure all the cash flow goes into a reserve account, so this way, in case one or multiple tenants leave the building unexpectedly in the same time, you have the money in the bank. Same with repairs.

Let's not forget that tenants move out of condo units also, and then 100% of your expenses have to be covered by you!

And again, it's all how you are looking at it! You can see it as a possibility to use the bank's money & multiple tenants to become a millionaire quickly or less risk and lots and lots of condo units to get to the same finish line!

 Hi Lumi, yup, I'm on board. Lol, when your right, you're right! Just spoke to my mortgage broker, while he can't get me an exact number. (Just refinanced, and he can't set up a new file until the funds go through)  I'll get a firm number on Monday but based on everything he has now, he feels strong I can get over 600k.

@Phillip Faries good for you!! Now it gets exciting! Keep me posted how it goes and what you decide to buy and let me know if you ever have questions!

Lumi Ispas, Century 21 SGR | [email protected] | 773‑392‑2906 | IL Agent # 475.113981

Originally posted by @Lumi Ispas :

@Phillip Faries good for you!! Now it gets exciting! Keep me posted how it goes and what you decide to buy and let me know if you ever have questions!

Hi Lumi, 

So I have an update...... I decided to go on a small detour from the Multifamily unit path. I came across a great opportunity to buy a 1 bedroom in a highrise in the City. Long story short, should I close on the foreclosure, (down payment, closing cost, fix up cost ) it will cost me $22,000 cash. Ill be able to rent it out conservatively for $13k-$14k per year, after all expenses, I will have a cash flow of just over $4,000 a year or $358 a month. As an exit strategy, I could also sell the unit with a 15-25k profit (after closing cost, taxes and selling fees and holding cost). I figured this would give me the opportunity to get my toes wet as a landlord, before jumping into the deep end and being a land lord for a 3-4 unit. I still have a Multifamily Unit in my cross hairs but i feel this is a good tester for me to learn from.

@Phillip Faries , the cash flow amount sounds great, and there should be very little to do in managing a condo, plus the equity is a bonus! Good for you!

Lumi Ispas, Century 21 SGR | [email protected] | 773‑392‑2906 | IL Agent # 475.113981

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