First home, plan to turn into rental in 2-5 years

25 Replies

Good Evening BP,

First, I would like to lay out the scenario, and then list the questions below. Not sure if it matters but I'm a single male in Dallas, TX with a steady salary. I am planning on getting into REI, but first, would like to purchase a single family property for myself. I intend to live in the home for the foreseeable future (3-5 years). Ideally the property needs some TLC, and I will rehab it while I live in it with the plan of renting it out after 3-5 years.

Here are my questions:

  • Does this sound like a decent plan?
  • Do I run analyze the property in the same way as if I were renting it out right away?
  • I have access to a VA loan, what are the pros/cons of putting no money down vs a down payment?

I realize these are pretty basic questions, but I want to make sure I’m thinking about the process in the correct way. Honest feedback is greatly appreciated!!

v/r

Jake

Welcome to BP, @Jacob R.

When an REI buys a rental, it's typically 20 to 25% down payment. If you are the owner-occupant, you have the advantage of the 0% down VA (or others, the 3.5 to 5% FHA down payment). An advantage to you.

Why not make your first home your first rental, and why wait 3-5 years? Other young singles or couples are on BP talking about "house hacking" a duplex/triplex/quad (wherein you qualify for the whole home, but tenants in the other 1,2 or 3 units pay the entire mortgage/expenses)....therein accelerating your REI capital available. Rental #2 could come after living in the 1st home 1 year.

Have you read about the BRRRR strategy?....another method of parlaying your small investment into faster growth.

To buy a rental with 100% financing, the net cash flow per month will suffer from the larger mortgage payment. But, look at 100%, 80% and 0% leverage....look which one builds your wealth faster. See if it works for you.

@Jacob R. I am planning on doing the same thing with the SFR I recently purchased and am currently living in. Being a VA Loan, we will live here until I get my next assignment then keep it as a rental. I analyzed it as a rental, and treat it as if I'm renting it to myself. We'll see how it turns out..

@Steve K.  , I am currently renting and would like to put that monthly payment into a mortgage. While fixing up the first property, I do intend to acquire a rental property and go from there. I am not opposed to the "house hacking" strategy but I have found it difficult to find multi-family properties in the areas I would like to live.

If you are using a VA loan in Texas make sure your lender knows how to do a Mortgage Credit Certificate. I had 2 lenders that were recommended to me not know what that was or how to fill out the paperwork to receive one. I then searched specifically for a lender that knew how to obtain one. I get 35% of the interest I pay each year as a credit on my federal taxes. It comes out to around $2k in savings each year for the years that you owner occupy.

If rental is your plan down the road do not invest in a SFH. They do not cash flow well and are higher risk due to 100% vacancy risk.

Invest in a multi as a house hack.

Originally posted by @Jacob R. :

Good Evening BP,

First, I would like to lay out the scenario, and then list the questions below. Not sure if it matters but I'm a single male in Dallas, TX with a steady salary. I am planning on getting into REI, but first, would like to purchase a single family property for myself. I intend to live in the home for the foreseeable future (3-5 years). Ideally the property needs some TLC, and I will rehab it while I live in it with the plan of renting it out after 3-5 years.

Here are my questions:

  • Does this sound like a decent plan?
  • Do I run analyze the property in the same way as if I were renting it out right away?
  • I have access to a VA loan, what are the pros/cons of putting no money down vs a down payment?

I realize these are pretty basic questions, but I want to make sure I’m thinking about the process in the correct way. Honest feedback is greatly appreciated!!

v/r

Jake

 I think its a great strategy, I might even recommend trying a duplex, triplex or even a quad if you can find one.  Live in one of the units for a year or two and let tenants pay for the rest.

Then a couple of years later you can go with a SFH.

I personally have modeled our house hacks as cost avoidance.  I have also done models to see how a property would do as a rental.  IF you are in a growing market, the numbers should get a little better after 2-3 years of living in the place.

I am sure a lot of people will disagree, but its not the worst thing in the world to take an ok return in the future on a property you plan on living in now.  By the time you take the deductions, and have cheaper loans on an owner occupied house, it will make up a couple percentage points on your return.  I wouldn't rely exclusively on living in a place as a model to buy anything, but IMO if you are planning on house hacking, its possible to think a little more long term about your purchase.

The plan is fine, if you buy the property as if it is a rental. Meaning, you can't pay $3,000 under retail value and think you got a great investment. I would run the numbers based on what you know the rent will be after renovation. Use that number and the expected rate of return to back into your purchase price. It should cash flow after all expenses and debt service. If it doesn't, you over paid.

I am not a fan of the VA loan because when you put no money down plus pay closing costs and a funding fee, you usually have zero equity or negative equity at the purchase. With zero equity and a small correction in the housing market, you are upside down. You will be a buy hold investor by force, not choice. Borrowing less money increases your cash flow.

I agree with @Thomas S. , if buy and hold is what you want to do, buying a duplex, tri, or 4-plex is the way to go.

@Anthony Dooley , do you have any recommendations on rehab costs when back-calculating purchase price? It seems like a variable that's hard to guesstimate based on the varying conditions of properties.

@Jacob R. Some people use $15 per square foot, but it depends on several factors. Repaired and cosmetically appealing is the standard I use. Nothing high end, but updated and in good repair. Don't get emotionally attached to the property. If it's not broken, don't fix it, but replace things that are going to cause problems later, like a 1988 water heater for example.

@Jacob R. I think you are going to have trouble finding a house in this market that will cash flow with 100% financing. You CANNOT count on the market going up or rents going up. If it doesn't work today only a fool would buy expecting it to work in 3 years. Also as others have said if the market falls you will be underwater and forced into paying out of pocket for a non paying property Ask me how I know. Been there done that. It took a re-finance with a $20,000 cash infusion with whatever loan pay down I had accumulated AND 4-5 years to get mine to support itself. I paid $200 (mortgage short fall plus PM) a month PLUS maintenance PLUS cap ex for 4 years until I could get it fixed. (Had to save $20,000 dollars up) That number does not include vacancy (sometimes 3 months at a time). Being upside down I couldn't sell the thing for enough to pay the loan off. Your way better off buying the 4 plex. (Some places the insurance on a 3 plex is the same as a 4 plex). At least do a duplex and make sure it will cash flow a little when it's fully rented TODAY not in 3-5 years. RR

@Jacob R.

If I owned the perfect SFH in Dallas that you want to live in for 3 years and then rent it thereafter, if I offered to sell it to you with $0 down payment, 100% financing, would you want it? would it be a "good deal"? (That's about what your VA loan does for you.) You need to analyze the net cash flow w/ all expenses, vacancy, etc....to see if that home is a good buy/hold rental at 100% leverage.

The BRRRR strategy (wherein your rehab profit is your 20-25% equity in the 75% loan) feels like 100% financing (because the rehab profit is not your precious seed capital), but the 75-80% LTV is easier to cash flow. This can have an infinite cash on cash return, if you refi all of your seed capital back out. It can be preferable to the 100% loan. If you're going to be fixing it up....BRRRR is worth considering.

If you're starting out single, no kids.....the house-hack (for minimum 1 year) may really launch your REI, especially if you're starting with little investable capital today.

(I'm not house hacking into a neighborhood that's less than my dream home.....full disclosure)....but other young professionals are. Look what one @Craig Curelop is doing, even though he can afford better housing, he goes ultra frugal while he's single:

https://www.biggerpockets.com/renewsblog/life-hacking/

Read the personal website/blog on @Billie Miller 's house-hacking success story (see the link at the bottom of any of her posts.....get inspired! See if it's for you.

If I were to go the house hacking route, how important is it the other unit(s) pay my entire mortgage? Or should I only be worried about positive cash flow and ROI when I move out in the future?

Thank you all for the advice!

@Jacob R.  

Although the goal of a lot of house hacking is to live "free", I personally don't believe that distinction is that important. My first BRRRR is a quad in Denver. I don't live there.....I have tenants in all 4 units.

The rent from 2.4 units pays the mortgage on the quad. So....if I lived there, I could say I live "free", or I could even say "I'm being paid to live there (collecting 3 rents, when 2.4 pays the mortgage).

So, what if the quad were a duplex, and all else is in proportion? The rent from 1.2 units is required to pay the mortgage on 2 units. Now, I'd say I rent one, and I have 80% of my own "rent" covered. I"m almost fully subsidized....but not a 100% hack.

I'd argue that when you move out and start renting (after the 1 yr minimum requirement on your VA or FHA loan) both of the above rentals are identical, in terms of rent/purchase price or cap rate or cash on cash or other metric.

So....it's easier to house hack a quad than a duplex.

@Jacob R. I personally think the house hack idea is over rated, especially on a duplex for the same reasons stated above. The other reason is that nobody lives there very long, so how much do you really save? And the exit is the third and best reason not to buy a duplex. Who buys duplexes and quads? Investors. Do investors pay full value for property? No. So there is really no appreciation and if there is, it's very small.  I think if you look around long enough, you will find a steal of a deal in your market that will cash flow. I would buy it for cash if possible, to maximize cash flow. Then refinance later after rehab and do another deal. 

@Anthony Dooley , do you recommend paying cash even if I intend to live in the property for the first few years? I'm trying to get out of renting and do more deals while I live in and rehab the first property. I'm thinking 20% down on the first property to have cash on hand for future down payments.

@Jacob R. Buying a house to live in is a terrible investment because it doesn't cash flow. It doesn't matter if you pay all cash or zero down, it doesn't make you any money. I would recommend that you buy investment property that cash flows by using your cash to put 25% down on existing rentals or an apartment complex. This increases your income, which can help you buy a residence later. I just sold my personal residence and I am so happy right now. I can now take that money and buy property that pays me more than it costs.

@Jacob R. and @Anthony Dooley , I confess, my opinions are biased by my own experience in Denver; I don't pretend to be an expert at markets elsewhere in Dallas or Georgia.

Nationwide, you can read a lot of experts opining on "rent vs own" your own residence. Anthony is correct that if you expect no appreciation, fear depreciation, and might want to move in short time....that favors the "rent" (and buy/sell transaction costs can really persuade you this way.) If you're just "consuming" this $/month part of your budget, by all means, minimize it and save all you can.

However, I'm a landlord in Denver precisely because the opposite is happening here. If you rented for the last 8 years, you missed 10% appreciation per year.....and you're not growing wealth the way you could have. Although I'm not getting 2% or even 1% of purchase price in monthly rent, rent is still higher than cost of ownership (here) and favors the landlord.

And, duplexes are appreciating here in Denver (again, I can't say that it's universal nationwide). I got beat out on 2 recent purchase ideas off MLS wherein ~30 cash bidders put in offers on rental duplexes/quads in the first 36 hours. Many of the duplex/quads on the market, I can see the past sales on a handful of them, where the seller paid about 30-40% less, just 2 years ago...and not due to remodel in the interim.

Granted, there are more buyers for a $300,000 single family home, than there are for a $450,000 duplex....but investors, and/or house-hackers are bidding up the duplexes too. To say that "duplexes don't appreciate" or "if they do it's small", may be true of Georgia....but I'm not seeing it that way in Denver currently.

And, given that a house-hack MFH can cashflow, and appreciates, and comes with 3.5% down payment, and the goal isn't to sell it in 12 months (suffering transaction costs), but to Fix/hold for long term rental....it could work. (Further confession: I've never house hacked personally. I don't live in any of my rentals. But I should have, if I'd have learned to be a REI 35 years ago when I was single.

Good Luck.

@Steve K. The real estate market in Denver, Colorado Springs, and areas in between has never been more expensive. Just like the U.S. Stock market, people are jumping in at the exact wrong time, which results in the buying frenzy that you described. For the exact reasons that you stated, I would not recommend buying a house to live in, especially in CO. The 10% appreciation train has left the station. Do you really expect that to continue? And if so, for how long? I can't speak for Dallas, but when the next crash happens, it will be a much slower in GA than in other parts of the country that are experiencing spikes in real estate costs. Our market is slower to rise, but also slower to fall.

@Jacob R. Do you want to live in an area where SFRs sell for $150k or less? If so, I think your strategy is a viable one. If not, I would rethink your goals.

As a general rule (i.e. unless you find a crazy good deal), houses that have a market value over $150k are not going to cash flow well. You can maybe stretch that to $200k in some areas of DFW. Because of the high taxes here, you've got to hit the 1% rule just to break even once you account for all of your expenses.

There are plenty of areas where this will work, but if you don't want to live in one of those areas, I would focus on a different strategy:

1. Buy a small multifamily that meets the 1% rule - hard to find but not impossible.

2. Keep renting yourself, but buy an investment property where the numbers make sense.

3. If you want to live in a higher priced property, consider running the numbers as a live-in flip rather than conversion to rental. There are tax benefits to selling your primary residence vs. a normal flip if you live in it long enough (I think 2 years).

4. Buy an SFR as a primary residence with your 0% VA loan and live where you want to live with a payment you're comfortable with. Use your savings to also buy a rental property with 20-25% down.

Just as an aside, I would be financially better off if I rented the house I live in rather than own it. And I don't live in an expensive house (~$250k in Dallas).

I own my primary residence for other, non-financial reasons. Not everything is purely about the numbers. You have to decide what is important to you.

@Andrew Herrig , I'd like to do something similar to option 4 with the purchase price being less that $150k. Can you expound upon why renting would be financially better for you? I realize it's specific to situation but I'd like to hear what you have to say.

@Jacob R. My PITI is around $1400 per month, and if you add in another $250 per month for maintenance/capex, that's $1650. I could realistically probably rent this house for $1700/mo.

On the surface it's a wash, until you realize I have a whopping $80k in cash stuck in the property. I could probably refinance and pull half of it out, but assuming I am a halfway decent investor, I should be able to get at least a 10% return on my cash. So that's another $300-600 per month in opportunity cost.

Plus when you own a house, there is always a project to do that isn't related to capex/maintenance. We've done quite a bit of remodeling already, which is something you wouldn't be tempted to spend money on if you were renting :)

Have you considered buying a 3 or 4 bedroom house and having a couple roomates? SFR's are much easier to come by in this hot market than multi-family houses.

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