Does this strategy make sense?

[Joshua Jessup]

Hi, I'm 24 years old and recently married in the DFW area with over $100,000 of readily accessible after tax savings and a decent income. I've never owned real estate, I want to use the funds responsibly, and I'm wondering if a plan like this makes any sense or if I'm being dumb:

Step 1, I buy a structurally sound house built circa 1980 with some cosmetic improvements needed for roughly $250,000 at 3.5% down in the mid-cities area. (North Richland Hills, Keller, Hurst, Bedford, etc).

Step 2, as soon as possible after this, (within 12 months) I buy another similar property, but I put 20% down on it, and it would be less distressed cosmetically. I then immediately attempt to rent this one out. Ideally this could be a house that already has a tenant.

Step 3, hold these 2 properties until we can afford to move into a third, which would either be a long term primary residence for us, or we'd plan to make it a third rental. By that time we would also have increased the cosmetic appeal of the first house to attract tenants more easily.

Summary: Even though the monthly costs on the low money down primary would be very high for that type of property, the combination of appreciation (assuming 3%) and principal paydown per month (assuming 200-250) might make it more reasonable than renting for a few years, and the other house ideally would give us some low to moderate cash flow with similar appreciation and principal paydown to the first house. This would leave us with at least two homes to our names with the option to rent both out later. Sounds like a much better use of our money than throwing it into mutual funds forever. I've done the math on my income and DTI and I strongly believe this is feasible, but not necessarily the best for us.

Potential snags I foresee:

1. Obviously these are older properties. Maintenance might negate a lot of the appreciation and cashflow.

2. I might not be able to get a tenant.

3. Maybe stupid high payments on a cheap house isn't the way to go and we'd be better off renting while we buy a slightly newer house to rent out to our own tenants.

4. I'm sure I'm missing a lot here.

Questions for older wiser investors:

What problems do you see with this?

Do you have a better recommendation?

(Disclaimer: I don't think 3.5% down on a duplex/quadplex will work for us due to income constraints and nearly impossible cashflow but I could be wrong)

Thanks for looking,

-Josh

[Kevin Sobilo]

@Joshua Jessup, I can't comment on your market but a few other thoughts:

1. House #1, you view as a starter home for yourself apparently using an FHA loan (3.5% down). In my market it would be hard to buy a single family for $250k and make it a good reliable rental. If it was really nice, I might be able to rent it and cover my costs or even make a little money BUT it would be hard to keep tenants a long time and I might have excess vacancy with each turnover because the rental market for that type of property is pretty thin. Most people who would want that kind of property would buy where I am.

So, I suggest go find some rentals that rent for $2700-$3000 per month and then see if you can find similar properties for sale in the price range you think. Just to see if it is plausible.

2. Use a calculating tool or spreadsheet to make sure you budget for things like Vacancy, maintenance, capex, etc etc. Those things could make or break you. 

3. Without running real numbers, it sounds like you are planning for "everything to go well", but in real life it does not! When underwriting an investment you budget for things like maintenance, capex, and vacancy. I think a good starting point is 5% of incoming rent for each. So, 15% total. So, if your rent is $2700/month that would be $405/month. 

4. Bad things are more likely to happen to you early on because you are not yet experienced. So, thinking that in "a few years" you will be better is not as likely to happen as you think. In the long run you should be but the first few years could be a test by fire. Many bad things are possible! Nightmare tenants, evictions, etc etc. 

5. You don't mention hiring a property manager, so I'm guessing you plan to self manage. That is fine but again you need to be ready for the worst. Have a reserve fund set up because even though you may set aside money from each rent payment bad things can crop up before that accumulates. 

6. You are comparing this kind of investment to something like a mutual fund which is great! Comparing one use of capital versus another is solid thinking. Transaction costs are expensive in real estate which is another reason why its a LONG game not a short one. 

For example, if property values remain FLAT, it will take you about 7 years of paying down your mortgage to break even! You are paying down that mortgage every month like you said, but after 7 years all you have done is cover the commissions and costs to sell the property and get your original down payment back. 

7. The idea of what you are thinking here is a "house hack", BUT its hard to make the scenario you set out work well because the kind of single family houses you think about are less ideal rentals. They are probably more "houses you like" personally. 

8. One hallmark of a successful person is "delayed gratification", sacrificing now knowing you can have MORE of what you want LATER!

To that end, have you considered a more traditional "house hack"? Buy a 2-4 unit with that FHA loan and live in 1 unit for a year and then buy a 2 unit and live in 1 unit for a year and then buy a primary. You end up with a couple small multifamily properties that are better suited as rentals and more likely to cash-flow better.

The sacrifice is that you need to live in a multi-family for a couple years, but its about setting yourself up for long term success!