"Worth" It? (CA Duplex)

18 Replies

Hi, folks.

I'm in CA Bay Area, where rents and prices are very high.  I'm considering selling my private residence which a RE agent said should fetch about $800k.  Decent area duplexes (3/1 + 2/1) are about $1.0 mil. After selling my home and fees and all, my net profit should be about $730k, leaving about $270k loan. I plan to be owner/occupant in the 2/1 and rent the 3/1.  So:

Est. Mortgage =$1300/month

Prty Tax (stupid high in CA)=$1200/month

Insurance =$100/month

Est. Total monthly costs=$2600

Est. Rent/unit= $2400 for the 3/1 unit

Given that this area, prices are rapidly on the rise, the equity should increase and could possibly stabilize in the next 2 yrs.  Of course, I've no idea but I'm going in with that in mind.  Even since 2013, prices have gone up about $100k on similar properties.

Ive read about the 50% rule, but in this area, unless you're Mark Zuckerberg or Larry Ellison, its next to impossible to put that much down.  What do you folks think?

Let us clarify some confusion about CA first.

-property tax rates are low 1.2-1.5%. Your 1mil property will be taxed at higher tax in texas (2.6-3.3%) and elsewhere.

-prop13 keeps property tax rate growth at 2%/yr while properties appreciate at 6+%. In other states each year your taxes go up if property appreciates while rents may not grow as much.

This means, if you buy and hold long term your property taxes will stay low even as appreciation allows you to cash out refi and get access to your capital. 

Look at return on equity (ROE) metric when you have predominant growth from appreciation and not cashflow. principal paydown itself will be around 1k/m and that will reduce ROE. when this happens below a threshold you refi to cashout. 

I think this could be a good investment. Are schools improving in this area? What are your exit strategies ? 

Get a CPA to evaluate how your depreciation, insurance costs will be calculated in this case since you occupy a fraction of duplex. Keep separate expense record for rental unit.

Come down to @johnson's meetup in san jose on 17th to meet local investors.  http://www.biggerpockets.com/forums/521/topics/206...

Good Luck.

Originally posted by @Abhay K. :

Let us clarify some confusion about CA first.

-property tax rates are low 1.2-1.5%. Your 1mil property will be taxed at higher tax in texas (2.6-3.3%) and elsewhere.

-prop13 keeps property tax rate growth at 2%/yr while properties appreciate at 6+%. In other states each year your taxes go up if property appreciates while rents may not grow as much.

This means, if you buy and hold long term your property taxes will stay low even as appreciation allows you to cash out refi and get access to your capital. 

Look at return on equity (ROE) metric when you have predominant growth from appreciation and not cashflow. principal paydown itself will be around 1k/m and that will reduce ROE. when this happens below a threshold you refi to cashout. 

I think this could be a good investment. Are schools improving in this area? What are your exit strategies ? 

Get a CPA to evaluate how your depreciation, insurance costs will be calculated in this case since you occupy a fraction of duplex. Keep separate expense record for rental unit.

Come down to @johnson's meetup in san jose on 17th to meet local investors.  http://www.biggerpockets.com/forums/521/topics/206...

Good Luck.

 Thanks Abhay.

Im new at this so any advice is appreciated. What do you mean exit strategies? Is that how to get out in a hurry? 

The schools have moderate good scores. They're not Almaden or Cupertino I'd still it desirable for many parents. 

I will definitely sign up for the Meetup group. It'll be to network with like-minded folks

Why would you put 700K down on that property? your return on your cash will be dismal. I would rethink that a bit.

Hey @Gary F.

I would have to agree with @David Schach . Your mortgage payment may be really low (which may be all you're looking to get out of this transaction) but your actual cash on cash return would be really terrible.

If I were you (and looking to to maximize my investment potential) I would still consider selling and buying into the duplex but not putting nearly as much down. Then with the remaining funds, allocate some to a secondary investment property (which could be something an hour or so away--think Hollister, Monterey or Salinas) where your dollar can travel a little father for similarly sized units. In other words, why use all your cash to buy one when it's more than possible to buy at least two leveraged out.

Feel free to reach out if you have any questions and best of luck on whichever route you decide!

I really appreciate the comments I'm receiving. 

So the numbers don't look great?  I was thinking since my monthly housing payment currently is about $1700 (mortgage, tax,  insurance) that if I get $2400 rent I'm ahead. Since this duplex would be my and investment. 

gary, you are selling in a sellers market and buying in a sellers market. you are going to do very well on your sale but very poorly on your buy. 

if you ran your numbers adding in "rental savings" and booked that amount towards interest earning accounts etc instead of using the net difference to fund your normal living then MAYBE it could benefit you.

i am in a similar situation and i am in a WAIT AND SEE mode right now. I am actively looking but extremely picky and critical of any RE deals I am looking at. Much greater downside risk buying today than upside. You need to do what works for you, but be cautious you arent getting into a duplex that will be flat or underwater for a decade. i know people who are just coming out of the red on properties in the bay area that they bought in 2005. We can and will experience LONG runs of flat or negative appreciation in the bay area. But when it runs up, it runs fast. You are selling at peak or nearing peak for this cycle. good job!

@Gary

To improve COC return (net income/cash deployed), keep minimal cash into the deal.

Remember if your leverage is 4x (you put 25% down), when property appreciates by 10%, your return on cash due to appreciation is 40%. Based on your cashflow needs, you may want to maximize leverage or maximize cashflow or choose a golden mean path :) where you target say 250/m cashflow and choose loan amount to meet that. Basically this has to do with your risk profile, your personal time value for money - do you need cashflow now? are you confident about appreciation? do you have reserves if market goes south for a few years?

Exit strategies refer to what do you do if planned outcome is not achieved. This is somewhat like a stop loss order in stocks.

e.g.

if area deteriorates I will ...

if units remain vacant beyond .... then I will...

etc.

Originally posted by @Abhay K. :

@Gary

To improve COC return (net income/cash deployed), keep minimal cash into the deal.

Remember if your leverage is 4x (you put 25% down), when property appreciates by 10%, your return on cash due to appreciation is 40%. Based on your cashflow needs, you may want to maximize leverage or maximize cashflow or choose a golden mean path :) where you target say 250/m cashflow and choose loan amount to meet that. Basically this has to do with your risk profile, your personal time value for money - do you need cashflow now? are you confident about appreciation? do you have reserves if market goes south for a few years?

Exit strategies refer to what do you do if planned outcome is not achieved. This is somewhat like a stop loss order in stocks.

e.g.

if area deteriorates I will ...

if units remain vacant beyond .... then I will...

etc.

 Excellent advice again, Abhay.

Please forgive my lack of knowledge so some of my questions and comments may seem minuscule to you and others. 

So, by putting less down I maximize the return on my down payment and also decrease my risk?  By putting all of my home's net profit of $700 as a down payment, I'm overextending myself and decreasing the return on investment?

Two problems:

Assuming purchase price of $1mil on duplex

1) I probably won't qualify for a loan of more than $400 max on a $1mi property. So putting $600 down, I'd need a $400 loan.  My monthly payments about about $2800/month (mortgage, tax, insurance but not including maintenance, vacancies, etc that I'm missing).  Then I'm negative cash flow. 

$2800 costs

$2400 rent

-$400

2) In this market, unless I have 100% cash or at least a large down payment and a prequal letter (my situation), I lose bargaining power and lose to other all cash investors. Is this correct?

Of course, my goal is for positive cash flow and hope appreciation happens. I don't know enough about how to predict appreciation but would sure like to know how. 

My risk tolerance is low. I have no reserves should the market go south.

I've sadly never thought of exit strategies and don't know what the options would be other than try to sell.

So basically what I thought may have been a good deal (as presented in my first post, may not be? Phew, any help appreciated.

Another thing. I don't have to purchase a duplex. I'd actually rather not have to sell my home and live next to my tenant, but am prepared to do so if I can invest wisely this way.

I do have a 250k HELOC I was prepared to use for REI. But there's no properties at that price in the Bay Area that I know of. I could purchase in the Central Valley. Or I was even thinking of buying trust deeds from another company.

What of those options?

@Gary F. In your above example you are forgetting about your rent that you are not factoring into your return.

2,400 rent (3/1)

-2,800 costs 

+2,000 for the 2/1(what your side would rent for if you weren't in it)?

=what the property will do as an investment

You also need to make sure you calculate all of your costs (vacancy, maintenance, capex, PM, ect.)

You will just be forgoing some of the profit by living in the unit but if you have a house payment now I would continue to act like you do and plow that into an account that you will use to purchase the next one or another investment.

Originally posted by @Gary F. :
Est. Mortgage =$1300/month
Prty Tax (stupid high in CA)=$1200/month
Insurance =$100/month
Est. Total monthly costs=$2600

Est. Rent/unit= $2400 for the 3/1 unit


Hi Gary,

As a former resident of the bay area, I feel your pain. Make sure you add CapEx, Repairs, and Vacancy into your equation, these can be quite costly and will give you a more realistic grasp of what you may make. I usually budget 8% for vacancy and 15% for CapEx/Repairs.

Now, the rest is really up to you - if you buy that property you are going to be negative cash flow, even with your down payment. You should also consider what the current tax basis is on your current house, as you will be exchanging it for a much higher appraised value. Basically, you're speculating that prices are going to go up, which they may, but there is no guarantee and they are already unattainable or many people. Also, give consideration to if you really want to live in a duplex, which isn't as nice as living in a SFR.

And to clarify about Taxes, if you lived in Texas (Used to live in Dallas & Austin), you would pay more per appraised dollar, but there are many places in Texas where you can pickup a nice 3/2 for 100k - 200k. It isn't great for appreciation, but for your average person, the cost of living is quite low.

-Christopher

Originally posted by @Chris Vail :

@Gary F. In your above example you are forgetting about your rent that you are not factoring into your return.

2,400 rent (3/1)

-2,800 costs 

+2,000 for the 2/1(what your side would rent for if you weren't in it)?

=what the property will do as an investment

You also need to make sure you calculate all of your costs (vacancy, maintenance, capex, PM, ect.)

You will just be forgoing some of the profit by living in the unit but if you have a house payment now I would continue to act like you do and plow that into an account that you will use to purchase the next one or another investment.

 Thank you, Chris.

Yes, true. Those other expenses are the reality I didn't factor in on paper.

And being that my current housing expenses are about $1700/month and going down, if I live in the 2/1, I'm essentially losing $300 and having to live next to my tenant and deal with the hassles.

@gary This is a good exercise. Get estimates think about all that could go wrong, get insurance where risk can be insured away. Remember Knowledge is big Insurance and it will increase your risk appetite! Research these topics on BP, meet people. I found it easier to take risks once I could clearly understand it better. 

   Nobody can answer your personal risk tolerance nor judge it. If house prices crash, will you be able to sleep at night with 20% down 30% down 50% down negative equity? These are scenarios you can evaluate and go with your gut instinct. Good Luck.

Originally posted by @Christopher Brainard :
Originally posted by @Gary F.:
Est. Mortgage =$1300/month
Prty Tax (stupid high in CA)=$1200/month
Insurance =$100/month
Est. Total monthly costs=$2600

Est. Rent/unit= $2400 for the 3/1 unit

Hi Gary,

As a former resident of the bay area, I feel your pain. Make sure you add CapEx, Repairs, and Vacancy into your equation, these can be quite costly and will give you a more realistic grasp of what you may make. I usually budget 8% for vacancy and 15% for CapEx/Repairs.

Now, the rest is really up to you - if you buy that property you are going to be negative cash flow, even with your down payment. You should also consider what the current tax basis is on your current house, as you will be exchanging it for a much higher appraised value. Basically, you're speculating that prices are going to go up, which they may, but there is no guarantee and they are already unattainable or many people. Also, give consideration to if you really want to live in a duplex, which isn't as nice as living in a SFR.

And to clarify about Taxes, if you lived in Texas (Used to live in Dallas & Austin), you would pay more per appraised dollar, but there are many places in Texas where you can pickup a nice 3/2 for 100k - 200k. It isn't great for appreciation, but for your average person, the cost of living is quite low.

-Christopher

 Hi, Christopher.

Thanks for the numbers to add in.  So basically I need to factor in another 23% to operating costs.  I'd be negative in that case. 

And that higher tax costs, yes that's going to hurt the net profit.

Sheesh. I might as well just do a couple of trust deeds or buy something in the Central Valley. Hmmmmmm?

@Gary F.

 There are a lot of ways to look at this, and other posters have done a good job bringing different perspectives to it.  Since many the details have been discussed by others, I'll skip them here.  In the end, in my opinion, it sounds like you are counting on appreciation to bail you out of a bad deal.    

Originally posted by @Abhay K. :

@gary This is a good exercise. Get estimates think about all that could go wrong, get insurance where risk can be insured away. Remember Knowledge is big Insurance and it will increase your risk appetite! Research these topics on BP, meet people. I found it easier to take risks once I could clearly understand it better. 

   Nobody can answer your personal risk tolerance nor judge it. If house prices crash, will you be able to sleep at night with 20% down 30% down 50% down negative equity? These are scenarios you can evaluate and go with your gut instinct. Good Luck.

 HI, Abhay.

Yes, great wisdom yet again. I have no idea of the market's future of course. So I guess it's better to go in assuming it will go down and have those exit strategies. 

Selling my home in this nice suburb with my comfortable low payment and low taxes is not my first preference. Especially if my equity drops (If I were in a duplex) and I'm sleeping next door to some stranger, who also may turn out to be Dr. Jeckyll for all I know. 

Originally posted by @Kevin Siedlecki :

@Gary F.

 There are a lot of ways to look at this, and other posters have done a good job bringing different perspectives to it.  Since many the details have been discussed by others, I'll skip them here.  In the end, in my opinion, it sounds like you are counting on appreciation to bail you out of a bad deal.    

 Hi, Kevin.

Hmm, good point. Not a good idea on appreciation that might not happen.  If only we could have a crystal ball. 

@Gary F.

If you want a good reason to make a move, try value add. Buy a place that needs some love. In a high rent area, you should be able to create your own appreciation immediately. I do not think I would ever incur the transaction costs of switching residence unless there were immediate upside on the new place. 7-10% disappears in agent fees, loan fees, moving expenses, surveys, insurance, etc. 

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