Better to invest in a growing smaller city or suburb of big city?

25 Replies

First-time investor/home-buyer looking at buying a multi-family property (duplex preferred) either around Chicago where I currently live or a smaller, but rapidly growing city in Minnesota where I'm from.

If I choose to buy a duplex in the Chicago suburbs, my wife and I would be living in it and renting out the other unit. On the other hand, if I buy a property in Minnesota, I would be renting out all 2-3-4 units and visiting periodically to make renovations or hire someone to manage the property.

I heard somewhere that if you don't live in the property you're renting out, then you have to pay additional taxes on it? What is this called? Also Illinois property taxes are twice as much as Minnesota's (2.3% vs. 1.1%), would not living in our rental property be equivalent to paying extra in Illinois taxes?

Our credit scores are both 700+ and we plan to save up the 20% down payment + closing costs before buying, possibly even borrowing money from friends with an agreement (probably a bad idea, but our friends are the ones interested in our investments).

Our goals are to break-even by renting out the other unit in Chicago or making small cash flow by renting out all units in Minnesota, eventually using cash flow for renovations or another property.

My questions are:

1. Which city is the better choice to buy a property in? We live 5 hours away from my hometown and don't mind driving occasionally to manage.

2. Which 1st-time home buyer programs should we take advantage of? Not looking to put only 3.5% down, but wouldn't mind tax benefits or a lower interest rate.

3. How much should we budget for vacancies, maintenance, and renovations?

4. Is it ever okay to borrow money from friends with a loan agreement?

Thanks for checking out my post, any advice for or against my plans is welcome!

@Jack Plantin

That's a great question. But in your situation, I agree with @Jordan Moorhead . Buy in your hometown. We run into this all the time with clients in Denver and Colorado Springs. They're both hot markets so sometime first-time homebuyers think they should invest out of state first. Admittedly, I have a dog in the fight, but I also truly believe it when I tell them that their first "investment" should be their primary residence, even if that's a small condo. 

Anyway, good luck!

@James Carlson I run into the exact same thing in Minneapolis. It's a hot market and people see the barrier to entry and want to go somewhere cheaper. I've found that I've made a lot more when the barrier to entry is high on the back end. My investments in Minneapolis and Austin have made me 5x what my investments in Louisville have.

@Jack Plantin

I will be closing soon on a duplex in Minneapolis and decided to go the route of owner occupied so I could put less down and use an FHA loan. This should be an option in Chicago but an expert should chime in.

The benefit is that I only need 3.5% down and therefore my return on investment will be pretty good. The down side is that the property needs to accept the FHA loan... the property needs to be in good shape or repairs specific to the FHA requirements need to be made prior to sell. There's an additional FHA inspection fee and smaller additional inspection fee if they call anything. Apparently they always call peeling paint. One other down side is the required loan insurance that drops my cash flow significantly.

I will need to occupy this unit but am planning on moving at some point to my next investment property.

Hope this helps. I’ll follow this chat if you don’t mind.

Originally posted by @Corey Hawkinson :

@Jack Plantin I’m a little biased towards Minnesota. However, a long distance rental might not be the best option for someone getting started. That’s just my 2 cents.


Biased how? MN is a hot area for investing right now? I can always relocate back to Minneapolis if live-in and investing in MN is the best bet.

Originally posted by @Jordan Moorhead :

@Jack Plantin definitely do the first one in Chicago where you can live in it and take advantage of the owner occupied loans. OOS investing is a bad idea for a newbie.

What is an owner occupied loan? 3.5% FHA loan? Is this even smart with $250 mortgage insurance? Or is it always smarter to save 20%?

Originally posted by @Shanna Barnes :

@Jack Plantin

I will be closing soon on a duplex in Minneapolis and decided to go the route of owner occupied so I could put less down and use an FHA loan. This should be an option in Chicago but an expert should chime in.

The benefit is that I only need 3.5% down and therefore my return on investment will be pretty good. The down side is that the property needs to accept the FHA loan... the property needs to be in good shape or repairs specific to the FHA requirements need to be made prior to sell. There's an additional FHA inspection fee and smaller additional inspection fee if they call anything. Apparently they always call peeling paint. One other down side is the required loan insurance that drops my cash flow significantly.

I will need to occupy this unit but am planning on moving at some point to my next investment property.

Hope this helps. I’ll follow this chat if you don’t mind.

I don't quite see the benefit of putting only 3.5% down unless you want to get started investing sooner than later. Wouldn't you end up paying more in interest payments down the line that would eat up cash flow, equity, and appreciation? I don't know the math, but I feel like the 16.5% savings (33k on a 200k down payment) would equate to many thousands more in interest during the loan term.

Let me know what you think. What your rationale behind FHA loan is.

 

@Jack Plantin 3.5% - 5%. Anything under 20% down requires PMI. It varies based on a few factors. People get caught up on PMI but if someone else is paying it WHO CARES! It's all about numbers and if you're cashflowing it's my personal opinion that I'd rather get a better CoC by putting down so little and still pay the PMI.

Originally posted by @Jordan Moorhead :

@Jack Plantin 3.5% - 5%. Anything under 20% down requires PMI. It varies based on a few factors. People get caught up on PMI but if someone else is paying it WHO CARES! It's all about numbers and if you're cashflowing it's my personal opinion that I'd rather get a better CoC by putting down so little and still pay the PMI.

 I understand about your tenant paying the mortgage insurance, but does the increased interest payments from not putting down 20% take away a lot from the profit once you sell the property? Hope that question makes sense.

I guess if you are starting out and looking out of state I would have someone with eyes on the ground that you could trust. If you don't have that, stay local with where you are familiar with and house hack away. I am newer as well, but have a close friend who is an agent that I have known for 15 years in the market I am looking at out of state. That is the only reason I am even considering it and they will be my eyes on the ground and handling the in person stuff that I can't.

@Jack Plantin it's all about math. If you can get a better CoC by putting 20% down then there's your answer. There is no standard answer. I'd rather put 3.5% down, get a 20-30% CoC and then save my other cash for a 20% down deal later when I can no longer househack. I'll continue to use owner occupied loans while I also buy 20% down commercial properties. It's worked well for building a portfolio worth close to $2mm so far.

@Jack Plantin , I'm sure I'm not the only one to say this but these questions are hard to answer until you make certain choices based on your specific situation. One place to start is to get connected with people in your desired areas and really dig into the scenarios. Your questions can be answered best when having a conversation with a good lender and realtor who know what options to give you after seeing your detailed situation.

That all said... I went the buying where I live, La Grange (Chicago West Suburbs), route. When starting out and managing yourself, it makes sense to have as much at your reach at a moment's notice. There are so many benefits to going the "house hacking" route. I moved from a SFH to 2-unit property. I ended up keeping the SFH and rented it out. Even if I would have sold the SFH, it made sense for me to move into the 2-unit. I was able to find the perfect property for what I needed. Each unit in the 2-unit is larger than my SFH. The public schools are good. The neighborhood is amazing. I'm paying off a more expensive property for less than what I was paying for in my SFH (this by itself is like doing magic). All of that, and I was able to lower my out of pocket expense for personal housing.

In this situation, I am not getting cashflow while I am living here. Meaning, the rent from the second unit is not covering the mortgage and expenses for this 2-Unit. If you want to be close to cashflowing or breaking even in these A/B suburbs then you most likely have to look for a property with more units to make the numbers work. Plus, I would have had to give up some of the benefits I mentioned. I was not looking for a cashflowing property in this house hack scenario because I figured the other benefits outweigh that. Lowering the out-of-pocket expenses for housing did help my savings rate get a boost. Which will help put together funds faster for the next investment.

No matter the location or the time, money is being made in REI by someone. I think as long as you set up your systems and people correctly, you should be able to make your investment work in either Minnesota or in the Chicago area. If I were to invest out-of-state (or further than a 2 hour drive from me) I would definitely consider getting someone to manage my property. There are several people on here doing out-of-state investing and make it work for them. I would just make sure to vet the potential property manager to make sure I am confident that they will care for my property well enough. And even then I would have to keep an eye over them to make sure there is no complacency.

When it comes to your last question, using other people's money to finance an investment is usually a nice tool to have. I would not do that on my first attempt but once I am comfortable with my abilities and have the systems and connections in place I would jump on that in a heartbeat. One suggestion I came across is when getting into any agreement with anyone, make sure each person/party knows EXACTLY what is expected from them throughout the process. Write down the type of control each person has in each phase of the process. Who can dictate what and how much responsibility each side has. That will lead to less headaches later.

I put myself in a position to get lucky. I reached out to people doing what I want to do and am learning from them. I got together with an amazing realtor in the area who knows what it takes to invest in properties. He was able to connect me the right lender, lawyer, and contractors. All of which know what is needed to make investments work. It took months for me to find what I needed but when I found the right people the right paths started showing up. I suggest you start looking to meetup with others that are doing what you want where you want.

If you need any help or are interested in the near west suburbs of chicago, let me know. I'll try to help any way I can. Good "luck".

Originally posted by @Alejandro Calixto :

@Jack Plantin, I'm sure I'm not the only one to say this but these questions are hard to answer until you make certain choices based on your specific situation. One place to start is to get connected with people in your desired areas and really dig into the scenarios. Your questions can be answered best when having a conversation with a good lender and realtor who know what options to give you after seeing your detailed situation.

That all said... I went the buying where I live, La Grange (Chicago West Suburbs), route. When starting out and managing yourself, it makes sense to have as much at your reach at a moment's notice. There are so many benefits to going the "house hacking" route. I moved from a SFH to 2-unit property. I ended up keeping the SFH and rented it out. Even if I would have sold the SFH, it made sense for me to move into the 2-unit. I was able to find the perfect property for what I needed. Each unit in the 2-unit is larger than my SFH. The public schools are good. The neighborhood is amazing. I'm paying off a more expensive property for less than what I was paying for in my SFH (this by itself is like doing magic). All of that, and I was able to lower my out of pocket expense for personal housing.

In this situation, I am not getting cashflow while I am living here. Meaning, the rent from the second unit is not covering the mortgage and expenses for this 2-Unit. If you want to be close to cashflowing or breaking even in these A/B suburbs then you most likely have to look for a property with more units to make the numbers work. Plus, I would have had to give up some of the benefits I mentioned. I was not looking for a cashflowing property in this house hack scenario because I figured the other benefits outweigh that. Lowering the out-of-pocket expenses for housing did help my savings rate get a boost. Which will help put together funds faster for the next investment.

No matter the location or the time, money is being made in REI by someone. I think as long as you set up your systems and people correctly, you should be able to make your investment work in either Minnesota or in the Chicago area. If I were to invest out-of-state (or further than a 2 hour drive from me) I would definitely consider getting someone to manage my property. There are several people on here doing out-of-state investing and make it work for them. I would just make sure to vet the potential property manager to make sure I am confident that they will care for my property well enough. And even then I would have to keep an eye over them to make sure there is no complacency.

When it comes to your last question, using other people's money to finance an investment is usually a nice tool to have. I would not do that on my first attempt but once I am comfortable with my abilities and have the systems and connections in place I would jump on that in a heartbeat. One suggestion I came across is when getting into any agreement with anyone, make sure each person/party knows EXACTLY what is expected from them throughout the process. Write down the type of control each person has in each phase of the process. Who can dictate what and how much responsibility each side has. That will lead to less headaches later.

I put myself in a position to get lucky. I reached out to people doing what I want to do and am learning from them. I got together with an amazing realtor in the area who knows what it takes to invest in properties. He was able to connect me the right lender, lawyer, and contractors. All of which know what is needed to make investments work. It took months for me to find what I needed but when I found the right people the right paths started showing up. I suggest you start looking to meetup with others that are doing what you want where you want.

If you need any help or are interested in the near west suburbs of chicago, let me know. I'll try to help any way I can. Good "luck".

Thank you so much! My goal is also to decrease housing expenses, while building equity and increase savings. I'll talk to an agent that specializes in the suburbs of Chicago. If you have any recommendations, it'd be great if you could PM me details. Also what's your opinion on low down payments? Should I wait for 20% or jump on a deal with only 5-10%?

 

@Jack Plantin the math almost always favors the smaller downpayment and buying sooner rather than later.  Of course, there are exceptions like when there is a value crash but this is not typical and while everyone thinks values will decrease in the next recession history does not support this popular belief.  

Here's the quick version of how this works.  If it takes 1 year to save 10K after taxes toward buying your first property and you were to buy a 300K property it would like something like this (simple math)

Year 1 

  • *Buy now, down payment 10.5K you own 300K property and FHA MI would be $204.17/month.
  • *Wait to buy, you have 10.5K at the beginning of year one

End of year 1 after 12 months

  • *Buy now value worth 309K with 3% appreciation (the 40-year average)
  • *Wait to buy, you have 20.5K but lost 9K to appreciation and received no cash flow, tax deduction, or amortization $5300.97 in a year on a 30-year FHA mortgage (tenant paying your rent).

End of Year 2

  • *Buy now value worth 318.27K with 3% appreciation (the 40-year average)
  • *Wait to buy, you have 30.5K but lost 18.27K to appreciation and received no cash flow, tax deduction, or amortization $10,811.06 cumulative on a 30-year FHA mortgage (tenant paying your rent).

  • End of Year 3

    *buy now value worth 327.81K with 3% appreciation (the 40-year average)
    • *Wait to buy, you have 40.5K but lost 27.81K to appreciation and received no cash flow, tax deduction, or amortization $16,538.48 cumulative on a 30-year FHA mortgage (tenant paying your rent).

    • End of Year 4

      *buy now value worth 337.64K with 3% appreciation (the 40-year average)
        • *Wait to buy, you have 50.5K but lost 37.64K to appreciation and received no cash flow, tax deduction, or amortization $22,491.84 cumulative on a 30-year FHA mortgage (tenant paying your rent).
        • End of Year 5

          *buy now value worth 347.76K with 3% appreciation (the 40-year average)
          • *Wait to buy, you have 60.5K but lost 47.76K to appreciation and received no cash flow, tax deduction, or amortization $28,680.01 cumulative on a 30-year FHA mortgage (tenant paying your rent).

          *Buy now -your profit on the sale would be $76,440.01 minus Real Estate sale fees. Of course, you also get your original $10.5K back, 5 years of cash flow and 5 years of depreciation on your taxes.

          If you are in a stable financial condition it rarely makes sense to save large amounts of money before you purchase. In fact, even if you do have the money now, you should buy 1 with 3.5% FHA as an owner-occupied loan and use the remainder to purchase a non-owner occupied property. @Jordan Moorhead

            I would typically lean towards doing an investment you can closely manage for your first one. I think that by doing this, you can see it first hand and know that it is good care. As far as running the numbers, I typically mark down 10% for each of maintenance/ capex, vacancy and management. If the numbers look good after taking 30% off the top, you should be in good shape. Best of luck and I live just a bit north if you want to talk about other investment areas. 

            Originally posted by @Jack Plantin :

            First-time investor/home-buyer looking at buying a multi-family property (duplex preferred) either around Chicago where I currently live or a smaller, but rapidly growing city in Minnesota where I'm from.

            If I choose to buy a duplex in the Chicago suburbs, my wife and I would be living in it and renting out the other unit. On the other hand, if I buy a property in Minnesota, I would be renting out all 2-3-4 units and visiting periodically to make renovations or hire someone to manage the property.

            I heard somewhere that if you don't live in the property you're renting out, then you have to pay additional taxes on it? What is this called? Also Illinois property taxes are twice as much as Minnesota's (2.3% vs. 1.1%), would not living in our rental property be equivalent to paying extra in Illinois taxes?

            Our credit scores are both 700+ and we plan to save up the 20% down payment + closing costs before buying, possibly even borrowing money from friends with an agreement (probably a bad idea, but our friends are the ones interested in our investments).

            Our goals are to break-even by renting out the other unit in Chicago or making small cash flow by renting out all units in Minnesota, eventually using cash flow for renovations or another property.

            My questions are:

            1. Which city is the better choice to buy a property in? We live 5 hours away from my hometown and don't mind driving occasionally to manage.

            The answer to this question should be data driven. What kind of data? Data that where you can assess and compare the potential Return on Investment from both markets. What will it cost you to purchase, hold & cash flow the property in the small town near Minneapolis versus whatever area you choose in Chicago? If the Cash Flow & Return on Investment is less in the small town, why would you invest in a property that brings in less cash? Are you betting on appreciation? When it comes time to sell what's the average days on market in the small suburb versus Chicago. Supposed because the pressure of time you can't drive the 5 hours to manage the property in Minneapolis? Can you still cash flow the property if you're forced to hire a property manager? You can answer your own question by gathering the data and comparing.


             

            Originally posted by @Tim Swierczek :

            @Jack Plantin the math almost always favors the smaller downpayment and buying sooner rather than later.  Of course, there are exceptions like when there is a value crash but this is not typical and while everyone thinks values will decrease in the next recession history does not support this popular belief.  

            Here's the quick version of how this works.  If it takes 1 year to save 10K after taxes toward buying your first property and you were to buy a 300K property it would like something like this (simple math)

            Year 1 

            • *Buy now, down payment 10.5K you own 300K property and FHA MI would be $204.17/month.
            • *Wait to buy, you have 10.5K at the beginning of year one

            End of year 1 after 12 months

            • *Buy now value worth 309K with 3% appreciation (the 40-year average)
            • *Wait to buy, you have 20.5K but lost 9K to appreciation and received no cash flow, tax deduction, or amortization $5300.97 in a year on a 30-year FHA mortgage (tenant paying your rent).

            End of Year 2

            • *Buy now value worth 318.27K with 3% appreciation (the 40-year average)
            • *Wait to buy, you have 30.5K but lost 18.27K to appreciation and received no cash flow, tax deduction, or amortization $10,811.06 cumulative on a 30-year FHA mortgage (tenant paying your rent).

            • End of Year 3

              *buy now value worth 327.81K with 3% appreciation (the 40-year average)
              • *Wait to buy, you have 40.5K but lost 27.81K to appreciation and received no cash flow, tax deduction, or amortization $16,538.48 cumulative on a 30-year FHA mortgage (tenant paying your rent).

              • End of Year 4

                *buy now value worth 337.64K with 3% appreciation (the 40-year average)
                  • *Wait to buy, you have 50.5K but lost 37.64K to appreciation and received no cash flow, tax deduction, or amortization $22,491.84 cumulative on a 30-year FHA mortgage (tenant paying your rent).
                  • End of Year 5

                    *buy now value worth 347.76K with 3% appreciation (the 40-year average)
                    • *Wait to buy, you have 60.5K but lost 47.76K to appreciation and received no cash flow, tax deduction, or amortization $28,680.01 cumulative on a 30-year FHA mortgage (tenant paying your rent).

                    *Buy now -your profit on the sale would be $76,440.01 minus Real Estate sale fees. Of course, you also get your original $10.5K back, 5 years of cash flow and 5 years of depreciation on your taxes.

                    If you are in a stable financial condition it rarely makes sense to save large amounts of money before you purchase. In fact, even if you do have the money now, you should buy 1 with 3.5% FHA as an owner-occupied loan and use the remainder to purchase a non-owner occupied property. @Jordan Moorhead

                      Clear explanation, thank you.

                       

                      @Alejandro Calixto thanks for the shout out! @Jack Plantin I would love to connect with you, and I specialize in the western suburbs area where Alejandro purchased his duplex. His post pretty much summed up the essence of house hacking. You have to make some decisions based on your quality of life as you are mixing investing with your housing. There is no wrong answer here as you can live for free in B or C class neighborhood, or live with a drastically reduced cost of living in an A class neighborhood. Alejandro chose the A class neighborhood, and frankly his unit is as big as most single family homes anyways! I have other clients who choose to live in the garden apartment in their three unit in Berwyn or Cicero so that they can truly have the PITI covered by the rents, and that is good too!

                      Jack,

                      1.  I personally would invest closer to where I live or plan on living long term, BUT I would keep an eye on Real Estate in other states such as Minnesota as I know first hand how you never know where an opportunity will strike.  With the tight market that we currently have, you should keep your options open and if a home run comes up in Minnesota, go for it, and if it comes up here in Illinois then go for it here.  

                      Regarding the taxes being higher for non owner occupants, when you buy an investment property in Illinois and you reside in it then you can claim the homeowners exemption which lowers your taxes a few hundred bucks.  That is probably what was meant there. 

                      2. Regarding the loans, if you buy and occupy the property as a primary residence, you can buy with an FHA loan and put just 3.5% down although I would recommend at that point buying with a 5% down conventional loan. I work with a great lender at Key Mortgage that can offer 1st time homebuyer assistance. PM me if you'd like their contact.

                      3.  How much you should budget for vacancies, reno and maintenance will depend on the deal.  Each property will be unique based on number of units, location, etc and I would suggest you find a Realtor to work with that has experience helping clients buy rental properties.  (PM me if you aren't working with an agent and would like to talk some more as I am a Realtor and investor in Chicago and in the NW burbs.)

                      4.  Stay away from "friend" loans!!!!!!!  It's never a good idea to borrow money from friends or family for that matter that can't easily be returned.  If you plow money like that into a mortgage and you can't easily get it back to repay incase that friend or family member needs it or demands it back, it can get ugly.  Buy with a smaller down payment but use all your own funds for the down payment.  

                      Marcin



                        

                      Originally posted by @Marcin Talaga :

                      Jack,

                      1.  I personally would invest closer to where I live or plan on living long term, BUT I would keep an eye on Real Estate in other states such as Minnesota as I know first hand how you never know where an opportunity will strike.  With the tight market that we currently have, you should keep your options open and if a home run comes up in Minnesota, go for it, and if it comes up here in Illinois then go for it here.  

                      Regarding the taxes being higher for non owner occupants, when you buy an investment property in Illinois and you reside in it then you can claim the homeowners exemption which lowers your taxes a few hundred bucks.  That is probably what was meant there. 

                      2. Regarding the loans, if you buy and occupy the property as a primary residence, you can buy with an FHA loan and put just 3.5% down although I would recommend at that point buying with a 5% down conventional loan. I work with a great lender at Key Mortgage that can offer 1st time homebuyer assistance. PM me if you'd like their contact.

                      3.  How much you should budget for vacancies, reno and maintenance will depend on the deal.  Each property will be unique based on number of units, location, etc and I would suggest you find a Realtor to work with that has experience helping clients buy rental properties.  (PM me if you aren't working with an agent and would like to talk some more as I am a Realtor and investor in Chicago and in the NW burbs.)

                      4.  Stay away from "friend" loans!!!!!!!  It's never a good idea to borrow money from friends or family for that matter that can't easily be returned.  If you plow money like that into a mortgage and you can't easily get it back to repay incase that friend or family member needs it or demands it back, it can get ugly.  Buy with a smaller down payment but use all your own funds for the down payment.  

                      Marcin

                      Thank you! Good advice. With a 5% conventional loan, you still need mortgage insurance correct?
                        

                       

                      Our first was a house hack that we lived in. It was great to be close and hands on. It was a big success.

                      While I have borrowed money from friends, I did not for my first couple of deals. While you are learning, a lot can go wrong. That is stressful enough without adding more by worrying about paying back friends or family. Along those lines, make sure if your project ends up taking six months longer and costing 50% more than you planned you are not going to be underwater. Budget for the worst case scenario.


                      Free eBook from BiggerPockets!

                      Ultimate Beginner's Guide Book Cover

                      Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks and techniques delivered straight to your inbox twice weekly!

                      • Actionable advice for getting started,
                      • Discover the 10 Most Lucrative Real Estate Niches,
                      • Learn how to get started with or without money,
                      • Explore Real-Life Strategies for Building Wealth,
                      • And a LOT more.

                      We hate spam just as much as you

                      Create Lasting Wealth Through Real Estate

                      Join the millions of people achieving financial freedom through the power of real estate investing

                      Start here