Am I over extending at 22 years old?

9 Replies

I bought my very first piece of real estate 3 months ago. Its a 3 unit apartment I got a great deal on, awesome tenants and things are so far running smoothly. I have my eye on a second property. A 6 unit up for sale at 145k. I have the 20% down for this property but don't want to spend it otherwise my wallet would run dry and I don't want to be in that situation! So I am considering seller financing the down payment and financing the rest through the bank. I had no problem getting a loan on this first property, and owe 48k on it. If I were to buy this second property, I would owe $115,000 as well as owe the seller $29,000. I am mentally prepared for this second property but am a little nervous that I may be over extending as a new investor in a short amount of time. I could save another $20,000 to put me in a more satisfying place where I am happy to put a down payment from my own capital which would take some time but I doubt the property will still be on the market by then. What should I do? 100% finance this property and have just under 200k in debt on 9 units? I am 3 months into the real estate world. I say that as if I am inexperienced, but I am very knowledgeable and ready to take on a second property. My biggest concern is the great amount of (good) debt, in a short period of time, and whether I am over extending myself at an early stage. This second property preforms outstanding and I don't want to pass up this deal. $250/door per month at a very conservative pace after all debt services. What should I do??

If you can 100 % finance it, finance it that way. Good for you for starting so early. You are the only one who can answer your question of over leverage. As long as its making money, then you should be fine. Keep your cash for reserves, and if you are worried about over leverage make sure there is no pre payment penalty so you can refinance out of the seller financing note. The seller will be able to foreclose a lot faster than a bank would so Im sure you will be closing on the property in an LLC.

Further, you may be able to look into a portfolio loan with a bank who can take the two properties and put them into one loan, thus allowing you to leverage equity in the first property to buy the second through a regular bank vs. owner financing. However, having done owner financed deals before ( have one of my multis done this way ) I would do it, and keep your cash for a rainy day or the next deal. Educate yourself on here and read books / use the podcast from bigger pockets and keep buying, but thats just my two cents. 

Six to twelve months living expenses in an emergency fund.

I have heard that phrase when they were talking about everyone from single soccer moms to professional poker players.

The guidelines for business expenses vary from person to person. Reserves for capital expenses, vacancies, etc. should be there for a certain amount of months (three to six? Twelve? Who really knows?!).

You are right to not feel comfortable if the above things aren't in shape.

You are doing great!, by the way!

Do these properties truly cash flow? Not phony cash flow = "rent - PITI". But real cash flow meaning accounting for true, long term expense. Even if you think the 50% rule is too pessimistic (cash flow = rent - (50% of rent for expenses, vacancy and capital) - P&I payment) at least apply the bankers rule of thumb: cash flow = 75% of rent - PITI. If these are truly cash flow positive, then they're putting money in your pocket.

Second, though, you must have cash reserves to cover big expenses that will pop up.  Houses have a way of waking up in the middle of the night and saying "please insert $5000 to continue playing."  I would consider at least six months rents to be a good reserve, but a minimum of about $5000.  Really big expenses do pop up.  They're unpredictable, but not unexpected. 

If you have the reserves to cover those big expenses, and you have properties that truly cash flow, keep going.

But one more thing to consider is that property values and rents DO go down.  We've been in a long upswing, just like back from about 2000 to 2006.  But we had a long downswing from 2006 to about 2012.  That WILL happen again.  It always does.  Don't put yourself in the position many people did when the last downswing hit.  If you have long term, fixed rate financing and your properties will cash flow if rents do decline, then you should be able to weather a downturn.

@Andrew Michaud As long as the 2nd. property pays for itself you should be OK. If it doesn't well then don't do it. If you are worried about having a reserve of cash then borrow the down payment from a private investor. Or what you could do is have what they call a capital reserve account- which is extra cash set aside each month from rents that you use to pay for big expenses that may come up. Again, this is all possible if the 2nd. property pays for itself.  Just some thoughts, if it works, you are young enough, you should over-extend yourself the right way at your age! That is how you get wealthy. Hope this helps. 

I agree with @Seth.

I'd like to add some advice that doesn't necessarily have anything to do with your question.

Do NOT quit your job as soon as your income from real estate matches your living expenses.

In my opinion you should figure out what you want your income to be, then double it. Also, if you're not taking money from your real estate business to live you can snowball into acquiring more properties that much sooner. Something else to consider, banks love W-2's. If you get rid of your W-2 job you may find it harder to get financing from the bank.

How fantastic that you're starting out at 22! I started when I was 26. Consider doing a house hack and live for free (assuming your not married or can talk your spouse into it). I'm excited to see where you'll be in 10 years!

Happy investing!

Most banks will not allow what you're proposing. You may be able to get a bank to bite on 10% seller financing. Just make sure as stated above that the numbers are really true numbers. Feel free to post the income/expenses you're using on your underwriting.

No reserves can become a real nightmare if problems happen. Now, if you have other assets you could liquidate in an emergency such as gold coins, stocks, etc, they could be your emergency fund. If you don't have reserves nor a way to  up with cash quick I would say don't do it. And as @Jon Holdman pointed out, make sure your calculations are correct. It is common to see investors "making money" when in fact, even if they are, it may be 1% or 3% actual gains. 
PGI
-VCL
+OI
=EGI
-OE
=NOI

This is NOI...NOT CASH FLOW. Then factor in financing costs to get a true picture.

@Andrew Michaud lot's of great advice above so let me just echo a bit.

Make sure your financials are correct on the first property and projections on the new one.

ALWAYS keep reserves for potential issues.

Use seller financing when you can as long as the property still performs.

Nothing wrong with growing quickly if you have opportunities and the risk -tolerance. When you're 22 is a good time to do it as you have time to recover if you mess up. 

Your age has absolutely nothing to do with it. You only discount your achievements by stating your age. It sounds like you are being conservative by not over extending yourself. By asking the question, it tells me you are on the right track. Good for you.

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