Build rentals or other?

Question

Hey BP,

I need some advice from someone/someones that have been in my situation. Im having a hard time pulling the trigger getting into rentals in my area (olympic peninsula in Washington State). Im 25 years old and have been flipping/buying properties for 4 years now. I ran a landscape business for the past 5 years and recently sold it to get more involved in real-estate.  The problem that i am running into, is that the monthly income that i was accustom to, (about $10k a month on average) is no longer there. I left the business for personal reasons that i cant explain quickly.  I work full time building custom homes with my father in law making about $2500 a month. My wife is a teacher and makes about $36k a year, so combined is around $4500 a month after taxes.I have saved, invested and grew a small nest egg to around $430,000.

So now that you have some info on my situation, the reason i am on here is to find advice to create the ever-so-glorious PASSIVE income. I know how to flip homes and have all the skills to build a home from the gound up, but i really want to get into rentals for the monthly income

The problem with my area is that the cost of a single family dwelling  (that needs fixed up a bit) runs about $200k and most duplex i know run about $260k. With the 200k single family, it will rent for about $1400 a month fixed up. I could easily buy 2 homes for $400k  and rent them for $2600 a month. But i would never exchange $400k for $2600 a month, i want to leverage the rental.

So my plan is to build a duplex from the ground up, in which i could do for around $210,000, and take 6 months. It would generate about $2400 a month which wouldnt be to bad for $210k and a few months of working after work. My problem is that im not sure if i could refinance the duplex with my current Debt to Income level since i have a mortgage on my primary residence. I would hate to build the building and then have to wait a year to use the income from the duplex to qualify for a refy. I want to start building the next duplex as soon as im done with the first, but want to make sure i can get the money out of the first one to get the second one going. I think i could have 4 units by this time next year bringing in $4800 a month-Mortgage of $(2400)-expenses/insurance$(400)=$2000 a month in positive cashflow and about $200,000 in equity between the two buildings.

So with putting about $80k down on the two builds, i would have about $350K in savings, and $280k in Equity in the rentals and a Cash flow of $2000. In theory i would think that the extra $2000 would get me enough income to do the 3rd duplex.

What are your guys thoughts on this system of getting into rentals? is it to risky? Do you think the numbers work? Is there another direction you would go if you were in my situation? Thanks BP!

Clancy Catelli · Answer

Thanks @Kevin R. I know the 2% rule is tough in my neck of the woods, heck 1 % would be tough as well. Big money from Seattle is coming over to the area to retire and escape the rat race. iv personally seen my primary that i bought alomost 2 years ago, go up in value over 30%. I would never get into a deal unless i knew it was going to yeld me the return i wanted or the profit that i would need. I always base my business/investing decision on a risk-to-reward basis.

I was hoping to stay close to my town since i want to do all the repairs/maintenance/ rehab myself. I enjoy doing the work and it doesnt really feel like work to me.

Kevin Romines · Answer

Some area's have better returns then others. If you don't have the correct returns on a project, then  it just may not be one of the better options. It might be better to buy in a different location or even a smaller community to get the correct returns right up front.

When the numbers end up with smaller returns, it has the ability to limit your choices and exit plans. As much as I love to make mortgage loans, no one ever wants to be a slave to the payments? I would weigh all your options and just make sure the level of returns are there? I have found that most investors want a 10-15% return after all expenses.

If there is a local landlord association in your area, I would go attend and talk to the experienced buy and holders and see what their rates of returns are and if they like the numbers you looking at?

The 2% rule means that you want to get 2% of the purchase price in rents. This is a quickie rule of thumb but can be a good starting point. Its really difficult to hit that in most areas in our state, but there are areas that will get you between 1.3-1.75% and if you were to buy a distressed property and rehab it, you generally can make your money there?

In the end, it doesn't really matter where your passive income comes from, its all a matter of the risks, time and head aches along the way as well as ongoing. That monthly check that might be smaller that comes in without any maintenance and head aches just might be better then a monthly check that comes in at higher numbers, but requires a lot of constant effort and head aches along the way?

Use BP's BRRRR calculator and it will give you a better sense of things to look for?