To Buy or Not To Buy Investment?
Hello, I'm currently in escrow on my second single-family home rental property and am having trouble deciding whether to move forward. Looking for honest feedback here.
My husband and I currently have a rental property in the same neighborhood and are very happy with our CF. Hoping to repeat the process, we opened escrow with a smaller property in the same community, but the math shows we will be losing about $300/month for the first year or two due to interest rates/inflation of home prices in the area. We were ok with that initially because we figured we could refinance after some time and increase rent. Since then, we've learned that through the inspection, the central A/C unit is damaged (refrigerant leak, not blowing cold air) and we've asked for a credit from the sellers to replace the unit (that's it - we figured we would fix the other issues on our own). They are saying they will service the A/C which could fix the issue for a year or two, but ultimately we are stuck with the cost of the replacement.
My question is - should we eat the cost with the knowledge we have for now to take advantage of what could be a good long term investment? (Potentially $10,000 more than we were prepared to spend on top of coming up in price on the house) We are hesitant due to knowing we won't be cash flowing initially, we are entering summer time, we're hoping to rent it out ASAP and know this will be an issue eventually. But at the same time, the community has appreciated rapidly in the past 2 years and we feel will continue rising.
We are just afraid to back out of this opportunity over $10K, but we are also weary as this could make our financial situation more difficult for the next year or so. We are trying to negotiate for a credit from the sellers but they aren't budging.
Thanks for your input in advance!
#4 All Forums Contributor
- Plymouth, MI
Never eat any cost you know you have a choice not to. I see no reason to buy this property at all, and every reason not to.
#4 General Landlording & Rental Properties Contributor
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#4 General Landlording & Rental Properties Contributor
- Rental Property Investor
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Stop looking at the $10K for the AC as a separate expense. It's a cost of doing business. The $10K also doesn't just disappear. It adds value to the property.
You use the terms "cash flow" and "losing". These are two very different things. Cash flow is what's in your pocket after all expenses are paid and reserves funded. It's also taxed today. Losses are the totality of the investment. Have you factored in principal reduction? Appreciation?
I'd imagine the OC market is close to the LA market and finding a SFH that is only negative cash flowing $300 a month is a rarity. I don't foresee rent prices or home prices going down in OC any time soon. That negative $300 is likely going to go away in 2-3 years of modest rent increases. The potential appreciation is huge. Even with the slowing housing market, going from nuclear hot down to surface of the sun hot, lots of experts are predicting a slowing of price increases - not a drop in prices.
You mention "good long term investment". Cash flow is today. Think in terms of long term.
#4 All Forums Contributor
- Plymouth, MI
Quote from @Greg M.:That 20k for the A/C is a cost that doesn't add value to anything until you cash it in. Until then, it is a cost you must recover from the CF before you can make a profit. Since there is no CF coming, it's just one of the reasons why this isn't a good deal...in any way.
Stop looking at the $10K for the AC as a separate expense. It's a cost of doing business. The $10K also doesn't just disappear. It adds value to the property.
You use the terms "cash flow" and "losing". These are two very different things. Cash flow is what's in your pocket after all expenses are paid and reserves funded. It's also taxed today. Losses are the totality of the investment. Have you factored in principal reduction? Appreciation?
I'd imagine the OC market is close to the LA market and finding a SFH that is only negative cash flowing $300 a month is a rarity. I don't foresee rent prices or home prices going down in OC any time soon. That negative $300 is likely going to go away in 2-3 years of modest rent increases. The potential appreciation is huge. Even with the slowing housing market, going from nuclear hot down to surface of the sun hot, lots of experts are predicting a slowing of price increases - not a drop in prices.
You mention "good long term investment". Cash flow is today. Think in terms of long term.
#4 General Landlording & Rental Properties Contributor
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#4 General Landlording & Rental Properties Contributor
- Rental Property Investor
- Los Angeles, CA
Quote from @Joe Villeneuve:
That 20k for the A/C is a cost that doesn't add value to anything until you cash it in. Until then, it is a cost you must recover from the CF before you can make a profit. Since there is no CF coming, it's just one of the reasons why this isn't a good deal...in any way.
I recognize that your definition of profitability and that of most other people is vastly different. I'm not of the opinion that you have to recoup 100% of your upfront costs before making a profit. The money paid out is retained in the asset purchased. OP spending $10K on an AC doesn't make her $10K poorer. It just changes her assets from having $10K in cash to having a $10K AC. Her net worth remains the same.
Too many people fail to mentally spread costs over the life of the item. The $10K AC will last 20 years. That works out to about $40/month. If OP gets more than $40 a month in return for installing the AC, it was a good investment. For a SFR in Orange County, OP would need to discount the rent significantly over $40 if there was no AC. I also suspect it would take much longer to rent the place. The return on the AC investment is massive.
And cash flow is great, if that is what you want, but you clearly know that California is not a cash flow investment... yet has done phenomenally well for investors over the long term.
As long as vacancy rates stay at all time lows in OC( I believe they are hovering around 2.4% right now) then you can expect rental costs to rise at a pretty quick pace over the next year or two. However you do want to be carful on the appreciation side of things. The market is in the middle of a transition period where it's really hard to expect double digit appreciation in OC going forward. If interest rates stay around where they are I would expect appreciation to slow down closer to the average of 3-4% a year. I have been seeing homes that would have received 10-15 offers a few months ago "only" get about 2-6 right now, price reduction are on the rise(they have gone from about 15% to 20% in the last few weeks in OC) and the number of escrow dropping out have been higher as well. I don't see prices coming down anytime soon yet but the market is definitely slowing down to a healthier pace. It sounds like you are ok losing money for the first few years with the anticipation of breaking even later and eventually cash flowing so as long as that fits into your long term strategy and you're not going to be forced to sell it in a few years it could still end up being a great investment in 5-10 years from now, however there are other markets around OC that also might be worth looking into, like the Riverside area where prices are still lower and rent is going up just as fast. This might get you to cash flow a few years faster. As far as the A/C goes depending on how you run your rentals, remember in CA that if you replace the blower, in order to stay code compliant you are also required to replace all of the ducting if it's older as well. Does everyone do this, definitely not, but just throwing it out there in case you weren't aware. Hope this helps.
#4 All Forums Contributor
- Plymouth, MI
Quote from @Greg M.:You're correct about the trade off between the cost of $40/month. However, if the $40/month added CF is trying to offset the full cost paid for in cash, that argument isn't valid. It's not a trade off, it's a recovery.
Quote from @Joe Villeneuve:
That 20k for the A/C is a cost that doesn't add value to anything until you cash it in. Until then, it is a cost you must recover from the CF before you can make a profit. Since there is no CF coming, it's just one of the reasons why this isn't a good deal...in any way.
I recognize that your definition of profitability and that of most other people is vastly different. I'm not of the opinion that you have to recoup 100% of your upfront costs before making a profit. The money paid out is retained in the asset purchased. OP spending $10K on an AC doesn't make her $10K poorer. It just changes her assets from having $10K in cash to having a $10K AC. Her net worth remains the same.
Too many people fail to mentally spread costs over the life of the item. The $10K AC will last 20 years. That works out to about $40/month. If OP gets more than $40 a month in return for installing the AC, it was a good investment. For a SFR in Orange County, OP would need to discount the rent significantly over $40 if there was no AC. I also suspect it would take much longer to rent the place. The return on the AC investment is massive.
And cash flow is great, if that is what you want, but you clearly know that California is not a cash flow investment... yet has done phenomenally well for investors over the long term.
Quote from @Emma Pagoria:
Hello, I'm currently in escrow on my second single-family home rental property and am having trouble deciding whether to move forward. Looking for honest feedback here.
My husband and I currently have a rental property in the same neighborhood and are very happy with our CF. Hoping to repeat the process, we opened escrow with a smaller property in the same community, but the math shows we will be losing about $300/month for the first year or two due to interest rates/inflation of home prices in the area. We were ok with that initially because we figured we could refinance after some time and increase rent. Since then, we've learned that through the inspection, the central A/C unit is damaged (refrigerant leak, not blowing cold air) and we've asked for a credit from the sellers to replace the unit (that's it - we figured we would fix the other issues on our own). They are saying they will service the A/C which could fix the issue for a year or two, but ultimately we are stuck with the cost of the replacement.
My question is - should we eat the cost with the knowledge we have for now to take advantage of what could be a good long term investment? (Potentially $10,000 more than we were prepared to spend on top of coming up in price on the house) We are hesitant due to knowing we won't be cash flowing initially, we are entering summer time, we're hoping to rent it out ASAP and know this will be an issue eventually. But at the same time, the community has appreciated rapidly in the past 2 years and we feel will continue rising.
We are just afraid to back out of this opportunity over $10K, but we are also weary as this could make our financial situation more difficult for the next year or so. We are trying to negotiate for a credit from the sellers but they aren't budging.
Thanks for your input in advance!
I think it's a bad idea. Sales prices are at an all-time high. Mortgage rates are going up. If you buy today, what happens if the market corrects and the rates go up another 1% or more? The property won't appraise high enough and a refinance will increase your payments, not lower them.
You're asking if you should gamble on appreciation. I wouldn't do it.
Quote from @Emma Pagoria:
Hello, I'm currently in escrow on my second single-family home rental property and am having trouble deciding whether to move forward. Looking for honest feedback here.
My husband and I currently have a rental property in the same neighborhood and are very happy with our CF. Hoping to repeat the process, we opened escrow with a smaller property in the same community, but the math shows we will be losing about $300/month for the first year or two due to interest rates/inflation of home prices in the area. We were ok with that initially because we figured we could refinance after some time and increase rent. Since then, we've learned that through the inspection, the central A/C unit is damaged (refrigerant leak, not blowing cold air) and we've asked for a credit from the sellers to replace the unit (that's it - we figured we would fix the other issues on our own). They are saying they will service the A/C which could fix the issue for a year or two, but ultimately we are stuck with the cost of the replacement.
My question is - should we eat the cost with the knowledge we have for now to take advantage of what could be a good long term investment? (Potentially $10,000 more than we were prepared to spend on top of coming up in price on the house) We are hesitant due to knowing we won't be cash flowing initially, we are entering summer time, we're hoping to rent it out ASAP and know this will be an issue eventually. But at the same time, the community has appreciated rapidly in the past 2 years and we feel will continue rising.
We are just afraid to back out of this opportunity over $10K, but we are also weary as this could make our financial situation more difficult for the next year or so. We are trying to negotiate for a credit from the sellers but they aren't budging.
Thanks for your input in advance!
I would push back, the rates have changed the market, and they may be willing credit more then just a service. My experience in the last 2-3 weeks is that there are a lot of people realizing that rates are changing the field of real estate and they are falling out of escrow more often than not. If they do not do that credit, it would be a tough one to buy due to it already losing money, the next way to look at it is that if it has appreciation play in it. If you are buying it 10%-15% below market (that does not sound like the case) that would be a better conversation. If you are buying it at the top and they are not willing to do any of the splitting costs or anything else on the A/C fix I would not take it.
That being said, if they are willing to pay a lot of money to get the AC redone or give you a large credit then I would be more open for you to move forward because the cashflow in OC will eventually pace out. That is especially if you have an upside like value add (ADU etc.).
@Emma Pagoria
I personally would be ok with negative cash flow right now in a market like OC as long as you can afford it. Appreciation is going to make you wealthy in the long term, and let's say the house is $1,000,000, with a conservative 5% appreciation rate you will be looking at about $50k a year in appreciation. Assuming you are putting 20-25% down, you could pull a HELOC out or cash out refi in 2-3 years and use that money to replace your AC with that I don't know if I'd rely on interest rates going back down into the 3's unless there's another catastrophe. Hope this helps!
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Are there any other properties in that same neighborhood that pop up for sale that would have better metrics? If not, then all the more reason to consider this one. If there are, no real reason to stick to this one.
After more negotiating and taking a step back to really consider our goals with this property, we are continuing with escrow. Thankfully the sellers have finally agreed to an $8000 credit and to service the A/C. We appreciate all of your helpful input in our decision making!
Glad you were able to get some extra credits on the sale! Like I said previously the market is slowing down so sellers are not able to be as picky as they were just a few months ago with offers and repair requests. Congrats!
I would make sure your home inspector covered any other issues in the report. Since you mentioned" financial strain " due to AC repair/replacement, a new maintenance order from the prospective tenants could be a financial headache.
Whether the OC market appreciates or not, no one knows . Definitely, the increased mortgage rates have slowed down the sales side.
Best of Luck !!