What would you do in this situation? First investment property!

9 Replies

Hey everyone. First post asking for advice. =)

Purchased a duplex for 90K on a land contract in August. About to close on it Friday the 26th and buy out the sellers mortgage with my own. His mortgage was 140, so I will inherit about 50k worth of equity. During the process of me applying for my loan I had to get an appraisal. It appraised for 220k. 

I needed to borrow 7k from my parents to get the loan approved, and I will have to pay them back after it closes. I plan on taking out a HELOC off the equity to pay them back.

My original plan with this deal was to get some tenants into the property to pay my mortgage for me so I "technically" wont have a house payment, and what I used to spend on rent before I bought my house, and any rent I collect will go into a savings account that I can use to purchase another property. (advice from the bigger pockets set for life book)

My question is, since I have to get the HELOC anyway, should I just get it for the max amount and use that money for my next property? Or I could then use that money and become a hard money lender correct? If I do that, what consequences arise from these decisions?

Should I just get a HELOC for the 7k that was borrowed from my family and put it on the market and see if it sells for the appraisal value, cash out and then have the money in cash and fill out a 10-31 exchange?

Speaking of a 10-31 exchange how does that work? does the next house have to be equal or greater value or lesser value than the previous house?

Any advice on what you would do in this situation would be super helpful. Thanks everyone! 

Firstly you need to identify your goals more clearly. All of the options you put out are valid but without knowing your goals it’s impossible to decide.

If this property is cash flowing and you want to be a buy and hold investor then why sell it?

If you want capital for a new project then as long as this property still cash flows (including expenses) after then a HELOC is a fine strategy.

10-31’s are complicated strategy and you should make sure to have an experienced person walk you through it.

Hard money lenders are usually experienced investors who have more money than time but know how to spot a deal and know people they can trust to lend to. Does that sound like you?

Personally I would work to pay the 7k off out of pocket, then when I had identified exactly what I wanted to go after and being sure I would cash flow with the HELOC, I would pull the equity and make another purchase.

@Nate Martin , A couple off the cuff thoughts.  First to sell that property that quickly and attempt to do a 1031 is a little risky.  1031 is available for property that you have purchased with the intent of holding for productive use.  So even though there's no statutory holding period - longer is better than shorter.  Most folks feel comfortable at a year+.  Related to that if you pull a heloc on that property immediately prior to selling and then attempt a 1031 the IRS will, if they examine your return, most likely disallow your exchange.  They view taking out equity immediately prior to a 1031 sale as just a way of accessing profit.  So without any other information that kind of makes your plan a non-starter.

To answer your question however, if you want to avoid all tax you need to do two things - first purchase at least as much as your net sale (contract price minus closing costs but before mortgage payoff).  Secondly you must use all of the net proceeds in the next purchase or purchases (the net sale minus mortgage payoff).  You can buy less than what you sell and you can take cash out.  But the IRS calls that taking profit so that amount would be taxable but not affect the rest of your 1031.

I love HELOCs, that is how I invest. The only downside, from my perspective, is that if you don't buy right and have sufficient cash reserves, you might lock up that money for a looonnnggg time, which is not good- you aren't liquid and interest rates are variable and out of your control. Beyond that, buy right, plan and work hard, you'll be fine.

Originally posted by @Jonathan Holmes :

Firstly you need to identify your goals more clearly. All of the options you put out are valid but without knowing your goals it’s impossible to decide.

Solid advice. The main reason for buying the property (besides it being a great deal) is to not have a house payment and to have tenants pay for the mortgage. When I purchased the property in August, and moved into the lower unit I did have tenants upstairs. They were 3 people paying 735 a month on a month to month lease (well below what this neighborhood rents for.) It cost me about 235 dollars a month to have them in the unit, plus I had to pay for the water bill. It did not cash flow at the time, but it was still less than I was paying per month when I was renting. 

I raised the rent on them by 140 dollars, which I didn't think was unfair considering rents are about 900-1000 in this area, and they were paying 735 since 2015 but they moved out in December. I am a little bit bummed that they moved in the dead middle of winter, but their previous lease didn't state they couldn't move in winter. When I purchased the property I probably should have had them sign another lease, but lesson learned.

When they gave their notice, I did put an ad out on craiglist and zillow and made some flyers for the gerocery store, hospital and college near by but I didn't have any luck finding anyone interested. I get it. No one wants to move in winter in Wisconsin. I instead decided to tear out the old carpet and refinish the hard wood floors and plan on moving upstairs once its done and rent out the lower because its in slightly better shape than the upper. There are more cabinets in the lower unit in the kitchen, and every room has a celing fan. The bathroom has nicer lighting fixtures. Nothing too drastically different, but all those little things add up to make it look nicer in my opinion than the upper unit. I can fix the upper unit at my leisure. 

Once it warms up and people start looking for places again, I'm confident that I can rent the lower for 975 a month. It will cash flow for about 60 dollars a month even with me living in it. (property taxes are insane in my city) 

Getting to the point, of defining my goals more clearly: 

This property is supposed to be used to cut my living expenses (previously paying rent) so I can save enough money in 2018-2019 for a down payment on another duplex or 4-plex. Ideally, I'd like my next property to be closer to work so I can ride my bike to and from work and just buy and hold this property. (again suggested advice from the set for life book)

I work in Hospitality Management and although its a fantastic job, I still have that entrepreneurial spirit that just wont shut up so I basically want real estate to be my long term exit strategy from having a boss. 

Buy and hold investment is what I'm pretty sure I want out of real estate. 

If I find another deal that was as sweet as this one, I can move into that unit and start the process over again. This property will definitely cash flow if I'm not currently living in it, but considering I'm already planning on taking a HELOC out for the 7k, I was thinking it couldn't hurt to take the max. amount out right away just so I have the cash on hand for the next deal. My brother is a knowledgeable real estate investor with over 10 years of experience so it will only be a matter of time before something else crops up. (that is kind of why I mentioned hard money lending because he knows people that are always looking for money for deals and he wouldn't set me up with someone that also wasn't experienced.)

How long does it usually take to be approved for a HELOC after closing? If its less than a month I wont worry about it but if its a long process a sweet deal may pass me by if I don't have the money to throw at the next deal.

Taking the max out on a HELOC will reduce my 60 dollar cashflow too. So that's something to also consider.

The great thing about real estate is that there are SO many options. The bad thing about real estate is that there are SO many options! =)

@Nate Martin - thanks for reaching out. I am surprised that you could not find tenants right away, even in winter. I just filled 2 SF and one appartment and got flooded with applications on the appartment. It sounds like you did  alot of marketing, so I wonder about your presentation. If you still have it live email me the zillow link. Winter is always a bit slower, but there is also so much less inventory to choose from, because most landlords will try to run their leases through March and so there are very little new vacancies comming on the market. Life still goes on and presents people with reasons to move regardless of season: a new job, a breakup, home sold, etc (your tenants moved too right, so they went somewhere).  SF are usually a little slower around Christmas, but now the market is pretty liquid again.

Now on your HELOC. You definitley want to go for the max amount, some banks will give you to 90% LTV. Sinze you only pay interest when you use the money there is no point in limiting the max. However, it depends on what you want to use the funds for. A HELOC is meant for short term funding and has higher rates compared to a 30 year mortgage. Its a line of credit that gives you flexibility. If you want to take some money out of your property and use as a downpayment for #2 I would suggest shop for a cash out refinance loan. It basically replaces your existing mortgage with a new one at 75% LTV loan to value. The difference between your old and new loan is a check for your bank account. Thsi will be a 30 year fixed rate low interest mortgage.

On the downside your house payment will go up and you will not be able to break even with your tenants. But on the other hand you will now have enough cash for a down payment on another duplex, which will produce positive cash flow and more than make up for your increased mortgage payment on #1.

Be very careful with lending money out. It takes experience. A friend of mine is fighting for his IRA now - he has been using the funds as hard money to lend it to a flipper and now it looks like the cash is gone.

There are a few things I'd like to do but I'm not sure what the smartest decision would be. 

I've got student loan debt of about 25k. With a HELOC or a cash out refi, I could wipe that out and save more money every month by not getting dinged on the student loan payment/interest.

I could potentially use the remainder to fix up the property to increase the value of the house right away and see if it sells in spring.  Here are things on my list for the upper unit:

Update the kitchen.

Put a concrete slab for tenant parking.

Or I'd like to use the HELOC/ cash out refi to get into a 4 plex or more. More doors means more cash flow, but that also means more costs upfront. I'm not sure if that is too ambitious considering I'm just starting out, but multi-families and commercial real estate is where I want to be. In order to scale I can't hang out in duplex land forever and expect to make enough money to be able to subsidize my current income.

If I took out a cash our refinance loan and found another unit to live in I could rent out the upper and the lower of my current unit which would mean that I still could break even with my tenants, or even start making money off of it.  The thing about Milwaukee though is that property taxes are very high. I was not expecting that. I could probably lower my rent by 200 bucks if I was in a different city. I am considering outside of the Milwaukee area for 4 plexes and am currently reading the Long distance investing book that bigger pockets just put out. 

I don't think I will be lending any money out. I'm too "green" to be able to do it safely and the whole original intent of this property was just to get rid of my rent expense. Now that I've gotten used to the idea of other people paying my bills for me, I want to get more out of it, but I want to be able to make a smart, calculated, risk adverse move that will get me in a better situation than I'm in now so I can eventually make real estate my full time gig. But of course I want to do it in a smart way so I don't loose my shirt.

@Nate Martin - a few thoughts:

- when you wipe out one loan with another make sure that you pay off the higher interest loan with a lower one (I am not sure what the rates on student loans are)

- when you improve your property, keep it in line with what the standard is on your street. I don't think that a concrete slab will have much return on investment (higher rents)

- duplex land is not a bad place to be! Your priorities are in this order: 1.) risk mitigation, 2.) cash flow, 3.) growth and 4.) net worth.

Here is why I personally like 2 fam better than 4 fam. 4 fam are often smaller units, one or two bedroom. Smaller units make for higher turnover, more management and higher expenses. 4fam will not appreciate as well as SF or 2fam. When you want to sell it your buyer will be an investor, and expect a discount. 2fam can be found with 3 BR and 1.5 BA, which makes for long term tenants, lower cost, less management. Snow and lawn is often done by tenants. A quality 2fam can be BRRRR-ed just like a SF. And when you sell a 2fam to an owner ocupant your buyers will pay full retail.

Focus on one thing and get good at it. There is nothing wrong with 10 or 20 duplexes. If you want to trade up later you can still do a 1031 into a larger appartment complex. And on that note - we are building so many brand new and very cool appartemnt buildings these days - I am glad I don't own a 40 year old cheaply built 12 family that has to compete with a 2018 facility!

The student loans range between 3.1% and 6.5% that total just under 24k. I would imagine a refi would be around 3-4.5%. I have decent credit around 700 and the loan I just closed on was for 4.5%.

The property on my street all have the same basic setup. Duplex, 2 car garage, skinny drive way, fence, and concrete slab for parking. I'm missing the concrete slab and the fence. The previous tenants were parking on the grass next to the garage and had another car that the lower tenant had sitting next to the garage that had weeds overgrown all around it for a total of 3 cars.The previous owner allowed this to happen. When the lower tenant moved out he removed the car that had the weeds overgrown all around it. The upstairs tenants laid claim to one garage spot, and had 2 cars parked in the grass still.

When I inherited them we were right at the cusp of the winter months and I found out that there is absolutely no over night parking on my street in the winter.  If I made them park on the street it would have forced them to park on the next block over and walk to the house. Everyone on the block has fences up with the exception of mine and my neighbors so they couldn't cut through someones yard after parking their car on the next block over to get to the house. Not that they would want to trot through someones yard after a fresh snow fall but even if they wanted to take a short cut through someones yard the option to do so isn't there.  It was a fight I wasn't willing to pick so I just let them continue to park on the grass.

The point is if I put a slab up on a street that has no winter parking during snow months, I could potentially charge more for a parking space. Right now there is only room for 2 cars in the garage, unless I allow the new tenants to park on the grass which I would rather not do. I'm not trying to be those neighbors, or that landlord. Besides the fact that it looks trashy, I don't believe its legal to do so in Milwaukee anyway. 

So a concrete slab I think is a good idea because I could keep tenants happy and I could pitch the slab away from the house to prevent water from seeping into the basement during spring.

- duplex land is not a bad place to be! Your priorities are in this order: 1.) risk mitigation, 2.) cash flow, 3.) growth and 4.) net worth.

Here is why I personally like 2 fam better than 4 fam. 4 fam are often smaller units, one or two bedroom. Smaller units make for higher turnover, more management and higher expenses. 4fam will not appreciate as well as SF or 2fam. When you want to sell it your buyer will be an investor, and expect a discount. 2fam can be found with 3 BR and 1.5 BA, which makes for long term tenants, lower cost, less management. Snow and lawn is often done by tenants. A quality 2fam can be BRRRR-ed just like a SF. And when you sell a 2fam to an owner ocupant your buyers will pay full retail.

Focus on one thing and get good at it. There is nothing wrong with 10 or 20 duplexes. If you want to trade up later you can still do a 1031 into a larger appartment complex. And on that note - we are building so many brand new and very cool appartemnt buildings these days - I am glad I don't own a 40 year old cheaply built 12 family that has to compete with a 2018 facility!

These are all excellent points. I'll do my best to mitigate my risk and focus on cash flow in 2018. I'm trying to shave things off my budget so I can have a runway of cash by this time next year to throw at another investment property. I just get so jazzed up when I read about real estate and listen to the podcasts I just want to jump in and take action. I'm ambitious but inexperienced which is a bad combo right now haha. I never considered single families to be something you could rent out.  Will broaden my scope with that in mind now. 

When I was renting my old place was On Jefferson St. I lived there for 4 years and watched that neighborhood go from having no apartment complexes to an entire metropolis of space to rent. Going down from Brady street to where it turns into Water street is claustrophobic now considering how tight they packed all those units in. I always wondered where all that money came from where they were able to put so many people to work and get those buildings up so quickly.

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