Real Estate Investor · New York City, NY · Member since 2013 · 11 posts · 0 votes
Hey everybody,
So my brother and I inherited my grandmothers house about a year ago and now are renting it out. The house is paid in full, so everything after taxes and insurance is cash flow, which is great. I however, don't know where to go from here. I've become very interested in long term holds now after getting this property, but dont know if the best move is to get a HELOC, equity loan or mortgage on the house to buy another investment property. I live in NYC and the property is in upper state SC. I will be moving to the SC area in about 3 years. I want to buy more properties in SC. Any thoughts on the best option to take advantage of this oppurtunity
Do not encumber your grandmother's house with a mortgage.
Its not grandma's house anymore. Its theirs.
I would say don't encumber it unless your brother is willing to be on the loan, too, and the two of you are going into the landlord business as partners.
But think about that carefully. Business and family don't always mix.
My personal opinion is that once a property is paid off, for whatever reason, it should be left paid off. Isn't that the point? Anyway, there are varying opinons. I would look toward trying to get a conventional loan on a second rental. Then you'll have one paid and one with debt service. I have one paid and one with debt service (just added the second one last month) and I think it is a good mix and also easing the transition to seeing what it is like to have more than one mortgage (including my primary).
Having two rental payments coming in, I feel comfortable having the rental mortgage payment autodebit from the rental account to keep everything segregated.
Couple of procedural questions first. First, did you get a deed into your name? That is, if someone checks public records do you and your brother show up as the most recent owner?
Second, did you do an appraisal at the time you inherited it? That will be very important because that establishes your "basis" for any gains on a future sale and for depreciation on the rental.
Now, what does your brother have to say about this? Does he want to be bought out? Are you going to be partners? Do you want to buy him out? Would the two of you be willing to sell? At this point, you're likely to have no taxes at all on the property. That may not be true in the future.
Realize that there are a lot of lies in this business. This is one of the biggest: "everything after taxes and insurance is cash flow". If you move to SC and hire a PM, you should assume that 50% of the gross rent will go to pay for the PM, taxes, insurance, routine maintenance (mostly caused by tenants), vacancy, utilities (at least when vacant), CPA, lawyer, and capital items (e.g., new roof, furnace, carpets, etc.) If you and your borther are doing the management, you can collect the PM's cut, which is typically 10% of the collected rent plus half a month's rent to fill a vacancy.
I like to have a buffer of six months rent to cover big, irregular expenses. If you don't have that, every penny after actual payment should go into that fund.
As to leverage on this property or not, that depends a lot on your brother. If you owned it yourself only, then leveraging it might be an idea. Do realize that owning rentals is a cash on cash game. Borrowing for one may let you turn around and buy another (with leverage on it, too), but that comes at a price. With good deals, you "cap rate" (i.e., the net operating income after all expenses/price paid) can be greater than the interest rate. So, buying more will generate more return.
This depends on the value of the property and the rent. If you're getting $1000 in rent and could sell it for $200,000, SELL! Take that $200K and invest in better rentals. OTOH, if you get $1000 in rent and could only sell for $50K, KEEP IT! In that second case, I'd just be accumulating the cash the property generates and when you've accumulated enough, buy another. If you can kick in cash from your day job, this happens all the sooner.
The deed is shared 50/50 between my brother and I. The property was appraised at $140,000 and there was enough in the account to pay for all the fees and taxes of inheriting it. My brother and I have discussed different options, but neither one of us really want to sell it, especially now that we are receiving rent on it. He is actually in Japan and doesn't really do anything with the property, but is willing to let me do what ever I think is best to invest in other properties for me and my wife.
I certainly miss spoke about the rest being cash flow. I only wanted to speak about there being no mortgage. Im not really sure of the cap rate yet b/c we just started getting rent in Feb, but assuming a 5% vacancy rate and 1% maintanance rate, $800 rent, $2200 taxes and $1400 insurance, im looking at about 3%cap rate, which now that I look at it from that perspective, maybe selling and buying something with better numbers, makes more sense. hmmmmm...
$800 rent on a $140K house is not a great deal. You could easily sell the home and net about $120K. Buy two $60K homes each renting for $800 and you have doubled your rental income. Or take the $120K and buy $500K worth of other rental homes with leverage. Either way, you will do a lot better.
Im def going to have to give this some more thought. My brother owns half the house though and i would only be able to keep half of the money from the sell. He doesn't really have any interest in investing from Japan. would you still feel the same way if i only had the 60000 in cash?
I get a 3.4% cap rate, with realistic assumptions, including use of a PM. If you're doing the PM job, you should be getting paid for that, then you and your brother should split what's left. After getting a good buffer saved up. Houses have a way of waking up in the middle of the night and saying "I'll take $1000 right now, please". When its your own house, you might take a cold shower for a night or two while you fix a water heater. When a tenant, at best you say "shut off the water, I'll have a guy there in the morning."
There are plenty of places in the US where you can pay $60,000 in cash and get $800 in rent. Unless your market is really slow, you should walk away with a bit more than that from this sale. If real estate investing (and making money) is the goal, I'd certainly sell. If there's sentimental reasons to hold on to it, hold on. But money wise, this is a crummy rental.
And you have these entanglement with your brother. Have a discussion that you should be getting 10% off the top and half a months rent every time you get a new tenant PLUS half the remaining profit and see how that goes :-).
The rent sounds low. I might recommend checking to make sure you are at market rates.
Leverage is a very powerful tool that can dramatically increase your ROI. The key is to make sure that each property can pay their mortgage and leave a little left over. Shoot for at least $100 per month per unit profit.
That being said, you would be able to get a HELOC on your 50% share of the property. This will give you the cash to invest in cheaper and more profitable rental properties in SC.
Do not encumber your grandmother's house with a mortgage.
Its not grandma's house anymore. Its theirs.
I would say don't encumber it unless your brother is willing to be on the loan, too, and the two of you are going into the landlord business as partners.
But think about that carefully. Business and family don't always mix.
Hey guys, thanks for all the helpful input. We are netting about $300 a month right now w/ no mortgage payment. With our cap rate being 3%-3.5%, but no mortgage, I assumed (perhaps incorrectly?) that this could be a good long term play for us, to take a HELOC or equity loan out for a new property.
Based on every bodies feedback, my real question is, do I worry about a low cap rate when there is no mortgage and positive cash flow? If we were to buy another property from the sell of this one, whats better? option a) the new house w/ a higher cap rate, but less cash flow and a mortgage or option b) sticking with no mortgage, cash flow and a low cap rate. (we don't need the cash flow, but it is nice building up a cash pile for unexpected costs). Our goal being to purchase many properties for long term holds w/ cash flow? thoughts?
To add a little more detail, we currently don't have a reserve that we could use for a down payment on a new property, and it would take us about 1.5 yrs to really build that up considering that we are in the process of paying off CC's from our wedding.
Ok, but you said you inherited the house, correct? That means you didn't pay $140k for it, you paid nothing for it. Therefore, the returns you make on it are technically infinite returns. You only need to worry about a cap rate if you want to sell it, if even then. Free house, free income! Why mess with that?
I would, however, absolutely take a loan against it and buy more properties (that do have nice cap rates). Let's say you can take $100k out of it, then you can make cash flow from 4-5 properties with leverage.
Not sure I'd be ready to give up Grandma's house yet. Wait until values drive up some more, since they are already on the up, and keep collecting the cash, pull out financing on it, buy more properties, sell it later if you want.
1.5 years is not that long to save to buy your second rental. The first few acquisitoins are usually the slowest for most landlord investors. Then it starts snowballing from there. This is what I have learned from speaking with several local investors - and some on BP.
Anyway, do whatever makes you comfortable. I personally don't see the point in reviving debt on a free and clear asset, but have no qualms generating new debt on new assets. I guess it's just psychological/emotional if not logical. As the saying goes, "Its better to have a bird in hand than two in the bush."
It doesn't sound like your property would perform well with enough debt against it to really help your future investments. Plus you need to consider that banks will see that debt and count it against your debt to income ratio when determining if they will grant you a new mortgage. If you are having a hard time paying off CC's and saving money, then my guess is that your DTI ratio might be a little tight. Plus you will need to season that money you pull out for at least 6 months so a new mortgage banker does not see it as borrowed funds being used for a DP which most prohibit.
So, look at the functional analysis as well as the numerical analysis before doing anything. Have a clear and complete plan of what you will do with that money before you borrow it and only then can you do a functional analysis.
If you decide to take out a loan and reinvest, you should make sure that property can pay the loan. You do not want to be dependent on your other investment to cover the debt. Considering that the property is only providing $300 per month - I cannot see that as a viable option.
Once again, I encourage you to double check your rental rates and expenses. Something isn't adding up here. Since you do not have a mortgage and you have a single family tenant, then your only expenses should be real estate taxes, property insurance and maintenance. Your tenant should be paying for all utilities.
If you honestly evaluate the property and that is the best you can do, then from an investment standpoint, I would sell the property (or let my brother buy me out) and reinvest the money into properties that create a better cash flow and cash on cash return.
Thanks Simon,
Im def going to check closer on the local rents. There is a friend of the family in there right now, so we didn't give it a lot of thought at first b/c he is VERY reliable and we don't have to worry about maintenance, plus at first we weren't thinking about RE being a means of income at the time. The area is very rural SC so the rent's are just not very high in general, but we just started getting it all together in Feb and there has to be some ways that we can save a little money.
I think that we have decided to take a HELOC out on the property w/ the idea of using it as a down payment for another one. We are in the process of getting approved now. We figured that even if it costs us a little bit each month to pay for the HELOC, we would have been saving that money for a down payment anyway, and this way we can get started on buying a house now instead of in a year or so. We are trying to structure it so it is less than $300 a month payment for the HELOC, so we are covered.
I completely agree with you though about selling it for a better income on another property. I think we will really start to consider that once we have another house up and running and we need another down payment. Anyone have any thoughts about this?
Here is another idea. How large is the property? Could it be split? If so, you could look into putting a house on the other piece and either renting or selling it. Excess vacant land does not generate cash flow. If the extra lot is worth the same amount as the HELOC - well there is another investment option.