Elk Grove- Rental Investment for Appreciation?

Question

Hello all,

Considering an SFR in Elk Grove 95757 ~475K like a new build but with negative cash-flow @ 7.125% rate. Buying for equity build-up and appreciation. Good school district. Planning to hold for 7-10 years.

James Peterson · Answer

Elk Grove is a good location for appreciation and typically good tenants. Why not find something that can be more profitable over the long run and build a larger portfolio using the brrrr method, force appreciation by adding units, rehabbing etc? I would consider B and A neighborhoods in Sacramento, close to downtown, homes with 80% of the buyer pool demand will be the most stable, Folsom and Roseville are also excellent choices, good schools, growth etc. A negative in cashflow would be the least of my worries, finding something that does cashflow right away signals low appreciation and bad areas/problem tenants etc. If you can financially support that small negative, you'll be in a great place in 10 years as you'll capture a much higher rate of return than cheap areas. If your goal is to build wealth.

Dan Sundberg · Answer

Hey @Dinesh Singh - $475k is going to be tough for Elk Grove new construction, however there is a large new construction development in Southeast Rancho Cordova that is in the Elk Grove School District. Prices are less than EG, but rents are still very good and you can get a new construction home in the $500s.

Michael Hyun · Answer

I also play the appreciation game in Livermore, CA. I have two SFH there, but I'd do things differently now that I look back on my investments. In total, these two properties will negatively cashflow 2k a month. Pretty terrible investment, right?

These homes allow me to not pay any federal income tax this year (thats another 2 hour discussion right there), but the tenants are A+ tenants. No headaches, they auto pay on time, they are very communicative, etc.

I got a 3.25 and 4.25 interest on these homes, and I'm negative about 2k a month. I just found out, however, that there are much better loan options out there for this style of investing (appreciation play investing).

THIS IS MY FIRST TIME RUNNING THESE NUMBERS. PLEASE CHECK MY ASSUMPTIONS AND MATH AND LET ME KNOW IF EVERYTHING CHECKS OUT.

Let's use the numbers from my actual purchase but with different loan options:

Assuming:
1. 900k purchase price
2. Interest only rate is slightly lower than a conventional since its interest only

3. The rent I can collect is $3400 (currently the actual rent I am charging)

1. The conventional loan(I went with this because I didn't know about option 2). Amortized Interest and Principal payments for 30 years.
- 4.25 interest
- 2500 interest per month
- 1000 principal per month

- 1000 for insurance and Tax

- TOTAL PITI: $4500

pros:- principal pay-down (but is this a pro? - i'll explain below)

- 30 year fixed - no balloons, fixed rate. Unless you get an 7/1 or 10/1 ARM.

cons:

- principal paydown (1.2k more per month compared to option 2)

- higher monthly payment

With this option, I'd be cashflow negative about $1100 a month. Not including any other expenses, like maintenance, vacancies, etc.

2. 40 year interest only loan

- 3.75% interest

- 40 year term- ~$2300 per month

- $1000 for insurance and taxes

- TOTAL PITI (in this case, "ITI"?): $3300

pros:- no principal pay-down

- cashflow breakeven (much easier to hold the property when cashflow is tight)

cons:

- no principal pay-down

- 10 year balloonWith this option, I'd be cashflow POSITIVE about $100 a month. Not including any other expenses, like maintenance, vacancies, etc.

You can see from this calculation that even a 900k SFH in the bay area can ALMOST be cashflow BREAK-EVEN with the right financing.
BUT I don't get principal pay-down. After revisiting the concept of principal pay-down, can someone help me understand why principal pay-down is a good thing?

I would much rather have an interest only loan and KEEP the extra $1000 in my pocket every month, rather than being forced to pay it to my equity each month. The problem is that every month I put in $1000 into my equity, but my monthly payment doesn't change.

Sure, you'll pay less interest over time, but having and extra $1000 in my pocket each month allows me to actually re-invest it rather than putting it into my equity, where it doesn't even reduce my monthly payment. What's the ROI on the $1000 that I put into the equity each month? Plus, the interest only loan has a better interest rate anyways, so I don't think you'll actually save much more in interest over 10 years.

Compare that to how I could invest that extra $1000 per month into buying more real estate. Why is principal pay-down a good thing?

So with that in mind, I'm leaning towards doing a 40 year interest only loan for my next deal, or maybe my own primary home. Maybe for places like the mid-west where homes barely appreciate over 10 years, I wouldn't do this. But in the Bay Area, I'd be willing to bet that my home appreciates at least a small amount to where I would probably sell the home or 1031 MUCH before the 10 year balloon of the interest only loan. I'd probably have less equity than the conventional financing route, but I'm willing to bet that there will be enough equity for me even without the principal pay-down, where I could 1031 exchange into some nice cash-flowing properties later.

These are just some thoughts that I had, please feel free to poke holes in my assumptions and opinions!

Dinesh Singh · Answer

Thank you, James, for an insightful response. I was chasing cash+ve property, probably not the best approach. Folsom is on my radar and was looking at a duplex. Will keep in touch.

Scott Scoville · Answer

Hey Dinesh,

I'm a local investor and real estate agent. I grew up in Elk Grove and know it well. Let me know if you'd like to chat about the EG market.

Elk Grove- Rental Investment for Appreciation?

Elk Grove- Rental Investment for Appreciation?

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