All Forum Posts by: Account Closed

Hello All, 

I recently purchased my second rental property. It is in a ready to rent condition with the exception of the kitchen that is very outdated (See picture below).  I have a total budget of around $3,500. 

The kitchen is around 200 square feet in total. The appliances I would like to replace are: New Refrigerator $600, dishwasher $350, electric range $400, under cabinet of range hood $150 = $1,500. I have found updated laminate counter tops and a contractor willing to install them. The all in price is approximately $950. $1,500+950 = 2,450.

I would like to update the cabinets and am thinking of creative ways to update them with the remaining $1,050. My question for the BP community is given by budget constraint of $1,050 should I stain the cabinets, replace and stain new cabinet doors, try to install new cabinets on my very limited budget or wait until I have a bit more $ and have the contract replace new cabinets and counter tops all at one time. 

I am not dead set on one of my options so if you have any creative ways you have saved money on any of the above items please let me know. Also, any general kitchen remodel experience would be much appreciated. Thanks for your help!

@Andrew Merritt I have pretty gone the 1st route you mentioned by buying two "turn-keyish" properties and renting them out and have two comments you may or may not find useful.

1. You don't need to buy a newly renovated 100% turnkey property to benefit from a more conservative rental strategy. When I say turn-keyish I mean a modest but quality home in a stable area that requires around $5k of work to increase rent by 20-25%. For example, I recently purchased a property that was in great condition but had really ugly paint colors and older kitchen cabinets (pictures below). I purchased the property and painted it a more neutral gray, fixed some of the warn down baseboards, replaced some really ugly window fixtures and stained the kitchen cabinets a natural wood color (all in around $4k of work some self performed some contracted). I was able to rent the property for $1,200 a month and 6-months into the renal it is on track to generate a 19% cash on cash return. 

Before

After

2. Like all investments higher return generally means higher risk. When the BRRRR method works out there is no question it pays a higher return than a more conservative rental strategy. However, a successful BRRRR requires the economy remain strong, that you find a significantly undervalued property (your valuation needs to be correct), perform all renovations without any problems or cost overruns, get the renovated property appraised at the value you want, find a lender willing to give you close to an 80% loan appraised value loan, find a quality tenant in the up and coming area etc. It is definitely possible that all of these things work out but requires a lot of research and work and it is important to know what your limitations are in the case that things do not work out as planned.

 From your profile it looks like you have a wife and new child (congrats!) which I would imagine drastically changes your risk tolerance. As long as you put in the hard work and put together a well thought out contingency plan I am sure you will be successful with either route. Good look! 

@Aaron Linden @Mike Shemp I just wrote a blog post that provides a checklist for investors to use when evaluation the quality of various insurance quotes. Hopefully this is something you find helpful. 

As I noted in the post, the best policy varies depending on the value/condition of the property and the cash restrictions/net worth of the investor. While this checklist is not a substitute for a consultation with a knowledgeable agent it can serve as a good starting point. 

David Dachtera You are completely ignorant of the basic principals of finance. Arbitrage has nothing to do with my analysis. The time value of money is the only way to determine whether it's worth prepaying debt now (decreasing cash flow) to increase cash flow at a later date. I picked this up while graduating with a finance degree from the Indiana Kelley School of business (currently #4 ranked b School in the nation). Debt acceleration is clearly effective in paying off debt quicker and reducing interest. The problem is this actually decreases your return in every case unless your earning less than your paying in interest in which case you shouldn't have made the investment in the first place. Encouraging small investors with limited capital to utilize variable rate lines of credit to pay down their fixed rate debt is irresponsible at best and a total scam at worst. Your comments are uninformed, self serving and dangerous and should not be tolerated on BP. Just for the record how many investment properties do you currently own?

@David DachteraSurprising! Your ego has allowed you to totally miss the point. That point being successful people understand areas where they have and do not have an expertise. They rely on the council of experts in most areas and focus on their true areas of strength.

I am not an expert in the practice of selecting pms myself. Instead I have consulted pm and investor clients with 100s of units under management and decades of experience. Sharing what those experts have shared with me can be useful to people on this forum. I can help others by relaying what I have learned from others without pretending to be an expert in the area. It is important to me that I disclose I am relaying information to the best of my ability but others should not use my advise without consulting a true expert.

You post opinions as if they are facts in some attempt to appear more knowledgeable than you actually are without any real world experience. Arguing with people that have real world experience based on what you learned in a seminar from a local investment club provides no benefit to anyone and shows you care more about looking smart than being helpful.  

Since I am not a pm screening expert I can not speak with absolute authority and say that I am right and you are wrong. Financial modeling is another story. I literally spent fives years working 90 hours a week modeling bond issues for large multi-use real estate developments that combined retail, mutli-family, assisted living, hotels and single family town homes. If I made a mistake it would have literally costs a developer $10s of millions of dollars. That being said I am 100% confident your analysis is incorrect. THis is not because your numbers are wrong but because your numbers only represent one small piece of the picture. I hope you will take the time to read this analysis and understand that financial models can be taken out of context as easily as statistics. Simply put if a 12 year old can recreate your model it is probably not a good model. 

Real Financial Modeling Can Not Be Done by a 12 Year Old

You are correct that the HELOC method greatly reduces interest expense. You are also correct that a 12 year old could model the interest savings using this method. Your mistake comes from the faulty assumption that lower interest expense generates a more profitable investment. Your incorrect assumption is due to the fact that you have not properly accounted for the time value of money or the benefits of compound interest on excess cash flow. This is understandable since you are in fact not an investment professional.

I have gone ahead and put together a spreadsheet proving that when you earn a rate higher than your borrowing rate investment returns are higher when you delay principal payments due to the compounding of investment returns.

You will likely notice the fixed rate scenario has around $95,000 in interest payments while the HELOC method has around $44,000. Your short sited analysis stops there and assumes that lower interest expense translates into higher profits. As we will see this could not be rather from the truth.

The first scenario shows a $100,000 investment that returns 10% annually using a 30 yr fixed rate loan with a 5% interest rate. Total interest expense is approximately $95,000 through the life of the loan. Instead of using surplus cash flow to pay down the loan the surplus is reinvested at 10%. In Year one interest expense is $5,000 or 5% X $100,000 and investment earnings are $10,000 or 10% x $100,000. Subtracting the mortgage payment of $6,505 from $10,000 gives you surplus cash flow of $3,495. This $3,495 earns 10% the following year or $349.50 and increases year 2 cash flow to $3,844. This $3,844 earns 10% the following year of $384.40. Compounding returns increase cash flow every year through year 30 when investment of excess cash flow earns $51,000 or 5x more than the $10,000 annual cash flow from the investment itself. Using a discount rate of 5% the NPV of the investment is $178,000.

If the investment earns more than 5% those earnings pay the interest + additional principal and result in a net profit. If the investment earns less than 5% the earnings do not offset interest and you have a bad investment. 

In the second scenario the $20,000 of the fixed rate principal is paid off using a HELOC and all excess cash flow from the 10% earnings goes toward paying down the HELOC. Once the HELOC is paid down another $20,000 is drawn from the HELOC and paid down using the excess cash flow. You are correct that this method greatly reduces interest expense and allows the loan to be paid off in 15 years. However, since all excess cash flow went toward paying down the loan there is no money to be reinvested at the 10% rate. In year 16 when the loan is fully paid off the cash flow from the investment produces a cash flow of $18,952 which is much greater than the $10,000 in scenario one. This is more than offset by the $11,104 in the earnings on the cumulative excess cash flow. Using the same 5% discount rate the NPV of scenario 2 is $71,000.

Why? Because A dollar today is worth more than a dollar tomorrow. Using cash flow to pay down principal reduces cash flow today in order to increase it in year 16. This is counter-intuitive to the way investing works.  A dollar today is worth $1. Using a 5% discount rate a dollar in year 16 is worth 45.8 cents. Trading one for the other is a terrible investment strategy. 

Finally nothing is more beneficial to creating a solid financial projection than certainty. A fixed rate mortgage eliminates all uncertainty from the borrowing side of the equation. Another financial crash could happen tomorrow and you borrowing cost will not be effected in the slightest and your loan will remain outstanding. A HELOC on the other hand is an adjustable rate instrument. The HELOC borrowing rate could increase 5% tomorrow. The loan could also be called by the bank at anytime creating a cash crunch and possible default situation.

Final Notes 

My analysis shows annual payments instead of month for the sake of simplicity. Using monthly payments would only increase the cumulative effective of the earnings in scenario 1 further proving my point. If anyone would like to spend a few hours breaking out monthly payments be my guest. 

It may not be realistic to assume that excess cash flow in scenario 1 can be immediately invested into another investment earning 10%. For this reason, i tested a 3% investment rate and the results were scenario 1 having a NPV 42% greater than scenario 2. Going one step further and assuming a 0% investment rate scenario 1 still has a 12% higher NPV.

@David Dachtera I couldn't agree more with @Mike Dymski . I would put up with an elitist attitude from someone with 1,000s of properties and the wealth of knowledge that comes with it. Condescending and self aggrandizing comments from someone who has a few rental properties and a few years experience in a local Real Estate Investment Group is almost laughable. I would more than likely laugh it off and move on if it weren't for the fact that you are regularly spreading misinformation to people just starting out in real estate whose financial future may be negatively impacted by your comments. 

Others with real world experience on this forum are telling you that the reality of the PM situation for SFH is that there are a lot of PMs who are not great at what they do. Many have good intentions and can be fine when there are no problems but lack experience and resources to deal with inevitable issues. Many SFH PM operations simply don't have access to quality cost effective screening programs, have a legal team to stay up to date with how to evict someone without violating their rights or have the network of contractors required to fix complex problems. Instead of trying to prove you are the smarted person in the room why not learn from others with real life experience and save your comments for issues you do have an expertise in.

I will be the first to admit I am not an expert in screening PMs. However, I am an expert in financial analysis and can say without hesitation your loan acceleration plan does not have merit. The level of confidence you have in being totally incorrect is very dangerous to both you and others who take your opinions as fact.  

A basic understanding of the time value of money is all you need to understand why these acceleration plans are a total sham. Simply put if you earn a higher rate of return on your borrowed money than the interest rate on your loan you are better off regardless of the amount of interest paid during the life of the loan. 

It is true that paying off your loan faster reduces interest expense. It is also true that paying off your loan faster reduces that amount of capital you have to reinvest in more profitable projects. The video you reference shows the interest savings from early payment of the loan but neglects to show the opportunity cost of not being able to invest that money. I put an example at the end not to bore people who don't want to spend time sifting through it.  

Before you reply with your typical rebuttal  please take a moment to consider our life experiences. According to your profile you have passed a real estate licensing exam, an insurance exam and attended many real estate workshops. I graduated with honors from a top 5 business school, worked for one of the 15 largest investment banks in the world and served as the lead analyst on dozens of bond offerings with a total value of more than $1 billion.  I am sure that description came off as braggish but I needed to get across the point that in this area (and very few others) I am an expert and telling you for a fact that you are incorrect. 

To know what you know and what you do not know, that is true knowledge." - Confucius

Example

A $100,00 20 yr fixed rate mortgage at 5% interest generates $60,485 in interest. You could pay off that loan today and save $60,485 or you could invest that $100,000 in a 10% profit generating investment earn $200,000 over the 20 yr life of the loan and pay the $60,485 in interest leaving you with $139,515 in profit. You would clearly prefer the second option.

Using a HELOC to pay down $15,000 of the $100,000 loan will knock off around $13,000 in interest like your video shows. However, if you pay off the loan at the same speed you paid off the fixed rate loan your outcome is exactly the same. The only way to truly save on interest expense is to pay down the $15,000 faster than you would have paid the fixed rate loan. This sacrifices the profit you could have earned using that $15,000.

@Clarke Wegener It is my understanding that everything you were able to write off in the past (taxes, interest, insurance, depreciation, etc.) can still be written off no matter how high your income is. However, these expenses can only be used to offset other passive income (I believe including stocks, bonds, rental income, etc.). So as long as you are creating enough passive income to be offset with these expenses nothing really changes. You can still carry losses forward as well. These loss carry forwards can still only offset future passive income. Basically the only thing you loose it the ability to offset ordinary income and of course your tax rate changes.

Offsetting ordinary income with depreciation from investments is an awesome perk but the tax advantages of real estate remain pretty amazing no matter how rich you become. This Link does a pretty good job of explaining the topic. That being said I have had my taxes done by an actual accountant the majority of my life and have found the extra expense is generally worth it for anyone without straight w-2 income. 

Clarke Wegener I am not a tax professional but feel somewhat well versed in this issue. My understanding is that if you make under $100,000 a year you can deduct depreciation against your ordinary income up to $25,000. Once you exceed $100,000 that offset declines by $1 for every $2 you exceed $100k. $100,002 you can deduct $24,999. $120,000 you can deduct $15,000, etc. If you are currently deducting depreciation against your ordinary income you will no longer to do that. You can however, deduct the depreciation against rental income from other properties. If you have enough other rental income to offset your good. AMT changes how fast you can depreciate stuff but not the overall amount you can deduct overtime.

Rose Davis The St Louis home building and remodeling market is a very small world. Everyone knows each other and finding a reputable contractor only takes a few calls. I would imagine Davenport Iowa is the same way. A good starting point would be to call your local home builders association and ask for a list of quality contractors. In today's market most reputable remodelers will have a website with testimonials and pictures of past projects. We represent over 35 home builders/remodelers in our area. My experience has been that most reputable contractors will require you to pay for a portion of materials up-front and then request draws as needed to pay for additional materials and labor. Some will provide a fixed fee for serving as gc and others will build profit into the work. A contractor who requires a large down payment without a detailed schedule of when and why $ is needed is probably having money problems. A contractor who will work with no down payment is also likely starving for work. Like anything in life if it doesn't pass the sniff test there is probably a good reason. Good luck!

@Lee Rimmer Since I was not in the room with you I cannot speak with any certainty what was or was not said. However, it seems like a miscommunication to me. A deposit is generally refundable if you do not get the property because the firm leases it to someone else or for some reason the property is not leased at all. 

That being said the purpose of a down-payment/deposit/earnest money is to prove your serious about taking the property when and if it is available. Again, while I can not say whether or not this was clearly explained to you I can say it is common practice and seems odd you would give a deposit and continue looking for other properties. 

It also seems odd that anyone at the property management firm would respond to your complaint in a public forum with anything past a general statement that the firm is aware of the issue and working to find a solution equitable to both parties. Nothing good can come of debating the issue in an open forum where things can be misinterpreted. 

Again, I was not in the room and have no real knowledge of what was or was not said.