Investment Property: Need Advice

[Keim]

I have a chance to purchase an investment property and have a few questions for the more experienced folks on the board.

First the facts:
I have a chance to purchase a well kept 3 bedroom home constructed in 1939 for $185k. It is in an excellent area for rentals. It would need a pro inspection, but I don't see any major issues. In my market it would rent for $1050/month. I have known the owner for years, and he just inherited the property from his mother. I mention this because it means: A. He is reasonably motivated to sell (He doesn't need the money. But, conversely, he doesn't want to pay upkeep on an empty house.) B. He trusts me enough he is willing to explore holding the note on the property, and allowing me to pay him over approx. 20 years. I can get cashflow from day one if I put down 30%, and talk him into a 0% loan, at $600 per month.

Now the questions:
1. I am looking at two possible ways of financing the downpayment: a. HELOC. b. Pulling money out of my stock portfolio.

Which would you recommend?

2. I am not very familiar with HELOCs. Can someone describe the pros and cons, or point me to a good web info source?

3. I've read in a couple of books (Such as Weekend Millionaire Secrets to Investing in Real Estate) about getting a HELOC to make the initial down payment. Then immediately getting a mortgage on the new property to pay-off the HELOC. Perhaps I'm dense, but how does this work?

4. What are the odds of the current owner giving me a 0% loan?

5. Are there other ways of financing that I should consider?


Thank you for any and all advice!

 

[CybrMike]

I have a chance to purchase an investment property and have a few questions for the more experienced folks on the board.

First the facts:
I have a chance to purchase a well kept 3 bedroom home constructed in 1939 for $185k. It is in an excellent area for rentals. It would need a pro inspection, but I don't see any major issues. In my market it would rent for $1050/month. I have known the owner for years, and he just inherited the property from his mother. I mention this because it means: A. He is reasonably motivated to sell (He doesn't need the money. But, conversely, he doesn't want to pay upkeep on an empty house.) B. He trusts me enough he is willing to explore holding the note on the property, and allowing me to pay him over approx. 20 years. I can get cashflow from day one if I put down 30%, and talk him into a 0% loan, at $600 per month.

Now the questions:
1. I am looking at two possible ways of financing the downpayment: a. HELOC. b. Pulling money out of my stock portfolio.

Which would you recommend?

2. I am not very familiar with HELOCs. Can someone describe the pros and cons, or point me to a good web info source?

3. I've read in a couple of books (Such as Weekend Millionaire Secrets to Investing in Real Estate) about getting a HELOC to make the initial down payment. Then immediately getting a mortgage on the new property to pay-off the HELOC. Perhaps I'm dense, but how does this work?

4. What are the odds of the current owner giving me a 0% loan?

5. Are there other ways of financing that I should consider?


Thank you for any and all advice!

If you can get a 0% loan you should always take it. FREE money. I'm skeptical he'll give you a 0% loan, but if he does, like I said, free money.

On the other hand, $1050 in rent to pay off a $185K mortgage sounds like a horrible deal (I'm from Indiana, $185K here buys a BIG house).

$185K loan @ 6.5% (more realistic rate) is $1169.33 per month, not counting taxes and insurance. Again, horrible deal.

Here in Indiana, I'm currently looking at a duplex that sells for ~$80K and each side rents for $600 per month. This should give me sufficient breathing room for maint., repairs, etc. Your deal is upside down from the start. No room for anything.

 

[RunningBum]

4. What are the odds of the current owner giving me a 0% loan?

I'd say the odds are 0 unless the owner really wants to help you out. Why would anyone give a 0% mortgage, unless they have way overpriced the house? In other words, if this is a personal decision, we have absolutely no insight into it so we can't tell you the odds. If it's a financial decision, there's no reason at all for him to do that.

And if you can get a 0% mortgage, why put 30% down? Why not ask for 100% financing, especially since it sounds like you may finance the 30% anyway?

 

[cute fuzzy bunny]

Given a house built in 1939 and renovated many times, make sure you inspect for lead pipes, lead paint, asbestos and all sorts of other goodies that you might have to remove or mitigate.

Someone willing to give you a zero loan for a long time seems too good to be true, so maybe he knows something about the property that you dont?

 

[Keim]

If you can get a 0% loan you should always take it. FREE money. I'm skeptical he'll give you a 0% loan, but if he does, like I said, free money.

On the other hand, $1050 in rent to pay off a $185K mortgage sounds like a horrible deal (I'm from Indiana, $185K here buys a BIG house).

$185K loan @ 6.5% (more realistic rate) is $1169.33 per month, not counting taxes and insurance. Again, horrible deal.

Here in Indiana, I'm currently looking at a duplex that sells for ~$80K and each side rents for $600 per month. This should give me sufficient breathing room for maint., repairs, etc. Your deal is upside down from the start. No room for anything.

CybrMike: I should clarify-the loan would be for about $145k by the time I make the first downpayment.

I wish we had your prices here. The price he wants is average for our market. Thats why the deal only works (cashflows) if he is willing to carry the loan at 0 or 1% interest. I agree the odds are low of him accepting such. But they are even lower if I don't ask!

I can think of a few favorable reasons for the owner financing at such a low rate:
1. Taxes on a 185k lump sum house sale will be high.
2. He might like getting a low risk $500+ check every month for the next 20 or so years.

 

[Keim]

I'd say the odds are 0 unless the owner really wants to help you out. Why would anyone give a 0% mortgage, unless they have way overpriced the house? In other words, if this is a personal decision, we have absolutely no insight into it so we can't tell you the odds. If it's a financial decision, there's no reason at all for him to do that.

And you are correct: For the current owner it would come down to a personal decision. We have known each other a long time, and are friends. Financially he can take his money and make more elsewhere, though I believe he is already fiscally set. And, I would understand if he chose to take his money elsewhere! Conversely, he might like a dependable (dare I say: annuity-like) $500+ check every month for 20 years. And, he has said he wouldn't mind helping me out a bit if he can.

And if you can get a 0% mortgage, why put 30% down? Why not ask for 100% financing, especially since it sounds like you may finance the 30% anyway?

Cash doesn't flow on a nothing down deal with this property if it is paid over 20ish years. And, I suspect the owner would like some cash in his pocket right away. I'm in a college town. So there is a large rental market, and competition keeps the rents from getting extremely high (though, of course, the renters might not agree with that).

 

[Keim]

Given a house built in 1939 and renovated many times, make sure you inspect for lead pipes, lead paint, asbestos and all sorts of other goodies that you might have to remove or mitigate.

Someone willing to give you a zero loan for a long time seems too good to be true, so maybe he knows something about the property that you dont?

CFB: You are smart to suspect a problem. I have inspected the home, and not found major problems. But, any deal would be contingent on a professional home inspection.

I will say that the house has not been remodeled several times. The bulk of it seems original. Which, of course has its own host of concerns to be addressed...

 

[honobob]

I agree the odds are low of him accepting such. But they are even lower if I don't ask!

I can think of a few favorable reasons for the owner financing at such a low rate:
1. Taxes on a 185k lump sum house sale will be high.
2. He might like getting a low risk $500+ check every month for the next 20 or so years.

1. What taxes are you talking about? If he just inherited from his mother he has a stepped up basis.

2. Why would he prefer a $500+ check every month for only 20 years when he has a $1,050 (increasing annualy at say 3%) for LIFE!!? OK, take out $200 for property mgt. and maintenance but he's still keeping appreciation.

Are you young or cute enough that when you mention zero interest financing he/she will laugh it off or will they be disgusted that you would attempt to take advantage?

If a major concern is to cash flow why are you considering a HELOC? It sounds like you stumbled upon a property for sale and have not really done any home work on investing in real property but think you can get a "deal". Good luck with that.

 

[Keim]

1. What taxes are you talking about? If he just inherited from his mother he has a stepped up basis.

2. Why would he prefer a $500+ check every month for only 20 years when he has a $1,050 (increasing annualy at say 3%) for LIFE!!? OK, take out $200 for property mgt. and maintenance but he's still keeping appreciation.

Are you young or cute enough that when you mention zero interest financing he/she will laugh it off or will they be disgusted that you would attempt to take advantage?

If a major concern is to cash flow why are you considering a HELOC? It sounds like you stumbled upon a property for sale and have not really done any home work on investing in real property but think you can get a "deal". Good luck with that.

Answer to #1: Good point!
Answer to #2: In this case he doesn't want to be a landlord. He prefers to sell.

Since writing my initial note I've taken HELOC off the table.

You are somewhat correct about the homework. I have done some (a good chunk, actually), and am in the process of doing the rest. I've read books, looked at other properties, but not made an offer before. My questions here are part of that learning process.

I'd be surprised if I can get a "deal." If I can, great. As an investor if I can't get the property to cashflow, I'll look elsewhere. The owner won't be offended by my offer. He just won't take it if it isn't of interest. Also great.

I doubt if my age or cuteness would be advantageous to me!

 

[honobob]

OK, so if all the figures you've given are market then you are saying that the only way you are an investor in this market is if the owner subsidizes your financing to the tune of $105,000 over the next 20 years on a $185,000 market value property.

I'm asking if you are an investor, opportunist, or maybe just a young dreamer?

Do you think your expectations are realistic?

 

[RunningBum]

I can think of a few favorable reasons for the owner financing at such a low rate:
1. Taxes on a 185k lump sum house sale will be high.
2. He might like getting a low risk $500+ check every month for the next 20 or so years.

1. As honobob points out, what taxes? And even if there were taxes, he'd get hit with them now anyway for selling the house, no matter when he actually gets all of the money.

2. If he doesn't want to be a landlord, selling the house for $185k and getting a 4% return on it would get him a larger check every month, and he could do that quite safely. And have $185K principal to show for it in addition to the interest. So let's see, if I'm the owner, do I want $185K now and get a safe $600/month check, or do I want $40K now and a $500+/month check?

You said 100% financed at 0% doesn't work for cash flow, but how does it work if you finance 30% of it with a HELOC? You still have to pay interest on that HELOC loan.

What happens if you can't keep the house rented, or your renter starts skipping payments?

This just doesn't sound at all realistic.

 

[cute fuzzy bunny]

I will say that the house has not been remodeled several times. The bulk of it seems original. Which, of course has its own host of concerns to be addressed...

Wow...70 year old kitchen and bathrooms?!? Holy frijoles!

If no remodels, then you've definitely got the trifecta. Probably lead pipe or iron thats had it, the drains are probably shot, lead paint, and most likely some asbestos insulation, shingles or flooring.

I'd also have a real close look for any pests like termites or powder beetles. Older homes like that which havent had their innards reworked a little might be loaded with them

 

[Keim]

OK, so if all the figures you've given are market then you are saying that the only way you are an investor in this market is if the owner subsidizes your financing to the tune of $105,000 over the next 20 years on a $185,000 market value property.

I'm asking if you are an investor, opportunist, or maybe just a young dreamer?

Do you think your expectations are realistic?

I can legitimately call myself a young-ish dreamer. I've certainly been called worse.

Realistic expectations? I don't know-depends on what the seller wants. You make good logical arguments for why the seller would not do it. And you are probably correct. But, people don't always make logical decisions.

You'll notice in my initial note that I am open to other financing suggestions. But, I can't figure how to get the cashflow without putting over 40% down at anywhere near market rate. In which case, the house isn't workable as an investment property. I am completely open to suggestions.

 

[Keim]

1. As honobob points out, what taxes? And even if there were taxes, he'd get hit with them now anyway for selling the house, no matter when he actually gets all of the money.

2. If he doesn't want to be a landlord, selling the house for $185k and getting a 4% return on it would get him a larger check every month, and he could do that quite safely. And have $185K principal to show for it in addition to the interest. So let's see, if I'm the owner, do I want $185K now and get a safe $600/month check, or do I want $40K now and a $500+/month check?

You said 100% financed at 0% doesn't work for cash flow, but how does it work if you finance 30% of it with a HELOC? You still have to pay interest on that HELOC loan.

What happens if you can't keep the house rented, or your renter starts skipping payments?

This just doesn't sound at all realistic.

Runningbum: Thanks for the input. I can afford to do it without a HELOC, so have taken that out of my considerations. My personal cashflow is good enough that I could afford having late renters, etc. That would not be a major concern for me. Of course I'd rather avoid that!

 

[Keim]

Wow...70 year old kitchen and bathrooms?!? Holy frijoles!

If no remodels, then you've definitely got the trifecta. Probably lead pipe or iron thats had it, the drains are probably shot, lead paint, and most likely some asbestos insulation, shingles or flooring.

I'd also have a real close look for any pests like termites or powder beetles. Older homes like that which havent had their innards reworked a little might be loaded with them

I said it hadn't been remodelled. Not that it hadn't been touched! The place has generally been kept in good repair, having formerly been owned by a house builder. Appliances, etc have been updated as they needed to be replaced. Thus, toilets, oven, etc are newer. But, no one has come in and done additions, moved walls, etc.

Roof is newer, siding is metal, floors are hardwood. Would need to check plumbing and electric.

Thanks for the input.

 

[cute fuzzy bunny]

Thats a relief! My definition of remodeling may vary from others. If I do enough work on a house that I want to bury my tools in the back yard and i'm irritated enough to want to jump out of a window, its a remodel. Anything less is a renovation.

Check out whats under the metal siding. Might be a big stack of asbestos shingles. Which wont cause you any problems unless you decide to remove the metal siding to do repairs to the frame or want something different for siding. Lift up any carpet at the corners to see what sort of flooring is in place under the carpet pad.

 

[Nords]

I said it hadn't been remodelled. Not that it hadn't been touched! The place has generally been kept in good repair, having formerly been owned by a house builder. Appliances, etc have been updated as they needed to be replaced. Thus, toilets, oven, etc are newer. But, no one has come in and done additions, moved walls, etc.
Roof is newer, siding is metal, floors are hardwood. Would need to check plumbing and electric.
Thanks for the input.

Keim, you want a really really old guy to inspect your home. Preferably a guy who was a contractor in the 1950s/60s, has been retired, and is willing to come out of retirement to tell all his geezer construction-horror stories. Or else you want the home inspector to be accompanied by his grandpa.

You're looking at the kind of place that makes the "This Old House" crew practically drool to renovate. You almost certainly have lead paint, lead seals around the cast-iron plumbing drains, and maybe even lead in the water-supply pipes. The wiring is almost certainly insufficient to handle modern appliances and the fuse box (I mean fuses, not circuit breakers) may not even pass inspection-- a number of older fuseboxes have not aged well and have been deemed fire hazards. You may not even have a utility feed rated at 100 amps, let alone two 100-amp lines like today's modern homes.

If you're really having a bad day, there may be asbestos in any linoleum floors (underneath newer kitchen/bathroom floors) or in the wall/attic insulation.

The house is probably a heating/cooling nightmare-- the windows are probably less than energy-efficient, the walls/attic/floors may leak air, the insulation is probably decades out of date, and I'm not even going to speculate about the utility bills.

Then there's the maintenance-- if anything leaks or cracks or wears out you won't be able to repair it. You'll probably have to replace it, and if you end up going into a wall then there'll be other code issues that you'll probably be required to update/fix.

If you were planning to live in the home (sort of a perpetual museum project) then it might be different. But what you're contemplating is the equivalent of buying a 1938 Hupmobile and renting it out to eager drivers. I'm not sure how many customers you'd get for that, and I'm not sure that they'd understand how to care for it.

Unless you have some skill & experience with old homes, I'd run away fast.

 

[cute fuzzy bunny]

Ding ding ding!

I was trying really hard to not make him worry too much about the house. But you're right on.

This is why I'd never look at a house built before 1970. Many stick built homes were made to last around 50 years before they've pretty much been used up. Some older homes that have been kept up with the times may be better than one built 5 years ago.

But there are a lot of issues to contemplate and evaluate. A lot.

 

[Keim]

CFB and Nords:

Thanks for the comments. Exactly the constructive dialog I was hoping for.

I am reasonably familiar with the problems of older homes. My own home is of only slightly newer vintage than the property we're discussing. Lots of potential pitfalls to look for.

One nice thing around here. Tenants pay electric, gas, etc. Thus, modern insulation and energy efficiency is less of a concern.

 

[Nords]

One nice thing around here. Tenants pay electric, gas, etc. Thus, modern insulation and energy efficiency is less of a concern.

We rented a 1927-vintage house in San Diego (Kensington neighborhood) for three years. As a tenant, I was exceptionally creative at getting the landlord to be quite concerned about our utility costs...

 

[Keim]

We rented a 1927-vintage house in San Diego (Kensington neighborhood) for three years. As a tenant, I was exceptionally creative at getting the landlord to be quite concerned about our utility costs...

Sounds like you have some fun stories, Nords...

 

[cute fuzzy bunny]

Mine are simpler. My dad tearing the innards and outtards of a similar era property throughout my youth...and swearing a lot.

 

[Marquette]

CFB and Nords:

Thanks for the comments. Exactly the constructive dialog I was hoping for.

I am reasonably familiar with the problems of older homes. My own home is of only slightly newer vintage than the property we're discussing. Lots of potential pitfalls to look for.

Problems of an older home you plan to live in are different than problems of an older home you plan to rent out. It's a given that you'll be handing out lead disclosure pamphlets to potential renters. Aside from that, check rental codes for your county if you haven't.

In the city where we had our rental you had to get a rental license which had to be signed by the fire marshall, who was a stickler for things like proper fire escapes from potentially inhabitable areas (he wanted us to lock off the attic entrance because it was nice enough up there that someone might try and sleep up there) and wiring (luckily ours was already rewired to something more modern than paper-wrapped wire so we just had to upgrade the 60 amp fuses to a 200 amp circuit with a 20 amp feed for the dryer). Oh, and code in our city was a 100 amp service so it was unrentable when purchased.

 

[Marquette]

I can get cashflow from day one if I put down 30%, and talk him into a 0% loan, at $600 per month.

Include all costs (x% for repair costs, y% for vacancy cost, %a for advertising and any background checks, don't forget taxes, find out if there are licensing costs for rentals). I've head that a good rule of thumb is 5% for vacancy and I would budget a higher amount for repair cost if the roof or any major appliances are getting close to end of life.

Come up with scenarios that incude not getting a 0% loan. See what your breakpoints are. Check the area. Maybe you do 25% down and a 5% loan and take a cash flow loss now and count in appreciation and being able to raise the rents over time. Maybe you put more down to cash flow from the start. Maybe he agrees to 0%. Find out when it does and doesn't make sense for you.

Now the questions:
2. I am not very familiar with HELOCs. Can someone describe the pros and cons, or point me to a good web info source?

You get a line of credit that's a portion of the equity in your current house. One I've seen a few times is that you can draw for 10 years and then the outstanding balance is amortized and paid off over the next 10 years. The interest you pay on the HELOC may be tax deductible. A HELOC can be frozen by the bank.

3. I've read in a couple of books (Such as Weekend Millionaire Secrets to Investing in Real Estate) about getting a HELOC to make the initial down payment. Then immediately getting a mortgage on the new property to pay-off the HELOC. Perhaps I'm dense, but how does this work?

Say you have the following scenario:

You own a house with $50k of equity. You get a HELOC for $20k. (if you max out the HELOC, you now have $30k of equity in your house)

You find a property for $100k and the seller wants $20k up front and will carry back $80k at 4%.

You can just write him the check for $20k from your HELOC and then, once you have the property, take out a mortgage on that property to pay off your HELOC balance. The interest rate will likely be lower on the mortgage than the HELOC and all of your liability is transferred to the new property.

I'm guessing it's easier to do something like this with owner carry back financing than arranging a full closing and getting a mortgage broker and closers and all that lined up.

I'm not sure what the other benefits are.

4. What are the odds of the current owner giving me a 0% loan?

I would probably laugh at you, and I'm a pretty generous person. I think you should be able to get somewhere between a money market and 80% LTV conforming loan. If there's outstanding debt on the house then a big enough lump sum up front to wipe that out might make any other offer more appealing.

You may want to start by asking him what he'd loan the money at... you could be pleasantly surprised.

5. Are there other ways of financing that I should consider?

Convince him that you're a deity and you demand the house as payment for his past sins.

Convince him there's gold buried under the house and you'll give him a cut in exchange for the house

Become a government and declare eminent domain. Raise his taxes to fund buying his house from him.

 

[Keim]

1. What taxes are you talking about? If he just inherited from his mother he has a stepped up basis.

2. Why would he prefer a $500+ check every month for only 20 years when he has a $1,050 (increasing annualy at say 3%) for LIFE!!? OK, take out $200 for property mgt. and maintenance but he's still keeping appreciation.

Are you young or cute enough that when you mention zero interest financing he/she will laugh it off or will they be disgusted that you would attempt to take advantage?

If a major concern is to cash flow why are you considering a HELOC? It sounds like you stumbled upon a property for sale and have not really done any home work on investing in real property but think you can get a "deal". Good luck with that.

Honobob:

I've been thinking a bit more about this. One strategy for the owner would be to invest the money I give him (be that at 0% or some other WAY low %) in a CD or other extremely reliable device. Then he makes the going CD rate, and has a nice predictable income from me for the next twenty years to grow. Yes, all the money now would be better for most buyers-but this doesn't seem to be a high priority for him.