buying a townhouse for purposes of renting

[JohnDoe]

On a scale of 0 to 100 I am at about 5% of buying a 2nd house and I have some questions.

Are mortgage rates typically higher for investment properties?

Is there a down payment percentage that is required?

Thanks.
JD

 

[clifp]

Yes at least 1% higher. Generally banks want 30% down for rentals, but I know they will do business at 20-25%.

 

[JDARNELL]

I am seeing .25% higher for investment property with 30% down.

JDARNELL

 

[arebelspy]

You could always move into the new house and rent out the old one, get an FHA loan requiring 5 percent or less down and get owner occupied rates.

 

[l2ridehd]

I own a few rental properties. So far very successfully. Although I studied the options and took a unique approach it has really worked well. I found that banks wanted .5% more and 25% down vs 20%. Might just be the bank I was dealing with, but they were the easiest to work with at the time. I have used the rentals for a couple different options. While I am working they provide some level of tax shelter although most paper losses are deferred as current income does not allow them. But that's OK as retirement income will and they will benefit me then. It provides two retirement options that I am still deciding which way to go. I can continue as now and just break even, get the tax advantages, and build the equity and at some point in the future sell them for the equity. Or I can accelerate the mortgage payoff and use the rental money as extra income.

I retire in 160 days or less (still working the final date) so I will decide which option when I see the retirement cash flow actually in place vs in a plan. Right now I believe I can live as planned and pay down those mortgages fairly fast, but need to get there to make sure it will work. If it does then I have both options in place. Monthly income and the ability to take a lump sum cash if needed.

 

[Amethyst]

Why not take a mortgage or HEL on your residence, and use it to buy the rental property?

Amethyst

 

[Fishingmn]

I am actively buying townhouses as rental investments. I bought the first 5 with cash but with cash running low and investment options plentiful I'm now looking at financing as well. Just this week I put in an offer on a short sale townhouse that was accepted (still need bank approval). It's 100k and I'm getting a conventional 20% down loan at 5% with no points - so it's about 1% higher for an investor loan. I could certainly pay points and buy down the rate and might do that when it comes time to lock.

The nice thing about financing is that my ROI is actually better than the cash purchases since I'm using leverage. While I was getting 9-10% on the cash deals I'm projecting 16% on this one (assuming the bank approves it which is not a slam dunk).

 

[Meadbh]

I own three rental properties, all purchased within the past 4 years with downpayments of 25-32%. The rents are paying the mortgages and management fees. Currently I have approximately 55% equity overall. My goal is to pay off 1 or 2 of these mortgages prior to ER and use the surplus to pay down the third mortgage faster, generating an income stream. Unlike an annuity, I keep my equity and have the option of selling it in the future. I can also refinance and realize a lump sum which would not be subject to tax.

 

[harley]

The nice thing about financing is that my ROI is actually better than the cash purchases since I'm using leverage. While I was getting 9-10% on the cash deals I'm projecting 16% on this one (assuming the bank approves it which is not a slam dunk).

I'm curious about the math on this statement. You mean that after subtracting the mortgage payment from the rent payment you'll be getting 16% return as opposed to 9% on the ones where you don't have a mortgage payment to subtract? That must be one hellacious rent payment, or an incredibly cheap house and mortgage.

 

[JohnDoe]

Why not take a mortgage or HEL on your residence, and use it to buy the rental property?

Amethyst

I currently have a mortgage on my primary. I rather have a fixed rate for anything I would purchase. I do have a LOC at prime minus a quarter, though.

I don't think I have enough cash for 20 or 30% down so I would have to tap my LOC.

There are a couple of townhouses I've been following that are about 5 mins from my house. They have been on the market for a while and the prices keep dropping.

I'd only be interested if the price was right but I am new to this. I have lots of research to do.

 

[Fishingmn]

I'm curious about the math on this statement. You mean that after subtracting the mortgage payment from the rent payment you'll be getting 16% return as opposed to 9% on the ones where you don't have a mortgage payment to subtract? That must be one hellacious rent payment, or an incredibly cheap house and mortgage.

Townhouse #1 with cash

Purchase price - $105,000
Rent - $15,600/year
Expenses+Vacancy Projection - $5,885/year
Net Op Inc - $9,715

ROI = 9,715/105,000 = 9.25%

Townhouse #2 with only 20% down, 5% rate

Purchase price w/ loan costs - $106,300
Rent - $15,600/year
Expenses + vacancy projection - $6,443
NOI - $9,157
Debt Service - $4,815
Cash Flow - $4,342

ROI = 4,342/27,100 (my cash outlay) = 16.02%

 

[arebelspy]

I'm curious about the math on this statement. You mean that after subtracting the mortgage payment from the rent payment you'll be getting 16% return as opposed to 9% on the ones where you don't have a mortgage payment to subtract? That must be one hellacious rent payment, or an incredibly cheap house and mortgage.

Absolutely using leverage gives you a greater ROI. Also exposes you to more risk if the underlying asset goes down in value.

 

[Fishingmn]

Absolutely using leverage gives you a greater ROI. Also exposes you to more risk if the underlying asset goes down in value.

Not sure I agree totally with this statement. If the prices on both my townhouses go down $30k I still lose $30k either way. Yes, if I want to sell both I need to bring cash to the table on townhouse #2 but I'm out the same amount of money.

The more correct statement is that my ROI has much more variability in a leveraged deal - but that relates more to income and expenses.

What I mean is that if my market rent goes down from $1,300/month to $1,200/month my ROI on the all cash townhouse goes down by 1% but my ROI on the financed townhouse goes down by 4%. The impact of income and expenses in the financed deal are much more pronounced.

 

[harley]

OK, I guess I was confusing ROI with cash flow. Probably another reason I'm not a landlord.

 

[JohnDoe]

Townhouse #1 with cash

Purchase price - $105,000
Rent - $15,600/year
Expenses+Vacancy Projection - $5,885/year
Net Op Inc - $9,715

ROI = 9,715/105,000 = 9.25%

Townhouse #2 with only 20% down, 5% rate

Purchase price w/ loan costs - $106,300
Rent - $15,600/year
Expenses + vacancy projection - $6,443
NOI - $9,157
Debt Service - $4,815
Cash Flow - $4,342

ROI = 4,342/27,100 (my cash outlay) = 16.02%

How does your vacancy protection work?

 

[arebelspy]

How does your vacancy protection work?

Projection, not protection.. I.e. The amount of vacancy he expects to have, due to tenant turnover.

 

[Fishingmn]

Projection, not protection.. I.e. The amount of vacancy he expects to have, due to tenant turnover.

Here are my cost assumptions - yours may differ:

Vacancy Loss - 5% of gross rent/year (safer might be 1 mo/year)
Accounting/Legal - $300/year (build up a fund for legal actions like evictions)
Insurance - $100/year (I buy townhouses with Ins coverage so this is for $1M liability)
Repairs/Maintenance - 1 month's rent/year (I do most of my own repairs)
HOA dues - Insurance, outside maint, water/garbage (usually $160-200/mo)
Property Taxes

Tenant pays gas, electric, cable

I do my own property management so that saves the 10%/year a professional would charge.

 

[JohnDoe]

Projection, not protection.. I.e. The amount of vacancy he expects to have, due to tenant turnover.

Yea. I read that wrong. lol

Thanks.

 

[Bimmerbill]

I wish I could find properties for 100K up here.

 

[harley]

Can't even get a garage for $100K in the DC area.

 

[Finance Dave]

On a scale of 0 to 100 I am at about 5% of buying a 2nd house and I have some questions.

Are mortgage rates typically higher for investment properties?

Is there a down payment percentage that is required?

Thanks.
JD

I have gotten into rental properties this year and learned a great deal. My experience is that investment loans are considerably more expensive (almost double). Let me explain in more detail....

We have an LLC for rentals. If I tell the banks I want to buy the properties through the LLC, the rates are much higher. This is for a variety of factors, such as little equity currently in the LLC against which to borrow, no history of income of the LLC, etc.

In addition, when you buy an investment properties, there are different "rules". For example, if I buy one that's vacant and not "livable", they will loan me only 70% of the purchase price. If I buy one with a tenant in it, they will loan me 85% of the appraised value. One strategy to deal with this is a bridge loan until it's livable, then refinance.

Another factor is that most investment loans are not truly fixed rate. I've spoken to 4 local banks, and none of them will give a 15 or 30 year fixed. Rather they will give 5 or 7 year ballon, amortized over 15 or 30 years. This essentially translates significant interest rate risk to the borrower. As a result, we've elected to borrow only enough that we could pay the loan off entirely in 5 years should rates skyrocket.

Now, there is a way to get around the high rates. Instead of using the business to secure the loans, use your primary capacity. That could mean a HELOC against your primary residence, a personal mortgage instead of a business mortgage, and so on. Obviously this only works if you have income or assets to show the bank your repayment ability. The other complication is that you are then "crossing lines" by borrowing from a personal capacity for an asset owned in an LLC. Although I don't believe this is illegal, it certainly creates some gray areas for the accountants and lawyers and most them advise caution in this area.

Our solution? Use HELOC to secure funds, draw down the HELOC, send this to the business as a "cash contribution from owner", then use those funds to bridge until the property is livable, then refi through the business on a 5-year balloon with the intention of dramatically overpaying the 15 year amortization schedule so that a balloon in 5 years is doable.

The above is admittedly not in alignment with many "experts'" philosophies on using OPM (Other People's Money) towards advancing ownership, but it's the way that suits us.

 

[Bimmerbill]

Yeah, buildable lots in my town are $50 to $70K (3 acre min lot size).

 

[JohnDoe]

The nicer townhouse properties around here are in the 130 range but I don't think the rents command more than 1k. (still researching)

With my debt I would be taking on and probably a mgmt fee, cash flow would be minimal.

The properties are pretty nice though and are within 10 mins.

Properties priced around 100k are not necessarily in the suburbs which is what I would want.

 

[JohnDoe]

I have gotten into rental properties this year and learned a great deal. My experience is that investment loans are considerably more expensive (almost double). Let me explain in more detail....

We have an LLC for rentals. If I tell the banks I want to buy the properties through the LLC, the rates are much higher. This is for a variety of factors, such as little equity currently in the LLC against which to borrow, no history of income of the LLC, etc.

In addition, when you buy an investment properties, there are different "rules". For example, if I buy one that's vacant and not "livable", they will loan me only 70% of the purchase price. If I buy one with a tenant in it, they will loan me 85% of the appraised value. One strategy to deal with this is a bridge loan until it's livable, then refinance.

Another factor is that most investment loans are not truly fixed rate. I've spoken to 4 local banks, and none of them will give a 15 or 30 year fixed. Rather they will give 5 or 7 year ballon, amortized over 15 or 30 years. This essentially translates significant interest rate risk to the borrower. As a result, we've elected to borrow only enough that we could pay the loan off entirely in 5 years should rates skyrocket.

Now, there is a way to get around the high rates. Instead of using the business to secure the loans, use your primary capacity. That could mean a HELOC against your primary residence, a personal mortgage instead of a business mortgage, and so on. Obviously this only works if you have income or assets to show the bank your repayment ability. The other complication is that you are then "crossing lines" by borrowing from a personal capacity for an asset owned in an LLC. Although I don't believe this is illegal, it certainly creates some gray areas for the accountants and lawyers and most them advise caution in this area.

Our solution? Use HELOC to secure funds, draw down the HELOC, send this to the business as a "cash contribution from owner", then use those funds to bridge until the property is livable, then refi through the business on a 5-year balloon with the intention of dramatically overpaying the 15 year amortization schedule so that a balloon in 5 years is doable.

The above is admittedly not in alignment with many "experts'" philosophies on using OPM (Other People's Money) towards advancing ownership, but it's the way that suits us.

For financing, it was suggested to me to initially take out a new mortgage so that I am the owner of the investment property. Then refinance the property using a no cost fixed HE loan against my current residence of which I have plenty of equity - even though I am still making payments on it.

So then I would be left with the mortgage on my primary residence and the term HE loan against my primary. Even with all of that my loans to value would be less than 70%.

At some point I will need to get a real cost of what my debt service would be at different price points.

 

[haha]

The nicer townhouse properties around here are in the 130 range but I don't think the rents command more than 1k. (still researching)

With my debt I would be taking on and probably a mgmt fee, cash flow would be minimal.

The properties are pretty nice though and are within 10 mins.

Properties priced around 100k are not necessarily in the suburbs which is what I would want.

Here, there are $250K very ugly townhomes in mediocre areas. Some of these may even be cheaper in areas with crime reputations. And a bit north or south of city limits likely a bit cheaper too. Attractive townhomes in central part of city usually start at $450k+ and go way up. Some of these are very attractive.

But no way would any of these work as rentals. Rents are just not that high. My condo that I am buying is much cheaper, and in an area with good rent demand- but it wouldn't begin to work either-figuring payments on 100% of price.

I think posive cash flow in northwest coast cities must depend on large owner performed rehabs or something.

If I were not an inflationist I would continue to rent. I also expect a greater and greater price premium on prices and rents in attractive, close-in areas of growing cities. My major reason for buying is that I want some lifestyle protection. I really would not like to be priced out down the road.

Ha