Investment Real Estate question....

[FDCaptain]

I am new to the forum and would appreciate some outside insight.

My wife and I are in the process of buying a 4 plex apartment building. We have been landlords before (although single family) and my question is basically a financial one. The four plex is an easy decision for us...5 minutes from our home and well maintained with 2 long term tenants. Even considering vacancy rates and maintenance/repairs the property should cash flow enough to pay off itself in about 12 years. We do not need the cash flow for income now. We plan to retire in about 13 years.

So here is the caveat, behind the four plex is a duplex offered by the same seller. Maintaining both next to each other would be ideal. However the duplex has a negative cash flow. Both properties together would still cash flow positively but not enough to facilitate much of an early pay off. The duplex is also well maintained and has even longer term tenants.

Of course the question is do you buy negative cash flow property? I like the idea of the property paying itself off early. I would rather not put any other income towards the early pay off of the real estate. However, in 2 years I will have a jump in income that could be placed toward the rental property.

I always pay attention to net worth. Going by that I should buy both. Debt reduction from rents adds to the bottom line, not to mention appreciation. Even if it is slower than I would like it to be.

Thank you for your opinions and advice.

 

[honobob]

OMG Becky, Buy!

 

[2B]

OMG Becky, Buy!

I'm not sure whether this is a recommendation to buy or if you are just being sarcastic. I certainly have made sarcastic comments in my time but I usually wait until someone demonstrates an unbearable level of foolishness or outright stupidity.

My comment is that I would need more information about your situation. I personally would never recommend someone have most of their investments in illiquid real estate. I am also concerned about being geographically focused with all of your property depending on a single local economy. That positive cash flow situation may change suddenly when the local Ford plant has a lay off and without ample liquid reserves you might suddenly find yourself in foreclosure.

Unless you are a real estate pro, I'd be very careful not to tie yourself up into a mini-real estate empire to fund your future retirement. I encourage index mutual funds that are highly diversified. REITs cover the real estate asset class. I personally think REITs are worth 5% or so of a portfolio. Of course, if you bring special real estate knowledge and background to the table you don't need our comments.

 

[FDCaptain]

I'm not sure whether this is a recommendation to buy or if you are just being sarcastic. I certainly have made sarcastic comments in my time but I usually wait until someone demonstrates an unbearable level of foolishness or outright stupidity.

My comment is that I would need more information about your situation. I personally would never recommend someone have most of their investments in illiquid real estate. I am also concerned about being geographically focused with all of your property depending on a single local economy. That positive cash flow situation may change suddenly when the local Ford plant has a lay off and without ample liquid reserves you might suddenly find yourself in foreclosure.

Unless you are a real estate pro, I'd be very careful not to tie yourself up into a mini-real estate empire to fund your future retirement. I encourage index mutual funds that are highly diversified. REITs cover the real estate asset class. I personally think REITs are worth 5% or so of a portfolio. Of course, if you bring special real estate knowledge and background to the table you don't need our comments.

Thank you for your response.

By local economy, do you mean real estate should be held in different cities? Would I need to move out of the region as well? Just curious what you would consider a diversified economy if you will.

Your caution about cash flow is warranted, we do have capital to handle vacancies. The units rent between 425 and 450, this makes them affordable for most working would be tenants.

At the time of retirement I plan the properties to be approximately 20% of our portfolio. More than your 5% to REITS but a balance of compromise I think.

I do like index mutual funds as well.

I do have real estate investment knowledge. I am far from a pro or expert. Just looking for outside insight. Any is appreciated (sarcastic or not).

 

[Hamlet]

I would not be interested in the negative cash flow property. Why buy something that is going to suck money when you have the opportunity to buy properties that cash flow?

I'd look for more properties like the 4-plex, rather than invest in a less ideal property simply because it is next to your current property.

 

[tryan]

Of course the question is do you buy negative cash flow property?

Of course the answer is "no". You'll be better off DCA into a no-load mutual fund. No sweat, blood or tear required.

That said, the 4 plex sounds like a good deal. I'ld take the 4 plex and make an offer on the duplex at a price where it cash flows. You might be surprized with the result.

 

[honobob]

I am new to the forum and would appreciate some outside insight.



Of course the question is do you buy negative cash flow property? I like the idea of the property paying itself off early.

I always pay attention to net worth. Going by that I should buy both. Debt reduction from rents adds to the bottom line, not to mention appreciation.

Thank you for your opinions and advice.

Yes! Yes! Yes! The only reason NOT to buy negative cash flow property is because you don't have the funds to back it! But in your case the portfolio of properties that you're buying is cash flowing. I assume that if there is another that cash flows you'd buy that and not the one you're looking at. Four apartments good? Six apartments better! Are you really puting MOST of your money in real estate or are you putting in a little and using your tenants money to build your net worth? Try to convince someone to contribute to your mutual fund.

 

[tryan]

The only reason NOT to buy negative cash flow property is because you don't have the funds to back it!

A second reason not to buy a negative cashflow is because you don't want to keep your day job to provide those funds....where else are those funds coming from? Negative cash flow - by definition - is anti FIRE.

I'ld take the opportunity to separate out the problem.

 

[hellbender]

Of course the question is do you buy negative cash flow property?

The cash flow situation is only one factor which needs to be evaluated when considering buying an income property. The phrase "negative cash flow property" is inappropriate. If you paid cash for the property it would probably cash flow . . . right? So we see that the cash flow situation is not a characteristic of the property but rather the terms of purchase/ownership.

I have owned several properties which initially had negative cash flows. I was willing to do this for several reasons. Maybe I wanted to conserve my cash-on-hand to purchase a property with a large positive or for other desirable immediate purposes. Maybe the tax advantage, appreciation potential, the rate of loan paydown and/or other characteristics of the property were overwhelmingly favorable. Maybe I could have easily turned the cash flow situation around with a cash infusion or out of current income but preferred to maximize my lerverage instead.

It is possible to have a bad experience even with proiperties that initially had positive cash flow. You should be asking yourself if you have sufficient reserves to outlast the worst that could happen. If major repairs, local economic upheaval and loss of tenants happend simultaneously, how long could you hold out? Do you have a plan for dealing with such events? Do you underdstand the additional management hassles associated with the ownership/management of multiples?

If you don't have an answer for any of the above, it might be better to start smaller. If you do have good answers, then go for it.

 

[Meadbh]

Cash flow is king. If you buy a negative cash flow property, you are banking on future equity appreciation. And we all know that isn't a great assumption!

Based on the information provided, it makes sense to buy the fourplex provided that it remains within your desired asset allocation and that you are ready for the hassles of landlordhood. It may make sense to buy the duplex depending on the following:

1. Calculate the breakeven and bid on that basis. Your bid may be accepted. The current owner wants to liquidate for a reason.
2. Long term, nice tenants are wonderful, but only if they are making money for you. Their rents are below market. When can you legally increase the rent by a reasonable amount?
3. Can you invest the building in a cost effective manner that will justify higher rents?
4. If you buy the fourplex but not the duplex, will it fall into the hands of undesirables?

IMHO, if the answers are yes, yes, yes and whatever, it makes sense to buy both buildings. If the answers are no, no, no and yes, it doesn't make sense to buy either building.

 

[cute fuzzy bunny]

You're going to be working for ~15 more years, presumably you've got enough coming in that cash flow from the properties isnt going to make or break you and I'm presuming that you can get by with the usual vacancy rate without dipping too deeply into your pocket.

Given that you've got a good salary coming in, the positive cash flow from the four unit building might give you a few tax owies. A little negative cash flow from the other would offset that somewhat. While the six tenants pay off your properties for you.

Good levels of appreciation and rent increases over time would be a plus. Income from six units that are substantially paid off when you retire and start collecting your pension might be a good thing.

Being able to control the tenant mix in a substantial area is also a plus. You as a multiple unit property owner combined with six families complaining about an adjacent neighbors bad behavior carries a lot of weight with the police, animal control and the local politicos.

 

[calmloki]

...That said, the 4 plex sounds like a good deal. I'ld take the 4 plex and make an offer on the duplex at a price where it cash flows. You might be surprized with the result.

I agree, though we've bought stuff that doesn't cash flow before - usually because we feel that repairs/improvements will bring it up. Any room for rent bumps? We found that most tenants are freaked out by their homes being sold and a $10-15/mo bump at takeover is greeted with a sense of relief - "that's all?" There is much to be said for economies of scale - if you are doing repairs/maint. it's nice to have one closet for supplies and/or one mower rather than two. Also real nice to have units close by for showing or repair calls. $425 is where we are on our 1 bedrooms - a bit of churning as people lose work, but a big rental pool eager to fill empty units - this is in small town Oregon.

 

[FDCaptain]

The phrase "negative cash flow property" is inappropriate. If you paid cash for the property it would probably cash flow . . . right?


Yes, you are correct "negative cash flow property" is incorrect. Thank you for pointing out my mistake.

The duplex property has a low return rate. At current rents the property would have a 5.8% Cap. Rate w/ 8% vacancy and moderate repair/maintenance expenses. It would take 30% down ($37,500) for the property to break even w/ the above stated variables and a 30 year loan.

The four plex on the other hand w/ 10% down ($15,000) has a Cap. Rate of 9.55% and cash flows $4,600 per year with a 30 year loan.

I do have resources to handle vacancies. I believe I have a good understanding of the commitment needed for these properties. The seller is a personal friend of ours and the discussion of this deal has spanned to just under one year. The properties are not on the open market. We also have experienced investors in multi-family units to mentor us. As it works out my wife works for a large residential and commercial developer.

Thank you for your insight.

 

[CitricAcid]

It all depends on the local market as well, as 2B stated. The jobs in the area are very improtant, but if the place is diversified enough/suburb/exurb, there shouldn't be too much volatility in that market. Many markets in the midwest or others don't appreciate that much, but generate great positive cash flow where many other places (Northeast, Chicago, SF Bay) are difficult to create positive cash flow, but have historically higher appreciation rates (again, tough to predict the housing market). Knowing your local real estate market's nuances should help the decision greatly.

 

[FinanceDude]

Don't buy.........stay away.........

 

[FDCaptain]

Yes! Yes! Yes! The only reason NOT to buy negative cash flow property is because you don't have the funds to back it! But in your case the portfolio of properties that you're buying is cash flowing. I assume that if there is another that cash flows you'd buy that and not the one you're looking at. Four apartments good? Six apartments better! Are you really puting MOST of your money in real estate or are you putting in a little and using your tenants money to build your net worth? Try to convince someone to contribute to your mutual fund.

Are you recommending I invest the cash flow and not use it to pay off the property?

Thank you for your input.

 

[FDCaptain]

It all depends on the local market as well, as 2B stated. The jobs in the area are very improtant, but if the place is diversified enough/suburb/exurb, there shouldn't be too much volatility in that market. Many markets in the midwest or others don't appreciate that much, but generate great positive cash flow where many other places (Northeast, Chicago, SF Bay) are difficult to create positive cash flow, but have historically higher appreciation rates (again, tough to predict the housing market). Knowing your local real estate market's nuances should help the decision greatly.

Historically the market in the area has had little volatility....no big run ups but no big drops. The market will hold apartments priced in this range...they are two bedroom so likely a small family with possiblity of two incomes.

I also believe that with the changes in lending practices it is an excellent time for rentals. Many people that should not have gotten loans before will not get them now and will be renting.

 

[honobob]

Are you recommending I invest the cash flow and not use it to pay off the property?

Thank you for your input.

That’s what I did and ended up a multimillionaire (in real estate equity). First property paid for the next and so on. The original property was paid off 15 years ago only because a 15 year mortgage was all that was available at the time. The difference of the smaller payment was 28% of the rent then ( I could have used that money then) but only 4.6% of the rent in the last year if I’d had a 30 year mortgage. So maybe I’d pay more in interest but because of inflation and the time value of money I probably paid more in hours of work to pay the property off in 15 years. So in year thirty I have a property worth $400,000 free and clear or I owe maybe $3,500 for a net of $396,500!

So as long as I can get fixed low rates I’m gonna keep property financed. Appreciates at the same rate paid off or not! I had originally considered liquidating and placing in the stock market but I believe recent events have shown that not to be a good plan. People talk about how liquid stocks are but then have to plan 5 years of cash so they don’t have to sell in a down market. Liquid? I think not! I can always get cash from my properties at market rates and change when rates get even better! As long as I can anticipate fixed mortgage costs, rising rents and a 9%+ long term appreciation rate I think I’ll take my liquidity from real estate!

 

[haha]

People talk about how liquid stocks are but then have to plan 5 years of cash so they don’t have to sell in a down market. Liquid? I think not! I can always get cash from my properties at market rates and change when rates get even better! As long as I can anticipate fixed mortgage costs, rising rents and a 9%+ long term appreciation rate I think I’ll take my liquidity from real estate!

This point is OT I guess but very interesting. Stocks, at least ones that trade frequesntly are easily sold. That is not a very good definition of liquid though, if by liquid we mean that we can go to bed Thursday night and walke up Friday to sell our stocks at or close to Thursday's close. We may be able to, but maybe not.

Ha

 

[honobob]

This point is OT I guess but very interesting. Stocks, at least ones that trade frequesntly are easily sold. That is not a very good definition of liquid though, if by liquid we mean that we can go to bed Thursday night and walke up Friday to sell our stocks at or close to Thursday's close. We may be able to, but maybe not.

Ha

fo' shizzle my nizzle

 

[FDCaptain]

That’s what I did and ended up a multimillionaire (in real estate equity). First property paid for the next and so on. The original property was paid off 15 years ago only because a 15 year mortgage was all that was available at the time. The difference of the smaller payment was 28% of the rent then ( I could have used that money then) but only 4.6% of the rent in the last year if I’d had a 30 year mortgage. So maybe I’d pay more in interest but because of inflation and the time value of money I probably paid more in hours of work to pay the property off in 15 years. So in year thirty I have a property worth $400,000 free and clear or I owe maybe $3,500 for a net of $396,500!

So as long as I can get fixed low rates I’m gonna keep property financed. Appreciates at the same rate paid off or not! I had originally considered liquidating and placing in the stock market but I believe recent events have shown that not to be a good plan. People talk about how liquid stocks are but then have to plan 5 years of cash so they don’t have to sell in a down market. Liquid? I think not! I can always get cash from my properties at market rates and change when rates get even better! As long as I can anticipate fixed mortgage costs, rising rents and a 9%+ long term appreciation rate I think I’ll take my liquidity from real estate!

Thanks for your insight.....something to think about.

Do you hold your properties in an LLC?

 

[FDCaptain]

Don't buy.........stay away.........

Any reasons?

 

[honobob]

Thanks for your insight.....something to think about.

Do you hold your properties in an LLC?

You're welcome. My experience only, YMMV.
I hold everything in a revocable living trust. It's been 30 years and the LLC's seemed overkill but then I don't buy the rental car insurance either. Probably will look into it more in the future.

I think you are from Kentucky. I grew up in Northern KY and when I left I was renting a newer 2bd1.5ba in a 12 unit bldg in a cul de sac (called Cookbook Lane) with about 6 bldgs all with the same owner. The rent was $175 mo. in 1977 and my rent was $250 for a small studio in Honolulu that rents for about $1,000 today. What do your rents look like?

 

[FDCaptain]

You're welcome. My experience only, YMMV.
I hold everything in a revocable living trust. It's been 30 years and the LLC's seemed overkill but then I don't buy the rental car insurance either. Probably will look into it more in the future.

I think you are from Kentucky. I grew up in Northern KY and when I left I was renting a newer 2bd1.5ba in a 12 unit bldg in a cul de sac (called Cookbook Lane) with about 6 bldgs all with the same owner. The rent was $175 mo. in 1977 and my rent was $250 for a small studio in Honolulu that rents for about $1,000 today. What do your rents look like?

I am in Kentucky.
The apartments are 2bd 1ba and rent for $435. The properties are in an "apartment community" of individually owned buildings, either 4 plex or duplex. Their are approximately 15 buildings covering 2 blocks. The 4 plex is in a cul de sac. The duplex on the main road, next to a single family.

 

[tryan]

Do you hold your properties in an LLC?

If I had to do it again, I'ld use an LLC. Currently have an S Corp for the free n'clear property (to shield it from the leveraged). Problem is the annual state filing fee ($495) and CPA tax bill ($1050) ... both of these are non-existant with an LLC.