Refinance to buy a rental property?

[DaveH]

We're thinking about refinancing our current house and using the equity to purchase a rental property next door. It would be a stretch but would cover the new larger mortgage if 2 out of the 3 apartments are rented.

Has anybody done this and have reccomendations?

Thanks.

 

[Ron Hanz]

That depends . I'm a real estate appraiser in Texas and I have a few rental properties.

First off, it may not be a good idea having your tenants living so close to you.

Would having a tenant knocking on your door at 10:00 pm complaining about a plugged up toilet and they have to go, RIGHT NOW, upset you?

It does happen, I can assure you.

What is the demand for rental housing in your area? Based on recent past experience, what has been the vacancy rate of this particular property? Has recent foreclosure activity in the area driven people to rental housing versus owning?

You indicate the cash flow from rental of two units out of three would cover the new mortgage payment. Will the new mortgage payment include PITI (principal, interest, taxes and insurance)? Make sure it does.

How are you arriving at a price to pay for the property? Have you looked at recent sales prices of comparable rental properties? How many similar properties are listed right now/how many have sold in the past 6-12 months?

If you decide to run with it, do you have the resolve to put away a cash reserve for replacement of short-life items/repairs to the property, and a cushion for when a tenant moves out and you have to wait a while between tenants.

When I was in my 30's-40's I'd take a chance on just about anything, but now I'm a heck of a lot more conservative about investments.

Many questions to answer before you take the plunge.

If you have more questions about this possible investment opportunity, I can try to answer here, or send me an email off-forum if you'd prefer.

 

[DaveH]

Ron, thanks for the questions, email sent.

 

[Bob W]

I've been considering purchasing rental properties as well. Break even hopefully, with the rent income balancing out the mortgage and maintenance. Then sell the properties at a profit when entering retirement.

No way that I'd risk my own home in the dealing though.

First off, it may not be a good idea having your tenants living so close to you.

Around here, having the rental close by to keep an eye on them would be an advantage.

One other concern. Around here renters are trash. They'll jack you for rent, all the while destroying the property. Therefore I would only rent by word-of-mouth to people I know or friends-of-friends who vouch for their quality. It sounds like you're looking at more of an apartment situation where those sorts of arrangements are more difficult.

Good luck!

 

[DaveH]

BobW thanks for the post.

Yes, we actually know of a couple of instances where renters not paying rent, that is a real concern.

 

[Triton]

1) Never risk your house or a questionable (or even a "sure thing") investment. If you've got extra money to play with fine, but don't gamble with your home.

2) Never go into debt to finance an investment.

3) Dealing with renters is a royal pain in the tail, in the best case it is lucrative but that just means it's a lucrative pain in the tail. In the worst case it is an expensive pain in the tail. Unless this is a high end rental property the renters you are going to get are people that either can't afford anything else or more likely can't get the credit to buy something else. Either way chances are good that you are going to end up with more then a few individuals with rather poor decision making skills being involved in your financial life. Get a months rent as a deposit to, because chances are at one point you are going to go knocking and they will have disappeared. Hopefully they will have not taken the bathtub, the sink, and the stove with them as they went out kicking in the walls and peeing on the carpet.

In short... why not just refinance your house to get the lowest payment you can, and invest in some nice mutual funds or something or better yet work on getting out of debt entirely?

 

[Bob W]

I agree with Triton's three points. But here's something to ponder that might offset some negatives... Are you personally familiar with the current renters? People you trust? People who are current on rent payments? Clean people with good credit histories?

And are they long-term renters? Meaning are they likely to stay there for several years after you buy, or will you be dealing with a new batch of strangers every few months?

 

[DaveH]

I can answer some of those.

Are you personally familiar with the current renters? People you trust? People who are current on rent payments? Clean people with good credit histories?

And are they long-term renters? Meaning are they likely to stay there for several years after you buy,

yes to all. if it goes through we would just have to rent 1 apartment.

why not just refinance your house to get the lowest payment you can, and invest in some nice mutual funds or something or better yet work on getting out of debt entirely?

We're already at 6% on our house and that's the only debt. I didn't mention it above but our retirement is already significantly invested in the stock market, we were considering this as a diversification move.

 

[Triton]

I
We're already at 6% on our house and that's the only debt. I didn't mention it above but our retirement is already significantly invested in the stock market, we were considering this as a diversification move.

By 6% do you mean that's your current mortgage rate? Or is that the balance that you have left to pay?

Good on you having requirement already in the plans. Real estate can be a good investment but I still wouldn't go into debt to do it. Consider... when you are debt free you are recession proof. Get that house paid off and then heck gamble any way with your money that you want, it can't hurt you!

I'm still trying to figure out how to get my own house paid off so please don't think I'm being holier then thou, mine is at a 6% rate... and I want more then just about anything to get rid of that debt. At that point I've got all the money in the world to do what I want with.

 

[Gollnick]

2) Never go into debt to finance an investment.

Never say never.

Interest on money borrowed for investment is tax deductible.

A better rule is that all investments that will keep up with even favorable interest even after tax deduction will involve some risk. So, don't borrow money for an investment unless you could afford to pay it back even if the investment goes south. Otherwise, a bit of careful borrowing can be a good way to increase the amount of money which you have to invest which will increase the amount which you earn. It's basically called "levraging." Leverage refers to a lever. Using a lever, you can move a heavy object with less effort. But, levers work both ways. If you can move a large object with less effort, if there's a potential benefit to you, then a lesser problem on the other end has a greater effect on you too.

Let's say you've got a hot stock tip. If you invest $1000, it will grow to $1200 in one year (20%/year). If you borrow another $1000 at 10% interest, you can make $330 after you pay the interest (allowing for tax consequences). So, you increased your return by 60%, a handsome result. Of course, if the company you bought the stock in goes bankrupt, you will loose your thousand and still owe the lender a thousand too. If you can afford to pay that loss and have good confidence in the investment, then take the loan.

In the case in question, a three-unit appartment building has got to be a pretty big chunk. If it goes south completely and you are unable to either rent it or sell it, can you still keep paying for it? If not, then this possible borrowing for investment is not a good idea.

 

[DaveH]

can you still keep paying for it?

That's a good point, it would be very close. We'll work out some SHTF scenarios.

The bad news/ good news is that there is a fair bit of foreclosure going on so the rental market is tightening up.

Thanks.