First Property - Which of these 3 Options Should I do?

Question

Hey everyone, I’m a new investor ready to get my first deal and wanted other opinions on several different directions I could go with my first purchase.

My Goals: start out with a focus on LTRs with SFHs, self-managing and beginning locally in Memphis. I would like to have at least a couple properties before moving out of state that will at minimum break-even on cash flow as a LTR with property management long-distance.

Other info:

• Looking to move out on Memphis with my wife in the next 2-4 years
• Looking to start a family in the next year or so
• Comfortably have ~50k ready to invest sitting in HYSA, excluding Cash reservesHave an extra ~$70k in stocks
• Have an extra ~$70k in stocks
• Most interested in A- to C+ neighborhoods
• I currently own & live in a 2/1.5 Condo locally (3.5% interest rate)Not allowed to rent it out
• Not allowed to rent it out
• HOA fees have risen to where PITI + HOA = $1100/mo.
• Have ~$100k trapped equity, good zip code I could sell quickly

• Have an extra ~$70k in stocks

• Not allowed to rent it out

Option A: Purchase another primary home locally I could live in for 2 years (lower interest rate), with intention of eventually converting it to LTR when I move out of state. Idea is I could “trade-up” houses, get some trapped equity out of condo, and eventually keep this in my portfolio long-term, for a similar PITI. Then I could start purchasing regular investment properties.

Option B: Find an investment property first (higher interest rate) that pencils out while continuing to live in my condo, and then find another primary I could “trade-up” for with my condo, where I could eventually use it as LTR

Option C: Just focus on finding investment deals that pencil out at a higher interest rate with existing cash, and when I eventually move out of state, sell Condo. This may potentially require a HELOC or something similar if I don’t have enough cash left for deal #2.

Taz Zettergren · Answer

@Graham Lemly what a great situation to be in. With the goals you've mentioned, as bad as I hate to say it, I'd sell the condo and buy a single family home for you to live in. It hurts to let the 3.5% rate go but since you're not going to be able to rent that place out in the future I'd take advantage of the equity you have in it and start the investment road you're wanting to go down with a single family. Since you'll be able to put less down on the primary you should still have plenty of cash to buy another single family home as a rental.

With today's interest rate's option C is going to have very few opportunities, in areas you'd want to be in, that pencil. Feel free to reach out if I can be of any assistance! Best of luck

Graham Lemly · Answer

Thanks for the insights,

@Jordan Ray I'm aiming for properties that need light-medium rehab using conventional financing, although wouldn't I only want to go the HELOC route after I've used up all available cash first? I think I have enough cash to comfortably do 2 deals, without tapping into home equity. I don't think I fully understand using HELOC to pay points and holding costs only.

Taz, that was my initial thought as well - even though it would hurt to get rid of a 3.5% interest rate, I could get an equivalently priced home with today's conventional primary residence rates and have about the same monthly payments that I have today, simply because of the HOA fees.

Drew, I completely agree about resisting the temptation of buying more than I need, especially if I want it to make sense to then turn into a LTR after 2+ years.

I am leaning towards purchasing a primary that would require light-medium rehab, in the $125-175k range, possibly with less than 20% DP. Anything much more than that price without way more value-add than I'm comfortable with on my first deal (I'm also not very handy unfortunately) makes it difficult to turn it into an at least break-even LTR when I move out.

I think I have a short window of opportunity to buy as a lot of people are still waiting on the sidelines for lower rates, so less competition. I think that I can still make a deal work though, given my situation. Memphis seems to be a balanced market right now, and I would have to turn around and sell my condo anyway.

I'm not sure how much this matters in terms of staying longer in my condo vs buying a new primary, but I did just a few months ago upgrade my HVAC ($12k) and am doing other value-add to it in the meantime.

Drew Sygit · Answer

@Graham Lemly if you're serious about moving out of Memphis in 2-4 years, buying another primary will have risks if you need to sell to finance your move. There may not be a lot of equity in it in just 2-4 years as real estate isn't increasing in value as fast as in the past.

If you want to build a rental portfolio, your unrentable condo isn't going to help.

Buying a new primary, that you can eventually rent out, would be better for building your portfolio.

A challenge will be finding a new, TEMPORARY home, for your family that will be a good rental when you move from the area. Resist the temptation of buying what your family wants and instead buy something you'll be able to easily rent when you move!

Since you'll be buying at least a Class B property, try to put at least 10% down and hope in 2-4 years it'll have increased enough in value to get rid of the PMI. Even if you can't, once you rent it out the PMI will become tax deductible.

While you are doing that, start looking for rentals to buy. You seem to have enough cash to do both. If not, get a temp HELOC on the primary (don't tell the bank it's temp!).

Be sure you understand the differences in the tenant pool between Class B and Class C properties. Read our copy & paste info about this and adapt to Memphis!

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Recommend you first figure out the property Class you want to invest in, THEN figure out the corresponding location to invest in.

If you apply Class A assumptions to a Class B or C purchase, your expectations won’t be met and it may be a financial disaster.

If you buy/renovate a Class A property in Class D area, what quality of tenant will you get?

Similarly, if you put all Class D tenants in a Class A 4-plex, what do you think will happen?

So, when investing in areas they don’t really know, investors should research the different property Class submarkets.

Here’s our OPINION for the Metro Detroit market (use as a template for your target area!) that we’ve learned in our 24 years, managing almost 700 doors across the Metro Detroit area, including almost 100 S8 leases.:

Class A Properties:
Cashflow vs Appreciation: Typically, 3-5 years for positive cashflow, but you get highest relative rent & value appreciation.
Vacancy Est: Historically 10%, 5% the more recent norm.
Tenant Pool: Majority will have FICO scores of 680+ (roughly 5% probability of default), zero evictions in last 7 years.

Class B Properties:
Cashflow vs Appreciation: Typically, decent amount of relative rent & value appreciation.
Vacancy Est: Historically 10%, 5% should be applied only if proper research done to support.
Tenant Pool: Majority will have FICO scores of 620-680 (around 10% probability of default), some blemishes, but should have no evictions in last 5 years

Class C Properties:
Cashflow vs Appreciation: Typically, high cashflow and at the lower end of relative rent & value appreciation. Can try to reposition to Class B, but neighborhood may impede these efforts.
Vacancy Est: Historically 10%, but 15-20% should be used to also cover tenant nonpayment, eviction costs & damages.
Tenant Pool: majority will have FICO scores of 560-620 (approaching 22% probability of default), many blemishes, but should have no evictions in last 2 years. Verifying last 2 years of rental history very important! Also, focus on 2 years of job/income stability.

Class D Properties:
Cashflow vs Appreciation: Typically, all cashflow with little, maybe even negative, relative rent & value appreciation
Vacancy Est: 20%+ should be used to cover nonpayment, evictions & damages.
Tenant Pool: majority will have FICO scores under 560 (almost 30% probability of default), little to no good tradelines, lots of collections & chargeoffs, recent evictions. Verifying last 2 years of rental history and income extremely important to find the “best of the worst”.

Make sure you understand the Class of properties you are looking at and the corresponding results to expect.

Jordan Ray · Answer

I would actually recommend a hybrid of option B & C. You could try getting a HELOC with your primary and using this money as short term funds to acquire rentals that need a light-medium renovation using 100% purchase/rehab hard money and just using the HELOC to pay points and holding costs. With this strategy you could be out of pocket $10K or less per deal and essentially scale at a comfortable rate without over leveraging. This would result in a higher cash on cash return and also would work great for acquiring deals in C+ areas. You could sprinkle in some section 8 vouchers in the mix for a perfect recipe of Memphis investing! Let me know if I can help using this strategy or in any other way in Memphis! Talk soon!

First Property - Which of these 3 Options Should I do?

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