Is this a good idea to start out with?

Question

I am new to BiggerPockets.  I have been listening tirelessly to the podcasts for the last month or two.  I really want to get started in real estate investing but have little cash on hand...

The property below seems like the best way to get started.  I know it does not meet the 2% rule or the 50% rule but both of those rules are basically unattainable anywhere near where we live.

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We live in a town home near a major university in an affluent neighborhood. We "rent" from my wife's elderly father who also lives with us. Thus, we do not have a primary mortgage. Because of my profession, their are special primary loans available that are $0 down without PMI.

Our attached neighbor is currently a rental property and I have noticed the owner is growing tired of managing and would likely be willing to sell (although it is not on the market currently).

The market rent is $2000-$2400, probably on the upper end of that range.  The property's market value is $310,000 to $350,000.

I would opt for a 5/1 ARM (current rate 2.8%) with the plan to refinance in 5 years when my income is much higher (I will be done with training; I also hope to have some cash flow real estate properties by then as well!) when cash-flow is less of a concern.

The monthly mortgage including taxes and insurance would be median $1450-$1600 depending on the sale price.

I know the roof is in great shape.  HVAC was replaced in the last 1-2 years.  The chances of additional expenses are quite low and we live next door so I can handle most issues immediately.  The water is actually not separated from us so we know the water bill - ~$60 for both town homes.

Therefore, monthly cash-flow without unexpected expenses would be $370-$920.  (There are lots of assumptions but I think the likelihood of being in this range is >95%)

I know this is not a "home run" investment but my cash on cash return is essentially infinite with a $0 down mortgage.  Also, I want some practice as a landlord and it would be nice to start out living close to the property. Further, because of the neighborhood, this is a "Class A" property and I could easily get a very responsible tenant, which would further decrease the likelihood of unexpected expenses.

Eventually, we will utilize our current residence as a rental property and it would be nice to own the entire structure (2 town homes).

I apologize for the long post and I appreciate any input that anybody has related to this potential "deal."

Mark Ferguson · Answer

@Bill S. I think short term loans can be very risky, but my ARMs are amortized over 30 years and have no balloon payment. Yes the payment can go up after five or seven years, but the amount it an go up is limited.   The bank can't call it due unless I don't make the payments.

I am curious about the low money down loan as well and how that would work.

Bill S. · Answer

@Chad V. I'll fourth or fifth getting only a 30 year fixed rate loan. Interest rates and underwriting can change fast. Ask me how I know. I had a property under a short term loan. In the span of a year nothing changed for me and if anything it got better but the bank decided they wouldn't renew and told me they would foreclose if I couldn't refi somewhere else. This happened to many people. Don't be caught in that trap. Mark is in a different place in his career and has many more resources to bring to bear on the situation if things get difficult.

The purchase price and rent seems like a very good deal for the Denver market in the class of neighborhood you speak of. Situations where rent pays your mortgage and puts a bit into your pocket in those kind of neighborhoods are not common.

I would say this most first time buyer loans require borrower occupancy in the subject property as a condition of the loan. Many of these loans also require you to sign an affidavit of occupancy. It's criminal fraud to buy using those programs with no intention of occupying the property securing the loan. You could buy, move in there, bring your father-in-law with you and rent out his place. I know it's super tempting but cutting corners is not a good way to start in the business IMO.

Mark Ferguson · Answer

Welcome @Chad V.    This is an interesting scenario since you can get it for so little down. I think it all depends on how much you can buy it for.   There are definitely better numbers in Greeley, but you wouldn't get 0% down.  Deals are also drying up here as well.

As far as the ARM goes, I am a fan of them. But you have to make sure you can afford it if the payment goes up.  I would save your cash flow and create an emergency fund that could be used in the worst case scenario; prices drop, rents drop, you make less money and can't refi. To me that all seems pretty unlikely.  I think ARMs are great because they create more cash flow and save you money now. Money now is worth more than money in the future due to inflation.

Bill S. · Answer

@Chad V. to elaborate a bit on the difference between a due on sale clause and an owner occupancy requirement. With a due on sale clause they just want their money if they catch it and the seller is one who would technically have violated that clause. With the owner occupancy, you sign a statement at closing saying you are going to occupy the residence and it is fraud to do so knowing you are not going to move into the property. Your attorney would fill you in on the specifics.

As for the current property, perhaps the seller would do an owner carry for you. Many owners don't want to sell because they have nowhere to put the money. They can sell and carry the loan and get a better return and defer the capital gains taxes. You may want to inquire along those lines.

Chad V. · Answer

Mark and others,

Thank you for making me realize the seriousness of the owner occupancy clause. I definitely would have involved a lawyer (as is always recommended) so I don't think I would have gone through with it, but it is nice to know that there are people out there to warn me before doing something stupid and have the whole deal trashed.

It appears that investment loans will probably have a higher interest rate than what I anticipated and I will check with the mortgage broker I have been in contact with but I'm guessing that the loan I was thinking of may be for primary residences only and it might not be possible to remove the OOC.

That being said, it would not be a huge thing to move across the wall into the other property and rent out our current residence. In fact, the rent  that our current home would get is likely higher than the neighbors since we have completed a few updates. It might take some time to get used to because the units are exact replicas but in the opposite direction... ha.

The other option would be to buy both townhouses under one loan, which would double the size of the loan and I may not qualify for a $600,000 loan...

Are there any other suggestions others might consider?

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I might start to look at other investment strategies while I sort out this potential deal.

If I was able to get a 2% rule property for the same loan amount, my monthly rents would be more like $7000 instead of a measly $2400. Of course, this would definitely require a down payment.

Mark Ferguson · Answer

@Chad V.

I use ARMs as well because of necessity and the increased cash flow.  Most likely your rate won't go up more than a point of two each year after the 5 years and will max out at around 8 or 9 I would think.  You would have to keep that loan for at least 8-12 years before you paid as much interest as you would with the 30 year fixed.  If you have disposable income and cash flow, it is a no brainer to me to use ARMs.  The risk would be if the ARM adjusts enough that the cash flow disappears and you don't have any money to make up the difference, equity in the home to sell or increased rents in that time period.  All that could happen and that is why I prefer properties with the mortgage payment about a 1/3 of the rent.

As far as the owner occupant rule, you can use it with multi and live in one unit.  You have to have them under the same loan and financed together not separately.  It is a pretty big deal to break owner occupant rules on loans, it is fraud pretending to be an owner occ when you are an investor.

Braden Silverman · Answer

Hi Chad,
     I am a beginner looking for my first investment property. I believe I was offered the deal that you are considering. It's a unit by DU with similar numbers. This seemed like a great deal at first and I was about to seriously consider it as my first investment property until I found out about the 5/1 ARM. The risk here is too great in the long run. That being said, DU has amazing appreciation potential and this could turn out to be a very profitable endeavor.

Chad V. · Answer

So this is not a subsidized homebuyer program, it is a type of loan that is available in some states for physicians or physicians in training. I have not seen a contract for this type of loan before but from the way it is advertised it appears the loans can be used for real estate investing as well.

So I should have asked this question in my original post: So I know that you can buy a multifamily and legally live in one unit and rent out the others;  is it different if the property is split under two different loans and the owner of the one property lives in the one side that is not on the loan he/she has in his/her name?

I knew this was a nuance in my plan and it is awesome that several people picked up on that.  Perhaps it is a grey area... @Bill S. I agree that moving to the other property might be the most "by the book" way to handle this but I'm not sure the bank would care as long as the mortgage is being paid.  Kind of like the "Subject to" deals with "due on sale clauses" that they talk about on the podcasts.

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About the ARM, so some back of the napkin calculations.

If purchase price is $330,000, current fixed rate mortgage is around 4.1%. The monthly cost basis for this would be around $2100 including interest, principle, taxes, insurance, garbage and water. This would leave me with a maximum cash flow of $300 and I may not get $2400 in rents.

The same scenario with a ARM on a 30 year loan with a 2.8% interest rate (fixed for 5 years) would give me a cost basis around $1600 and a potential cash-flow of $800. So after 5 years I would have a potential cash flow of $48,000 minus repair costs, vacancy, etc. instead of a maximum of $18,000.

This is thinking in terms of 5 years, rather than for the long, long term but as an optimist (like @Mark Ferguson) I always think things will be better in 5 years!

I do agree that this would be risky and probably not particularly smart under normal circumstance.

I guess the elephant in the room is that my (job) income will go from ~$55,000 to >$200,000 when I complete training in 2017 or 2018 and this is virtually guaranteed unless the US healthcare system completely unravels.

I am a bit more risk tolerant with that in the back of my mind. My wife also has a good job so we have a fair amount of disposable income. If things go awry we have cash to plug the hole.

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Final note: I really look forward to working with experienced BP investors when I have real money to invest circa 2018.

Troy Best · Answer

Hi Chad and welcome to BP. You came to the right place for a wealth of information. I would recommend not doing an ARM at all. If you do that and interest rates go up and your income does not then you have major issues.

Josh C. · Answer

@Chad V. Just curious what loan program offers 0 down for non owner occupied? I didn't think the VA did, but I could be wrong. Spy NINJA loan?

Also, I would second the advice above in favor of fixed rate. Being that rates are at historic lows, the accepted assumption is they are heading north. For a 50k loan it doesn't matter much, but on a 330k loan every point is $200 per month in added interest.

Good luck!

Is this a good idea to start out with?

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