I think I have a good plan... right?

Question

So I think I have a fairly safe way to enter the world of real estate investing but I wanted to post my plan here and see if I was missing anything. I've done a lot of reading & research so I think I have a good handle on the details, hopefully you all agree! To ensure that this is a "safer" play the numbers I've used throughout I feel are conservative.

Small Back Story:

I bought my current house in 2009 in Madison, WI- as you can imagine I got a pretty good deal and today I have about 40k in equity (using comps in my neighborhood as well as a comparison created for me by a friend who's a real estate agent). My house current value is estimated at around 180k, 3br 2bath. I recently got engaged and am lucky enough to have found a fiancee who is financially stable, we're currently saving about 80% of her salary to move in to a new house in 2 years.

The plan starting in 2 years:

We will have a sizable amount saved for a down payment, so my plan is to take about 15k, pay down my current mortgage and refinance (I estimated 120k, 30y, 4.5%). Then put my current house up for rent. We would stay there until it is rented then go live with my parents for a few months while we find our next house. I feel like this greatly reduces the vacancy risk, at least for the 1st year. We will still have at least 20% (probably more) to put down on our personal residence when that time comes. I would rent out my current house for 3 years at which point I would look to sell, conservatively I think my house would be worth at least 200k (hopefully more) with my loan value at less than 114k, even if I paid 10% for realtor, etc. upon sale I would end up with 77k. The reason I would want to sell in 3 years? Since I lived in it for 2 of the past 5 I my understanding is that the IRS would consider it a primary residence, that that 77k would then be mine tax-free. That is on top of the almost $200/mo cash flow I would generate in those three years (math at the end).

At that point I could evaluate how I felt about being a landlord and decide if I wanted to continue, or just cash out if it wasn't for me. If it was for me I could easily turn that 77k in to two other properties, perhaps even 3. My feeling is that even if after 1 year I hate the whole process I could still sell the house, for a profit, and be done with the experiment still financially ahead. Am I missing something or does this seem like a decent way to go?

Math:

Gross Rent: $1,500/mo (comps today are $1,400 so that's my two year estimate)

Mortgage & taxes: $610/mo + $275/mo

Vacancy (1 mo/yr), Repairs (15%), Insurance: $115, $225, $90

Cash Flow: $185/mo

Cap Rate: 7.07%

Cash/Cash Return: 14.8%

Gross Rent: 1.11%

Whew! That was a lot of typing, thanks for reading and you thoughts in advance!

Christy Harris · Answer

Echoing what @Dave Foster says, there is a great BP podcast about taxes - where the guest speaker says that the IRS assumes depreciation for the time it is rented, whether you take it out of your taxes or not. Also, here - if it isn't your primary residence, the taxes are doubled. Also echoing what @Kevin Kurt mentioned....not sure why you'd refinance to put money back into the house unless you're getting a way better APR rate...I've heard a good rule of thumb is about 1% or better makes it worth it, bc you're going to pay 2k+ to refinance.

Kevin Kurt · Answer

If your numbers are correct 40K of equity in a 180K house should keep you out of PMI.  The $225 a month  should keep you well ahead on a single family, for small thinngs.  The only thing that would bite you is a large hit early like a furnace going out or a roof that needs to be replaced.  Moving the cash flow up $25 bucks a months but putting an additional 15K down really won't help with that, but 15K sitting in an index fund that could easily be turned into cash would.

Andre P. · Answer

@Dave Foster, @Kevin Kurt

Thanks for the input, good things to consider for sure!

Kevin- The 15k was a way for me to ensure that I could refinance, lose my PMI payment, and help me get a better cash flow with the new payments to address any issues that may arise, especially early on. I do see what you're saying, about putting it to work somewhere else though.

Kevin Kurt · Answer

There are two small things I see that I would question.  The first is why do you plan on putting an extra 15K into the original refinance, I would invest the 15K somewhere else and use the additional leverage, but everyone is different on how big a lever they like to use.

The second is your vacancy rate is 1 month/year and you set aside $115.  I think it should be 1500/12 = 125 per month.

Overall looks like a good plan, I think you are probably being too conservative on repair costs and vacancy, but no one ever got hurt from being too conservative.

Dave Foster · Answer

@Andre P., it's a well thought out plan.

One suggestion - watch your calendar on that 5 year period very carefully and don't try to schedule your closing too close to the 3 year mark.  You don't dare go over.

One reminder - When you sell that house you will still have to recapture depreciation on the time it was used as a rental.  It won't be too much but you still want to plan.

One warning - That's the law now.  And no man's person, property, or liberty are safe as long as congress is in session.  The law can change tomorrow.