Which future rental should we choose?

[Libbie Grant]

Hi, everybody! I'm new here. A friend of mine who works in the same professional field strongly recommended BP (the forums and the podcast) to me, as she has gained so much knowledge and confidence (and money) with her real estate investments from BP. I'm really looking forward to learning, and starting a lifelong practice of real estate investment on the right foot! :)

Here's a run-down of our situation. My husband and I live in Friday Harbor, WA, which is in the San Juan Islands. We absolutely love it here, but it's kind of a unique market. We have been renting here for the past year, to be sure we really want to commit to buying. There's a very strong market for vacation/transient rentals, with some VRBO properties earning gross receipts of up to $75,000 annually. There is also a very hungry long-term rental market here--there is never enough housing to go around for year-round island residents; it has become a major problem for the community. So these factors make us feel that the islands will likely be an excellent place to invest in real estate. 

HOWEVER, county codes regulating VRBO properties are pretty strict. These rules are supposed to protect the long-term rental market for island residents, but IMO do very little to actually resolve the issue. And although there are tons of potential renters at any given time, they can't necessarily afford rents that will create strong cash flow for landlords. Combined with fairly high average selling prices on properties, that makes for a potentially very slim profit margin on renting. In some cases, landlords may only be meeting their PITI obligations each month, not making any profit from long-term renters.

So here's my big question. We had been planning to buy our "dream home" first and then buy investment properties later. However, somebody else beat us to the punch and our dream home is now under contract. Darn! We thought, "What the heck. We'll just buy our first investment property to start with, and live in it until another 'dream home' comes on the market here." Because there's always another one, right? :)

We are now thinking seriously about two options. We've been making our list of pros and cons for each, but I wanted to see what more experienced investors thought...what you would do in our situation.

Property 1: Is small...1100 sf, 2bed/1bath in the main house. It has a code-compliant, attached vacation rental with existing VRBO permit (a unit over the garage.) The rental unit brings in about $30K per year, which would be enough to pay for all but $200/month of this property's PITI. Someday, when we find a long-term house for ourselves, we could rent the main house for about $1200/month and continue to rent and manage the VRBO unit, and would end up with about $1000 cash flow. I can also see several ways to build fairly quick equity on this property, just by updating some features in the kitchen and bath, and by making the yard space look a whole lot prettier than it does now.

The "pros" are strong with this property, but it's TINY. I work from home and need office space...so if we did end up getting it, we'd probably put about $15K into installing a prefab "studio shed" in the back yard so I could have some work space. Our biggest stumbling block would be adapting to life in a small house, for who-knows-how-long, until another "dream house" finally turns up.

Property 2: Happens to be the house we're renting now. Our landlord just notified us last night that she has finally decided to sell it. It's 1700 sf, 4bed/2bath...which is maybe a little larger than we need, but we took what was available when we moved up here, because this rental market is so volatile. It's within the town limits, which means there is no chance to get VRBO income out of it. It would have to be strictly a long-term rental in the future. And I have no doubt that we could find tenants, but our margin would be SLIM on this one, maybe even non-existent (i.e. we'd break even on PITI.) Because this house was so beautifully and recently updated when we moved in, I don't see much chance for making improvements and gaining equity, so I don't think it's likely that we could refinance in the near future to get a more favorable mortgage and give us more of a profit margin from rent.

So the pros aren't as strong on this one, but on the other hand, we already know it has plenty of space for both living and work, and that we can live in it comfortably while we wait for something else we like to come on the market.

So...which house would you buy in our situation?

Thanks!