My first investment-please help....

[David Robertson]

I'm new to the forum, but would appreciate anyone's help about my first investment.

About Me: I just turned 24 and have owned my residence, a 3 bedroom/2bath since October 2009. I have a background in construction and an interest in investing. Over the past year I have had much of my financial wealth in the stock market, but with the lastest economic downturn I am looking for a new place to invest. I have been interested in buying real estate for the past several years and I feel like right now is a great opportunity to pick up some properties for cheap with low interest rates to rent until the market is right to sell.

Currently, I have been eyeing my first investment property. I found a 3 bed, 1 bath that is near my residence in an okay neighborhood (good schools, low crime, amenities nearby, but neighborhood somewhat rundown), for about $39,000. With interest rates currently at about 4.5% the PITI payment would be approximately $270 per month or approximately $420 per month with $150 per month of maintenance. I reviewed the rental market in the area and I am confident that I could receive around $800 which is +$380 CF per month or +$4560 a year.

I have several questions:

Question 1: Would it be wiser to buy the property in cash or take out a loan with a $5000 down payment?

--My thoughts are that if I paid cash my holding costs/vacancy risk would be lower and cash flow would increase. However, if a get a loan with a small down payment my risk/investment decreases and I can use leverage to maximize return on investment.

For example if I paid cash and invested $39,000 & $3,000 in capital improvements my ROI would be $4560/42000=10.8% return in the first year.

However, if I only put down $5,000 and invest $3,000 in capital improvements my ROI would be $4560/$8000=57% return in the first year.

Taking out a loan would maximize my return on investment and allow me to free up capital for another purchase. Thoughts?

Question 2: Should I create an LLC to hold the property? If so, do I purchase the property as an LLC or do I have to transfer it to the LLC from my personal name after purchase?

Thanks for your time and help!

Dave

[Vikram C.]

Dave, please read the landlording forum and the 50% rule in particular. Your expense assumption of $150 per month with rent of $800 per month is unrealistic.

Using the 50% rule, your operating income will be about $400 per month and not $650 per month. Given your purchase price of $40K, this works out to a 12% initial yield (CAP rate). That means that leverage will help you if your cost of funds is less than 12%, which I am sure it will be. Therefore it makes sense to use some leverage in purchasing this property.

Use an amount that you and your lender are comfortable with. I do not know much about lending but I have read here that lenders typically will lend up to 75% of the value of the property for investment properties, which seems like a reasonable amount of leverage for this type of investment.

That brings me to the bigger issue, which is the value of the house and the rent that you can expect. It is important that you evaluate both these carefully so that you avoid a potentially poor investment. I personally do not like homes with 1 bathroom and suspect that tenants will also not like it. But perhaps that is common in your area. Make sure you evaluate the rent potential carefully before proceeding.