Sound plan to convert current home into rental?

Question

Hi All!

I'm very excited about getting into RE investing and would like some help with a plan to actually make it happen! I'm still in the learning stages, but my desire to get "into this" isn't new. The goal for some time now has been to eventually turn our current home into a long-term rental income property when we're ready to purchase our next home. I realistically think that we're only a few years away now, and I know preparation for this won't be completed overnight, so what I'm looking to do now is learn and come up with a feasible plan that will make this goal a reality.

Starting with getting educated, in addition to reading online I've ordered How to Invest in Real Estate: Ultimate Beginner's Guide and The Book on Rental Property Investing. I figure this is a good place to start really gaining some knowledge.

Current Home & Finances

• Our current home is on a 15-yr fixed at 2.85%; home value about $150k, loan amount $72k, purchase price $106k. Mortgage payment is $599 (PITI $875). It is a 1000sqft bungalow in a good neighborhood (homes have held value and appreciated pretty well by comparison to surrounding areas).
• This home (we believe) would be a great rental candidate on the surface. Our neighborhood is popular with younger couples, on a quiet street but walkable to restaurants and such. We have lived in this home 10 years and have upgraded/remodeled almost the entire house including the "big stuff" so we know the ins-and outs of it down to the bones. From a quick search, rents are around $1500/m.
• My wife and I are fortunate to be in good financial shape. We have close to 800 credit scores and have no other debt aside from the mortgage on our current home (DTI 6.5%). 
• In cash I'd estimate we're 1/4 of the way there saving towards our next down payment (plus a buffer for expenses)...so we have some work to do here over the next couple years.

Current Tentative Plan to Get Started

• In ~2 years, do a cash out refi on our current home. Say with a loan balance of $60k and a property value of $150k, we do a loan for $90k. 
• This loan would be a 30 year to maximize what will be cash flow once converted to a rental (in another year to satisfy any "must live here" rules). From an online calculator...call that $450/m for P&I.
• After say $5k closing costs we'll have $25k to round out our savings for the down payment on our next home plus expenses.
• We should be approved for both mortgages. Our estimated DTI with both mortgages would be (conservatively) about 20%. 
• The rental property should cash flow. According to the 50% rule it's passable even if the mortgage payment creeps up AND rents creep down by up to 20%. Further analysis is of course needed here...but conservatively this looks pretty solid to me.
• We would plan on using a property management company.

Is this a sound plan?

I would greatly appreciate any feedback or thoughts!

Thanks!

Christian D. · Answer

Thanks for your thoughts!

This is partially true. Yes we are looking to upgrade...but with valid reasons. We have always tried to have the smallest and most affordable house that fit our needs...so we're not going to be buying an unnecessarily large home nor stretching ourselves with a huge bloated mortgage. But we are already feeling the need for more room for entertaining guests, more closet space, etc etc, so we know a move is going to come. Plus with a young child and our school district not being super great once elementary is over...that is a big driver as well.

I guess my train of thought was to keep this home as a rental because even though it's a SFH (which I thought was a good place to start...??) it's in a good spot that I would *think* would be appropriate for renting it...lots of young couples and close to downtown...etc. Then I could work towards getting a duplex or something after that.

It's true my mindset is on the small size right now...I guess I just was thinking that RE would be a small part of my portfolio in retirement as opposed to a majority.

Thomas S. · Answer

If I were in your position I would be planning much differently . I would stay where you are and save to invest in a multi unit rental property. Pull the equity out of your home to purchase the largest multi unit property you can afford with minimum down. You probably do not have to move and are only doing so to upgrade.

Alternately if you need more bed rooms due to a growing family I would save for the DP on your next home, being conservative with what I buy and how much I spend (most people have way more home than they need), and when ready sell the house, buy the new one and buy a purpose built multi unit rental.

If you want to own a rental property they buy a rental property don't try to convert a SFH into a rental. You will be much happier in the long run.

Christian D. · Answer

Just giving this a bump.

Would be curious if anyone else has thoughts on the overall plan and/or the cash out refi vs keeping my current financing (which would make the rental-to-be cash flow less but would be paid off much sooner).

Christian D. · Answer

Thank you! We have been fortunate of course but I'm also good with numbers and am a hard worker!   ;-)

I think we would be approved for another mortgage without selling or doing the refi to lower the payment on our current mortgage. Again loose numbers based on some online calculators...but if we took on a $300k mortgage right now with 20% down and 30 years @ 4% on our next home and kept our current mortgage, our DTI would be 21%. So I don't think this would be a limiting factor.

In fact, my initial thought was to do exactly this. I thought to myself even if the property hovers around zero cash flow for a few years...it'll be paid off relatively soon and then we'd be in a nice spot. But, then I read more about leverage and so forth and wondered if this would be the smartest route or not.

The other catch is saving up for the down payment. We're going to work on increasing savings a bit by cutting expenses, but not at the cost of contributing less to retirement accounts or negating our savings for future vehicles which we plan to purchase in cash from here forward. Those 2 buckets eat up a lot...so it might take longer than we want to wait to come up with say $80k in cash for our next down payment plus some padding for expenses.

Plus...if the house is cash flowing nicely with the refi loan and we have our separate savings account for the property funded well...we can always pay down debt with the extra. I plan on having our primary home plus this rental property paid off before retirement. I'm 33.

Another idea I had rattling around (because a side note is a good buddy of mine also wants to get into RE) is to flip a house sometime in the next couple years to earn that down payment sooner. Our only issue would be how to finance the purchase...I don't think we collectively would have enough in cash to purchase the flip for a while yet.

EDIT: Re: being my own landlord...I'm relatively busy with a day job plus a side business already. Even though we'd live fairly close...at least right now I think a property management company would be a smart decision due to my lack of time to invest and lack of experience in actually being a landlord.

Jim Goebel · Answer

@Christian D.

Congrats on seemingly a good start financially.  Also, congrats on naturally being a little more conservative it seems with how you are approaching risk.  That said, see if you can get approved for another loan without a contingency /requirement to sell.  If you can do this, can you come up with another down-payment to purchase another house?  Based on the numbers you threw out on your primary - there's no question you're going to be cash flowing.  If your new house is close enough where you can handle being the landlord, I'd see this as being a great option.  Your current primary note is a great rate, although low term.  But, you'll be building equity rapidly and continuing with that - nothing wrong with that!!!

I'd be inclined to investigate the above rather than the cash out refinance on that home.  You may end up looking at both but for me continuing to aggressively pay down your equity and enjoy the cash flow may be more accessible than you think.