CA Newbie:Buying New Home For Parents and Leveraging Current Home

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CA Newbie:Buying New Home For Parents and Leveraging Current Home

Bryant To
New to Real Estate · San Diego CA · Member since 2018 · 6 posts · 1 vote

Hi all, 

A little bit about myself, I'm a newbie ibased n San Diego, CA. I've been listening to podcasts and trying to educate myself for a while, but have been stuck in analysis paralysis with all the shiny paths I could take in real estate. 

I'm currently in the phase of educating myself with regards to long-distance investing (BRRRR) in the midwest, but before I move in that direction, I wanted to buy a nice, new home for my parents. I realize this is a non-investment property, but it was an eventual goal of mine and they are nearing retirement age so I don't want to wait until they're too old to buy them a home.

That said, I have a lump sum saved up (and financial support from my parents) to buy a non-investment property. 

 - Between me and my parents, we can afford to do a conventional owner-occupied loan. But out of curiosity, I'm wondering if there might be a smart/creative way I can leverage my parent's current home (which is fully paid off and in a nice area of San Diego)?

- I'm not sure how appealing my parent's home is for a renter. Some of the interior is a bit outdated (namely bathrooms) but they do function fine, so I'm not sure if it's necessary to rehab this. Should I have someone (I would guess an investor-friendly contractor?) take a look at the house? 

I would appreciate any insight/constructive criticism on this! :) 

Regards,

Bryant 

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Andy EakesPro Member
Property Manager · San Diego, CA · Member since 2020 · 205 posts · 162 votes
6y

Hey Bryant! That is so awesome you want to get your parents a new home! And you have a few options..

It sounds like your parents own their home and it's paid off correct? If so, then you could do a 1031 exchange on the house if you are not too tied to the home. Essentially this means you take their existing property and exchange it for a home of equal value without having to pay capital gains tax and any other federal income taxes (I am not a CPA but I live in San Diego as well and can recommend a great CPA who does a ton of 1031 exchanges and could explain it much better!). Then you wouldn't have to pay anything and you could take that savings you planned to use for this property and use it to buy up investment properties in the mid-west.  

If that is something you aren't interested in, thankfully we live in San Diego! People are going to want to live here and pay rent. And with the housing crisis, San Diego has eased restrictions on adding ADUs to your property. If you were up for adding another building to your parents property (or even converting their garage or another separate building they may have), that could be even more income and with your parents house paid off and tenants paying off the utilities, the only bills would be property taxes. You could have a pretty nice cash flow! But be careful, if your renters can't pay rent for whatever reason, you are unable to evict anyone until September.

If you wanted to fix up the house and have it refinanced as well (BRRRR it), that's a great option! With a cash out refinance, you can take out up to 80% of the home's equity and put it toward another property. My parents just refinanced their home in San Diego and got a 2.1% interest rate! Unheard of. You could pull out that cash and buy a new home for your parents and have a low enough interest rate where you could positively cash flow with renters. It's already been said that the rates won't go up until the end of the year, so you have some time. But don't wait too long with this too because many people are refinancing right now and so lenders are very busy!

You have a ton of options thankfully. And you are sitting on a lot of money with your parents house. I would consider using the equity in your parents house to your favor! I hope that helps!

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  • Nicole Holcomb
    Realtor · Encinitas, CA · Member since 2020 · 125 posts · 92 votes
    6y

    @ Bryant To

    Are you currently working with an agent? 

    My recommendation is to have your agent look at your parent's house and give you their opinion on the rent it will bring in as is vs. renovated. This will give you a good starting point. I would also do a CMA for selling your parent's house as is and ARV. Knowing the value of your parent's house as well as the rental income generating power will help you run the numbers and make the best financial decision for your family.

    Once your paren't house is generating income, are you planning on taking out a mortgage to purchase other investment property? I guess it would be a RRR or a RR is you skip the reno.

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  • Andy EakesPro Member
    Property Manager · San Diego, CA · Member since 2020 · 205 posts · 162 votes
    6y

    Hey Bryant! That is so awesome you want to get your parents a new home! And you have a few options..

    It sounds like your parents own their home and it's paid off correct? If so, then you could do a 1031 exchange on the house if you are not too tied to the home. Essentially this means you take their existing property and exchange it for a home of equal value without having to pay capital gains tax and any other federal income taxes (I am not a CPA but I live in San Diego as well and can recommend a great CPA who does a ton of 1031 exchanges and could explain it much better!). Then you wouldn't have to pay anything and you could take that savings you planned to use for this property and use it to buy up investment properties in the mid-west.  

    If that is something you aren't interested in, thankfully we live in San Diego! People are going to want to live here and pay rent. And with the housing crisis, San Diego has eased restrictions on adding ADUs to your property. If you were up for adding another building to your parents property (or even converting their garage or another separate building they may have), that could be even more income and with your parents house paid off and tenants paying off the utilities, the only bills would be property taxes. You could have a pretty nice cash flow! But be careful, if your renters can't pay rent for whatever reason, you are unable to evict anyone until September.

    If you wanted to fix up the house and have it refinanced as well (BRRRR it), that's a great option! With a cash out refinance, you can take out up to 80% of the home's equity and put it toward another property. My parents just refinanced their home in San Diego and got a 2.1% interest rate! Unheard of. You could pull out that cash and buy a new home for your parents and have a low enough interest rate where you could positively cash flow with renters. It's already been said that the rates won't go up until the end of the year, so you have some time. But don't wait too long with this too because many people are refinancing right now and so lenders are very busy!

    You have a ton of options thankfully. And you are sitting on a lot of money with your parents house. I would consider using the equity in your parents house to your favor! I hope that helps!

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  • Twana RasoulBusiness Member
    Real Estate Agent · San Diego, CA · Member since 2017 · 1k+ posts · 1k+ votes
    6y

    Hi @Bryant To It is awesome that you are helping your parents purchase a property.  I have rentals here in SD if you'd like to shoot me a PM with location and idea of size and condition I can help you estimate what you can get for rent. Sounds like the rent from this property will be helping your parents with their monthly expenses which is great!

    @Andy Eakes brought up a ton of great options worth thinking about.

    best of luck!

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  • Bryant To
    OP
    New to Real Estate · San Diego CA · Member since 2018 · 6 posts · 1 vote
    6y

    Thank you all for your generous input and words of encouragement! I genuinely appreciate it. 

    @Nicole Holcomb I currently am not working with an agent, but it seems @Twana Rasoul may be able to help! I did a little of homework myself to do a ballpark check on how much rent could go for via Rentometer as well as a quick skim on CL for home rentals with the same # of bedrooms. It could go for somewhere between $2.8k (Rentometer) to $3.2k (listing on CL), which won't be able to cover mortgage with a 20% down but from the perspective of "paying rent", it's not bad at all. I can supply further details about my parent's home at the bottom of this post! 

    @Andy Eakes Thank you for the incredible list of insight and information. I actually had not thought of 1031-ing the house! I've been mulling over it and while 1031-ing would definitely help me keep upfront cash to use towards other investments, I do like the idea of keeping this house as a long-term hold primarily because of it's prime location. 

    BRRRR sounds like a great option! I'll definitely need some actual numbers to crunch to consider the logistics, so I will be looking into this. We do have a garden shed at the moment ... maybe this can be replaced with a small ADU. Definitely worth considering and looking into!

    Broad property details:

    So my parent's home is a 3BD/2BA located in Clairemont, which seems to have a very low supply from what I can tell from the MLS. It's near all the major freeways and I would consider it a pretty nice area. That's why I'm considering keeping it as a long term investment -- it's quiet for families and close enough to a lot of food areas (e.g. Convoy) and cool things for younger folks. It's not hip like North Park, but I'd say it's a solid area.

    @Twana, I'm not sure about the size so I'll look into that, but I will PM you with more information! 

    @All, just to spew an idea, in what case would a HELOC or Home Equity Loan be beneficial over a refi? I'll do some perusing on my end tonight to try and answer this myself, but insight would be helpful! I've heard of HELOCs here and there throughout podcasts, but I'm not familiar with the minute details of it.

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  • Jake BakerBusiness Member
    Flipper/Rehabber · San Diego, CA · Member since 2020 · 1k+ posts · 695 votes
    6y

    I agree with @Andy Eakes. Great suggestions Andy. BRRRRing the properties will bring in better (more long-term) renters. Run the numbers to see if it will actually cash flow.(BP rental property calculator) You don't want a headache on your hands if it doesn't.

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  • Dan H.Pro Member
    Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
    6y

    @Bryant To

    The 1031 suggestion does not work because it is your parents’ residence.  1031 are for investment properties.  In this case, the gains will already be exempted if sold because your parents have lived in it at least 2 of the last 5 years.  

    HELOC versus refi: virtually all HELOC are variable rate. I therefore choose HELOC only when I am expecting to have the loan for short durations such as a purchase with a planned refinance after performing a value add. For unknown or long duration loans, I prefer the refi as I sleep well with 30 year fixed rate loans.

    From your posts, I conclude that you do not understand rental expenses. Your example at 80% LTV has huge negative cash flow. Research rental expenses. Understand the 50% rule. Realize your plan relies on appreciation for any positive return. This is not to indicate that it is a bad plan. Historically San Diego has outstanding long term appreciation. However, in the short term there have been numerous depreciation cycles. It is my belief that Covid has increased the chance of a depreciation cycle.

    Good luck

    2Reply
  • Bryant To
    OP
    New to Real Estate · San Diego CA · Member since 2018 · 6 posts · 1 vote
    6y

    @Dan H. Thank you for the info and insight! 
    Both the capital gains exemption and HELOC vs refi info are helpful to know.

    You're absolutely right about the plan being highly dependent on appreciation and big negative cashflow. I wasn't planning for this to be a cashflowing deal per se -- just an idea I'm exploring to give a new home to my parents and maybe leveraging their current home in a creative way, if possible. But I realize it's not a great idea for cashflow -- I appreciate that you called this out.

    On a side note, could you elaborate more on the "depreciation cycles"? Is this related to how the Straight Line Method is calculated (# of months you use a property to produce income)? I'm familiar with depreciation in general as a tax write-off at a high level, but that's about it. Any pointers to resources would be appreciated as well! 

    - Bryant 

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  • Dan H.Pro Member
    Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
    6y
    Originally posted by @Bryant To:

    @Dan H. Thank you for the info and insight! 
    Both the capital gains exemption and HELOC vs refi info are helpful to know.

    You're absolutely right about the plan being highly dependent on appreciation and big negative cashflow. I wasn't planning for this to be a cashflowing deal per se -- just an idea I'm exploring to give a new home to my parents and maybe leveraging their current home in a creative way, if possible. But I realize it's not a great idea for cashflow -- I appreciate that you called this out.

    On a side note, could you elaborate more on the "depreciation cycles"? Is this related to how the Straight Line Method is calculated (# of months you use a property to produce income)? I'm familiar with depreciation in general as a tax write-off at a high level, but that's about it. Any pointers to resources would be appreciated as well! 

    - Bryant 

    San Diego RE has appreciated for any long term period for more than half a century.  However, in that half century there have been numerous shorter depreciation periods.   For example the Great Recession took almost a decade to have the prices recover.  The early 1990s had a less severe depreciation cycle.   

    Historically if you hold long term, the San Diego property appreciated.  However, if for example you purchased in 2006 (just prior to the Great Recession (GR)) you would have had to hold quite a few years before the RE would reach your purchase price.  There were areas in San Diego County that experienced ~40% depreciation (Valley Center, Jamul) and many areas that experienced ~30% depreciation during the GR.  These short depreciation cycles are the depreciation waves that can occur.

    It is my view that Covid increases the chance for a depreciation cycle. Virtually all San Diego STR LL lost thousands of dollars in rent (we experienced ~$60K of lost STR rents). Many LTR LL have been unable to collect rent from some of their tenants and have been unable to do anything about it. The percent of LTR tenants that have not paid their rent varies by source but is usually listed as greater than 33% are delinquent in their rent. The local unemployment rate recently hit an all time high. The RE listings hitting the market for the last 3 months is down significantly from a year earlier indicated a potential backlog of listings. This adds up to me to increased risk of a depreciation cycle. Note I am not saying there will be a depreciation cycle (no one knows), but clearly the risk of a depreciation cycle is greater than it was pre-Covid.

    You are considering a plan that has negative cash flow and relies on appreciation to produce a return. You are considering this plan with record unemployment, no way to collect rents, nationally at least 33% or tenants being delinquent in their rent, and every local STR owner having rent lost thousands of dollars (in our case ~$60K).

    Analyze the risks versus potential return.  In my opinion your plan has too much risk for the level of return (at this time), but I expect high level of return with fairly low risk (mostly via value adds).  Note if Covid was not present, your risk would be lower.  I am still unconvinced that the potential return (too low return) would warrant the risk, but it would be better risk/reward ratio than the current situation.

    Good luck

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  • Bryant To
    OP
    New to Real Estate · San Diego CA · Member since 2018 · 6 posts · 1 vote
    6y

    @Dan H. That was a great in-depth explanation -- thank you for taking the time to elaborate that.
    I certainly did not factor in the idea of depreciation as well as all the risks, but I will keep it in mind now and in the future. I'll keep low for now and keep an eye on the market and factor in risks for any moves I plan to make. 

    I truly appreciate all the insight! I'm glad I made this my first post as it enlightened me on how truly novice I am. 

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  • Dave Toelkes
    Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
    6y

    @Bryant To

    I don't understand the issue.  Your parents are already living in a free and clear home.  Why do you want to move them into another home?  Do they want to move?  I admit that I did not read the entire thread because I don't understand why you are trying to fix something that is not broken.

    If your parents need cash to support their lifestyle, have they considered a reverse mortgage?

    If you want to buy them a house out of the goodness of your heart, why not buy the one they already own, and let them continue to live in their present home rent free?  Let them stay in their neighborhood with their friends and near their church.  Why uproot them?

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  • Bryant To
    OP
    New to Real Estate · San Diego CA · Member since 2018 · 6 posts · 1 vote
    6y

    @Dave Toelkes 
    There's no issue and no proper investment motive behind moving my parents. They've always had an idea of a "dream" house is all and I wanted to give that to them, if I can, while they're still physically able-bodied and can enjoy the charms of a spacious, modernized home. Our current home is a nice home in a nice neighborhood, but it was purchased as a family home to raise me and my sister as opposed to something that my parents truly loved. And they also don't any particular attachments to this home (e.g. church/friends nearby) other than the sentiment behind witnessing my sister and I grow up.

    That said, my topic is out of curiosity to see if there's any creative ways I could leverage the current home to reduce expenses (other than buying a new home and renting out the current home traditionally). 

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