Need some advice. Should I buy a second rental?

Question

Sorry if this is the wrong section, but I am new to the website. Some general facts to consider about me:

1) Age: 25

2) Located in Houston, TX

3) Current net worth: $173,000

4) Debt: Primary Mortgage, no credit card debt

5) Income: Salary from work is $63,000 plus $1,500 a month in rent that I am currently getting from friends on a 3 bedroom condominium.

6) Liquid assets: about $15,000 worth of gold and silver at today's market price, $62,000 in liquid stocks that are not in a 401k or IRA.

So here is my situation. I recently got a new job on the opposite side of town and traffic is pretty bad here in Houston anywhere you go. I purchased a Condominium here in Houston this past July with the intent of living in it and renting the other two rooms out. I am looking to move in order to save time and gasoline, and I have been toying with the idea of purchasing a 3-4 bedroom house that is closer to work with the intent of renting my current room out to another friend, then living in the new house while renting out 1-2 rooms out in the new house.

So here is my financial situation. I am currently 25 with no debt and an annual salary of $63,000. My current condominium has an outstanding mortgage of $190,000 and I collect $1,500 a month in rent from my friends with all bills inclusive. In order to break even (mortgage, taxes, utilities, cable, inet, maintenance), I am looking at right around $2,200 a month assuming NOTHING goes wrong. If I choose to move out, I have notified one of my friends that rent as a whole for the entire condominium will be $2,450 per month. This nominal return does not take into account the tax refund at the end of the year or the equity return from the mortgage payment.

Given my scenario, would it be wise to pick up another mortgage? I would like to do this due to the income stream the second house would produce, but I am afraid that I would be over-leveraging myself. Any advice would be appreciated.

Steven Hamilton II · Answer

Sounds to me like overleveraging at this point. The condo is showing a loss. Seems you are not including expenses for repairs/maintenance.

If it has appreciated maybe look at a 1031 and roll your gain into the house as you suggested or if you can find a 3-4 unit that might be higher debt, but could be worth it.

Brie Schmidt · Answer

You have to make sure the new purchase makes financial sense, but on the lending side they look at DTI ratios on top of your cash. DTI is debt to income and the banks want a max 28% front end or a 36% back end (this can be more flexible) Lets say you make 5k a month before taxes. Your max mortgage (PITI) would be $1,400 - 28% of your income. Lets say that you have a $500 car payment. For your back end they would take 36% of your income minus current bills. So $1,800 minus $500 car payment = $1,300

The bank would allow up to the lowest of the 2 - so $1,300

Have you claimed the rent you are currently receiving from roomates on your tax returns?  If not on paper you have no landlording experience and they usually require 2 years of experience to use that money to qualify for a loan (the $2450 on the $2200 mortgage)  Local banks will be more flexible with this requirement if you have a lease on the unit (get one asap) and you have sufficient cash reserves for your current mortgage (6 - 12 months)

Roy Schauer · Answer

Hi Justin,

Here is the link for you to find distressed properties in Texas:

Homepath

There are other ways to gain revenue from a property without having to be a landlord.  Not familiar with what works in Texas, I know their Lease Option statues are very tight. The easiest way to deal with it might be to sell if you think you can recover market value, and do a 1031 exchange.  Congrats on the new job and good luck!

Justin Moon · Answer

Robert,

Do you have any sources on how to find undervalued property?

Robert Leonard · Answer

Congratulations on the new job and the fact that you appear have your finances in order.  But with 63k of annual income, I think the idea of taking on over 400k of debt would be overleveraging!  The "break even" numbers you stated are pretty certain money losing numbers.  I would sell that property while interest rates are low and you stand a good chance of getting out quickly.

I started buying real estate at 22, 22 years ago.  I would never borrow as much as what they said I qualified for and that looks like what you are doing.  Are you buying properties near their retail value?  That's also a high risk way of investing.  I understand the need for accepting risk as an investor, but you can reduce it significantly when you follow the right strategies.

Do you have written agreements with all of these friends?  If you want to be in this business, you have to treat it like a business.  Without written leases, you have no proof of the income, unless it was on last year's tax return?

I do recommend you invest in real estate, but you have to learn the ways of buying undervalued properties.  Homepath.com comes to mind for someone in your situation.  There are houses on there in the full spectrum of price ranges from the teens to over 5-600k.  You are looking to buy an owner occupied residence and you can buy a distressed property (bank repo, not necessarily a fixer upper) which is usually a fair amount below retail value ahead of investors with very attractive financing terms.

Justin Moon · Answer

Michael,

As much as I would like to make it happen, I am looking for advise from some well experiences investors on whether I should or not. My biggest fears are either (1) I won't qualify for a second loan or (2) I am over-leveraging. In order to fund the down payment, I would have to sell some stocks and/or hard metals.

Realistically, I am looking at another house in the 220-240 range.

Michael Lemieux · Answer

I wish I had more real experience to share with you, but here are three thoughts on the topic.

1. I wish I hard started at your age!

2. If you can make it happen, do it.

3. Don't assume NOTHING will go wrong, it WILL.

I hope you can make it happen.