Purchasing my first rental property - Should I create an entity?

Question

I am about to take the plunge and become a landlord.  I just wanted to run some numbers by and see if it sounds like a good deal and if I should create a corporation first for myself or some other legal entity and purchase the property under that.

House cost $104,000

20% down - $20,800

Monthly rent collected - $1300

Am I meeting the required numbers to make this work?

I would like to have about 5 homes rented out as my 3 year goal.  Would you suggest I pay this one off first? or should I fill it with a stable renter and then purchase another one and another one and so forth.  My only worry would be multiple evictions/broken leases/destroyed homes which would eat up my cash flow to pay the notes down.  I do have a cash stash to carry me a few months on the properties if someone didnt pay.

Robert Steele · Answer

@Rob Anderson Sure, sure, I get it. But just as underestimating your expenses can be detrimental so too can overestimating. You might walk away from a perfectly good deal because the cash flow appears too thin.

Which brings me to another point I'd like to make and that is; cash flow ain't the be all and end all of assessing whether a property is a good buy or not. I am probably going to get lambasted for saying that but I am not talking about banking on capital appreciation.

For instance, where in this equation is buying a new house versus an old house? A new house is not going to need as much capex as an old house. What about rent projections? A house in a tired old neighborhood may not see rents rise as much as a house in an up and coming area a few years down the road.

For example, I bought a near new house, REO, back in 2010 in a new development that was on the edge of town. They were still building houses in the neighborhood. Rent was $1300. A couple of years later and the city has expanded, there are new schools nearby, a new hospital down the road, new business popping up everywhere and affluent people moving into the area. The rent is now $1650. My expenses have largely remained unchanged. When I bought it the cash flow was maybe $100. Now it is $450.

I know a lot of people think buying a house that barely cash flows is nuts but I believe we have been wrongly conditioned to think cash flow is king. I think that is short sighted. If you have enough capital reserves and you don't need the cash flow today but do expect to need cash flow in the future for retirement than I think you should be focusing on the future cash flow and not so fixated with today.

Flame on!

Michael Seeker · Answer

@Robert Steele - I agree completely!

You can certainly do it and most likely get away with it.  But I personally wouldn't be able to justify lying and possible deception to get my rate from 4.75 to 4.25.  There are plenty of people that are doing it and getting away with it, but I was just pointing out that it's not technically legal :)

I almost always turn right on red at intersections with a "no right turn on red" sign as long as there are no cars coming.  I am risking getting pulled over and probably a $75-$100 ticket.  I have no idea what the penalty for lying about occupancy would be, so can't comment if it would be worth the risk or not.  I would just choose not to do it.

Robert Steele · Answer

You only have to have the intent to move in within 90 days.

Shit happens, plans change. I see other investors doing this all the time and I get pissed when I miss out on picking up a bargain because I play but the rules.

I doubt the lender is actively following up 3 months later on all their loans. Hell they've probably already sold them to someone else. Maybe they do a few random audits. I don't even know how they would find out if you are living their or not. Who knows. In any case isn't it the entity bringing the suit that has the burden on proof? They would have to prove you never intended to use it as your primary residence.

I have never ever ever heard of anyone getting busted doing this. Have you?

Michael Seeker · Answer

If you're going the route of conventional financing (30 year fixed rate loan) then it will be extremely difficult to make the purchase with an LLC instead of in your personal name.

If you're using a commercial loan (unlikely for your first investment property) then they will usually require you to have an entity set up and personally guarantee the loan.  So, to answer your question - I wouldn't even worry about setting up an LLC or anything just yet.  Wait til you get down the road a bit and start building a portfolio and decide if you want to then.  Don't let that be a roadblock to getting your first deal under your belt.

Purchase price and rent sound okay - I don't know the Austin market, but that's better than what I get in my area but I also focus on medium to high demand college rentals.  You can certainly find something better or something worse, but with those numbers it should work just fine.

As long as interest rates are low, I'd try to leverage and lock in rates long term.  Once rates start going back up into the high single digits or double digits, then you want to start saving up money to pay all cash (not paying down those low interest rate loans early).

Sounds like you're on the right track - best of luck with the purchase!

Robert Steele · Answer

@Jerry Jones that cash flow number looks good to me! You have plenty of padding for unexpected surprises. The insurance seems a little high. I wouldn't expect to pay anything over $100/month but rates may be higher in Austin than Dallas so who knows? Maybe something to shop around for some more.

I have never heard of paying a higher rate for mortgages under $200K. I have heard of higher rates for Jumbo loans over $350K. I have also heard of some not doing smaller loans like $70K,

Jerry Jones · Answer

Here are my numbers so far let me know if i'm missing something.

Principle + Interest = $420

Insurance = $137

HOA dues = $33

Taxes = $210

Rent collected = $1300

Cash Flow at this point = $500

Also the Mortgage broker told me that any mortgages under $200K have a higher interest rate. Anyone know if this is true?

Rob Anderson · Answer

No Flame. You bring up a few good points on new vs old and the lack of calculations on that part. But that is what separates a good investor from a computer program. Not everything that goes in to the purchase of a good investment property can be quantified. I agree with that. BUT BUT BUT. I am an investor. By definition that means expending money with the expectation of achieving profit. To purchase a property that doesn't make since financially now because you believe in the future it could is ludicrous. When there are so many deals out there that can see great cashflow now and STILL see that potential to grow in the future.

Rob Anderson · Answer

@Robert Steele   I'm sure @Kenneth Hynes typically does not have a 10% Vacancy. BUT!!! That is indeed the suggested rate to factor cost. The idea being if you can plug in worst case scenario and still make an 8-12%  you should be in a good investment.

Robert Steele · Answer

10% vacancy? So 1.2 months out of the year your property is sitting vacant? I think you must be doing something wrong.

My vacancy rate is ~2% actual over the past several years. I have a SFR that has had the same tenant in it for 3 years just go vacant this month. I started marketing it 4 weeks ago. I have someone moving in on the 15th. So that is a 0.5 months over 36 months or 1.3% vacancy rate right there.

Kenneth Hynes · Answer

Would consider CAPEX those big ticket items you would see every 5-10 years..

ie New furnance , new roof, HVAC ro water heater.   items that are beyond normal maintenace an repair in the 5-10K range.  You budget $100 or so a month for it so you have $5-6K available every 5 years or so

Purchasing my first rental property - Should I create an entity?

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