Sell Primary Home, Invest the Equity and Become a Renter?

Question

Hello everyone, I wasn’t sure which forum topic would be best for this topic, so I picked this general topics forum.

I would like to get your feedback on my plan for freeing up funds to invest in Real Estate.  My wife and I live in a home that we plan to sell in the next year which should provide us with $200K of funds to invest (that is conservative, hoping for closer to $250K).  We would like to purchase multifamily units and use the cash flow to pay for our rent (ultimately, we would like to save and buy another home and have the multifamily units pay for the mortgage).

Basically, we would be selling our home and becoming renters again in order to hopefully have an investment that will pay for some or most of the rent expense. I do have some R/E investment experience, but not a lot.  We have owned a couple 4-plexes in Boise, ID for the past 10 years, though I am not actively participating in the management (we have property managers as we live in CA).  So what do you think?  Is this a good idea financially?

The second part of my question is more short term. Since we are planning to sell our home next year, should I refinance my 30 year fixed mortgage to a 3 year arm in order to save about $600 per month on my mortgage payment until we sell? Again, do you think this is a good idea? My concern is that if we don’t end up selling the home and rates go up by the time the ARM resets in 3 years.

Thanks everyone for your advice.

Matt Kvalheim · Answer

Thanks for the advice @John Malahay and @Walt Payne

Walt Payne · Answer

@Matt Kvalheim Selling then renting might not be a bad idea if it frees up equity and/or monthly cash income. But I would stay away from an ARM. Between closing costs and the risk of interest rates climbing it would not be likely to pay off.

John Malahay · Answer

@Matt Kvalheim - Areas for MFR/Apartments like Bakersfield.  If you wouldn't have to leave your Tustin home but acquire a 4-plex or below in that area.  Since the rent comparison to that area in almost just as similar to the LA metro, but the purchase price is much more lower than the big cities in So. Cal.  Unless you're really at the pulse of a particular area that's out of state, wouldn't you feel more comfortable if it's someplace close where you can just drive to for an hour or two?

Matt Kvalheim · Answer

Thank you all for taking the time to advise me!  @Brandon Turner @Doug S.

@Albert Bui . Thank you especially for pointing out the tax ramifications - I wasn't aware of how the standard deduction worked along with mortgage interest.  Last year, I had about $21K in mortgage interest and another $8K in property taxes.  That is definitely something to take into account!

Here is some more information on my home and what I have modeled out in terms of investment property.

The monthly PITI on my house is $3700.  It is worth about $850K and I have a 30 yr fixed loan for $550K.  The rent for a similar home in the area is about $3200.  The issue I have is the location (Orange County CA) and the price I initially paid for my house.  I can't rent it out to cover my PITI (plus I'd have to cover maintenance, vacancy, etc. on top of that).  If I could rent it for cash flow, I definitely would! However, we play to sell within the year and either buy another primary residence that better fits our needs or buy an investment property and use the cash flow to pay for our rent - that's the choice we've given ourselves.

So, if we did go the investment route, I was thinking that I would invest out of state where the cap rates are much higher and gain enough cash flow to live almost rent free (I think I would need a cap rate of about 10% on a $700K or $800K property).  We currently own 2 4plexes in Boise, but that market is very difficult for us out of staters to purchase anything good right now - at least, my contacts there haven't been able to identify the kind of investment I would be looking for.  So I need to find a different city to look in (any suggestions?).

This is what I modeled out (below).

Downpayment

25%

# of Units

15

Lease Amount

562,500

Purchase

750,000

Annual Interest Rate

4.75%

Downpayment

187,500

Period

360

Rent/Unit

700

Monthly Payments

$2,934

Rent

10,500

Vacancy @10%

(1,050)

Mgmt @10%

(1,050)

Repairs/Reserve @8%

(840)

Utilities

(300)

P&I

(2,934)

Insurance

(83)

Property Tax @2.5%

(1,250)

Net Monthly

2,992

2% Rule

1.4%

Cash Flow

199

50% Rule

154

Total Investment

187,500

ROI

24%

Monthly Cash

2,992

Cap Rate

9.5%

I think a seasoned investor could probably do a lot better, but I  want to realistic about what I might be able to find in the market.  What  do you think of my numbers?  What have I missed and do you think if I  were to buy an investment that worked out like this, would it be a good  idea to go for it instead of buying another primary residence?  Any suggestions for cities/locations where I might be able to find a somewhat hands off investment like this (I would have to hire a manager because I would still live in CA)?

Thanks again for looking at this post!  I understand if you don't have time to look at this as closely as I have (we're all busy), but any suggestions would be appreciated!

Doug S. · Answer

Hi Matt,

If I were you I would definitely do some number crunching to help make a decision.

Find out how much multifamily units cost in your area, how much you need for a down payment, and what the expected rent is.  Speak with realtors in your area and do research on your own.

The problem with selling real estate is that you are taxed (if you own as owner occupied less than 1 year) and pay the approximately 6% in realtor/listing agent commissions.  Have you considered renting out the house you are living in or a portion of it?   Maybe it is possible to rent out your current house for a lot more than your PITI (mortgage + taxes + insurance) so you have enough left over to pay rent for any other place you choose to live.  If you can do this, then it is essentially the same scenario as selling your home and buying a multifamily unit.  You live rent free and own a property, but you're better off keeping the single family home as they tend to appreciate more in value.

Also, not sure if this is what you want to do, but look into getting a home equity line of credit (HELOC) on your primary residence and then doing some remodeling work or building an addition to your home.  The numbers may work out well for selling or even renting a portion of your house.  If you open a HELOC and use those funds for home improvement, then when you sell you'll have to repay the loan in full, which works to your advantage.

Keep in mind that HELOCs affect your credit score.  Even if you aren't borrowing on the line of credit, it may affect your ability to secure a loan for buying real estate.

Hope this helped...

Doug

Albert Bui · Answer

It sounds like you've partly answered your question on the ARM refinance part after stating one of the con's of doing the refinance but it all boils down to your risk / reward tolerance. If you want the reward of 3/1 ARM refinance to save your 600 cash flow per month and you're okay with the maximum reset at the end of 3 years and you've planned your plan A, B, C exit strategies then you'll have clarity for 99% of possibilities that come up.

It may be good to sell your primary if your current primary is not providing you much interest over your standard deduction. If you were married its around 12,200 annually or around 6,100 in 2013. Its important to note that you only get to deduct the higher of either standard deduction or your itemized deductions(home interest & other) so if you sell you'll still get the 12,200 married or 6100 single deduction so you'd only lose the difference between your standard deduction and interest on your primary.

Example: So how you can see it is if by living in your primary residence you only get 18,000 total itemized deduction then by selling and leaving you'd only lose 5,800 deductions tax wise but like Brandon mentioned you give up appreciation as well.

If this is offset by the apprec/amort/cashflow/tax benefits of the new property you're going to invest in then sure you could consider that but its all about your risk tolerance and preferences on investing.

Brandon Turner · Answer

Hey @Matt Kvalheim welcome to the site! Sorry this post took a while to get a response - it got lost in the quick moving feed!

I don't think its a big deal to go back to renting - though you do miss out on the appreciation play of owning a nice house in California and the cheap financing you could get. But I don't think that its that big of an issue.

As for refinancing...  probably not a bad idea, but refinancing can cost $5000 or more (depending on lender, of course) so you'd want to weigh those options. Refinances are a pain in the butt (i'm doing 2 right now) so if its not a big enough trade off, I wouldn't do it.

Thoughts?