Should I purchase this duplex and live in half?

[John Stoller]

I currently live in a duplex which is now for sale. I am interested in buying it, but I cannot make up my mind. Any advice would be appreciated. Pertinent information is below:

The Property:

The duplex is listed at $400,000. Each side of the duplex is 600 sq feet. My rent is currently $1000. Rents in the area are comparable, but mostly higher. Experts in the area (Sacramento, CA) believe rental prices are going up. If Oakland is considered comparable, then I can see their point. I have my doubts due to an absent private sector.

The Neighborhood:

It is in one of the more desirable neighborhoods in Sacramento, California - specifically, Land Park. Similar homes just a few blocks away sell for 400k +, larger homes sell for 600+. At a square foot analysis, this does averagely. As a duplex, it is one of the cheapest I've seen.

Financing:

I've been preapproved for a loan at 3.75% with $0 in closing costs due to lender rebates. The rebate will even pay for a home warranty. It is an FHA loan with 3.5% down (a hair under 14k).

Monthly breakdown: PITI = $2552.78 [P&I = $1809; Hazard Ins. = $59; Mort. Ins. = $270; Taxes = 414.58]

Yearly breakdown: PITI = $30634 [P&I = $21708; Haz. Ins. = 708; Mort. Ins. = $3240; Taxes = 4974.96]

My broker estimates that tax benefits reduce the payments to $2137. 

Me:

I am 29 years old with no real estate holdings and no dependents. I make over $100k.

MY ANALYSIS SO FAR:

The way I see it, I am purchasing two homes for 200k each--one an investment property, the other a residence.

For the investment portion, I think it is a poor investment--at least short term. For one, it does not survive the various rules advocated on this: 

• One percent rule: There is no foreseeable way this place rents for $2000.
• Fifty percent rule: My cost for this property is at least $1050. I don't think it can rent for $1,500.
• Cash flow: I think it can realistically rent for $1200. (Area rental surveys range from 800 - 1700 for comparable units). Dividing insurance and taxes indicated above in half and then accounting for a bare-bones $100 in monthly maintenance Year 1 has a negative cash flow of $1884. Assuming a 4% rental increase even Year 5 has a negative cash flow; $391.

Now, if we consider tax deductions, then I see gains quicker. I expect to deduct $7201 in interest, $6512 in depreciation, $5616 in insurance and tax. Subtract $14400 from those figures and I expect a $4929 tax deduction from this unit. So my post-tax cash flow is negative $357. Assuming 4% rental increases again and I hit a positive cash flow in Year 3 (wait for it... $73).

That said, with appreciation and principal payments, I am increasing my net worth.

As for the residence portion, I think it is a decent investment. Effectively, my rent wouldn't change, but I now get tax deductions and increase my net worth through principal payments. So here, I deduct $7201 in interest and $5616 in insurance and tax. I estimate these tax savings to be $2677.

BOTTOM LINE?

So, am I right that the bottom line is that post-tax between the two properties I am looking at a net of about $2300 a year by Y-5?

Do you folks think this a good decision for me? I think my primary motivator is FOMO. Local experts expect the Sacramento area to continue rapid appreciation for the next two years and then level off. But who knows? The job market is slightly above national average in terms of growth; however, I doubt sustained growth. The recession hit the government sector hard, so this growth, in my mind, is merely restoring to the mean. We do not have an identifiable private sector outside of an Apple plant south of me (whose workers would unlikely rent my property due to distance). That said, the area has been trending up in both sales and rents. Please let me know your thoughts. 

[Account Closed]

Is this the great John Stoller from King Hall? If so, PM me!

Personally, I would not buy this place because the square footage is too small to cash flow for a loooong time. If you plan on living there for the next 5-7 years, it's not so bad, however you could do much better. If I were you, I'd look for a 4-plex, in a lesser area, that would eventually cash flow while still using your FHA loan. It will likely be more expensive up front, but you will be better positioned to catch later rent increases.

Also, the cost of utilities listed is too low. We are billed, as the property owners, $265/month for water/trash/sewer (all city provided services) for our duplex in 95822. I would recommend charging your tenant for their share because that's a tough pill to swallow.

Tax benefit - I wouldn't price those into your mortgage because a lot of the factors that determine your tax situation are still undefined and will be until the end of the calendar year. Deductions are not a dollar for dollar decrease in your tax liability, tax credits are. So, I would not price that aspect in unless you get your tax person to do it for you. This is not meant to be tax advice, but only my perspective.

Capex - even if certain items are new, it's been my experience that things you wouldn't think of still pop up, so you want to be prepared. Will you always be the gardener? Will you trim the trees that are on the property and fix the sprinklers? Etc. etc. Things always pop up and $100 is likely unrealistic.

Rent - I think you could easily get $1200/month for rent right now. Is this a 1/1 on both sides or something else? If you have a 2/1 you could rent a room in your place to increase your income. I've done that, and it was very easy. Also, you have to think about property management. Will you always manage the property? Since you make a lot, you likely work a lot. 

Bottom line: if you're looking for a deal or a good investment, this likely isn't it. But if you're looking for a smart way to live in a great area, why not? Not everyone is trying to be a real estate mogul.