Thinking of buying first house...please help!

[Benjamin K.]

Hi everyone...this is my first post on this website. I'm 20 years old, totally unfamiliar with the world of real estate but eager to learn how it works. Right now I have about 20k and I'm making about 1800 a month. I'm looking to potentially buy a house with my best friend, a very savvy, enterprising kid who's 22. He just finished college. He took some class on real estate and got a license. He also studied economics, and he's extremely good with people and negotiation. I'm certain he'll find some way to get rich. He's also trustworthy and generous; we've know each other forever. Anyways, he's scrapped up about 150k in investment money, split between 50 of his and 100 of friends and family friends. We've been looking around at houses to potentially buy, fix up, live in, and sell (we're not sure for how long we'd live there or when we'd sell it, just whenever the time is right.) We found a 3 bedroom one bath for 500k. I contacted some agent, and he said there's a septic problem which he estimates will cost 37k to fix. I feel like this is probably sort of a low ball estimation. Anyways, the house looks pretty ideal from the pictures I saw, and at a phenomenal price, when compared to similar houses in a similar location. Most of the similarly-sized houses in that area are going for around 700k. The location is great; it's about 10 mins away from college campus and downtown. It's right next to a creek and a big park, and close to an elementary school. The school system in my city is great. It's an extremely expensive place to live because it's a desirable place to live. Housing prices in my city are outrageously high, which, as my father explained, is good and bad, as the housing market could continue to soar or it could crash...anyways, there's an overflow of students looking for housing, which the University can't handle. Thus there should be a reliable influx of students eager to rent out our house, should we decide to rent it out or move, in the future. In the meantime, we would be living there with a couple other friends (whose money makes up the 170k down payment we would have). 

So...it looks like a potentially very lucrative and worthwhile investment. Mortgage would cost around 2300 a month. We could easily come up with that. I would be paying a lot of the mortgage because I'm actually making the most per month, and eager to invest it in something lucrative. The other kids would contribute, and we would rent out rooms whenever someone has to leave for a while, and the long term plan is to rent it out/live on it for a few years or whenever is a good time to sell it, and then sell. I read online that a "fixer-upper" house is one of the best ways to make money in real estate. We would fix the septic system, and maybe install a new bathroom. It's worth noting that the house sits on a 10, 000 sq foot lot, so there's plenty of room to garden or potentially build more rooms for students, even a whole separate outhouse type thing, to rent out...

My questions to the community: why is the house going for so low? What's the catch? It was built in the 1930s... What should I watch out for? And what kind of stuff could go wrong? My dad, who is conservative in every aspect of his life, thinks I should invest iver the long term in mutual funds, but this is way more sexy and exciting, and I'd get to do it with my friends. He thinks of there is such a great deal, some experienced contractor would have pounced on it already. Also, do you guys have any other suggestions for how I could invest money? Any advice would be greatly appreciated. Thanks a lot.

[Kevin Siedlecki]

@Benjamin K. - I'll preface this by saying that what follows comes from a place of concern. I don't mean to be a negative Nancy, but to give you a reality check and reign in your excitement with some further thinking about this deal. I obviously believe strongly in the power of real estate investing, but this is not the deal to start with. Hopefully you can learn from my explanation of my concerns.

First, and possibly most importantly, one thing does not add up for me.... how are you going to pay "most" of the $2300 mortgage when your income is $1800/month? Have you talked to a bank about getting the loan? With no landlord history and your $1800 being the highest income involved, I'll be very surprised if anyone gives you a loan.  A bank is also going to need to see cash for the downpayment and reserves in your name, and the money can't be coming in from other people. It will need to be in your accounts for 6 months before it is considered seasoned. Hopefully I've missed something and you've got that part figured out! Or maybe I should hope you haven't got that figured out, because then you won't trap yourself in this potential disaster of a deal. 

Honestly, reading the whole post, I think you might need to do a little more research before you jump into something with this much money - especially other people's money. I see three reasons you are going ahead with it. 1) You read on the internet that buying a fixer-upper is good. 2) Real estate investing is "sexy," and 3) The house is worth a little more than it's asking price. Tap the breaks. Those are terrible reasons to invest in this house.

The septic problem is definitely a good enough "catch" to explain the low price, but you don't mention any long-term exit strategies. What is your long-term goal here? If you live in it for a year and are able to sell it for $700k (which is something of speculation for such a short term, but any longer and this ceases to be an investment), after you price in paying a realtor, fixing the septic, and paying the mortgage, your profit is less than $100,000. If you stay in it for 3 years, like you say, you have even less profit, unless it appreciates significantly in that time. Three years is not long enough to count on any appreciation, especially in this market, where people expect a downturn pretty soon. I don't know your area, but quick math tells me you're going to need a solid $3,500-4,000/month in income to make any long-term money on the place. 

So with that in mind: what are the agreements with all of the money you raised? How much and when are your family and friends planning to get paid? How are you going to pay them when you're living there? What does the house rent for if you move out? 

In the long run, I think it's likely that this deal ends very badly. You could lose money, friends, your credit, and your faith in real estate investing. After writing this, I think I'm rooting for the bank to tell you "no." Unless you have a lot more understanding of the deal that you just didn't post, I think you need to do a lot more learning, go back to the drawing board, and find a better deal. 

Sorry if I sounded a little too negative! I just want to see people start right.