Does buying this house in Los Angeles make sense?

Question

My wife and I are first time home buyers in Los Angeles.  We got married in July and we are looking to start a family in the next year.  We are currently in Studio City paying only $1,400/month rent for our 1br apt and need more space. We have 5% to put down and have been preapproved for $570,000.  We really do not want to spend more than $525,000 on a property, but the problem is that there is no Single Family homes in the area that we like in that price range, so we were considering renting.  The problem is that the rental market is not very forgiving either.  We were looking at rents of 2600 and up for our needs

We made an offer on a 2br 2.5ba town home for $325,000 5% down.  Including PMI, Taxes and home insurance, our monthly nut would be around $2,450.  The rents in the area are going for $2,500 and has been a good rental property for the sellers.  We made the offer so that we could get into the market and not "throw money away" on renting.  We only plan on staying here for at most 2 to 3 years.

Here are my questions:

Am I off base to think that this could be a great potential investment property that i could hold onto when we eventually move on to a nicer home?

Does this property cashflow well enough at $2,500/month that we should rent it out now and stay in our current apartment where we could save even more money for the next house?

Would holding onto this place when we move hurt us in applying for our next loan?

Is there any advice you could offer for a good 1 to 5 year plan?

I appreciate you taking the time to read this.  thanks

David Faulkner · Answer

The decision to buy a primary residence in LA is NOT one of short term cash flow ... instead it is a decision of:

• If you plan to live in LA for a long period of time, then buying your primary insulates you to a large degree from the rapid cost of living increases driven by rising rents. A fixed rate mortgage on a primary residence fixes a large portion of your living expenses, which would otherwise tend to go up fairly rapidly in this market over time.
• Capture future price appreciation. This can be in the form of forced appreciation, market appreciation, or both. This equity can be either left alone in the property or later tapped via sale or cash out refinance if you need or chose to.
• Tax shelter in the form of deductible mortgage interest.
• Personal preference to have a place to call your own, provide a more solid environment for your family, an asset you can leave to your children, etc.

And to those who say that LA does not cash flow well, I disagree ... LA cash flows phenomenally well in the long run with the rapid rate of rent increases mentioned above, much better in fact than most of the so called out of state cash flow markets especially when you factor in the edge you have self managing your investments locally from purchase through to sale. I speak from experience here as I've owned rental properties both locally in LA and out of state over the last 15 years. You just need to take the long view while making sure you can weather any storm in the short run.

One other comment on rent vs own cashflow is a portion of your mortgage in principal pay down, this portion increases with every payment, and is essentially you paying yourself and should therefore be considered accordingly. As for the interest portion, be sure to factor in the effective interest (after adjusting for your tax rate/deduction). And of course as mentioned you have maintenance and capex when owning that also should be factored in. And finally, and this is the big one that most miss, rent goes up every year (faster than inflation on long term average going back decades in LA) while a mortgage (the "P" and "I" portion of it anyhow) stays the same ("T" goes up slower thanks to Prop 13, and "I" goes approx with inflation). So, taking straight PITI payment vs rent is not necessarily the best comparison.

My advise is if you plan to stay in LA long term, then buy as soon as you can find a great deal on a place that you can reasonably afford.

Walter Roby jr · Answer

Have you thought about buying a multifamily and moving out after 1 year?

Ali Boone · Answer

Generally, here is my response to the thought of buying a primary residence or not...in this article specifically comparing it to buying investment properties instead of a primary residence...

https://www.biggerpockets.com/renewsblog/2014/01/1...

I would run 3 scenarios of numbers... two that you mentioned (staying or going or renting out, etc.), and also what if you took the money you could spend on that 5% down payment and buy a couple or more cash-flowing rental properties with it? How much would those bring in (would have to be out-of-state for cash flow), and how does that compare to what you'd be paying to continue renting, etc.

Hope that helps.

James You · Answer

@Matthew Newman I'm in a similar situation as you where I'm exploring to buy due to my family situation.  I'm currently renting in DTLA, and shopping in SFV area right now.

Your rent in studio city @ $1,400/month is ridiculously good.  I would stay there as long as I can until you grow your family.  Deals like that will be very hard to come by.  Not sure what type of property and the area you've found the $325k, but if it is Studio City, i would consider it a great find.

As far as buying this for investment property, the rent will only cover your mortgage.  You need to add other expenses like taxes, insurance, vacancy, maintainence, property management (unless you plan to manage your self), capital expensiture, which will accumulate to a big chunk out of your pocket each month.

It is very hard to buy and hold a property for cash flow in LA.  You can consider flipping the $325k house for short term capital gain if the numbers make sense.

James You · Answer

@Matthew Newman What city or zip code is this property in?  It's most likely that you won't be able to cash flow much, especially in LA.  Try searching the 1% rule on this forum, which will give you a better idea of investing in rental property.  Your buying decision should be based on your current family situation and possible future appreciation in LA.  I would look into schools, crime rate, infrastructure, and developments going on around that neighborhood.

As far as cashflow goes, I plan on investing out of state where the numbers make sense.  I look to cash flow around $200~$250 per door after all the expenses and mortage.

Matthew Newman · Answer

@Kee You thanks for the insight.  That's just it though.  We've hung on here for as long as we can.  Been here since 2010.  We're planning to start with the kids here in the next 12 months and this apartment just isn't conducive to having a family.

How much would you say a property needs to cashflow monthly in order for you to hold on to it?

Does buying this house in Los Angeles make sense?

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