Prove my system wrong!

[Bryan Young]

Looking to have some negatives with my buying, holding System brought up that I might have missed. I am currently buying single family homes in metro Detroit for under $50,000 in good but low income areas. I am staying under $50,000 because I can buy these homes on land contract and have them paid off within 7 years. I won't pay more then 10% down and I also won't buy a house that needs any work. My theory is that my renters will pay off my notes and in less then 7 years I'll own these free and clear. I don't make much cash flow while under contract but I'm also not negative on any. Other the obvious negatives of what if somebody doesn't pay, or repair cost what negatives can you see in my system. So far I have 3 houses under my belt looking to add 5 a year. Thanks

[Andrew Johnson]

@Bryan Young I don't do what you do but I'll throw out some ideas around your plan:

1.) Buy-and-hold folks like me that do have cash-flowing properties are able to use that cash-flow to pay for unexpectedly high repairs, cap-ex items, etc. and not "come out of pocket".  If you're breaking even the inevitable cap-ex items that come up (over 7 years) will be completely out-of-pocket for you.  There's nothing materially wrong with that (if it's in your budget) but it's different than purposefully buy-and-holding properties that "self-support".  

2.) Inevitably you will also stumble into a "bad tenant" that you have to evict, damages the property, etc.  You may get lucky for a couple of years but if you have enough units it's going to happen at some point.  No matter how hard you screen tenants it will happen and I'd posit it will happen more often in $28K home neighborhoods.  Instead of that "$5K turnover costs" just hurting your cash-flow it's actually going to be an out-of-pocket expense for you.  So again, it's harder to get the properties to self-support during that first 7 year period.

3.) Economic hiccups do happen and if you're in break-even properties then having to reduce rents from $700/month to $650/month can hurt.  It might take away "pizza money" if it happens with one unit but if you scale with your strategy and end up with 15 properties over the next couple of years it's a $750 per month out-of-pocket expense.  That's okay if you have contingency funds but no-so-great if you don't.  Again, just something to plan around.

4.) Taxes are going to kill you at the end of 7 years.  You'll have rent coming in but I can't imagine there's much depreciable when it comes to a $28K purchase-price property.  Outside of a portfolio loan you won't get a conventional mortgage for the properties so you won't be able to deduct mortgage interest.  Bottom line: you'll be paying a lot when it comes to that marginal income.  Depending on your financial situation that could either sting a little or hurt a lot!

I think the net result comes back to your original assertion of taking out "what if somebody doesn't pay, or repair cost".  When I (and I'd posit many others) buy properties for yield we stress-test the properties.  What if vacancy is 10% instead of 5%?  What if repairs are 50% more than what I budget?  What if I have to lower the rent?  What if ALL of that happens at once?!?!??!  Will I still be able to pay the mortgage?  Will I still cash-flow?  Would I have to sell in a panic?