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Updated about 7 years ago, 09/15/2017
Acquiring a Buy and Hold
Hey BP community.
I am trying to obtain a buy and hold multi-family unit in Philadelphia. This is my plan; I plan to receive a gift from my parent which I hope to use as a down payment for the property. Assuming all rents are substantial they should be able to cover my debt service and any other expenses needed (repairs, water, vacancy, cap Ex, etc.)
Now after the seasoning period of 6 months to a year I plan to refinance and cash out to repay my parents and hopefully make a profit assuming the appraisal value is higher than my purchase price of the property.
How does that sound? I feel like it works in my head; but has anyone ever actually done this and was your overall experience? Any drawbacks or things I should look out for?
I know nothing about that market...that said...
What type of loan are you using to buy it? You'll need 3.5% down if it's an owner-occupied FHA loan. Or 20-25% down if it's a conventional or commercial loan. In either case, I doubt that market appreciation alone will allow you to refi out that amount. You'll need to find a value-add deal.
Sounds to me like you'd be better reading up on BRRRR investing and focus on that.
@Vincent Ngo Try to look for a property that has some value add potential. This will increase the likelihood that your reappraisal will be higher than the purchase price. Are there areas where you could cut your expenses or raise your income? Or are there areas where you can improve the house in general, such as hardwood under nasty old carpets that you can refinish. Can you turn a large 1 unit with say $1000 in monthly rent into 2 smaller units with $750 in monthly rent? If you just buy a turn key building chances are it will appraise for around the same value you paid for it, unless you are in a fast appreciating area. Or you can try and find an absolutely killer deal that will just appraise a good amount higher than you paid for it. These are the deals everyone wants, so it could get competitive
So this will be most likely be a conventional loan for an investment property; which I am hearing a 20% down payment required.
I actually bought my primary residence about 2 years ago; using conventional financing. Is FHA ONLY for first-time home buyers? This is my understanding. But regardless still an investment property.
Originally posted by @Brandon Hicks:
I know nothing about that market...that said...
What type of loan are you using to buy it? You'll need 3.5% down if it's an owner-occupied FHA loan. Or 20-25% down if it's a conventional or commercial loan. In either case, I doubt that market appreciation alone will allow you to refi out that amount. You'll need to find a value-add deal.
Sounds to me like you'd be better reading up on BRRRR investing and focus on that.
So this will be most likely be a conventional loan for an investment property; which I am hearing a 20% down payment required.
I actually bought my primary residence about 2 years ago; using conventional financing. Is FHA ONLY for first-time home buyers? This is my understanding. But regardless still an investment property.
@Vincent Ngo I think your plan sounds great, although there are a few things to watch out for. On a first deal it is very common to overpay for a property because of lack of experience in running the numbers. In order for your scenario to work, you need to purchase a property at a cost low enough that after you rehab the property you will be all in at less than 75% of the ARV (I say less than 75% because you also need to factor in the closing costs for the first loan and the refinance). New investors often get into trouble on their first deal because they under estimate the rehab costs for the property. Here is an example with simple numbers.
Estimated numbers
Purchase price 60k
Rehab estimate 10k
Closing costs for both loans 4k
ARV 100k
Total in 74k (74%). This scenario works.
Actual numbers
Purchase price 60k (plus closing costs 2k)
Rehab actual 20k
Closing costs for both loans 4.5k
Holding costs 1.5k
ARV 100k
Total in 88k (88%). You now have to keep 13k into the property and can only take out 12k on a 75% loan which is more common for loans on investment properties.
Then there are the costs associated with renting including vacancy, capital expenses, turn over, maintenance, property management, etc.
With a rental, it is very important to know what the market rents are so that you can know if you can cash flow. With this same property and an estimated rent at $1000 a month here are the numbers:
Mortgage $485 (75k at 4.75 for 20 year amortization)
Taxes $100 (This is a guess because I have no idea what they would be in your properties area)
Insurance $50 (This is also a guess but I am basing it off of my own rentals)
Property management at 10% $100 (This depends on if you will be managing it yourself or not)
Capital expenses savings for repairs 10% $100
Vacancy 10% $100
Monthly cash flow = $65 (6% APR rate of return on your 13k left in the property).
Now there are several variables in this example. You may not need to budget for as much capital expenses if you don't plan on holding it for very long and if you replaced some of the major mechanicals in the rehab. Also, your taxes and insurance may be higher or lower and you may be able to find a renter that always pays on time and never wants to leave so your vacancy is lower. Another thing that may happen is your bank may only give you a 5 year fixed rate that then adjusts after the first 5 years. Also, you may decide to manage the property yourself so that you can keep the property management fee.
All in all, I think it is a great idea to purchase a rental, even if it doesn't work out as expected as long as your willing to learn correctly from the experience. A couple of things to keep in mind on your first rental property would be:
1. Have a trusted contractor give you a solid bid and have them check the major mechanicals before you close.
2. Factor in holding costs and closing costs correctly.
3. Factor in Property management costs. A good property manager can make your life easy, a bad one will lose you money on your property.
4. Save for vacancy and maintenance.
Good luck to you.
@Vincent Ngo - You do not have to be a first-time homebuyer to take advantage of an FHA loan. It will have to be your primary residence, however.
If you can season it for one year, you can do a cash out refi based upon the appraised value rather than the purchase price. Prior to that, you may be able to get a loan based upon the appraised value, but it will typically be at a lower LTV which will basically put you in the same position as if it were based upon purchase price.
Be sure your numbers are calculated well, and base the anticipated value off of performance CAP rate, and you should be fine.
I'm surprised nobody has expressed concern over the source of down payment.
Apart from the concerns regarding building enough value to cash out refinance, the OP intends to use the cash to repay his parents, for the "gift" they gave him for the down payment.
If the gift is truly that, it shouldn't need to be repaid. If it is a loan, and you claim it as a gift on the mortgage application, it is fraud and very slippery slope.
Tread carefully.
Originally posted by @Alex Fortsch:
I'm surprised nobody has expressed concern over the source of down payment.
Apart from the concerns regarding building enough value to cash out refinance, the OP intends to use the cash to repay his parents, for the "gift" they gave him for the down payment.
If the gift is truly that, it shouldn't need to be repaid. If it is a loan, and you claim it as a gift on the mortgage application, it is fraud and very slippery slope.
Tread carefully.
This is a good point to bring up. My first home down payment included a gift from my family. The bank required a signed document from my family stating that the money was in fact a gift and I was under no obligation to repay it. If you're talking about a 20-25% down payment amount you're probably beyond the gift limit for tax purposes as well.
@Alex Fortsch yeah you're right- I would probably just keep it as a straight gift and leave it at that.
@Clayton Barnes what the typical gift limit? but you are just referring to the limit as per tax purposes right? but otherwise there is no limit?
There are much more intelligent CPA's on BP to confirm, but my memory is $14,000/year without any gift tax liabilities.
CPA's: Can he get creative here without crossing any lines? Is it $14/K per parent? Maybe have them gift you $14K on Dec. 31, 2017 and another gift of $14k on Jan. 1, 2018?
I'm fairly new to to posting on here, could someone tag any tax experts?
Originally posted by @Vincent Ngo:
@Alex Fortsch yeah you're right- I would probably just keep it as a straight gift and leave it at that.
@Clayton Barnes what the typical gift limit? but you are just referring to the limit as per tax purposes right? but otherwise there is no limit?
I believe it has been $14,000 for a handful of years now for tax purposes. I believe after that it is taxable. There isn't a limit to a gift amount as far as I know, but Uncle Sam wants his piece after a certain point. Sadly, I'm not in the business of gifting people tens of thousands of dollars,so I've never studied the specifics. You should consult a qualified tax adviser as I'm sure local taxes could add their own wrinkles.
There may be some sort of a partnership or other legal agreement that would make your family able to provide a down payment, satisfy the bank, not require fraud, and not run afoul of the tax man. I'm definitely not qualified to give any sort of advice relating to that, but it might be an idea you can pursue.
Another issue with respect to the source of the down payment is that while you can use gifted funds to purchase a primary residence with a conventional loan, you cannot use gifted funds as the down payment on an investment property with a conventional loan, to the best of my knowledge. One way around that is to combine the gifted funds with other cash (loan from parents or friends, HELOC, etc.), buy the property with no lien on it, and then immediately finance it without a seasoning period.