Better to invest in a growing smaller city or suburb of big city?

[Jack Plantin]

First-time investor/home-buyer looking at buying a multi-family property (duplex preferred) either around Chicago where I currently live or a smaller, but rapidly growing city in Minnesota where I'm from.

If I choose to buy a duplex in the Chicago suburbs, my wife and I would be living in it and renting out the other unit. On the other hand, if I buy a property in Minnesota, I would be renting out all 2-3-4 units and visiting periodically to make renovations or hire someone to manage the property.

I heard somewhere that if you don't live in the property you're renting out, then you have to pay additional taxes on it? What is this called? Also Illinois property taxes are twice as much as Minnesota's (2.3% vs. 1.1%), would not living in our rental property be equivalent to paying extra in Illinois taxes?

Our credit scores are both 700+ and we plan to save up the 20% down payment + closing costs before buying, possibly even borrowing money from friends with an agreement (probably a bad idea, but our friends are the ones interested in our investments).

Our goals are to break-even by renting out the other unit in Chicago or making small cash flow by renting out all units in Minnesota, eventually using cash flow for renovations or another property.

My questions are:

1. Which city is the better choice to buy a property in? We live 5 hours away from my hometown and don't mind driving occasionally to manage.

2. Which 1st-time home buyer programs should we take advantage of? Not looking to put only 3.5% down, but wouldn't mind tax benefits or a lower interest rate.

3. How much should we budget for vacancies, maintenance, and renovations?

4. Is it ever okay to borrow money from friends with a loan agreement?

Thanks for checking out my post, any advice for or against my plans is welcome!

[Tim Swierczek]

@Jack Plantin the math almost always favors the smaller downpayment and buying sooner rather than later.  Of course, there are exceptions like when there is a value crash but this is not typical and while everyone thinks values will decrease in the next recession history does not support this popular belief.  

Here's the quick version of how this works.  If it takes 1 year to save 10K after taxes toward buying your first property and you were to buy a 300K property it would like something like this (simple math)

Year 1 

• *Buy now, down payment 10.5K you own 300K property and FHA MI would be $204.17/month.
• *Wait to buy, you have 10.5K at the beginning of year one

End of year 1 after 12 months

• *Buy now value worth 309K with 3% appreciation (the 40-year average)
• *Wait to buy, you have 20.5K but lost 9K to appreciation and received no cash flow, tax deduction, or amortization $5300.97 in a year on a 30-year FHA mortgage (tenant paying your rent).

End of Year 2

• *Buy now value worth 318.27K with 3% appreciation (the 40-year average)
• *Wait to buy, you have 30.5K but lost 18.27K to appreciation and received no cash flow, tax deduction, or amortization $10,811.06 cumulative on a 30-year FHA mortgage (tenant paying your rent).

• 
  End of Year 3
  
  *buy now value worth 327.81K with 3% appreciation (the 40-year average)

• *Wait to buy, you have 40.5K but lost 27.81K to appreciation and received no cash flow, tax deduction, or amortization $16,538.48 cumulative on a 30-year FHA mortgage (tenant paying your rent).

• 
  End of Year 4
  
  *buy now value worth 337.64K with 3% appreciation (the 40-year average)

• *Wait to buy, you have 50.5K but lost 37.64K to appreciation and received no cash flow, tax deduction, or amortization $22,491.84 cumulative on a 30-year FHA mortgage (tenant paying your rent).

• End of Year 5
  
  *buy now value worth 347.76K with 3% appreciation (the 40-year average)

• *Wait to buy, you have 60.5K but lost 47.76K to appreciation and received no cash flow, tax deduction, or amortization $28,680.01 cumulative on a 30-year FHA mortgage (tenant paying your rent).

*Buy now -your profit on the sale would be $76,440.01 minus Real Estate sale fees. Of course, you also get your original $10.5K back, 5 years of cash flow and 5 years of depreciation on your taxes.

If you are in a stable financial condition it rarely makes sense to save large amounts of money before you purchase. In fact, even if you do have the money now, you should buy 1 with 3.5% FHA as an owner-occupied loan and use the remainder to purchase a non-owner occupied property. @Jordan Moorhead