Is this overleveraging?

Question

I currently own two rental properties.  I live in a rural area and my wife and I make about 55,000-60,000 a year.  We live modestly as she stays home part-time with our kids.

Anyways, one of our properties cash flows well (it meets the 50/2 rule).  The other property hardly cash flows but there's only 7 years left on the mortgage and the property is almost fully updated within the last two years.  At this point I am able to pay for repairs for both properties if I had to dip into my personal savings, etc.  I have very little consumer debt to speak of (although I have a car about to die and needs replaced).  That's the background information you need to know.

A coworker offered to sell me her duplex on owner-financing at a VERY LOW 5% downpayment and no closing costs.  Great deal for me.  The property is worth 65,000 and it rents for 1000 (500 each side).  On a 20 year payback (at 6% interest) the PITI would be approximately 600/month.   With increased rent it would be close to the 50/2 rule, assuming I could increase the rent payments to 600/month which is feasible for our area.

I cannot pay for this property with my personal income if something happened.  That's the risk if I do this.   So please give me your opinion on leverage.  Is this opportunity over-leveraging?

Steve Babiak · Answer

If you can't get a HELOC, do you have any credit cards that have a decently high limit?  That is one way to tide you over when reserves are a bit light.

The numbers on this opportunity sound pretty good, as long as no significant repairs are needed.  If they are needed now, or very soon (like how much longer will the roof and heating system last), then you will need the funds to pay to get that work done.  Just something to consider.

What sort of vacancy rate is common for that area?  What's the employment (or unemployment) picture like?  Population there growing or shrinking?

Jon Klaus · Answer

Bryan, did you end up buying the duplex?  How did it work out?

Bryan P. · Answer

Thank you all for your responses.

My current residence appraised for 93,000 and I owe 73,000 on it, so I'm imagining that I could get a HELOC at 90%, which would leave me about 10K.  I could also get 70% HELOC on the cash-flowing rental property, which would leave me about 7K.  So that's somewhat of a buffer zone, I guess.

I had a friend who runs a very successful business (very business saavy, but not really into real estate) preach to me that if you overleverage and don't own things outright, you'll eventually get burned.  I argued that if the numbers make sense and the cash flow covers expenses/vacancies/etc (via the 50/2 rule) then how is it any riskier than any other investment?  In my head that's how it's working.

Kevin Yoo · Answer

Bryan,

Better yet, use OPM. You will be over leveraged if you get a LOC because you will still be cash poor. I for one would do this deal with you and provide the cash needed in exchange for equity partnership if the numbers make sense. And on initial inspection, sounds like a good deal.

I recommend you put the numbers together and pitch this deal in Marketplace where BP investors can look at it and partner up with you.

Ali Boone · Answer

Can the property you own now that cash flows well cover the payment on this one should something happen? You're also talking about a duplex, so the odds of both sides flopping at once is less than if it were only a single-family.

The numbers are close, but my recommendation would be to go for it because the opportunity to get that seller-financing and with those terms is insane! I wish I could find that for myself! I'd hate for you to lose that. My recommendation would be to save a few months' reserve from the cash-flowing property and from this one when it is rented, so you have a nest egg to go off of in case of emergency.

Unless this is in a high-vacancy area, then it may be too risky. But if it should rent easily, you could be fine, just have to be strategic about it.

If not, pass it on to me, I'll take that seller-financing deal :)

Scott W. · Answer

Get a LOC on your house that's almost paid off. If you run into an emergency, tap into it. Meanwhile sock away all of the extra cash flow from this property into your reserves. That's 40% gross margin. That's good. Make sure you find out how much it's going to cost to rehab it, if any. If they're selling you the property, chances are they're in financial straights & have not maintained the property.

Ward Conville · Answer

Can you get a credit line against your personal residence or one of your other properites so you have access to cash in an emergency?  If not, I think the numbers are too close.

Is this overleveraging?

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