FHA Loan with high returns but no cash flow...???

Question

Background:

I live in a city in New Jersey with a high bar to entry that requires a sizable downpayment. Even though I could have the money to put down or find investors it would be much preferable to not have to use all my savings on one deal. I have looked in PA for smaller deals but it is a tougher market with less appreciation.

POLL:

What do you think about buying a 2-4 unit property locally with an FHA loan? The goal would be to live in it for a year and then rent it out. I expect the returns to be well over 20% on my money. THE CATCH is that there would be ZERO cash flow and my returns would come from principal paydown.

I would be analyzing the deal assuming regular maintenance, Capex, vacancy, etc. So technically it might cash flow more than the actual mortgage but the idea would really be to have an investment with great financial/economic returns but little short term cash returns.

Love to hear everyone’s thoughts!

Thanks!

John Warren · Answer

@Elliot Vann I am guessing the biggest risk no one is mentioning is the tax bill. What happens when that 8k bill goes to 12k? I know New Jersey is similar to the Chicago market, and this is something I talk about with clients all the time. I underwrite for future taxes as well as the current tax bill, and if you don't think taxes are going up in the #1 tax state in the US then you will be in trouble down the road! You need more margin for this to work well in the long run.

Joe Villeneuve · Answer

If the rent doesn't cover everything, then you're buying that mortgage paydown...and that's not good...it's a negative.  That becomes a cost to you...not a reward.  You're not gaining anything...you are in fact losing money every time you dip into your pocket and write that check.

Joe Splitrock · Answer

Mortgage pay down is not cash return. Your cash return is based on cash flow. When you go to sell the property, mortgage pay down + appreciation - sales expenses - taxes after depreciation recapture = your sales profit. You could then figure out your total return over life of the asset.

Gregory H. · Answer

Only if you think that you can get substantial long term capital gains in this particular market, thats the only way this makes sense. Obviously if you put near zero into a deal the returns are going to be high thanks to leverage, but high unexpected costs can wipe out years of profit in one fell swoop.

Joseph Scorese · Answer

@ElliotVann, have you considered going 2 family 5% down no mi product. Has all the benefits if FHA with seller assistance and gift monies allowed. Might be a better way to see cash flow sooner on a house hack.

Let me know if you have any questions

Regards

Joe Scorese

Mark F. · Answer

When you speak of negative cash flow, is that while you're living in it or after you move out?

Yes, it is possible to buy a 2-4 unit in that area with an FHA loan that cash flows. I assume by your post you are speaking in generalities and not about a specific house, correct?

John Warren · Answer

@Elliot Vann my wife is from that area of New Jersey, and where I work and invest in Chicago is very similar in terms of price points and capital requirements. You can invest successfully in New Jersey, but you will want to be patient. Do not accept negative cash flow as it truly just isn't worth it. You will HATE real estate if you do that. Spend your time networking to find other investors and agents who know the area and wait for a solid deal that makes sense.

Gregory H. · Answer

How low would this take your cash if you did the deal? What happens if you need some decent capex in the first couple years like new HVAC systems, new roof, etc. Would you be able to cover them with your personal cash without a struggle? How much vacancy/credit loss can you handle? With a single 2-4 unit investment, if one tenant stops paying, and NJ being the tenant-friendly state it is, what happens if it takes you 3-6 months to get the current tenant out, can you weather that?

Joe Villeneuve · Answer

You're not saying this property has negative cash flow, are you?

Elliot Vann · Answer

@John Warren

Lol, is it really possible to take away my love for real estate?! ;)

I totally hear what your saying. My really question though assumed there wouldn’t be negative cash flow just not positive.

Here is an example.

Rents $1,000 and $1,000

$24,000 annual income

-taxes $8,000

-capex, vacancy, repairs and management 6,000

-$10,000 debt service

=Zero cash flow

BUT some of those are just assumed costs so I would actually have cash flow after the mortgage and that is what would pay for any unforeseen costs

Principal paydown annually would be about $8,000 a year and I would have to put in about $30,000 into the deal which is a 27% return on my money!

Where else are you getting those numbers?!

Still think it makes no sense because a bug capex early on would ruin all profits and wouldn’t have returns till few years in? The same thing could happen with something that cash flows $200 a unit a month. One roof and you are out of business.

FHA Loan with high returns but no cash flow...???

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