Should I stay or should I go?

Question

I bought a duplex for 128k when the market suggested 140k. I have an amazing renter for 6 more months. Before I stopped thinking about real estate investing and starting applying action, I made some decisions I may have regretted. Some opinions would be great. I have 18 k student loan debt 7k ring payment, just got engaged. And now a huge house payment (1024) a month. I rent the other side for 650. My fiancé also has 40k in student loans. I understand that I need to pay off debt and build cash and that's why we have written our expenses and eliminated a lot of them and I have taken on a part time job. Should I sell this property to find a better deal on MFH? Also, it will be a long time until our debt excluding the house is paid off. Am I putting my nose to the grindstone for years until the debt is gone before looking into another property. I am definitely overwhelmed with all these questions. Thanks all

Jon Holdman · Answer

The 50% rules includes all expenses (taxes, insurance, maintenance, legal, CPA, lawn care, etc.), vacancy, and capital (roofs, furnaces, etc.) Its based on market rents, so if you're giving free days or a discount that's part of vacancy. That's "economic vacancy". From the remaining 50% you have to cover the P&I payments on your mortgage, if any. What's left is your cash flow, pre-tax.

Steven Bays · Answer

Thanks Harry. I really appreciate the break down and I will have to sit down and write it out for me to understand one hundred percent. I think with my extra part time job and saving, I can save closer to 2k a week to pay off the credit card and other debt and start another fund, since my current emergency fund is already saved, for my next property. It's a long road but the excitement had me staying up late at night. Definitely fulfilling to know I have the support from ya'll. Thanks again

Harry M. · Answer

@Steven Bays Hey Steven, First of all, congratulations on the upcoming wedding! I did a bit of number crunching based on the figures you gave and in my opinion, the duplex is your friend. For a quick analysis with the 50% rule, the best way to look at the numbers is to simply ignore the fact that you live there. First, if you hold the property long term, chances are you won't live there for the bulk of those years, and second, the rent you don't receive from your side cancels with the rent/mortgage you are not paying were your primary residence separate. Based on you saying that your interest is 4716, it sounds like you did this with a zero or verysmall downpayment. So it makes it hard to calculate a meaningful percentage return. Anyway, using the 50% rule, I get: Gross rent: 15600 (gross rent is your maximum theoretical rent if there were no vacancies) Expenses @50%: 7800 (this includes all expenses except P&I: rent not received due to vacancy, insurance, taxes, maintenance, set aside for long term capital expenses such as replacing roof, property management, and so and so forth). Gross rent minus the expenses above is called your net operating income (NOI), which is 7800 in your case. From that, you subtract your debt service, which is the P&I portion of your mortgage payment, which if I filled in the blanks correctly should be about 557/month, or 6685/year. Does that sound right? If so, this leaves you with 93/mo (1115/year), which is your cash flow. By the way, the reason the debt service is separated from the other expenses like this, is so that you can look at the performance of the property separate from the specific financing that an individual investor worked out. There is another consideration which is that some of your P&I is going to pay your principle down. Even though you don't get to see it unless you sell, that is your equity, so you should consider that in the numbers. Factor that in, and it bumps the income from the property to 307/mo, or 3678/yr. On to a couple of things more specific to your situation. First of all, are you managing the rented side yourself, or using a management company? The 50% rule includes management in the expenses. I wouldn't recommend buying a property without running the numbers with management included (even if you initially plan to self-manage, things can change over the long haul). But since you already own the property, we should rerun the numbers w/o management (if this is indeed the case) to see where things stand for the immediate term. Without management expenses, the 50% becomes more like 40%. So your cash flow jumps to 223/mo or 2675/year, and when you factor in the principle reduction from paying your mortgage, you are now at 436/mo or 5238/yr. While you are living there, there is another factor in your favor: the 50% rule includes vacancy in the expenses. A decent rule of thumb for estimating the vacancy component of the 50% is 8.33% (one month out of 12). This varies depending on property type amd area, but I think 8.33% is a reasonable estimate for a duplex without knowing anything else about your property/market. So, since you are technically your own tenant, you can half the vacancy estimate since you're unlikely to move out in the middle of the night without telling yourself ;). For the short term, while you are living there and managing the property yourself (I'm guessing), 36% is probably a better estimate of expenses than 50%. Taking that number, your cash flow works out to something like 275/mo (3299/yr), and your full return including the principle reduction is something like 489/mo (5862/yr). One other thing – does your tenant pay their own utilities, or do you? The 50% rule does not include owner paid utilities, so you would have to add back an estimate of their half of the utilities into the expenses if you are paying them. Bases on what you've told us (and especially if the tenant is paying their own utilities), it seems like the duplex is helping you quite a bit. I'd hang on to it. The other reason I'd be hesitant to sell is that unless you have a lot of equity, then the closing costs are going to eat up all the equity you've been building up (and maybe more). As the seller, you pay both agents commission which usually totals 6% of the sale price, and that's before you get into things like seller concessions, home warranty, and all the other junk on the seller side. Real estate isn't really that liquid. Hope this helps. Good luck! -Harry

Steven Bays · Answer

I appreciate everyone's feedback. All of these different equations are a bit confusing.

Steven Hamilton II · Answer

@Steven Bays , Another thing to consider if if both of you pick up a part time job doing something to make a few extra dollars to go toward REI or to pay down debt. Cut fast food, cut cable, cut everything you can. You'd be shocked how much money is flowing right out the door. Rent movies from the library

Steven Hamilton II · Answer

Remember to take into account interest rates. I earn well over 15% annually on my investments. My student loans are 6.8%. It does not make sense for me to pay them off if I can invest my money in a way in which it earns more. Net the spread. However, be responsible and keep a reserve fund.

Linda L. · Answer

@Steven Bays Since you live one side, only one side is generating income. Assume you put 20% down. The mortgage payment for one side is 223. assume expense is 50% of your rental income=325. So your cash flow=650-325-223=102. Assume your initial cost=15K for one side, then your cash on cash return=102*12/15000=8.1% If interest rate on your student loan is only 3%, then, it's better to keep the duplex. since it's generating 8.1% at the moment plus you can get some tax benefits from depreciation. If your other loan is 18%, then you can consider to cash out the duplex for now to pay off other high rate debt first or at least use some current cash flow to pay off that debt However, if you sell, the net profit is not gonna pay off your entire other debt, and you might need to spend more than $650 monthly for your own residence. Also, for new future property you acquire, you might not get such low interest rate as 3.25%.

Steven Bays · Answer

Rick I appreciate the feedback. I was certainly lucky to find this one. The fiancé I mean. What would you all suggest a goal fund for a next house purchase? 20k? Financing is very interesting to me and very curious about learning more.

Rick Baggenstoss · Answer

@Steven Bays You're well on your way to success! You've convinced your girlfriend to marry you. :-) Now if your other goals could pan out as well... they will in due time. If both sides of the duplex are equal, then your rent per month would be $1300 per month. That's 1% of the total value ... pretty good. 2% is the goal. (I would argue that 1% is great for first/second timers having never heard of the 1% rule). If you can, you should hold the property and let the dust settle. As you have extra money, pay off the ring and build a fund for your next property. Have a goal for doing this by a certain date. If you and your fiancee can manage thru the spending/debt reduction plan, then you'll have a far greater chance of being a happily married couple and a successful real estate investor. Best, Rick

Steven Bays · Answer

Correct me if I am wrong jon. If taxes are 3400 I would subtract that from my mortgage and count it as part of the50%. So as it stands. 3900 is income per year for one side being rented out with 8888 as my yearly p&i. I can safely assume my property is not cash flowing even if I were to rent both sides out yea?