What would you do with 100K?

[Jovon English]

Hello,

I recently sold a house in Southern California where the market is tanking so I do consider myself lucky enough to get it sold without losing a ton of money.  Anyway, what should I do with the profit?  I'm single now and don't want to buy another house or a condo in Orange County for $600,000 or so.  I will rent for a couple of years.  Here are my options for the money:

1. Deposit it in a high interest savings account at 2.45%

2. Pay off my rented duplex in Ohio.  Balance is about 100k at 4.5%

3. Pay off my Mom's condo mortgage in Ohio which is about 100k and then have her pay me rent.  The condo is worth about 115k.  My only issues with the condo is that the schools in the area of Canal Winchester are bad.  Also, it has three flights of stairs so its not a good rental unit for seniors.  However, when my mom moves out it could rent for $1,200 to $1,300.  Association is $200.

4. Invest it in a crowd sourcing commercial real estate site.  They say returns are around 9% to 12%.

5. Find another multi-family property and take on more debt.

6. Blow 1/3 of it in Vegas for my 40th birthday and do some more traveling.

What would you do? 

[Bill Manassero]

@Jovon English Great question!  I've asked the exact same question myself.  Here is what I came up with... 

So, in answering the question “What would I do with $100,000?”  I looked at three options of which I have direct experience::

1. Pay $100,000 cash for a house to generate monthly rental income free of a mortgage.
2. Buy 5 houses worth $100,000 each at $20,000 down with a mortgage for the balance
3. Buy a 15-unit apartment building

Please note: for simplicity's sake, I did not directly calculate closing costs into these explanations.  Also, I am an out-of-state investor.  In fact, I'm a neighbor, living in Laguna Woods, near you.

Let’s look a little closer at those options:

Option #1

• Pay $100,00 cash to purchase a house in-full
• Monthly rent: $800
• Monthly cashflow:  $300 (after expenses and an allowance for vacancies, misc*)
• Annual profit: $3,600
• Home value after one year (4% increase): $104,000

Advantages

• Don’t have mortgage payments
• 100% equity to borrow against if needed
• High monthly income
• Can deduct depreciation on taxes
• Only one tenant to deal with
• If you lose your tenant, you don’t have to worry about covering a mortgage each month

Disadvantages

• Can’t deduct mortgage interest
• Not enough cash flow to save for bigger emergencies
• If you lose your tenant you will have 100% vacancy
• Cannot force appreciation. Property is subject to market comps for value.

Option #2

• Pay $100,000 for 5 houses valued at $100,000 each ($20,000 down on each home and 5 new mortgages).
• Monthly rents: $4,000 (5 x $800)
• Monthly cash flow after PITI: $500 (50% rule says you'll get $2,000 per month but I'm being conservative)
• Annual profit: $6,000
• Home values after first year $520,000 minus debt

Advantages

• Can deduct loan costs and mortgage interest
• Higher monthly income
• Can deduct depreciation on taxes
• It you lose a tenant, you still have the income from the other 4 properties

Disadvantages

• Five tenants to deal with
• Five mortgages, property and insurance payments to make
• Five roofs, five buildings’ plumbing, electrical and structural issues to deal with
• If located in different states, 5 different property mangers to deal with
• Cannot force appreciation. Property is subject to market comps for value.

Option #3

• Use the $100,000 as a down payment on a $500,000 15-unit apartment
• Monthly rents: $7,500 (15 times $500 per month)
• Monthly cash flow after mortgage and expenses: $1,500 ($100 per door times 5 doors)
• Annual profit: $18,000 without value add or $6,000 with value-add improvements deducted
• Value add: Take out $1,000 per monthly for property improvements of $12,000 for the year
• Apartment value at the end of one year (with value-add rent increases and expense reductions) 20% increase – $600,000 ($100,000 plus in equity)

Advantages

• Can deduct loan costs and mortgage interest
• Highest monthly income
• Can deduct depreciation on taxes
• It you lose a tenant, you still have the income from the other 14 units
• Only one mortgage, property tax bill, insurance bill and roof to deal with
• All tenants in one property are easier to manage
• Property management costs less than a house. Houses are typically 10%, a building of this size could cost only 5-8% of the monthly income for property management
• You can force appreciation to boost the value of the property, resulting in:
  • Instant equity that you can borrow against to buy other properties
  • The opportunity to sell in 3-7 years for a significant profit
  • Higher valued property means higher personal net worth – a higher personal net worth means you are able to buy higher priced properties

Disadvantages

• 15 tenants to deal with
• 15 toilets, sinks, etc. to deal with
• However, with a good property manager at the helm, you wouldn’t have to deal with the two items above, my property manager would
• More activity because more tenants (again see the third item above)
• Requires stricter, more focused asset management skills and heavy oversight of your property manager

PLEASE NOTE: I made the examples simple to illustrate a point and are not real accurate on the specific costs involved. However, I believe the examples are close enough to present an accurate (though not detailed) picture. Below are my assumptions that I roughly (or not) adhered to. If you feel I did not accurately represent the exercise, missed key points or costs, or left something out, please post a comment or write me. I will respond. Thanks.

Asumptions

• DISCLAIMER: This is a quick assessment comparison only. It does not take into account closing costs or other fees that may affect down payments and monthly expenses. It is meant as a general, quick comparison only. I do believe, however, that properties can be purchased at the prices I listed above because I see these prices all the time (but never in California!).
• Monthly rent will vary significantly from market to market (I calculated low), I am assuming the property is a 2 or 3 bed/one bath in a “C” class neighborhood. The apartment has one bed/one bath units.  Rent is calculated at .8 of the purchase price
• Expenses: 50% rule (50% of income goes to expenses, not including mortgage payment) – -This is really just a rule of thumb and I’m more conservative than that. My “rule of thumb” is to get $100 per door and if you can get more that than – hallelujah!
• Regular Monthly Expenses factored in
  • Property management
  • Repairs and maintenance
  • Cleaning
  • Utilities
  • Trash service
  • Sewage
  • Lawn service/landscaping
  • Property taxes
  • Insurance
  • Cap-X
  • Misc (from my experience, there are always “other” or “miscellaneous” expenses
  • Allowance for vacancies and turn-over costs
  • Please Note: You may be able to have tenants cover some of these expenses, thus increasing cash flow

I have both single family and apartment buildings.  I'm drawing from personal experience.

Well, I hope that helps.