Is this a beaten path for starting out?

Question

Hi BP. I'd like someone to sanity check this for me.

I live in a house with a solid amount of equity. I'd like to keep that as is for a bigger deal that may come along.

We have been able to fight and save a decent amount of money. We have four kids and I work 40-50 hours a week.

I found a property that would net me $400/month after saving for cap x, maintenance, vacancy, etc. It's about a 12% cash on cash. (Like how I used all the BP terms? lol) So by all investment metrics, it's sound.

To purchase this, I would need to significantly deplete our savings.

The math just feels weird. Essentially, I write a check for $25k, and it takes me a long time to replenish that money.

I feel it's a solid investment because that CF number is pessimistic and I can endure a downturn if needed.

Obviously, long term the house would cashflow more, appreciate, loan paid down, etc, which is great. But it's tough to write that check in the now for the later because it makes the savings so much less.

Any thoughts on this or similar experiences?

Thank you.

Simcha Davidman · Answer

Hi @Chris Mackinlay good luck with this decision!

Please clarify what the issue is - are you concerned that you will use a significant portion of your savings to buy this new property?

Do you have any alternatives, aside from not making this investment? How about tapping into your home equity, since you mentioned your primary residence. Can you take out a second mortgage (home equity loan) or a home equity line of credit (aka HELOC)? This would allow you to have a certain piece of mind by keeping your savings intact.

Alternatively, how about using the savings that you have, but at the same time opening the HELOC so that it's available for a rainy day, and all it costs usually is like $50/year to keep it open?

Scott Passman · Answer

@Chris Mackinlay One thing I would clarify is that you aren't "depleting" your savings.  Rather, you are moving your money from a vehicle (savings account presumably) that likely earns you 1-2% interest per year to an asset (rental property) that has potential to earn you 12% CoC year 1 according to your calculations. Along with this comes a whole host of other financial benefits such as tax breaks, loan paydown, and appreciation to amplify and accelerate growth.  One of the things that helped me most to pull the trigger was reframing and realizing I'm not "spending" the money, I'm just moving it from one place to another where it has the potential to earn much more money for me.

As for a HELOC, if you have the cash for a down payment I would use that instead of taking out a line of credit on your home equity.  At the end of the day, you will be using the same amount of money but if you use a HELOC you now have an additional loan to repay with added interest.  It will cost you less to use the money you already have and it won't put your personal residence on the line as collateral.

DJ M. · Answer

Heres one way to think of it. If you just leave your money in your savings, sure, itll be a nice big number and look good.

The reality is, your actually losing money, since you will never outpace inflation that way.

Send those little minions out into the world to do your bidding, and bring some friends back :)

Noah Mccurley · Answer

@Chris Mackinlay

That is the fear of risk that many investors have to over come to buy their first deal. I wouldn’t let this fear hold you back. If it is as good a deal as you think it is, let logic take the wheel and invest.

Every success starts with action.

Chris Mackinlay · Answer

I think my primary hesitation is depleting my savings. You bring up a good point with the HELOC about splitting the cost 50/50 between the HELOC and Savings.

Tyrell D Bradshaw · Answer

maybe split the 25K (for personal family emergencies and the property) and look for a partner or other ways to finance the rest?

Tyrell D Bradshaw · Answer

After reading Scott Trench's "Set for Life" and learning about setting up a financial runway, I would say the 25K is that. If it were me, as long as I have a few grand for emergency situations saved as well then it sounds like a great choice to use the money. BUT, if you dont have the emergency money saved then I would say its a huge risk. Still a great deal but a huge risk to your personal finances.......But its a good deal lol

Chris Mackinlay · Answer

@Noah Mccurley

Thank you all for the advice and helpful words. As a quick update, I got a house under contract. Solid rental numbers.

Since I had the pre-qualification already, I called my lender and asked about a cash out refinance. I current have an FHA loan and am wasting $100/month on PMI.

Long story short, my primary residence monthly payment will increase $100 in a couple weeks and I have all the money I need for the 20% down on the new property without paying anything out of pocket.

Michael Noto · Answer

@Chris Mackinlay How is the area this home is located in and based on that how much day to day attention are they going to require? I think this is important to consider in your situation because of the fact that from your post the one thing you do not have a lot of is time and the last thing you want is to be dealing with a tenant class that takes up a lot of your time.

On the flip side, if the property is in a better area and there is a better chance of you getting a solid class of tenants this would be a good deal for you because your money will be working for you while you are busy working and raising a family, etc.

Simcha Davidman · Answer

Thanks, that's what I'm here for :).

Just for clarification, I did not mean split it 50/50 - but whatever works for you. I'm a huge proponent of being comfortable enough to sleep at night. Very few investments will be worth the crippling feeling of worry and discomfort that we may feel in certain risk situations, and that's for each individual to determine.

Is this a beaten path for starting out?

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