Renting out current house as first investment?

Question

Houston BP community,

I wanted to get people's advice / thoughts as I try to get started with my first investment property. I'm leaning towards buying a smaller house for my family of four with a conventional 20% mortgage, and renting out my current home to get started, the reason being:

1) Conventional mortgage can get me much lower interest rate (I've heard a full 100 bps lower vs. investor loans- someone please verify)

2) Current house is a bit bigger than we need (2,800 sq ft) and by downsizing to a smaller and cheaper house (thinking <2000 sq ft, $175K target price), we can get more in rental income from the bigger house while assuming a smaller monthly obligation from the new smaller house

Below are some numbers to clarify the situation. Thanks in advance for your insights!

1) Current home (to convert to rental)

• Bought for $245K a few years back, monthly PITI of ~$2,000 per month (3.125% rate 15-year mortgage with 20% down)
• Can fetch fair market rent of ~$2,000 per month once we move out and put on rental market; with some vacancies and maintenace built in probably more like $1,500 per month in net rental income per month
• Great neighborhood in NW Houston suburbs with lots of nearby commercial/retail development as well as excellent 10/10/9 schools, so good price appreciation potential

2) Target purchase home (to move family into)

• Looking to buy ~$175K home, much smaller square footage, with monthly PITI of ~$1,300 per month (assuming 4% rate 30-year mortgage with 20% down)
• Probably will buy in same neighborhood given great schools and retail development
• Essentially, I would gain $1,500 per month of rental income from the old house and assume an incremental $1,300 per month in PITI from the new house, so this would seem to help me generate some income

Fred Heller · Answer

@Alfie Park I think your home is way too pricey to make it a rental property. Best thing, in my opinion, is to sell and move on.

In my experience the sweet spot for rentals is $1200-$1500. For your home to make sense as a rental you would need to get $2500+. Properties in that price range are very hard to fill.

Alfie Park · Answer

@Rachel: which two price points are you referring to? I agree that $2000+ might be a bit pricey for rents in my MPC but the average rents I see on MLS are $1,600 to $1,800 per month and tenants seem to be accepting these rates.

@David: Good point about not letting emotions get in the way (although hard to persuade wife to potentially move away from our current house given the hassle for her hahaha). What are concrete action items you would suggest for the "forced savings and debt pay down" purpose?

Thanks again for all the helpful suggestions everybody, extremely helpful!

Rachel Pervis · Answer

Hi @Alfie Park in my opinion both price points are too pricey for rentals if your goal is to generate income.

Alfie Park · Answer

Great, thanks for the input everyone.

@Marco: minimum rents in my MPC is $1,500, and averaging more in the $1,600 to $2,000 range, so your idea could certainly work out although a $150K house here would be probably the smallest house that needs some TLC. But I'm willing to wait around for that kind of deal to come around and put in some work.

@ Everyone else: I know most people think I should sell the current house and buy another one that is more suitable for investing purposes. To add a bit more color, I generate enough income to afford two mortgages and provide down payment for the second house, so don't have to sell the current one. To get creative, let's assume I don't sell my current house (but i don't have to live in it). What would be the best thing to do given this constraint?

Again, thank you for all of the very helpful comments! That's the kind of stuff I was looking for when I originally posted.

Marco Pfeiffer · Answer

I agree with everyone else that your current house does not have the right numbers to make it a rental. However, you mentioned you think about downsizing. If you have the funds to buy another house I would stay in the current one and invest in a $150K home in NW in a strong rental area and turn that in a rental property. That should rent for $1,300 - 1,500. Your interest rate might be a little bit higher but with a 30 years mortgage you should still be positive cash flow on that one.

Alfie Park · Answer

That's some tough news to swallow. If I refinance to a 30 year at 4% interest rate, then I could lower the PITI for my current house to ~$1,600/month, which would bring me to basically break-even currently, and then expected to start cash flowing a few years down with rental rate inflation.

I'm just cognizant that there are significant transaction costs involved in real estate, which sometimes means I can't just keep churning to optimize the #'s but may have to do the best with what I already have? I'm looking at the current house as a "sunk cost" and thinking about how to maximize my INCREMENTAL cash flow situation, which I think I can do by adding rental income from my current house which would be bigger than the PITI commitment to my new smaller house.

Chuck Moreno · Answer

Yes the whole point of buying rental property is to have positive cash flow. Why have one you know is going to break even if fully occupied with a high chance of taking a loss annually.

Alfie Park · Answer

@Anant: The one negative for the refinancing move would be I would probably have significantly higher interest rates with the 30 year I'd think (Quicken Loans quotes 4.125% for 30 year vs. 3.375% for the 15 year). That's a big factor for me favoring just keeping my existing 15 year loan, especially since it's at a better rate than I can get in today's rate environment.

But I think it's worth checking with my bank to see what the rate impact would be so thanks for the suggestion.

Renting out current house as first investment?

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