Tell me if I'm being a chicken.....

[Denice S.]

Hello everyone!

I’m a single family investor who has always paid cash for my investment properties. My typical formula has been to spend 10-20k on the house, another 10-15k in repairs, rent it out for $800-900…rinse and repeat. This formula provides me with returns around 30% and a tremendous cashflow of between $500-600 per house and I’ve grown comfortable with the process. These properties are all in decent, working neighborhoods.

However, a few months ago I closed my first seller financed investment property. It’s in the ‘burbs and has a bit more land. Now that the rehab is complete, I’m having a difficult time deciding whether to continue with my plan to rent it out, or just flip it (1031 exchange) and move on. I think I’m hesitant because I’m not used to such high carrying costs...using other people's money is simply unfamiliar territory Having admitted that, I don’t want to chicken out just because I’m “not used to something.”

As a rental, the cashlfow on this property would be (conservatively) $125/MO

OR

If I sold it now, a quick sales price is 105,000. After all selling expenses this would leave me with around 30-35,000 profit….which I could use for my above mentioned formula. However, I realize having a tenant buy the majority of this house is an incredible opportunity too…albeit 15 years later.

I’d like some outside opinions as to whether you’d carry this house as a rental or sell it and move on to a higher cash flow opportunity.

Here are the #’s if interested…..thanks everyone.

Purchase – 55,000

Down – 10,000

Rehab-7,500 (all completed – new roof, all new mechanics, the place is tight)

Terms –45,000 at 5% for 15 years no balloon

Monthly Mortgage $350.00

Monthly Operating costs $450 (Tax,ins,PM,Water,repair fund)

Total monthly costs - $800

Rent – $925 (easily)

-Carrying the monthly cost between vacancies would not be a huge financial hardship.

[Andy Collins]

I'm a buy and hold investor and that wouldn't fit my model, I'd flip and take the cash.

Can you do a 1031 exchange on a flip?? I'm not into flips so I don't know, but I don't remember hearing of such

andy

[Aaron Montague]

@Denice S.

If I could get $950/month in rent, I'd keep it. That hits my minimums for SFH of $150/month cash flow and 15% cash on cash return.

If I couldn't get $950, I'd sell it and go back to the original plan.

All things being equal, if you can get a better cash flow elsewhere, do so. From the sounds of things you could turn the property from $125/month to $500/month using your original formula.

[Cal C.]

I don't see how you can make a bad choice. I think it would depend on what other deals are out there. If you can start flipping houses like this on a regular basis that ~$50K you'd take out of this house would come in real handy. However, if deals are hard to come by then I'd look to hold it for now and perhaps sell it when you start finding deals.

Doing a 1031 on it right now may be a bit problematic since you haven't rented it. Laws are about as clear as mud regarding 1031s/dealer status though.

[Denice S.]

Thanks Andy.... a fabulous reminder that I'd have to hold this a year to exchange...otherwise the rules are pretty much 'clear as mud'

[Engelo Rumora]

@Denice S.

Hi Denice,

Your buy, fix and hold strategy is great.

Some very sexy numbers with many investors thinking that they are not achievable.

Well done.

What areas do you buy in?

Similar numbers can be found in the Midwest.

Thanks and have a great day.

[Bill Jacobsen]

Given that you could buy a house with the profit from this house and it would cash flow at least $500 per month it seems like you should sell this house.

Your current house only cash flows $125 per month with mortgage pay down over 5 years only averaging $190.

You have a niche that few people have, that is to be able to crush the 2% rule. You are also doing better than the 50% rule.

Congratulations,

Bill

[Jean Bolger]

Well, you can't do a 1031 on a flip, so you'll need to take that out of the equation and add in whatever the taxes would be to your selling costs.

I'm usually a fan of leverage, but in this case I'd probably sell. And actually you'd really just be leveraging your 17.5k into, basically, another house for free that will meet your criteria. I'd take $500/mo for the next 15 yrs over $125/mo. (Not going into any complex "time value of money" computations here, just a quick opinion)

[Aaron Mazzrillo]

Is it an upgrade to your portfolio? Is your long term goal to own a bunch of $30K houses? I'd look to see if it fit in with my 10, 15 year plan. If you plan on upgrading the portfolio over time, this is a great opportunity to start now (I'm basing this off the sales price alone. I don't really have any clue if it is actually a better house than what you are currently pursuing.)

I love seller financed deals. A lot of my rentals are financed by the sellers and that works out great for me as I consider those long term negotiations. I've been able to discount some of those notes for pennies on the dollar. I once paid off a $60K note for around $25K. Best part about that deal was he contacted me about paying him off at A discount about 2 months before I sold it to a retail buyer and my paper holder would have been paid in full if he had just waited. There are so many back end strategies to get discounts on seller carried paper, I would never turn down an opportunity to create more.

[Cal C.]

@Denice S.

There is some really good advice above and no you are not being a chicken.

Here is a bit more detailed answer and some of it depends on your overall financial situation

1) If there are more flipping type deals out there and you like flipping then I'd suggest you continue doing that if for no other reason to increase your ability to buy under 30K rentals or as @Aaron Mazzrillo writes to help you upgrade.

2) If there are no flipping deals and there are more under $30k deals (presuming you want more) then you could almost buy two properties (fixing up would take more funds) with the ~$50K tied up in this property. You could also just use that to buy a slightly better house.

3) If there are no other houses that fit either model then I'd sit tight because your cash should be making you some nice returns.

4) I also like the idea of offering to buy the note back at a discount in a year or two, but that depends on your financial situation.

5) One other idea is to sell this house and look for similar seller type deals. Its possible you could buy three similar properties with the ~$50K.

[Roman Gwin]

Hi Denise,

If I read it write, you've been able to consistently acquire SFR's (all-in) for max of $35,000 and rent it out in a good neighborhood for coservatively $800? I'm pretty new to this forum and investing in general but if that were available in my town I'd "rinse and repeat" like you as often as I possibly could... that's similar to buying a house here in LA for $350,000 and grossing $8,000 in rent...I'd go out on a limb and say it's nearly impossible to do here.... if floating the rent between vacancies is a hardship, I'd sell it, buy another house and continue your proven strategy.... someone with more experience than me can probably help you figure out how to leverage the lower priced units in time for higher priced units that may have larger appreciation possibilities for long term portfolio health.

[Steve B.]

What non-warzone neighborhoods can you buy houses for 15k that aren't teardowns and only need 15k rehab to rent for 800+? Crazy numbers

[Denice S.]

Everyone! thanks for your advice and comments and for the 1031 reminder. I guess I never thought of my strategy as "the" plan it just so happens that its achievable here in Western NY when you know the area

@Engelo Rumora I live in Buffalo NY and invest in the working class neighborhoods, and some surrounding cities. You have to stay far, far away from the crime

@Aaron Montague you've made me see that I don't really have a criteria for a leveraged investment and I should probably get one. My only established criteria has been for an all in cash property

@Aaron Mazzrillo wow! you've made me see a potential power which never occurred to me. While this is currently my nicest property, my others are not far off with values between 70-90k.

@Cal C. all good points, especially #5, unfortunately the seller financed deals are in short supply around here.

You're all awesome and I'm continuing reading all of your posts. Thank you!

[Dawn Anastasi]

Originally posted by @Steve B.:

What non-warzone neighborhoods can you buy houses for 15k that aren't teardowns and only need 15k rehab to rent for 800+? Crazy numbers

There are several around the country.

[Bill Exeter]

I thought I would jump in here and comment regarding the 1031 Exchange issue. Your strategy has always been to buy and hold. It sounds like this property was also going to be a buy and hold, but now you are questioning that intent.

The Treasury Regulations require that you have the "intent to hold" for rental, investment or use in a business. If you get audited and you can prove that you had the intent to hold - but - your intent changed due to economic, business or investment reasons, you may still qualify for a 1031 Exchange.

It is not automatically a "flip" just because you had a short-term hold. And, since you generally buy and hold any way, it will be an easier argument to make.

[Cal C.]

Originally posted by @Jean Bolger:

Well, you can't do a 1031 on a flip, so you'll need to take that out of the equation and add in whatever the taxes would be to your selling costs.

Actually you can do a 1031 flip, I personally believe that this especially holds true for the first flip as long as there is a significant gap before the next one. Also, there are several things going for the OP in getting this done. 1) She has never flipped before. 2) She has several rentals 3) She has held most of those for several years 4) For this one she obtained a mortgage instead of paying cash, that extra expense (interest) implies that she was planning on holding it for a while especially if she had the cash to buy it outright.

Bottomline it is all about the intent and being able to prove intent in case of audit. Remember with the IRS the onus in on you to prove your innocence not for them to prove your guilt.

[Jonathan Marcus]

If you held on to this one, you're expecting $125/mo cash flow. If you sell it, you can potentially acquire 2 properties, based on your typical formula. With 2 more properties, again based on your numbers that's $1k-$1,200 in monthly cash flow.

So its $1,500 vs. $14,400 in yearly cash flow. Unless you see other overwhelming benefit to holding on to this larger house, go for the larger cash flow.

[Denice S.]

@Steve B.

@Steve B.

[Denice S.]

@Jonathan Marcus

good point...I tend to look at worst case scenarios as it's a formula that keeps me out of financial trouble. But as you suggest, the perfect storm of a rock bottom purchase price and a rock bottom rehab, all luck on my side gets me closer to 2 properties, interesting

[Bob E.]

I would sell it and pick up two rental that fit your usual model.

[Bill Exeter]

Originally posted by @Cal C.:

Actually you can do a 1031 flip, I personally believe that this especially holds true for the first flip as long as there is a significant gap before the next one. Also, there are several things going for the OP in getting this done. 1) She has never flipped before. 2) She has several rentals 3) She has held most of those for several years 4) For this one she obtained a mortgage instead of paying cash, that extra expense (interest) implies that she was planning on holding it for a while especially if she had the cash to buy it outright.

Bottomline it is all about the intent and being able to prove intent in case of audit. Remember with the IRS the onus in on you to prove your innocence not for them to prove your guilt.

We need to be very careful here. If an investor is audited and it can be shown that the intent was to rehab and/or flip, the 1031 Exchange will be disqualified. It is the intent that matters. Now, if the fact pattern demonstrates intent to hold (and not to flip), then the 1031 Exchange should qualify. But, the statement that you can do a 1031 flip is not correct. If there is documentation that indicates the intent was to flip all along, it will be disqualified.

[Cal C.]

Ok if it is not a 1031 flip then what is it? As I stated very clearly it is all about the intent and you have to prove you had intentions to rent it. You can call it anything you want but to me if you buy a property then you fix it up and then sell it before renting it, it is a flip. Even if you tried for several months to try to rent it.

[Bill Exeter]

Originally posted by @Cal C.:

Ok if it is not a 1031 flip then what is it? As I stated very clearly it is all about the intent and you have to prove you had intentions to rent it. You can call it anything you want but to me if you buy a property then you fix it up and then sell it before renting it, it is a flip. Even if you tried for several months to try to rent it.

I understand what you are saying. However, calling it a 1031 Flip when flips do not qualify can really mislead other readers. If the investor had the intent to hold them for rental or investment, but something has changed and they are selling early, they are really not flips. Perhaps an unintentional flip, but the intent to flip was not present. I just want to make sure that readers are clear about the issue.