Investing direction advice

[Kenny Gill]

Finally put some change together to be able to purchase a house outright cash for 21k it's an REO & with a little luck & the right timing i got it under contract. ARV should be around 120k. I need advice on how to proceed after closing. It was being used as an illegal 2 fam. I want to put it back to a 1 fam. My question is should I be more conservative & put the work in the house myself w/ my own funds 10K & have a fully paid off house that will cashflow 100% it may take me 2 months to do this. Or should I take a mortgage out on it for say 60k, pay off my personal debt maybe about 15k thereby raising my credit score & take the rest of the money & buy another house cash? & continue that process.
I know that I should leverage this house to continue to buy houses. But there is something about owning a house free & clear of any mortgage that is in the back of my head. I mean people work their whole lives to pay off a house. If I were to take the conservative approach I could save up enough funds in a year to buy another house for cash 30k.
Your advise is welcome

[Jon Holdman]

Actually, most lenders would include the money you spent on the rehab, in addition to the purchase price, to determine a value. I was able to get a lender to use a new appraisal after six months. However, this will be harder for you because I was doing a rate and term refi and paying off a hard money lender while you will be doing a cash out refinance. I suspect that may well require one year before you can do that refi using a new appraisal. So, at this point you're probably stuck putting your own cash into the deal.

As an investor, you have to do the math. You say you would have a total of $31K invested in this property, and it would return $1300 a month and be worth $100K. You don't really say what your current income, credit and debt situation is, and that will be critical to getting a mortgage on this property. If your credit is 600 and your DTI with the new mortgage is 50%, you're probably not going to get a loan. If your credit is 750 and your DTI with the new loan is 30% (not including the rent on this property), you're in good shape. I realize there's a lot of room in between there. But, lets assume you can get a 70% (80% is impossible, 75% would be the absolute maximum) LTV loan based on the new value at current investor loan rates. Lets use 6% though I think they might be a bit higher right now.

Rent: $1300
Expenses, vacancy, capital: $650 (read in the Rental Property forum about the "50% rule")
NOI: $650/month, $7800/year

Now, if you have the $31K cash invested, you're getting a cash-on-cash return of 25%. That's excellent. Assuming these numbers are correct, this is a great deal. I'll take two, please.

Now, if you put a $70K, 6%, 30 year loan on it, it looks like this:

payment: $450
Cash flow: $200/month, $2400/year
Still quite good for a rental property.

You pay yourself back the $31K. You'll have about $3000 in refinance costs. That leaves you cash in hand of $36K, in addition to the $31K.

Now, if you have a lot of expensive debt, you might want to knock some of that out. That's personally my goal right now. I would not go blow any of this money on new cars or toys or any of that stuff that tempts me when I have cash in hand.

With the loan, your cash income is much less. However, you have NOTHING investing into the deal, so your cash-on-cash return is infinite. Assuming you can repeat this process, I'd take that $67K along with that $7800 you earned in the time you had it without a mortgage and repeat the process. You can do two deals in the second year. If they're like this one, and you refinance a year after you buy each one, then roughly 2.5 years from now you have three properties, $600 a month in real income from these properties, and something like $160K in cash. Don't know how much debt you have, but hopefully that $160K will knock it off without making too big a dent.

Now you're on a roll. By this point, you should establish a good relationship with a small(ish) local bank. You will have demonstrated a business model that works, you'll have cash, and your credit will be improved. You can probably do a few more properties with conventional loans, but at some point you'll hit the limits. That's when you really need this relationship. The right bank will be able to do portfolio loans. These are loans they keep on their books rather than selling off. So, they don't have to follow the "conventional loan" guidelines. The rates will be a little higher, and the terms shorter, but this will allow you to build up a significant portfolio.

So, assuming you can swing it and the deals are there, this is what I would do.