Is my friend about to make a horrible investment?!?

Question

Today, I was texting one of my good friends from Memphis, TN. We are both recent graduates from The University of Tennessee, and both have good paying full time jobs. I recently finished Set for Life by Scott Trench and I've texted all of my friends telling them to read it. I texted this guy about it today and he told me he was about to make the following "deal":

He currently rents a condo out in a decent area for $1250/month. He's looking to buy that condo for $155k, live in it for 5 years, then rent it out for 10-15 years later as a cash flow property. He said "It'll be worth double or triple in 15 years". I told him that the market could turn and cause him to lose a ton of money but he seems convinced. I know this isn't a ton of information, but am I missing something? Is there anyway this works out well? Is there anything I could say that would deter him? I know some people just need to learn the hard way but I would hate for him to buy this condo and lose thousands of dollars.

Chris Clothier · Answer

Matthew,

You ask if there is anyway this works out well.  The answer is yes.  There is a way it could work out well.  His plan to hold the property for 15-20 years is presumptuous because our plans as investors are constantly evolving.  But, if he were to hold it for that amount of time, allow a resident to pay the principle down on the property while its rented and he either invest the difference (assuming there is a positive difference after all costs) or reduce the principle faster by applying the difference to his note, then yes, his plan could work out very well for him.

You can tell him that his condo will not be worth double or triple what he is paying.  It is not going to happen in an urban downtown area unless there is an outside event such as a sudden growth in building, new companies moving to town or some other outside event such as revitalization.  A lot of that is happening in Memphis right now and there is a lot going for Downtown right now.  That being said, it is not going to double in value in that time, so that part of his plan is unrealistic.

You can't make his decisions for him and probably shouldn't try to influence him either as a friend.  Your suggestion to read Scott's book is a great suggestion.  In the end, he will define what is a good investment and what he is happy with.  His criteria may be different that yours, mine and even Scott's, so don't judge him or his investment on what any of us say is good or bad.  Instead get him to define his idea of a successful investment and then you'll know the likelihood of it working out.

Best to you -

Alexander Price · Answer

Account Closed

Assuming he holds it for the 15 years after he lives in it, the best case I see, using ~3.5%/yr, he'd have appreciated 67%. My 3.5% is a rough estimate from the increase in median home prices for Memphis over the past 20 years or so. I am not a native, nor an expert, but Memphis lags behind the national average in appreciation. It is a cash flow market.

That said, it is not an investment at all until he is no longer living in it. He should reevaluate then.

Gus Ross · Answer

Account Closed in a market trending south, condos are an easily hit asset class due to the financing restrictions of buyers.  For example, most FHA loans have extremely strict requirements to approve a loan on a condo unit which in turn reduces potential demand/buyers for the asset.

Predicting a 2x or 3x appreciation with a 10-15 year horizon seems like a bet I'd like to be on the other side of at the current moment.

Buying a condo versus renting one seems like a solid plan, but in my opinion some of the critical assumptions are off.  Hope this helps, and best of luck to your friend.

Account Closed · Answer

Thank you to everyone for your input and advice!

@Scott Trench That's why I suggested he read your book. I didn't fully know what my goals were for investing but Set for Life resonated with me so much it basically set the goals for me. I think he likes the idea of investing, and is currently exploring real estate as a vehicle to invest, but I'm not sure what end game he hopes to achieve with this investment. I hope it works out for him though.

@Chris Clothier Very well said. I think that last sentence is great: "get him to define his idea of a successful investment". I guess we all get caught up in our own investment style and preference that sometimes we have trouble seeing it from different perspectives.

Scott Trench · Answer

Many people have different goals when they buy property. With the little knowledge we have from this deal, it does not sound like it is a particularly efficient way to move toward financial freedom, but if your friend is planning to live in that spot for 5-10 years and is fairly certain of that decision, he or she may come out ahead financially vs continuing to rent the place.

Either way, this person's housing choice will not significantly expedite financial freedom, as they are paying a lot of money to live in a condo, presumably on their own. They will have to make progress elsewhere by cutting back expenses, earning more income, and hustling and bustling to build or buy and then grow alternative assets.

They could expedite their progress by buying an investment property that would generate more cash flow from neighbors and roommates.

I think that few BiggerPockets investors would be interested in a $155K condo in Memphis generating $1250 in rent, but I could be wrong!

John Thedford · Answer

If he lives there for five years he can sell and keep any profit up to 250K tax exempt if single. I don't like to buy on future assumptions of value. Markets cycle. In fact, it could start declining right after he purchases it and the market not recover for some time. When I buy, I always want to buy under market to have a cushion for when the market does cycle.

Nick C. · Answer

He sounds more like a speculator than an investor. I would never buy a condo. They don't appreciate as well as SFH, they are produced en masse so the supply could drastically change killing the demand, and they have HOAs you have to answer to. The condo rules could change not even allowing rentals, or they could slap a huge assessment on the unit.

Tell him a few strangers on the internet told him it looks like a bad investment!

Ron Dayley · Answer

I really don't see the condo appreciating 2 times much less 3 times the current value in that time span.  From what little we know about the property it's hard to say what his headroom is to increase rent for better cashflow.

Is my friend about to make a horrible investment?!?

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