@Jovon English Great question! I've asked the exact same question myself. Here is what I came up with...
So, in answering the question “What would I do with $100,000?” I looked at three options of which I have direct experience::
- Pay $100,000 cash for a house to generate monthly rental income free of a mortgage.
- Buy 5 houses worth $100,000 each at $20,000 down with a mortgage for the balance
- Buy a 15-unit apartment building
Please note: for simplicity's sake, I did not directly calculate closing costs into these explanations. Also, I am an out-of-state investor. In fact, I'm a neighbor, living in Laguna Woods, near you.
Let’s look a little closer at those options:
Option #1
- Pay $100,00 cash to purchase a house in-full
- Monthly rent: $800
- Monthly cashflow: $300 (after expenses and an allowance for vacancies, misc*)
- Annual profit: $3,600
- Home value after one year (4% increase): $104,000
Advantages
- Don’t have mortgage payments
- 100% equity to borrow against if needed
- High monthly income
- Can deduct depreciation on taxes
- Only one tenant to deal with
- If you lose your tenant, you don’t have to worry about covering a mortgage each month
Disadvantages
- Can’t deduct mortgage interest
- Not enough cash flow to save for bigger emergencies
- If you lose your tenant you will have 100% vacancy
- Cannot force appreciation. Property is subject to market comps for value.
Option #2
- Pay $100,000 for 5 houses valued at $100,000 each ($20,000 down on each home and 5 new mortgages).
- Monthly rents: $4,000 (5 x $800)
- Monthly cash flow after PITI: $500 (50% rule says you'll get $2,000 per month but I'm being conservative)
- Annual profit: $6,000
- Home values after first year $520,000 minus debt
Advantages
- Can deduct loan costs and mortgage interest
- Higher monthly income
- Can deduct depreciation on taxes
- It you lose a tenant, you still have the income from the other 4 properties
Disadvantages
- Five tenants to deal with
- Five mortgages, property and insurance payments to make
- Five roofs, five buildings’ plumbing, electrical and structural issues to deal with
- If located in different states, 5 different property mangers to deal with
- Cannot force appreciation. Property is subject to market comps for value.
Option #3
- Use the $100,000 as a down payment on a $500,000 15-unit apartment
- Monthly rents: $7,500 (15 times $500 per month)
- Monthly cash flow after mortgage and expenses: $1,500 ($100 per door times 5 doors)
- Annual profit: $18,000 without value add or $6,000 with value-add improvements deducted
- Value add: Take out $1,000 per monthly for property improvements of $12,000 for the year
- Apartment value at the end of one year (with value-add rent increases and expense reductions) 20% increase – $600,000 ($100,000 plus in equity)
Advantages
- Can deduct loan costs and mortgage interest
- Highest monthly income
- Can deduct depreciation on taxes
- It you lose a tenant, you still have the income from the other 14 units
- Only one mortgage, property tax bill, insurance bill and roof to deal with
- All tenants in one property are easier to manage
- Property management costs less than a house. Houses are typically 10%, a building of this size could cost only 5-8% of the monthly income for property management
- You can force appreciation to boost the value of the property, resulting in:
- Instant equity that you can borrow against to buy other properties
- The opportunity to sell in 3-7 years for a significant profit
- Higher valued property means higher personal net worth – a higher personal net worth means you are able to buy higher priced properties
Disadvantages
- 15 tenants to deal with
- 15 toilets, sinks, etc. to deal with
- However, with a good property manager at the helm, you wouldn’t have to deal with the two items above, my property manager would
- More activity because more tenants (again see the third item above)
- Requires stricter, more focused asset management skills and heavy oversight of your property manager
PLEASE NOTE: I made the examples simple to illustrate a point and are not real accurate on the specific costs involved. However, I believe the examples are close enough to present an accurate (though not detailed) picture. Below are my assumptions that I roughly (or not) adhered to. If you feel I did not accurately represent the exercise, missed key points or costs, or left something out, please post a comment or write me. I will respond. Thanks.
Asumptions
- DISCLAIMER: This is a quick assessment comparison only. It does not take into account closing costs or other fees that may affect down payments and monthly expenses. It is meant as a general, quick comparison only. I do believe, however, that properties can be purchased at the prices I listed above because I see these prices all the time (but never in California!).
- Monthly rent will vary significantly from market to market (I calculated low), I am assuming the property is a 2 or 3 bed/one bath in a “C” class neighborhood. The apartment has one bed/one bath units. Rent is calculated at .8 of the purchase price
- Expenses: 50% rule (50% of income goes to expenses, not including mortgage payment) – -This is really just a rule of thumb and I’m more conservative than that. My “rule of thumb” is to get $100 per door and if you can get more that than – hallelujah!
- Regular Monthly Expenses factored in
- Property management
- Repairs and maintenance
- Cleaning
- Utilities
- Trash service
- Sewage
- Lawn service/landscaping
- Property taxes
- Insurance
- Cap-X
- Misc (from my experience, there are always “other” or “miscellaneous” expenses
- Allowance for vacancies and turn-over costs
- Please Note: You may be able to have tenants cover some of these expenses, thus increasing cash flow
I have both single family and apartment buildings. I'm drawing from personal experience.
Well, I hope that helps.
