All Forum Posts by: Nate Garrett

Hi @Kimberly Gillock 

The Tulsa rental market is doing great.

Zillow.com recently named it the 3rd best city in the nation for small landlords.

Housing is plenty affordable, but the housing stock was not overbuilt before the downturn like many other places so there is a good balanance between rental properties and owner occupieds. We are still seeing strong rental demand and getting properties leased on average less than 1 month on the market. 

TU and Florence Park are experiencing good price appreciation as well as rental increases. If you haven't been by the TU area recently, you should. TU has purchased a bunch of real estate on the outskirts of campus and redeveloped it. The campus is getting better by the day and the area is really thriving.

@Jeff Trevarthen 

As I'm sure you know, right now there is a significant difference in rates on 15 and 30 year mortgages. I was quoted 3.75% for a 15 year or 4.625% for a 30 year with 0 points. 

For the $77,000 loan above, I would pay $23,793 in interest on the 15 year note or $65,518 on a 30 year note if paid on schedule, for a difference of $41,725. I would also have a free and clear asset 15 years earlier by taking the 15 year option.

If I understand you correctly, you are asking why I wouldn't take the 30 year mortgage and pay it on a 15 year schedule. Valid argument. The 30 year note would provide some safety margin if rents fall.

For me it comes down to the spread between the 30 and 15 year interest rate. If the spread was less significant, I might consider doing exactly what you suggested.

My personal reasons for investing are more wealth-driven than income-driven, so I am comfortable locking myself into the higher payment with the knowledge that I may have to "feed the alligator" if rents fall. 

I don't have all of my properties on 15 year mortgages. Actually, most of them are on 30 year mortgages. I guess in this case, the significantly lower rate on the 15 year was too good to pass up. 

I agree with @Chris Clothier 

Every property will have negative cash flow at some point as the amortization period of the debt is reduced.

Cash flow is only one measure of investment performance. There are other measures that should be considered as well such as cap rate and IRR. We deal with plenty of investors that conscientiously choose negative cash flow on 15 year amortization because they want to have the property paid off as quickly as possible.

Nothing wrong with that as long as the overall picture suits their needs. 

Hi @Ceril S. 

Good question. These are my definitions of the terms you provided:

Property Manager: Responsible for the overall management and oversight of the property, including tenant relations, maintenance coordination, accounting, etc. Often times this individual or company will also provide leasing services to the owner. Many states require a person to be licensed to conduct this role. Check your state's real estate code.

Handy Man: Typically this person provides maintenance for a property but does not engage in tenant relations, accounting, leasing, etc. If you decide to self-manage, you might consider hiring a handy man to provide maintenance while you play the role of property manager and/or leasing agent.

On Site Property Manager / Superintendent: This individual may play many of the property manager / leasing roles listed above. An on-site manager or leasing agent may or may not need to be licensed, again, check your state's real estate code.

Regards,

Nate

@Roger Rouse 

Great point re: "Opportunity cost of capital". I agree that term should be reserved for the rate of return that could be generated by your second best opportunity. Buffett always has a way of making things easy to understand!

I guess I wanted to give some consideration to the fact that the "rate of return" generated by buying down an interest rate is a guaranteed, zero-risk investment, assuming you keep the mortgage. Maybe a better term would have been "risk-adjusted rate of return".

@Bryan Hancock 

Thanks for the point out on the mortgage calculator. I had linked to that as well in my second post, but if you didn't read it I don't blame you. I was really getting in the weeds. Also agree re: cost of equity.

@Ryan Dossey 

What you're really after is a property management policy and procedures manual.

You might consider Landlord Source. You can fully customize their manual and they already have many default policies in the template that you can use.

Regards,

Nate

Disclosure: I have no relationship with them, just a satisfied customer. The owner and author of the manual is a very experienced property manager and long-time member of NARPM.

@John Chapman 

Completely agree. Do the hard work up front. You will generate economies of scale by doing everything right the first time.

On each successive property, I find myself spending more time "getting it right" prior to placing the for rent sign in the yard. 

A property that has been gone over with a  fine-tooth comb will rent faster and for a higher price. Tenants can tell right away when they walk in to a property. They also take better care of the property, because they know how much work went into it and that demonstrates your concern for the condition of the property.

Your return on investment will thank you.

Edit: If you don't want to read a bunch of boring calculations and just want an easy way to determine the "rate of return" on points paid to buy down an interest rate, I found this calculator. If you want to get into the weeds, continue reading at your own risk.

@Doug McLeod 

You bring up an important point that I had not thought of. There are tax implications involved in this decision as well. 

I reviewed IRS Publication 527 and it appears that there are several ways in which the points can be amortized. For simplicity's sake, let's say that I amortize the points equally over the term of the loan.  

In my initial analysis I also failed to take into account that the interest and principal amounts paid in year 1 will be different. Let's revisit the calculations:

Tax Implications

Option 1: 3.75%, no points

1st Year Interest Paid - $2,820.93

Amortized Points Deduction - $0.00

Option 2: 3.25%, 1.29 points ($993.30)

1st Year Interest Paid - $2,442.52

Amortized Points Deduction - $993.30 / 15 = $66.22

Total Interest + Points Deduction = $2508.74

Difference (Option 1 - Option 2) in IRS Deductions = $312.19

Assuming one is in the 28% tax bracket, option 2 would result in the loss of $87.41 in tax savings.

Principal Balances

The principal balances would also be different at the end of year 1:

Option 1 (3.75%) Principal Balance : $73,101.41

Option 2 (3.25%) Principal Balance: $72,949.92

Difference: $151.49

Conclusion

Let's revisit the total advantage gained by buying down the rate:

$226.92 in P&I payment savings + $151.49 additional principal paid down - $87.41 lost tax benefit = $291.00 total advantage

The adjusted year 1 "rate of return" on the points paid would be:

$291.00 / $993.30 = 29%

Whew. I'm sure there's a spreadsheet out there that does all of these calculations. If not, there needs to be! Edit: see top of post, of course there is one!

If you're still reading, thanks for sticking with me. I realize that's a lot of effort only to discuss the rate of return on a measly $1000.00 investment!

@Bryan N. 

Thanks for the kind words!

@Cal C. 

I guess it was partially a rhetorical question haha. It is in fact a blog post I wrote this weekend for our website.

I am hoping the topic will elicit feedback from other investors on how they go about making the decision. I am not so bold as to assume mine is the only way.

Regards,

Nate