I’ve always been very interested in real estate. I can remember as a young kid in the back seat of my parents’ car looking out the window and wondering who owned all the houses we were passing or who owned the office buildings in the distance. Even then I thought “wouldn’t it be nice to own these buildings and rent them out and ride your earnings into the sunset?” If only it were that easy.
Fast forward to today and I’ve spent the last few years seriously considering purchasing both residential real estate and commercial real estate. I live in a very high cost of living area outside of New York City, which I’ve come to realize makes finding those hidden gems where you can really make a decent return hard to come by.
Everyone who’s in the real estate game knows the money is made when you buy. Find a steal of a property and it could provide a nice, semi-passive, cash flow stream.
Here’s an example of a property I found in what would most likely be considered a Class B area (Class A being the best with low crime rates, better schools, decent amenities):
- Two-family (5 bed/2 bath) house for sale for $315,000.
- Taxes $8,690/year
- Rent potential: $3,300/month
- $1,500 for the 3 bed/1 bath unit
- $1,100 for the 2 bed/1 bath unit
- Close to transportation, some restaurants and other amenities including a park
- Listing claims house is in need of TLC
For the sake of simple math, let’s say I’m a good negotiator and am able to purchase the house for $300,000. Of course, I’m putting down 20% to avoid private mortgage insurance which equates to $60,000. Let’s assume $5,000 in closing costs and another $5,000 in costs to give the house some TLC. So for the first year I’m into this house for $70,000.
Here’s what the numbers look like for the first year.
- Rent: $2,600.00/mo
- Mortgage: $1,146.00/mo
- Taxes: $724.16/mo
- Insurance: $83.00/mo
- Property Manager: $260.00/mo
Total Expenses: $2,213.16/mo
Net Monthly Income: $386.84
Net Yearly Income: $4,642.08
My assumptions are as follows:
- I’m able to rent both units for the requested rent immediately after closing and updating the units.
- I was able to secure a 30-year fixed rate mortgage at 4%.
- Insurance is approximately $1,000/year.
- I’ve decided to pay a property manager to maintain the units. Going rate in my area is 10% of the monthly total rent.
If I chose to secure a 15-year fixed rate mortgage at 3.3%, my net monthly income would be in the red at ($164.16).
The net monthly income figure with the 30-year mortgage isn’t nearly high enough to get me excited about this idea. Nor does it make me want to tie up $70,000 in the first year.
I also researched cheaper houses in a worse part of the same town to decrease my initial outlay of cash (lower down payment, etc.). However, those neighborhoods don’t warrant the same rent figures, so the outcome would be even worse then the example above with lower monthly cash flow.
The figures above also don’t take into account issues that come up. Ideally these would be budgeted for, but the margins are so thin already, this deal just doesn’t make sense financially.
I have also researched the option of an FHA loan, which would provide a lower interest rate. However, living in the house does not work for my family and me, so that option is out.
While I understand and appreciate the thought of someone else paying the mortgage for me, there are still serious risks to investing in residential real estate. While I can overlook most of these, my biggest concern is vacancy risk. The property manager I hire would be responsible to find and vet potential tenants, however, there is no certainty that they will be able to find tenants quickly that pay on time, do not destroy the place, and sign multi-year leases.
There is also the risk of not being able to sell if need be. That’s why I hadn’t even considered researching this idea until our emergency fund was fully funded and we were maxing out our 401ks and other investment vehicles.
Real Estate Crowdfunding
I have also toyed with the idea of crowdfunding real estate investing. While I appreciate and admire the work that companies like Realty Shares and Fund Rise are doing to bring real estate investing to the masses, I find it difficult, if not impossible, to jump into these ventures for several reasons.
First, the vast majority are in locations where I have never been to or know anything about. I have a very hard time investing in something physical and concrete when I haven’t visited the property and kicked the tires.
Second, I would need to place a large amount of trust in the ability of the employees of these companies (whom I have not met personally) to perform the proper due diligence to the standards that I would uphold.
Finally, investing in a property outside of my home state would require the company to send me a K-1 for tax purposes, which sounds like it would just complicate my taxes even further.
I do think the low investment minimums and diversification opportunities are beneficial if that’s the kind of the investments you’re after. However, I’m not sold on this as an option to build real, lasting wealth.
For now, I’m sitting on the real estate sidelines and enjoying the significant bull market we’re experiencing in the markets at the time this post is published. The most likely plan is to eventually invest in parts of the country where there are higher yields. This will also afford me a lot of diversity.
Have you invested in rental real estate, either residential or commercial? Did you struggle with the same items I described above? Let me know in the comments below.