Thanks Everyone!! Re Should I Use Equity - Posted by Brenda

Posted by Dave T on August 11, 2007 at 11:57:00:


You may also want to reconsider your plan to use 15-20 year loan amortizations rather than 30 years. I know that the long term goal for many buy and hold investors is to own property free and clear. Shorter loan terms may get you there faster and may have slightly lower interest rates.

Shorter loan terms also carry higher monthly loan payments, which means lower cash flow or maybe even breakeven cash flow for marginal markets.

I suggest you consider that the most experienced buy and hold investors are not buying a property, but instead, they are buying the “cash flow”. This investor buys a property that produces a monthly income stream and a lump sum cash flow when the property is sold.

Buy and hold investors want to minimize the amount of cash out of pocket that they put into a property to produce an acceptable cash flow. They prefer to let their tenants buy the property for them. They still get to free and clear properties over time, just with their tenants’ money.

By minimizing the amount of out of pocket cash you invest in the property, by taking 30 year loan terms that have a smaller monthly payment, you will get a better return (yield) on your invested cash.

Nothing prevents you from using excess cash flow to pay down your mortgage loan faster. You can always pay off your 30 year mortgage in ten years by sending in a double payment every month. If you do so, then you are doing it with your tenants’ money. If you don’t have the cash flow to pay off the loan any faster than a 30 year amortization will, then you are not in the negative cash flow situation you would have with a 15 year loan.

Just more food for thought.

Thanks Everyone!! Re Should I Use Equity - Posted by Brenda

Posted by Brenda on August 09, 2007 at 20:23:01:

I also posted the message below under my original post, but I am including it as a new post so that you guys will see it. Thanks again for all your great advice!!! FYI, I prefer to keep things simple as I am new to this.

Wow, everyone has given me great advice. Let me give you some numbers on a property I am looking which happens to be a neighbor.

First - Background:
I know the property is reasonably priced based on other sales in the area. The indv. has not listed the property yet, so there would not be realtor fees.

He told me (before I showed any interest), that a realtor advised him it could be placed on the market between $109K to $117K. It is in a nice tree lined street. It is a smaller home with only 2 bedrooms. There are no updates needed, except for new shingles needed on a very large garage. I understand I would need an inspection and title search done. He was also told by the realtors he could rent it between $800 - $900 mo. He and his family used to live in the property. They moved and had it on the market 2 years ago for 5 months. It did not sell. In the meantime he has gone through a divorce and is now looking to remarry soon. He and his new wife are both selling their properties to buy a joint property. He had been renting this property, but it is currently vacant; however, it is an easy property to rent and there is already a tenant lined up. He also has 2 side garages; one of which he has been renting for $40 monthly for the past 7 years - the other one could be rented out as well.

Okay, now the numbers:

As I said, asking price will be between $109 - $117K

Gross Rent: $850
Vacancy Factor ($42) (5%)
Net Rent $808

Management Fee ($51.00) (6%)
Maintenance Reserve ($64.00) (8% of net rent)
Taxes: ($141)
Insurance ($66)

Net Rent: $486
Plus side rent for 1 garage: $40

Total Net Rent: $526.00

I’m not sure what I could get the property for, but thinking between $85K - $93K. Is that enough of a discount?

Okay, how do I make this work so that mortage is less than $526.00?

I have about $5,000.00 cash. I have great credit.
I have 100% equity in my home. I guess I could sell some stock that is currently and has been for some time at a loss to add to the down payment. What is the best scenario for me. Using 100% equity just to keep payments low until rented for sure, and then mortgage the property to pay back HELOC? Use HELOC just for deposit? What are the best types of loans? I don’t think I have a problem making a 30 year mortgage work with these figures, but I believe an investment property should be at a 15 - 20 year rate.

You guys are great. I appreciate any advice.


Re: Thanks Everyone!! Re Should I Use Equity - Posted by Dave T

Posted by Dave T on August 10, 2007 at 14:42:07:

Your vacancy allowance is too low. A 5% vacancy is only 18 days a year. With a single family dwelling unit, better plan for one full month of vacancy per year or about $71 per month for your vacancy allowance.

Additionally, you made an allowance for property management for the dwelling unit but no allowance for the garage. Who will be collecting the rent on the garage if your property manager is not doing it? A 6% management fee seems low. The best rate I am getting is 9% and that is a discount for having multiple properties under management with the same company.

Let’s say you rework your numbers and your net monthly income turns out to be $500. You want this number to be at least 125% of your loan payment to ensure that this net income covers the monthly payment and leaves enough left over for the unplanned expenses that always come up.

Divide $500 by 125% and you get $400. This means that the maximum amount your rental income can afford for your monthly loan payment is $400. Now, we need to know what your loan terms will be to calculate the loan amount that would have a $400 monthly payment.

We can make some guesses just to get a ballpark figure. Let’s assume that you can get a 30-year fixed rate, fully amortizing loan at 6%. I don’t have my financial calculator in front of me, so I am going to guesstimate that a $66,675 loan would have a $400 monthly payment.

If these are your loan terms, then $66,675 is the largest loan you could put on the property and still have sufficient cash flow to support the property. If your purchase price is $85K, then you will need to bring about $20K to the settlement table for downpayment and closing costs.

To improve your cash flow, make a larger down payment. Hope this helps.

Re: Thanks Everyone!! Re Should I Use Equity - Posted by Bill Jacobsen

Posted by Bill Jacobsen on August 10, 2007 at 10:31:49:

You did a great job of estimating the net income from the property. Getting 7.4% net income from a property (assumes purchase of $85,000) is a good number in my part of the country. Adding a 3-5% appreciation factor to this gets you 10.4-12.4% total income. This is good for a rental but is not one in which I am going to borrow money on. To borrow money, I require st least a 10% spread. In other words, if it cost 8% to borrow I will require an 18% minimum return. I certainly am not going to risk my home for an investment.

I would consider this property to buy and then lease/option it out over a one to two year period. The numbers would propbably work to create a 20% annual return. Another alternative would be to flip the property if you could buy for $85,000 and list with a RE agent for $109,000.

Under the flip or lease/option alternatives I would be willing to borrow if I didn’t have the cash on hand. I usually use cash to buy but if I am short I am willing to use HELOC’s on other investment properties.


Using equity - Posted by dealmaker

Posted by dealmaker on August 10, 2007 at 04:19:40:

Forget about using the equity, or any other way of buying this, it’s not a good investment!

Let’s assume you can get it for $85K and your net rent is $526/month, that’s $6312/year. That’s about 7% on your money. That’s a bad return in my book. BTW, I didn’t see an allowance for redoing a roof.

At least you had reasonable figures for your other expenses, vacancy, management etc. Most newbies ignore those things and then lose their butts.

Your gross rent is about 1%/month of purchase price, right there that’s a bad deal.


Re: Thanks Everyone!! Re Should I Use Equity - Posted by Brenda

Posted by Brenda on August 10, 2007 at 17:50:34:

Actually, my rate is 7.2%.

Its seems like the chances of making this work are getting slimmer and slimmer. Coming up with 20% down would be a big chunk of change for me.

Thanks for everyone for your very helpful insight.