Buying a second house

[senorfartman]

The back story:

I'm 24 and purchased my first home last August in Baltimore City in an 'urban revitalization' neighborhood for $165,000. It is a 3br, 2 ba on 2 lots and if the area turns over like Federal Hill and Canton, I should be sitting on a nice little payday in a couple years.

However living in Baltimore City isn't exactly where I'd want to raise a family. What the house currently has going for it right now though is the location. It is walking distance from UMD med school (new crop of renters each year), 2 minutes from 95 N/S and 10 minutes from BWI.

My current tenant offered to rent the entire house out with a few of his work friends who are flight attendants and basically need a place to crash. In doing so, they would pay my entire mortgage and allow me to leave the city.

Real Estate is something I just really enjoy. I like working on houses and fixing them up and such. With the market sucking worse than a saigon whore in Maryland currently, purchasing a 2nd house with the 1st rented out is becoming more and more of a viable option.

A few waterfront homes are opening up and have been on the market from 1/2 to a whole year with the pricing coming down below what they have paid. In this area, waterfront is very hard to come by and when the market rebounds, I'd be sitting on a cash cow. Of course these are fixer uppers but they'd be in nice neighborhoods outside of Annapolis where the chances of being picked off in a drive by decrease substantially.

The facts:

*I bought a house for 165,000 at 7.125% because at the time I was technically unemployed (laid off) but I was still receiving paychecks because I had a year long contract.

*At the time I was making $36,000

*I'm refinancing as soon as I get my first paycheck. I'm going back through the lender I used and should get me down into the low 6's making my payment decrease from $1450 to ~$1200

*I'm an hourly employee that travels 50% of the time for work. The only reason I requested hourly is because of the massive amount of overtime you make in the TV industry. This past week alone I have 35 hours of OT

*Currently, with the shows I'm scheduled for, I'm on pace to make between $50,000 and $60,000

*The neighborhood my current house is in is prime for renters due to the proximity to the inner harbor, Orioles/Raven's stadiums, medical school, airport and highways

*With 3 tenants, I could easily get $400 per head. Currently I get $425 the renter in my basement

*Even without the place rented out, I could still afford both properties.

*The places I'm looking at are near the Chesapeake Bay or tributaries and are under $250,000. Realistically with the market in the ****ter and some houses being on the market for over a year, it puts me in the driver's seat for negotiation

*I'm in no rush whatsoever so I can really take my time and start saving up again.

CN:

*thinking about buying a 2nd house

*am refinancing my current house in Baltimore City and then renting it out

*income is around the 50 - 60k mark

*houses on the water in and around Annapolis, MD are becoming attainable again

*dream of becoming a slum lord could finally become true

So what sayeth OT? I think I included all the vital information. If I left anything out let me know. I haven't slept much in the last 40 hours or so from traveling with work

 

[sirsloop]

You're asking a bunch of drunk guys on your homebrew forum for financial advice?? LOL!!

Want my opinion? You've got a lot of cash tied up in real estate and probably not enough liquidity. What if... your bank isnt going to let you take cash out of your mortgage if you hit the rocks.

I would seriously to have a talk with some professional financial advisor's before deciding on ANYTHING.

 

[MikeFlynn74]

You make 60K and you are looking at purchasing a second house in the 250s?

wow.

 

[brauhaus]

save what money you can... $36k a year with $1400 a month mort sounds steep... granted $50-60k is nice, but I'd wait until you start making that much and then give it a year to check your finances...

the best thing would be to talk to a Financial adviser.

 

[Ryanh1801]

You make 60K and you are looking at purchasing a second house in the 250s?

wow.

Thats what I was thinking.

 

[the_bird]

You can make some pretty good money leveraging into real estate.... but that's also how so many people have gotten into big trouble in the past year. The risk is that you are unable to keep good tenants. Remember, there are a LOT of rental properties available these days; everyone and their brother who bought a second house as an "investment" and is now worried about it being foreclosed on is trying to find renters. If you aren't in a position where you *could* cover both mortgages without having all the units rented, you're taking on a huge amount of risk.

 

[ohiobrewtus]

With a possible recession looming you may want to hold off for a while. At least I would.

Bird makes a very solid point about having the ability to cover both mortgages in the event that you can't find tenants. If you are unable to do so, then it should be an easy decision.

 

[zoebisch01]

If you have the cash flow, then now (well soon) is a good time to buy. Wait as long as you can for prices to fall more. Cycles are typically 5 to 7 years. And you need to secure a mortgage with low low interest. Renting a house is not for everyone either. If you really want to do it, there is no better long term investment as long as you take advatage of every single tax break.

Short term rigidity (in the form of static assets as mentioned before) can be a real ball buster if you have tight cash flow to begin with. The big thing in your favor is that you don't have to support a family. You can cut your losses at any time if things went sour and only impact yourself. If you wanted to live on the waterfront, here's what I'd do...buy the house, fix it, rent it. Then when the market turns again, sell your current home for plenty of cash, pay off the waterfront home and then wait for the market to dip again and then reinvest.

One other word of caution. Make sure you have a realistic idea of the cost and amount of work needed on the home. It is very easy to underestimate. Better to overestimate and have leftover cash. Plus look into any incentive for improvements, i.e. window replacement tax rebates, efficient heating rebates, etc.

It's a risk, yup. But you do have the potential for great gain if you approach the problem logically. And again, there are no garuantees that the market will shift again, but historically that is what happens.

 

[TexLaw]

Listen to Bird and the others. You don't have to agree, but listen. Rental income is not guaranteed.


TL

 

[zoebisch01]

Rental income is not guaranteed.

That's another point I forgot to emphasize. Make sure you have at least half a year's mortgage payements tucked away, and cash on hand for emergencies. Also make sure you do your homework on the current rental market in that area. Just because it is bad in areas around the nation (actually this is generally true, we just see it more now because of the people who got wrapped up in subprimes so it is coming into the media) doesn't mean it is bad everywhere. People always need a place to live, you just have to make sure that the numbers work and you can get what you need.

 

[kornkob]

And you better spend some time with a lawyer who is up on what a landlord can expect in your market. Being a landlord sounds like it is easy on the face of it. 'It's just like being a roommate but you don't live there' is false.

A landlord typically has specific requirements they have to fullfill that are often not widely known or understood (because landlords don't WANT tennants to know the law) but those laws can hit you where it hurts. The following questions are all relevant to becoming a landlord and this list is NOT inclusive:

-You prepared to pay interest on the security deposit?

-Speaking of security deposit: what can you ask for and what can you hold back? What documentation is required for holding back money?

-You gonna have liquidity to fix the heat/roof/electrical/appliances/windows inside 24 hours if they are damaged?

-What is the process for suing a tennant for back rent/eviction? How soon after a missed payment can you do anything about it? How long after the process starts can it be before you actually get them to vacate?

-What standards are you allowed to apply to applicants? What questions can you ask? What things can you require NOT be done/kept at the home?

-Are you required to accept Section 8 applicants? (And if you do not know what section 8 is that's a new question)

-Does the community you are renting in have any laws that allow the city to take your property away if someone is using the property for a criminal enterprise? (Yep-- those laws exist) And are you in a position to monitor the property for criminal activity?

-Is your insurance going to cover you for renting?

-Can you do basic repairs on the property (fix roof, replace electrical fixtures, basic plumbing) or are you required to pay a licensed pro to do them?

-When a tennant calls you with a complaint, what are your responsibilities and what are the repercussions?

These things are all handled DIFFERENTLY in different communities and in some communities landlords are really on the losing end especially if the tennant knows their rights.

Becoming a landlord is very much like starting a business and you really need to approach it like a new business venture. Make sure you have the proper business plan and have your ass covered from both the finanacial and legal angles.


One last thing: this roommate of yours. The moment, the very instant you sign the new mortgage, that's the moment that he stops being just 'your friend you live with'. He and his roomates instantly become your customers and tennants. Your relationship changes. Get in front of that early and often.

 

[srm775]

Everybody here posted very good things you should make note of before you consider buying a second house and becoming a landlord. Since I stayed at a Holiday Inn last night, I thought I'd add to it:

1. If you're buying a new house without sufficient down payment, you'll have to pay PMI. Don't forget that and lenders are getting more strict with PMI and down payments now.

2. If your interest rate is 7.125%, then your credit scores don't appear to be the best. If you're purchasing a second home, then you'll end up with a similar interest rate. Also, since the real estate market has taken a huge dive, you'll have very little equity built up in your home since homes aren't increasing in value like they traditionally have been.

3. IMPORTANT: Whatever rent you recieve from from your property will be considered income and you'll have to pay taxes on it. Though you'll recieve federal tax deductions for your mortgage interest, I don't believe the deductions are as much as your mortgage interest on your primary residence. So, if you're only covering your mortgage, then you'll be at a net loss.

However, if you sit down and go through everything very carefully with a lawyer and an accountant and proceed with caution, you could quickly build a very solid base of wealth.

 

[Donasay]

The key is to get your second house super cheap. I can't afford to buy a place now, but I have been looking, and when I see a place I like, I check and see how long it has been on the market. If it is longer than 6 months I make a super lowball offer, i.e. 50% - 75% of the asking price. One time I actually had someone get back to me with a counter offer, they were obviously desperate and I was the only person with an offer, I told them my initial offer stands and was good till the next day at 5:00. I didn't hear back from them, but you can bet your ass that if they had said yes to 120,000 for a place listed at 220,000 I would have found a way to make it work.

 

[Bulls Beers]

I have some rental property. There have been times where I wasn't getting rent from a few units. It sucks..I've been lucky with some good tenents now..There are some real horror stories out there. Make sure you have enough capital in reserve, do your homework and good luck..

 

[homebrewer_99]

I remember going to the finance officer for my first home. They told me I could get up to 3X my annual salary. At the time I was only making about 25K. The thought of being in that much debt scared me then.

My current house is worth 250k even though I only paid 132k. I could have paid it off in cash, but I didn't want to let that much go at one time. I did pay it off in 2 years 2 months.

I've been where you're describing so I know the neighborhood somewhat. Your description/situation sounds great. I would do it.

 

[senorfartman]

Sorry it took forever for me to reply but thank you for all the comments.

The reason my interest rate is high as **** is because at the time I closed I was technically unemployed and the lender used some creativity to get me in. My credit score is around 750-780 last I checked.

I'm a little anal retentive and always have around $10k in checking which is stupid but I come from a long line of people who kept their savings in their mattress.

With my new job, I would be able to afford both homes granted I would need to cut back a bit on this life of luxury that I currently afford myself :haha:

As per renting, more than likely I would claim my Baltimore house as an investment property to deduct the entire thing so I don't get hosed with the income tax.

My current tenant is I think like 60 years old and a Vietnam veteran so hopefully I can keep him around as long as possible.

Some new scenarios rose as well. He has offered to purchase the home. I think I could get around 180k which after what I've put in, would be about $5000 in my pocket. I just keep having nightmares about kicking myself in a few years if the area continues turning over at its current pace.

I'm not looking at a 250k house. The one I'm semi interested in is listed at 179k but has been on the market for 2 months and was originally listed at 229k. I'm absolutely in no rush whatsoever so the earliest I would do anything would be around the summer time.

Basically I'm not jumping into this blind. I've known my previous RE agent for 10 years, I coach with 2 RE agents that work in the area and coach with another who used to rent properties and I'm buddies with my lender. On top of that, all of my friends and most of my family are in someway associated with construction. The house for 179k is almost assuredly a dump but it would be a fun project.

 

[MikeFlynn74]

The house for 179k is almost assuredly a dump but it would be a fun project.

No such thing.

You really should be making enough money to cover both sets of bills, motgages and any issues that may come up.

I bring home 70K and wouldnt even think of a second house let alone one that needs any work whatsoever.

You may think you have it planned out- But you probably dont know all the Tennant landlord laws, state laws and state taxes.

Most states say that a tennant can stay for up to 90 days without being forcably evicted- then what happens if they trash the place? You cant go after someone who has 0 money and then add lawyer fees.

Id seriously stick to other invetment options if I had the disposable income.

 

[zoebisch01]

Some new scenarios rose as well. He has offered to purchase the home. I think I could get around 180k which after what I've put in, would be about $5000 in my pocket. I just keep having nightmares about kicking myself in a few years if the area continues turning over at its current pace.
.

Unless you are desperate DO NOT SELL. 5k in your pocket is a pittance when it comes to homes.

 

[jas0420]

I've done the buy it/live in it for a while/move out and rent it thing a couple of times in the past. Easy way to get rental property since the down payment is typically way less for owner-occupied property. Still have one rental property now. I've personally had good luck.

I may have missed it if anyone pointed it out above, but one thing to consider is lenders won't accept 100% of your rental income as income towards your new mortgage. Last time I did it, they allowed 75% of what I was leasing it for as income. They do that to cover vacancy. These were national lenders, but for property in TX. Perhaps that allowance changes from state to state, but just wanted to point that out so that you can take it into account.

I use a property management company for mine. They take 50% of the first month's rent to advertise the vacancy, screen (credit & background checks) potential renters, and take care of all the legal paperwork. After it is leased, they charge 8% per month to manage the property... That includes things like collecting rent checks, taking all of the calls for maintenance, locating and scheduling contractors, etc. The actual expenses of which are still passed on to me, but I personally think it's worth the 8% to be "hands-off. It's mailbox money at that point!

Good luck!
jas

 

[Bobby_M]

3. IMPORTANT: Whatever rent you recieve from from your property will be considered income and you'll have to pay taxes on it. Though you'll recieve federal tax deductions for your mortgage interest, I don't believe the deductions are as much as your mortgage interest on your primary residence. So, if you're only covering your mortgage, then you'll be at a net loss.

Also just a Holiday Inn guy....

Maybe I'm missing your point but I'm always confused when people caution against earning income due to the tax liability of that income. When you have a rental property, the rent money is income but the cost of owning that property is deducted from the income just like any other business (though I'm sure rentals have slight nuances). When you need a new roof or furnace in your primary residence, the IRS couldn't care less. When it's a rental property, that expense is deductible.

Even though the RE market is flat as a pancake, a break even rental could be a good investment if it's well-leveraged (doesn't have too much of his own money tied up). The math needs to consider the current equity (house's current value minus what he owes) and the net annual growth in equity (this can be increased by value appreciation but is otherwise just the principal being paid down on the mortgage). A really general example is: Paid 165k with 20k down. The annual principal goes down by $1k a year, no appreciation, break even income. That's a 5% return right? Of course, that's based on a minimal equity right now. If you have 50k tied up in the property, that $1k of principal reduction per year is a sad 2% and you will then be banking on appreciation to make it worth it (Or you need to be making enough rental income to add to this annual return). If neither, sell the place.

My grandmother was a mattress saver because she couldn't stand making a dollar interest to pay the IRS $.20 of it. I couldn't get her to understand it no matter how many times I tried. I still catch my mother saying things like that.

 

[jas0420]

I agree w/ Bobby_M. The tax system is very favorable to property owners. In rentals, your mortgage interest is still deductible, your maintenance expenses now become deductible, you can depreciate things like a dishwasher or AC replacement… It by no means is a given that you’ll get rich, or break even for that matter, but if you’re payin’ taxes, you’ve almost certainly made some money in the process. I’m content with just breaking even, or taking a little loss even each year. Some years I’m positive, some I’m negative. The property is appreciating (hopefully that continues!!) though and the mortgage is decreasing so to me, that equity is just another form of savings that I’ll cash out on some day. On the topic of cashing out, do note that unlike selling your primary residence, you pay taxes on your profits. Again, it just means you’re making money IMO, but it’s there nonetheless. You can postpone this tax by doing a 1031 Exchange (buy another rental property with the profits).

All that said, be sure to find yourself a good accountant to help you along and make sure you jump through all of the right hoops and give you professional guidance.

 

[shaundesjardins]

I wish I could offer you some advice but as a risk manager for a bank here in Canada I work with different guidelines and we're in a different real estate environment.
Generally a rental property can be a good idea just mitigate your risk as much as possible by have liquidity on hand if needed. (the suggested amount varies but I would suggest at least 3 months of living expenses)
Do your research with your RE agent on how the rental market is doing in the particular area. (vacancy rates, rent prices etc.)
If you have a good tenant lined up already that can be a bonus.
Either way, just think it through and make sure you're on solid ground financially first and foremost.