Help a Reader: Investing in Real Estate

Here's an email I recently received from a reader:

I am married with a 4 year old daughter and a 6 month old son. I will be turning 29 next week. For 28.5 of those years, I was a complete spendthrift with the attitude of "why make money if you can't spend it." Today, I can give you roughly 29,250 reasons why (that's not even counting student loans!). You see I have large balances on 2 credit cards and a small business loan that I am paying. With your help, and the help of other personal finance blogs on the net, today I can proudly say that my lifestyle has changed. No longer do I charge expenses on the credit card. In fact, both of my credit cards have been cut to pieces the day I said enough was enough. No longer do I pay minimum balances on my debts. I have successfully paid off a small furniture credit card and several small medical bills utilizing the snowball method of debt relief. I am now paying $1,050/month towards the credit card with the lowest balance. I plan to have it paid within 4-5 months. No longer do I spend money on frivolous wants. No longer do I ignore the coupons that arrive in Sunday's paper... The list can go on, but the point has been made; I am a changed man.

Since my transformation, I have opened a savings/emergency account. I currently transfer $30/week thanks to a small raise I received from work. We're living off of the same amount of money, yet, I get to watch my savings grow. I also opened a Roth IRA via Sharebuilder this month. I only started with $100, but I want to get into the habit of paying into that account.

I pay mortgage on a 2 bedroom condominium (about $850/month for mortgage, PMI, & escrow + about $200/month in HOA). We've only been there 2.5 years, so I pretty much owe the full amount. We really like the location in the small city where I live. We are also roughly 50 paces from my mother-in-law. After my mother passed away, I decided it was important for my daughter to live near her grandmother, so we moved from 900 miles away to 75 feet away.

Now for my question: The lady in the condo right next door to us is moving. She hasn't listed the condo for sale, but she has approached us and wanted to know if we are interested and that she'd give us first 'dibs' on the place. It is a 3 bedroom and is literally adjacent to our 2 bedroom. We did not discuss the price at all, but she said she'd be willing to do owner-financing.

In short, if the price is right, should I buy it?

My thought is this, buy the condo and move my family right next door since its a bigger place. Then, rent out the 2 bedroom where we are currently living. In the time that I spend looking for renters, I can use the 'snowball' that I've accumulated from paying off credit card debt to carry the second mortgage. Meanwhile, back to paying minimum balances + any little extra on debt. As soon as someone starts renting, I can return my snowball to its rightful place; paying credit cards. Once credit cards & loans are paid, I'd like to continue (the majority of) that snowball to the mortgage of one of the properties.

Long term, I would consider opening up the two condominiums and creating a large 4 bedroom 4 bath living space with tons of extra space (i.e. home office etc.) Or simply rent both units and find a house somewhere else with my family.

The pros

• more space for my family
• having a rental property right next door
• potential to one-day join the condos into a super-condo

The cons:

• complete and utter fear of having a second mortgage
• ~$500/month in HOA fees (for both units)
• living in a condo vs a house
• delaying paying off my loans

I value your advice and would very much appreciate your two cents.

I gave him my advice and asked if it was ok to share this with all of you. He said he'd love to hear your thoughts. So, what suggestions do you have for him?

Comments

[Angie]

I know its really tempting. And it sounds like there are benefits down the road. But I would think of the worst case scenario rather then the best case. Two mortgages and no job. Leaving your family homeless. Plus, where would you come up with the downpayment for this new place. I personally would not be thinking of investment properties if I had credit card debt.

I'm guessing there may also be regulations against your dream supercondo.

[Jim]

I would recommend they do NOT buy a rental property at this point.

I think they should get their credit card debt paid off first. Sounds like they've got a couple more years to pay that off. Putting the cash towards the credit cards will be the best return and safest move in the short term.

Big reason they shouldn't do it is when they said: "complete and utter fear of having a second mortgage"
If they are not ready to be a landlord and confident in that level of risk then they should not do it.

I own rental properties myself and I think they are a great investment. BUT they come with a fair amount of work and added financial risks. What happens when the heater breaks on Christmas Eve? You're the one dropping everything and fixing it. What happens when the renter is "a little short" on the rent? You're out the money. What if you can't find someone to rent the place? You get no rent. I would only buy a rental property if you can handle paying the mortgage when you aren't getting rent. Rental properties are more like a small part time job than a typical investment.

Right now we've got a vacancy in a rental. It will be vacant with $0 rent for about 2 months. In the meantime we're making $1k monthly mortgage payments. We also have to fix up the place and will be putting a good $3k-$4k into repairs and maintenance. (renters aren't often gentle) This is not atypical for rentals. There WILL be vacancies and there WILL be maintenance & repair costs.

IF you are really interested in buying rentals then thats fine, but I'd get your finances in a little better shape first. Pay off the debts and give yourself some more margin in your budget.

Your fear of a 2nd mortgage is probably rationally based on your inability to easily cover 2 mortgages at once.

[Mike B CPA]

Don't do it! You have an excellent plan in place so see it through. When you are debt free and have paid most of the current condo mortgage then even better opportunities will come to you. Rental property is wonderful cash flow when it is debt free but a heavy burden when you have to service a mortgage with no rent.

[Stephen]

I second Jim's comment. Rental properties can be provide significant income, but require a lot of work and pre-existing capital to cover unexpected expenses and income gaps. There will always be examples of people who started with little extra cash and made it work -- but there are far more stories (especially these days) of people who tried it and soon were over their heads financially.
Chalk this opportunity up as yet another chance lost due to previous mistakes and yet another reason to get out of debt and build a solid savings that allows you to take advantage of such opportunities in the future.
It's easy to get so focused on the upside that you lose sight of the risks until one of them blindsides you :(.

[leah]

I agree with the above posters: Not now.

Your debt repayment plan is very good. It sounds like you have the drive to make it happen.

You mentioned you have started an emergency fund. With 2 kids and a wife, I would encourage you to keep saving until you have pay off all of your debt, you have 6 months of living expenses in the e-fund, then and start to pay down that mortgage. Also make sure you and your wife have adequate insurance.

It sounds like with a second mortgage you might be pushing the limits of all credit available to you (considering your high balances as well).
Remember that now *you* have the ability to pay down your debt (with God's help) but if you plan that rental income, you are relying on someone else, which may or may not happen.

[Shakela]

I think it depends on how hot the rental market there is and how good a deal it is. If it's a really good deal and he can carry the mortgage while still paying his minimums it's worth it. However, if he can't, then it doesn't make sense. Also, how secure is there income? Is his job at all unstable? Does his wife work? Does he have any other sources of income to help out if there's an unexpected expense or heaven forbid a layoff? What's the state of the emergency fund? If he feels stable then definitely do it, but don't turn it into a super-condo until everything else including both mortgages are paid off or you really really need the space (aka you have twins or something) If you're comfortable with the condo you're in then the chance to make extra money is a good one to pick up, but you're also taking on some big risks.

[Claire]

I think the line "complete and utter fear of having a second mortgage" is one that you should listen to. We have fear for a reason - to protect us from doing things that will otherwise hurt us. If you are terrified of doing something, then this isn't the time to be doing that thing.

[steve]

Sorry to burst your bubble but a single unit rental property is not a good real estate investment for one simple reason. You lose a month's rent and it can blow your whole profit margin for the year. Lose 2 months and it goes on and on. It could be years before you even start to realize a profit. Then there's the condo market. A majority of the condo buyers in the last few years have lost equity almost immediately. Find a 2, 3 or 4 family where the owner will take on some financing and use that as your down payment. Then play leap frog. Take equity from that property to buy your next, and so on. People pay me for this advise but I'm giving it to you for free.

[Ron]

You also listed in the "pros", "the rental unit is right next door". This can also be a "con". Remember, your renters may run to you with every little thing. Better to get out of debt first, then use the snowball method to purchase rental RE if that's what you want to do.

[Financial Samurai]

It really doesn't seem like you have enough finances to buy ANOTHER place if your first place barely has any equity.

Follow my 30/30/30 principle, and then maybe. Otherwise, keep your finances simple!

[Christine]

I agree with the posts above. Buying the 3-bedroom is too risky.

On another topic, wouldn't you get a better price on the 3-bedroom if you waited until it had been on the market awhile? In this economic climate, why jump at the neighbor's offer of "first dibs"?

[Josh]

Do not do it!!! Sounds like greed is starting to set in... I agree with all the prior posts. Its not worth putting everything you have right now plus your family at risk. Once your debts are paid and your above water then you can think about investing. Get the picture?

[dogatemyfinances]

If you're paying PMI, you don't even have 20% in your own condo, you know, the one you actually live in. Hate to break it to you, but that means you are BROKE, no matter how many $100/month accounts you have set up at the moment.

Besides, you can't get those 0-down, no cost mortgages anymore, and there's a reason for that. The last thing you want is a shady loan with a person instead of a bank.

There will be more condos when you have money. Until then, get rid of the PMI!!!

[Peter]

Don;t do it. You are just beginning to get your things in order. I hate to see you go backwards this because of not your spending but because of "over planning" or greed. Sometimes, waiting is the hardest thing. But, you have to stop the adrenaline rush.

[Richard]

Don't do it.

If you're only able to contribute a $50 here & there to extra savings, then you are not in the position to afford two mortgages. Keep on keeping on and don't chase the quick buck!! Put it this way:

IF IT WORKS...then you're looking at years until you realize a profit and living next door to your tenent who will want you to take care of every single issue.

IF IT DOESN'T WORK OUT...then you're stuck with two mortgages, no financial cushion, no bail-out, and a condo that requires you to pay HOA fees each month.

It's not worth it in my opinion.

[MBirchmeier]

For the most part I agree with the don't do it crowd.

If... and this is a big if, upgrading is a serious consideration, I might consider a house swap. You take her condo, and she takes your condo, (and likely you take a loan with her). You can take on a comfortable amount of risk, a comfortable amount of debt, have a slightly bigger house, and know *exactly* what your situation is at the end of the day.

I tend to echo the rest of the crowd though, I just don't think it's worth it right now. It sounds like you're doing a good job paying down debt, might as well keep at it until the job is done. (Which sounds like only ~2 years away!)

-MBirchmeier

[Crystal]

Diddo for the just-say-no vote.

1) You are finally getting out of debt. Concentrate on that and you will feel good when goals are achieved. If you get more debt, you will have more stress.

2) We rent out our third bedroom, and you do not want your renters so close. We don't hear about much (it's just a bedroom and bathroom in a 5 year old house), but we still have heard some really silly things. Our current roommate thought it was our problem when he needed someone at home to receive a package (we cleared that up real quick). Even our favorite roommate, who was low hassle, asked me to take a look at his cable box one day when his tv wouldn't work...his remote needed new batteries. Not a big deal, but it is still something to think about. Renters require time, patience, communication skills, and money when something does break...

PS Before someone asks, "Then why do you rent out a bedroom in your home?", because it is a relatively easy $500 a month for a couple with no kids and a 3 bedroom house in Houston, TX. I'm actually going to try to talk myself into not renting it out again after my husband gets his masters next year, but it will be really hard to give up the extra money...

[Phil]

Well, not much to say that hasn't already been said. But I agree with most posters. You shouldn't buy now. Try to stay with what you got and don't add any more bills, ie. second house payment. What you should do instead is try to pay off your present house payment by paying more on the principal every month. Become totally dept free and then you can think about ... bigger home. or rental property etc. Keep on the track your on... good luck

[Strick]

looks like there are different reasons you want to do this, but:

If this is a "purchase", you just can't afford it (you just started down a good financial path, but from your numbers you've got 3 more years of paying down just the credit card debt). If she gives you a great deal and you can sell your old place simultaneously for close to that amount, maybe you're making sense (but I'm not sure why'd you'd get a sweetheart deal unless this neighbor is really that good of a friend)

If this is an "investment", this is even worse than all of your eggs in one basket (you're borrowing most of the eggs)

[Always Asking]

NO--NO--NO

[Matt Goche]

I agree with everything whose advice was no. Patience is hard, but continue doing what you're doing!!! Look at how far you've come already and give it another 5-10 years. Then you will have some "real" money built up. Keep your eye on the ultimate prize!!!