Help a Reader: To Buy or Not

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

I am interested in buying an additional vacation rental property as an investment (instead of stocks or mutual funds) and would like to know if my logic is okay or just plain crazy. 

• We are married.
• I am 60 my wife is 58.
• We are both retired.
• Our current combined incomes are about 72K plus 13K rental income.

We own the following outright:

• Primary Residence outside of Boston worth about 350K
• Vacation rental property within an hour drive that is worth about 300K and nets about $13K annually - we currently perform all management of the rentals

Our investments:

• 401K's that total about 700K
• Savings/Cash 280K

We would be taking the all of the cash (that is not earning much) and using it to pay for that new property.  It would net about $13K. I am reasonably sure that it would net that much as the one we currently own it is in the same location and will be offered at the same rental rate as our current property.

We currently sell out our rental every summer by mid-March
 
My question is should we do this or just invest it.
 
I will only want to keep both of them for  approximately 5 years - so you think it will be worth it with capital gains and property values (up or down).

We will probably keep one as leverage if we live long as rents will increase with the cost of living and our pensions will not

OR

should I just invest in some very secure instruments?

What's your advice for him?

Comments

[cmadler]

13k on 280k is 4.6%. And since you perform all management, you have to consider the hours you put in as well. The only way it's worth it is if you think the property value will rise significantly during the next 5 years. If the property value is relatively flat, I suspect you could do better than 4.6%, and spend less effort on it by investing elsewhere.

[Nate]

I would NOT do that. Don't make a bet on wether you will realize capital gains. I would like for a good Muni bond and sleep easy. ALSO -- you would be adding additional property management to your workload -- just let your mney work for you while you chill! Plus don't forget that rates WILL rise in the future for secure instruments. Maybe go with some CD ladders to take advantage of that.

[Strick]

If it is as much of a duplicate of the other property as the reader says it is, the two will rise and fall together with the local property values. To have half your net worth in these houses is not the kind of diversity I'd think you'd be looking for at this age, especially with only a 5 year time frame for the one. With even just a slight drop in property values over the 5 years (can't imagine that price point at that location is too volatile like a $1M home could be), you would have done a lot of work and used a lot of capital for nothing, or worse.

Of course, as long as the current pension/rental income is sufficient for now without touching the 401Ks, sounds like this person has the room to take this sort of risk, and it could obviously pay off greatly. I'd at least calculate the net after hiring a management company to see what that looks like in case in 5 years property values have gone down and you don't want to sell but you no longer what to manage the property.

[Paul]

No no no. I would roll some of the cash into foreign stock funds (preferably Latin America and emerging markets) and some into bond funds, and keep some as cash. This is much less risky and much less of a headache than a 4.6% rate of return and a big headache from another rental property.

[Mr. Cheap]

I agree with the other commenters, I don't think this is a good investment. 5 years is a VERY short time frame to be hoping for capital gains.

[mikegardner64]

I was ready to say "go for it" until you mentioned you would be selling in 5 years. Given that, I would either keep some of it parked in a money market account and put the rest, say 70-80% in either Treasurys or other bonds. With as short a timeline as you've given, you can't guarantee the property will appreciate faster than what you could get by investing it. If it were longer than 5 years, I would say "go for it".

[Darin H]

I'm with the others, selling in 5 years? You should absolutely NOT do this.

[Mike B.]

As with the others, my guess is you can do about as good as 4.6% without the hassle or the risk.

My question for others that have commented: why not buy something dividend producing/fairly stable, like an energy stock. I don't have much in it (just the $1K I used in my Chuck Schwab account I opened to get my 2% back), but it seems so solid and income producing (the dividend is ~5%), that I'm wondering why I shouldn't pour a lot more into it. The 1.something I am getting from ING makes me cringe. What am I missing here?

[Budgeting in the Fun Stuff]

I wouldn't do it if you're selling in 5 years. Look into stable, high dividend stocks or something...not short-term rental property. You don't want that much tied up in one area anyway, right? Good luck!

[jim]

Don't do it. 5 years is too short.

1) sinking all their cash into an illiquid investment, 2) $13k on $280k return rate isn't high at 4.6%,
3) sales costs will eat your returns. You'll have to pay realtor commissions, closing fees, title search, etc. Figure those in and your return over 5 years is closer to 3%.
4) I'd expect that the property will appreciate in 5 years, but theres no guarantee. Theres a risk that property values could go DOWN.
5) Your income isn't guaranteed. What if you can't rent it? What if the furnace breaks down? What if the city raises your taxes or a drug dealer moves in next door?

Seems if you buy this then you'll end up doing work to get yourself ~3% before taxes and lock up all your cash in the process with some downside risks. On the other hand you can get almost 3% in 5 year CD's with zero risk.

I'm generally a fan of real estate investing, but in this case I don't think it makes sense.

[segfault]

Something to think about: You will probably not be able to perform all management and maintenance as you get older. You will have to hire a property management company if you keep the property, and that will get expensive.