Help with investment

General Real Estate Investing
1

Real Estate Investor gurus,

Here is a situation. I have a friend, who owns a home with 87K left in his mortgage. His current interest rate is 5.125% for 15 years (6 years left on the mortgage). The house is appraised around 400K. Credit score is 768. He is looking to buy another property around 500K and rent his current place out. The problem is he doesn’t have any cash at the moment, however as you can see he has a lot of equity in his house.

Here are the questions:

  1. Should he refinance his home with cash out option and uses the money as a down payment on his new house? If yes, is this a smart choice? If no, why? Please explain.
  2. Should he wait for another year before making the decision since the market is still very much volatile at the moment?
  3. Or any other investment suggestions? Please advise.

Thank you in advance.

Best Regards

2

I would pull the cash out for a down payment. He can do that easily on a LOC, or with a cash out refi. In his position a LOC would probably be best.

3

More Info needed…

  1. How much cash does your friend need?

  2. How long has he lived in the proeprty?

  3. What was his purchase price of existing property?

  4. What will he be using the cash for?

  5. Why does he need cash with a 768 Fico?

4

NDLM,

Glad to meet you.

The question being…where is the property located?

John $Cash$ Locke

5

Remember on the movie Wall Street when Gordon Gecko asked the kid that unless his dad is on the board of another company then he can’t see any use for him. That is how I see real estate. You need to have a way to find deal after deal. Unless your buddy is going to buy a house wait 9 years move out and buy another one wait another 9 years etc, he doesn’t have a business.

I general the houses you buy to live in don’t rent very well. What is that house going to rent for $3,000/month? How many people can afford to rent that? As Sam Walton said (kind of) rent to the classes eat with the masses, rent to the masses eat with the classes

6

All:

I hope with the additional information I provide below will give you a better idea of his situation. Please let me know your suggestions, or nvestment ideas. These questions might seem obvious to you/others, however it will be a wealth of knowledge to my friend and will help him to make a right decision. Thank you all for answering!

Stevie-o:

Why is LOC better than the refinance w/ cash out? Please explain!

$Cash$:

The property is located in Northern Virginia.

MichaelQuarles:

  1. How much cash does your friend need?

100K-150K

  1. How long has he lived in the property?

9 years

  1. What was his purchase price of existing property?

200K

  1. What will he be using the cash for?

As a down payment to another property, and rent his existing place out. Base on his current situation, is this a smart idea for investment?

  1. Why does he need cash with a 768 Fico?

His money is currently being tied up in other things. In addition, his tax bracket is pretty high (33%). He’d like to find a strategy to minimize his taxes. Please let me know your investment ideas.

Bluemoon06:

My friend is looking to buy a place and hold since the market is still doing the correction right now., plus interest rate is lower comparing to last year.

House can be rent for $1,800.00-$2,100.00. That is an average rent within the surrounding neighbor hood. Should my friend wait for another year before making the decision since the market is still very much volatile and doing correction at the moment? or any other investment suggestions?

Best Regards!

7

What is your friend’s motivation? Why does he want to move into another house? Does he have any landlord experience? Has he done a cash flow analysis to determine whether renting his current home will produce a positive cash flow?

You say your friend would like a strategy to minimize his taxes. If your friend is in the 33% tax bracket, then rental property probably won’t reduce his tax bill. To gain any immediate tax benefit from rental property ownership, he has to generate a passive loss from his rental AND he has to have a low enough gross income to take advantage of the passive loss allowance.

In your friend’s tax bracket, it is unlikely that his income is low enough to use the passive loss allowance. If your friend has a lax loss on his rental property and can’t use the passive loss allowance, then he has to carry the loss forward to the next year. Thus, no immediate tax benefit on his current year’s tax return.

If an immediate reduction in his tax bill is his motivation, then owning a rental property will not help.

Since your friend has $87K left on his current mortgage, he can either cash out some of his equity with a refinance on his primary residence or take out a HEL to do the same thing. If the proceeds are not used for an investment purpose, he can still deduct the interest on the first $100K of his cash out as a home mortgage interest deduction on Schedule A.

If taxes are motivating your friend’s investment plans, then your friend is investing in real estate for the wrong reason. In his tax bracket, he has to spend a dollar to save 33 cents. I would rather save the dollar and pay the 33 cents because I will have more money in my pocket after taxes.

What might make better sense for your friend would be to spend a dollar to save $1.40. Quite a few years ago, there were investments in Master Limited Partnerships and Low Income Housing limited partnerships that were generating 140% tax credits. I don’t know if any of those things are still viable with all the recent changes in the tax codes, but, it may be productive for your friend to have a chat with his financial planner/wealth manager.

8

Dave T:

Thank you for your response.

Best regards!

9
House can be rent for $1,800.00-$2,100.00. That is an average rent within the surrounding neighbor hood. Should my friend wait for another year before making the decision since the market is still very much volatile and doing correction at the moment? or any other investment suggestions?

In my opinion, renting a $400,000 house for $1,800 to $2,100 per month is a huge mistake. Even if he only borrows $100,000 and therefore owes $187,000, it will not cash flow. In addition, that is a very expensive house to allow tenants to tear up.

I would just sell it.

Mike

10

Yes I agree with Propertmanager… There doesn’t appear that there will be a tax consequence from the sale of the house so sell the thing…

11

MichaelQuarles, PropertyManager:

Thank you both for your responses. After talking to him, he said that the house only has 6 yrs left of payments with the interest rate at 5.125% (15yrs term). It is hard to find this rate again in the future (even with 2 times rate cut by the FED recently). Therefore, he is hesitating with the idea of selling the house.

PropertyManager:

“In my opinion, renting a $400,000 house for $1,800 to $2,100 per month is a huge mistake. Even if he only borrows $100,000 and therefore owes $187,000, it will not cash flow.”

If he has to refinance the 87K with 100K cash out, here is rough estimate:

Term: 30 Years
Interest rate: 5.750% APR
Loan amount:$ 187,000.00
Monthly payment: $1,091.28 a month (PI) + TI = ~$1400.00

Rent = $1,800.00 / per month (lowest rent, it can be higher)
Maintenance Expense = 200.00 per month

Cash Flow = $1,800.00 - ($1,400.00 + $200.00) = $200.00

I am not sure how this can be a negative cash flow. Please explain!

However, he and I definitely agree with PropertyManager on the idea that “that is a very expensive house to allow tenants to tear up”.

Possible Solution:

My friend told me that he would try to liquidate some of his assets that are currently tied up in other things and use that money as a down payment on the next property if he ever decides to purchase a second property (properly the end of 2008, hopefully the housing market correction has finished, and the FED decides to lower the rate again - I doubt it). In the mean time, he will continue making payments on the 87K he owes, and try to pay it off at one point.

Is this the a good solution to approach (assuming that he doesn’t have to worry about minimizing his taxes anymore) ? Please let me know what you think!

Best Regards!

12

One appliance replacement (water heater, dishwasher, refrigerator, washer, dryer) and two to four months of cash flow vanish.

One month vacancy between tenants coupled with an interior painting and general cleanup, and a full year of cash flow disappears.

One major system replacement – new roof, HVAC replacement, new carpet and vinyl – and two or three years of cash flow is gone before it is even earned.