possible purchase of first home (non investment)

Hello all,

There’s a home in which I might purchase to hang my hat instead of renting at my parents. as many investors say their home of residence is where they lose money. the property im looking at is a fixer upper. so this may* be a possible investment down the road, but not your typical quick flip. my question is, rather than obtain a mortgage would it be better to have my father (who has 200k of equity on his home) pay the home in cash (so we can get a better deal) and then make the payments to him? this would be my first purchased home, so all info would be helpful. as always, thanks in advance.

ryan

Ryan,

What a great opportunity. It sounds like it might be difficult to mortgage this property. Use Dad’s money. I’d encourage you to consider having him purchase the property and then buy it from him on a contract sale. Take the contract down to the county recorders office and have the contract recorded. When making payments to Dad pay with a personal check. Make sure your Dad hangs on to the settlement statement from the closing. Taking these three steps will make mortgaging the property easier when the time comes. Your Dad will need to purchase landlord homeowners insurance and you will want a rentors policy.

Good luck with the rehab.

-H

thanks for your reply. it’s not that i can’t afford this project, it’s that i feel i can get a few grand off if i’m offering a cash. that way my pops acts as the bank and i can pay him off. is this not a good strategy?

what benefit will i have with the contract sale? it seems by this route there’s an extra cost in having to purchase landlording insurance…plus he will have to pay taxes on his income then no? maybe i’m missing a few details here.

…anyone else have any “creative ideas” in which can make this a more profitable deal?

It’s a great strategy because:

(1) you can still deduct the interest
(2) your dad gets a better rate of return than in savings or a CD
(3) you can negotiate a better deal for cash

Keith

great! thanks for the replies. if anyone else has a different view i’d like to hear it as well.

Okay,

Why do you think that you’ll get a better deal with cash (remember, it’s all cash to the seller anyway)?

Even if you use your Dad’s cash initially, is it in your best interest for him to finance the property long-term for you? Remember, having your own financing, and of course, making the payments on time, will improve your credit score. And regardless of what many say, having a good credit score makes buying ANYTHING much easier.

On another note, this can still be your personal home AND an investment. Sounds like you’re single (this works best for single people), so here’s what you can do.

Buy the place (however), title it in your name, move in, spend two years fixing up the place, then sell. Under the current tax laws, any money that you make on the deal will be tax free. I know of a person that averages $30-50K per year just doing this.

Finally, if your Dad is willing and able to get access to $200K and let you borrow it, I’d suggest that you setup some kind of partner deal with him on OTHER investment property. Investment loans are MUCH harder to get than first time home buyer’s loans, so I’d save Dad’s access to $$$ for the deals that really need them.

Raj

Raj has it down.

Don’t be confused by ‘cash’ when you’re purchasing property. To the seller there is only cash or some sort of seller financing. If you aren’t getting any financing from the seller then to him it’s all cash regardless of if you borrowed the money from a bank or you pay him in pennies. What you may be able to leverage for a better deal regarding getting the money from your father is a quicker closing and thus a better price. To the seller that’s about the only difference. To you, the other differences include the amount of fees, title insurance (I’d get this even if I paid in change, but you’re not obligated to if you use money that isn’t borrowed), origination fees, junk fees, appraisal fees, and the upfront expense of establishing an impound account to escrow for recurring costs (insurance and taxes).

Remember this (just to elaborate on Raj’s point), under the current tax code any residence that you occupy for 181 days during a calendar year that you own for 2+years is not subject to capital gains taxes for the first $250,000 in profit you make (or if married that number goes to $500,000). So if you buy it at a discount due to it needing repairs, and the home appreciates in value then when you sell it all the equity you have is tax free (as long as you meet the above requirements) from federal taxes.

here’s a little update for everyone. i visited the home and it turns out that EVERYTHING needs to be replaced. The kitchen, batroom, all sheetrock needs to be replaced and painted, the rug, new windows are needed, the porch, the siding, maybe the roof, certain steps and parts of the home need new wood because it’s rotted. the sellers are facing foreclosure in 60 days. im trying to analyze everything to take necessary precautions and to come up with an offer price. as a side note, i will be doing the landscaping, sheetrock and painting…the kitchen, bathroom, siding, porch (maybe roof) will be outsourced.

plan:

-estimate the total cost of repairs.
-add in profit i’d like to make from the deal
-tack on the sewer assesment (we are not sure of how much this is but it can be as much as $20k)
-add in other costs (closing, etc.)
-subtract this number from the ARV which will be our absolute highest offer
-offer $10k below this to leave some room for negotiating (if they accept we get it even a better deal)

concerns:

-right now i’m planning on fixing basically everything, however i understand that there are some things which don’t increase the value even if fixed. anyone have any thoughts on what these might be?

-we figure roughly the ARV will be about $300k (the list price is $215k by the way), however the market seems to be changing where we live (homes are on the market longer) so this will obviously affect our profit if we plan to sell in about 6-8months. how do we factor this in?

-even if this deal would profit me only 10k, i’m still interested. my partner (father) says $10k is not enough profit for him to invest $200k along with labor. obviously this is a personal choice, but is he right in the sense for someone doing the rehab and not wholesaling the deal…you should profit more than 10k?

-income tax and capital gains also concern me a bit. as of now, i don’t plan on living in the home for a full 2 years. i know some people use a 1031 solution to defer tax, however if there isn’t another deal in which would make a 1031 a good option…i’d like to know some other options i have so that my profits won’t take that big of a hit

-i’d like to get more accurate numbers estimating cost of repairs. i will not have enough time to get individual contrators in there to give me estimates. we believe a fast closing from offering cash will be enticing enough to seal the deal before a bidding war starts. how can i get pretty accurate repair estimates in a short period of time? i don’t want too general estimates here because it could turn out costing me money.

…i apologize for the poor grammar or scattered thoughts. i have a ton of ideas racing through my head faster than i can type them. please feel free to add on, correct, etc. any of the assumptions or concerns i have. also, i there’s anything which i’ve neglected to address, feel free to point that out as well.

a possible first deal we’ll see how it turns out ;]

edit: according to the title company, the land was assessed at 179k

Regarding taxes. The 1031 exchange is a good option if you’re purchasing another property within 90 days. Otherwise you’ll pay taxes. It is America so you’re assured of paying Uncle Sam what he deems is his fair share (coincidentally I always disagree as to what his fair share should be, but that’s another discussion). If you hold the property for 12+ months you’re only paying capital gains taxes and not taxed at your ordinary tax rate so this is much more favorable. But there isn’t a huge way around the taxation issue as a private investor without a tax shelter.

thanks DFWHoldings!

…that’s one down. anyone wanna take a wack at any others?

A couple of thoughts.

If the marketing time is 6-8 months then you should consider your holding costs to be normal marketing time plus rehab time plus some contingency time. By this I mean if you are doing the work yourself and you think it will take 3 months, it’d be wise to build in 6 months time to rehab the property to make sure your numbers work. It’s better to be conservative and be pleasantly surprised than the other way around.

Profit margins are normally based on making at least 15% per deal. So on a $200K investment, there rule of thumb is then to make $30k. You’re almost assured of making that type of profit if you buy the property at NO More than 75% of the After Repaired Value (that you conservatively come up with, not the HIGHEST you could sell it for) minus Rehab costs and estimated holding costs. Most people recommend 70% of ARV for purchase price + rehab cost, I just add in the holding costs and use 75% for my numbers.