Underwater rental

Rehabbing, Fix and Flip, Rental Properties
1

I have a rental I am underwater on. It was a former primary residence and I am renting it out. I can’t refinance without putting cash into it, and the area is continuing to slide downhill. I am $175/month short of making the payment, so it’s a considerable loss. The only good thing is that the basis is high and depreciation is huge on it.

My plan is to keep it and see what happens. I got a USDA rural development loan when I bought it, and my income is too high for a refinance with the program. A refi would bring my payment to about even with the rent. I offered it to the tenant for payoff and the payment was less than the rent, but he didn’t want to by it.

What would you do here? Is there a way to get the bank convinced a refi is in everyone’s best interest?

2

You are what I call an accidental landlord. An accidental landlord is a person that did not go out to start a business and then buy houses to rent to bring that business to fruition. This is a person that a life situation placed a house in your hands that you decided to rent out. In all cases if you have a house that is renting for less than its expenses there are only 2 things to do. #1 (which I suggest) sell it. Even if you sell it for less than you owe… do it. You get one big painful event and then you are on your feet again. If you keep it and rent it you will lose $175 per month and then still sell it and take that hit anyway so sell it now and avoid all those losses each month. Time is of the essence. Or you can do #2 buy some more houses. I only recommend this if the value will come back and you just have to hold on until it does. If you do #2 you have to look at that house as a part of the “enterprise”. Now you have an enterprise of 1 house with a negative cash flow of $175 month. If you buy 2 more houses each with a positive cashflow of $175/month each you have turned your enterprise from 1 house valued at $100k losing $2,100/year to one with a total value of $300k with a positive annual cash flow of $2,100/year. Buying other houses that have positive cashflow will allow the other houses to pay for the negative cash flow of the house you are trying to save. I only recommend this if there is a lot of up side that you actually expect to achieve and the time frame is expected to be short.

No matter what people say almost every accidental landlord I meet has this problem. The problem of a rental that is problematic in one way or another. I always suggest if you don’t want your primary residence or you inherit real estate sell it. Use the money to go into real estate in a planned manner. Nobody ever accidentally becomes rich. It is always a planned event.

3

Sometimes people use the term underwater for two situations:
Is it’s value less than you bought it for, or less than you owe.

If it’s the former sell, if its the latter you have a decision to make, but that decision generally should be sell unless the value is coming back up.

4

If you have good income & credit, you can buy or refinance almost anything if you can put 20% down. So if you don’t have any equity in the property, you could putting 20% down and refinance on a 30-year note but pay it off using a 15 year amortization schedule … and if your interest rate goes down far enough you might actually walk away still making a profit on the property each month. And by having a 30-year note and paying it off on a 15-year schedule you will have the flexibility of making a smaller payment if or when you have a financial complication in life (loss of a job, etc).

Also - you should check around with several different banks, and mortgage brokers. Mortgage brokers are nice as they sometimes deal with 10 or 20 or more banks … and know which ones are more flexible on refinancing vs others. You might be able to do the above trick with 5% down if you find the right bank.

Good luck!

5

I started with the one and have been expanding my rental business from there. My problem is that none of this was organized and none of my rentals are really cash flowing. Property A is this one, that I am underwater on from a former primary residence. Property B is a farm that has a small house on it we are renting out. We will be renovating that house and moving there starting this summer, but the rent doesn’t cover the mortgage there either. Property C is both sides of a duplex we purchased to move into while renovating the farm house. The one side pays most of the bills but still doesn’t cover the mortgage. I have since purchased another house that will be a rental and a pretty good purchase.

I guess I know the answer - I need to renovate that house at the farm and move there and rent out my duplex. This place really probably ought to get paid off or sold. I lost my shirt on it already - if I’m going to throw cash at it I might as well pay it off. I owe 100k, it’s worth 70-80k. Refinancing will cost me 45k down in cash. The problem is that I can buy a whole property for that, so never get around to selling this one.

If I didn’t have some kind of ethical hangup with walking away that might be the best scenario. If the bank would just give me a loan at current rates I could break even on the place, but why would they do that?

6

You need to stop buying random properties. Only buy properties that cash flow no matter what your expected exit is. That allows you to hold a property indefinitely if you have to. That will allow you to wait out until the prices comes back.

You seem to be buying whatever is for sale at the moment. You need to develop a plan for the type of property you buy and only buy properties that fit that plan. For example. I only buy 3 or 4 bedroom 2 bath 2 car garage single family houses between 1100 and 1500 sqft built on a concrete slab with brick on at least 3 sides and a pitched roof built after 1980 that is for sale for 50% to 65% of the ARV which will rent for a $400/month cash flow.

7

I’m trying to get this cleaned up. I realize my problem is that my portfolio represents the “accidental landlord” comment above. As soon as I get my house built the only thing that will be a problem will be this property, my old house.

Regarding your comment though - what’s the advantage of having such a homogeneous rental inventory? You are right, I have been buying what is cheap and cash flows well. Mine are all in the $400/month per unit range as well, for all the places that were bought to be rentals. I really want to be in multifamily buildings, but single family is cheap here and there’s not a lot of inventory in my small town that’s priced where I want to be.

Do you only look in certian areas for rentals or do you buy all over your territory?

8

Not picking on you but you are contradicting yourself. Also, you are misunderstanding Bluemoon. He is not getting just $400 per month rent…he is making $400 per month on top of the mortgage/taxes/insurance.

9

I have a homogeneous rental inventory because I don’t believe in making mistakes. When you are trying to figure out each property you buy you introduce an opportunity to make a mistake. You never want to cut brush. Follow the well worn path. That path takes you to these properties because in Houston Texas people move out of apartments for 2 car garages. The typical person in Houston makes $50k/year which means they can afford 1/3 of their income in rent or $1100/month. If I buy houses that cost $60-$70k I end up with a PITI of around $650 to $800 and that leaves me $300 to $500/month income. Houses that are smaller than 1100 sqft are not attractive to tenants houses over 1500 sqft are too expense to do make ready on. Houses with a lot of brick don’t need a lot of painting. I don’t care about the houses I care that these houses rent immediately (within a week) and make money. It is like Southwest Airlines only flying 737 airplanes. You don’t have to solve problems there is no learning curve you just cookie cutter what works.

10

I understand why you’re confused. I was trying not to go into a bunch of detail about my portfolio and making confusing statements. My point is that I have a portfolio that needs improving, as some properties were never purchased as rentals.

The ones that were purchased as rentals are doing well but I still have mixed use. I live in a duplex and rent the other side. It’s not cash flowing but if I were paying rent the cash flow would be in the $350/month range. My last place is being readed for rent but not available yet. It would fit in bluemoon’s buying strategy and should cash flow $525/month but I did a lot of work to get it here. It’ll be ready in a few weeks - I’m working nights and weekends on it.

11

I really appreciate the insight!

12

I don’t mean to hijack the thread or insult anybody and this is not just to you Estrogen Hostage but to everybody that reads this. Reading the posts on this site I realized that there is a weakness in planning on the part of most of us. When we go fishing we don’t just go to your bathtub and put a fishing line in just because we want to fish and there is water in it. We research it. We need to do the same in real estate. What I suggest we do is decide if renting is even possible. There are 2 things that you can’t control but need to know. They are static numbers we can’t control and will decide if we are swimming up stream or not. How much income do people make and how much can I buy hoses for. The amount people make is a direct hard and fast number that if you take 1/3 of that number tells you the most you can rent a house for and it will be affordable by most of the people in the market. Use census data you can find it at http://zipskinny.com/ and put in the target zip code to tell you how much people make. If that number is 30% of the people make $50,000/year that is $4,100/month that means you cant’ buy a house unless you can rent it for $1,300/month to appeal to most of the people there. You have to be able to buy a lot of houses in that zip code that will have a PITI of no more than $600 or $700. These houses also need to be the type of houses in your zip code that rent for that much. If you are in California or New Jersey it may not work without you having to pay a lot of money down to buy down the note. If it doesn’t work don’t spend a lot of energy on what houses are out there because it is like fishing in your bathtub. There aren’t enough fish there to make a business out of it. As kdhastedt used to say. Move closer to the food. Just like you can’t farm for a living in Manhattan you can’t fish for a living in Arizona you may not be able to landlord for a living in California.

13

Believe me - no offense taken. I appreciate the insight - I truly mean that.

I think you are right about a lot of this. I cannot rent a house out for $1300/month in this area reliably. It might rent out, but have vacancy issues. Around here $1000/month is a soft limit. It’s creeping up here lately, but it’s still about what people will pay to rent a house. An average house here costs $120,000 and up.

That makes it more difficult to buy houses. I wonder if it’s not much easier in a larger city.

For instance, I saw a place pop back up for sale that’s been there before. It’s in below average shape but rentable with paint and carpet. Listing price is $23,000. It’s been on the market for a LONG time. I was considering offering $7500 cash with a fast closing to see if they bite. Taxes are $800/year and insurance probably $400. I can rent it out all day long for $550 and likely get a list of applicants wanting it at that price. It would likely have a tendency to attract difficult tenants, but still provides good cash flow. The chances of being able to fix it up and resell it in the area it’s in are not really impressive. It’s in the same small town as the other rental I am underwater on. There’s not a lot of jobs there, and the price of gas keeps going up. I like it because a cheap place ALWAYS rents and carrying costs are low for a vacancy.

Would you pass on a deal if it presented to you? Or do you not consider places like this deals? It fits your buying strategy for cash flow but nothing else. It’s completely different than the other stuff I have, would be my cheapest rental if I were to buy it.

14

Why don’t you move into the underwater house, fully rent out the duplex, and continue to rent the farm house until your situation with the underwater house improves. Depending on your market, you could be in much better shape in a few years. I’m of course assuming the underwater house payments are affordable.

15

I’ll chime in with some thoughts that might give you some hope here.

Buying investment properties is a BUSINESS. If you think like a business person, you’ll probably see the answer in all of this.

For example, let’s take how a retailer approaches business. They might sell products that are seasonal. Or products that go obsolete all the time (ie. technology). They do their level best to buy inventory that costs them $1 and try and sell it for $2. The difference (profit) is their focus.

But sometimes they buy something for $1 and the market goes down, competitor opens across the street, inventory doesn’t sell and they get stuck with inventory they can’t sell for more than $0.75.

Basically that’s what a lot of investors have found themselves in. They bought something at some perceived price, leveraged other people’s moneys (ie. banks) to get it, and then surprisingly it went down in price. Now they are losing money rather than making it.

What does a retailer do when this occurs? Well they realize that they might not make money on their current inventory, but if they can either sell it or hold onto it knowing that they will likely lose money, they focus on the next batch of inventory to get that they can actually make money on, and then add together the profit on the next batch, less the loss on the current, and hopefully either come out a little ahead or they breakeven (loss offsetting profit).

Why do they do this? Because they are in it for the long haul.

That’s what you have to ask yourself - did you get into this as a BUSINESS for the long haul, or were you speculating hoping to make a bunch of cash and get out? If its the latter, I pity you. If its the former, then the answer is clear.

Buy some new properties for pennies on what you would have paid for them at the height of the market, and rent for large cashflow. Use that to offset your current losses. When the market recovers, both properties will see significant increase in equity and you will be way ahead.

The richest people in the world got rich in the current situations we see ourselves in - not buying properties at the height of the market. For many, this is a golden age of wealth right now. Those that know that the bargains are out there. That wasn’t the case 5 yrs ago.

Myles

16

Myles, I like your analogy.

To take this a bit further, what does the grocery store do when the produce is reaching the end of its life? They sell it at a loss so they don’t have a store full of rotten produce.

I know it sucks but if you are financially able to bring the cash to closing to get out from under it, that may be best. It will allow you to use your most valuable resource (your time) to buy and manage the bargain properties that can be found today.

In most cases it is best to fix the problem instead of prolonging the pain.

Steve