I mentioned in my review of April that I’ve been considering purchasing another investment property. I’ve come to this decision after a very long thought process and a multitude of discussions with my brother. We’ve crunched the numbers together and what came out at the end made so much sense to us, that I’m willing to share it here with you.
If you listen to the news, it would make you run in the opposite direction of buying property at a time when you probably should be running directly to real estate. Apparently many of you do not watch the news either because, according to the U.S. Department of Housing and Urban development, existing home sales were up 5.3% in the first quarter of 2012 versus the same time last year. The housing affordability index is at its best, because of low housing prices and record low mortgage interest rates. The average interest rate for a 30-year fixed-rate mortgage was 3.88% during the first quarter of 2012. If you’re in a stable financial position and have been waiting for the right time, now might just be the best time to buy.
Personally, I’m not looking for a home to live in. I’m looking for a home that you or your friends would want to rent from me. Yes, I’m shopping for rental property that I plan to never live in. If I see the house more than four times per year it would just be for maintenance and changing the batteries on the smoke detector. That would pretty much be it.
Since purchasing my first investment property two years ago, I’ve learned quite a bit about how to make a better selection. It’s not that my first purchase was a bad decision, it probably just wasn’t ideal. Going forward I would like to see the following in any home that I purchase:
- At least two units. Three would be ideal.
- Outside of flood zone
- Less than $5,000 in remodeling work/repairs needed
- No major repairs such as roof, heater, gas lines needed
- Close to hospital (the main employer for the area) or good school district.
- Off street parking
- Gas or electric heat
- Delivered with no tenants
Of all the things that I mentioned, price was not one of them. The price itself does not concern me, as long as when I crunch the numbers, the math ends up being where I need it to be. To get to the income level that I’d like I’m doing the following:
[(Monthly Rental Income x 12)- 20%] – [Owner paid utilities (annualized) + real estate taxes + fire/liability insurance + lawn maintenance/snow removal] = Potential annual income
To translate I’m calculating the total rent by twelve to get the annual rental income. Then, I subtract about 20% for vacancies and/or unseen expenses. I then subtract all of the expenses that I would be responsible for to get to my annual income. I didn’t include fees for evictions, maintenance, etc. I’m looking at the maximum return here. For the property prices in the range that I’m buying, I hope to have a number close to $10,000 at the end. If it’s $9,000 that’s fine too, but $10,000 would be ideal.
How do I plan on buying property with so much debt? I’m doing something completely unconventional that most personal finance gurus would tell you to NOT do. I’m borrowing 100% of the cost of the property from my 401(K). I can hear the collective gasps right now.
Are you shaking your head thinking, “Oh, no she isn’t!” But, oh yes, I am!
Hear me out. My 401(K) is actually doing pretty well. It’s been averaging about 10% returns so far this year. I’d love to continue riding that 10% wave for a long time, and honestly, I have more than 30 years before my official retirement age. What I am looking at here is the potential for property to add to my income right now instead of 30 years from now. Although, if I keep the property long enough, it can probably supply me with income into my retirement.
But wait, you’re giving up the tax savings by not stashing money into your 401(K), you’re thinking. No, I’m not. I’m going to continue putting the same amount of money into my 401(K) to get my company’s match and I am going to pay the loan back into my 401(K) as well, plus interest. A strategy that I might employ is taking out a first mortgage on the home once I have held it for at least six months and using that money to pay off the 401(K) loan while having a tax deductible loan for the home in my name. I can see the light bulbs coming on now. Genius, isn’t it.
But, as you know, the best laid plans sometimes doesn’t come to fruition. I fully realize that I can be turned down for a loan. This is why I am contemplating selling the first property. I would use that to pay the loan off and bank the extra money, since the property has appreciated in value by about $20,000 since I purchased it.
I don’t know if it will all work out, but I hope it will. Just in case you think that no one else has done this successfully, reader Mildred wrote in to tell me that how she retired in her 50’s on income producing property that she purchased as a nurse. When I grow up one day, I want to be like Mildred!
So, do you think that I’m crazy? Is my plan nuts?! Would you do this?
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