In my last post I detailed Why Young Professionals Should NOT Buy a House. In this post I will explain why your first home should be shared with some tenants.
The author and radio host Dave Ramsey has said that a home or personal dwelling is a stake in the ground to which the owner is chained. Your life will most likely revolve around the area where you buy a home. You will work nearby, play nearby, and raise a family where you plant this stake. What if you want to change any of these items?
Often, professionals just beginning their career do not plan to spend their life in the same location that they find their first job. The energy of big city life is not as appealing when you have to raise a family. Their first job is a dead end and a graduate degree is required for advancement. Or you find great success in your career but the next promotion is in another state or another country. What do you do with that condo or fixer of a home you bought?
Imagine instead that you bought a fourplex (a single building with four separate living units). This fourplex in Concord, CA is a current example. Argyll Avenue – Fourplex
The property is listed for $375,000. According to the listing agent the property has 2 -2 bedroom units and 2 – 1 bedroom units. Let’s figure 3% for closing costs and fees for a total of about $386,000. Our first-time home buyer decides to make an offer at list price with 10% down. Their loan amount will be $347,000.
A loan of $347,000 at 5% interest will have a payment of $1,863 per month. Property taxes and insurance will add roughly an additional $612 per month. If our home buyer mows his own grass and does repairs himself, he likely won’t have many other expenses beyond the occasional repair or vacancy. The total expenses for the property will be roughly $2,475 per month.
According to the listing agent, the 2 bedrooms rent for $1250 each per month and the 1 bedrooms rent for $850. To be safe let’s knock $150 off of each of those and say that the 2 beds will fetch $1100 and the 1 bedrooms will get $700. Our industrious and frugal buyer doesn’t have a roommate and decides to live in a one bedroom unit. His gross income from the property will be 2 x $1,100 = $2,200 plus $700 = $2,900. If we imagine that each of the rented units will be vacant for 10% of the year, this would reduce his gross income by $242 per month. His or her gross income will be $2,658 per month.
In review, our home buyer will be receiving $2,658 per month in rent and expenses will be roughly $2,475 per month. The net income to our home owner will be $183 per month and he will be living rent free.
Besides living rent free there will likely be some tax benefits to our home owner. Cost recovery or depreciation can be claimed on the rented units. The owner may be able to offset taxes on earned income.
If our intrepid home buyer decides to pay down the mortgage by paying “rent” of $700 per month, the home buyer could apply $883 to principal each month ($183 in cash flow).
Assuming the fourplex does not increase in value at all the value would be $375,000 at the end of 5 years. The outstanding principal would be a shade under $260,000. The home buyer has equity of almost $115,000. Calculating selling and closing costs at 8% of the gross fourplex value ($30,000), our investor has net equity of $85,000 to roll into his next purchase. Our investor could refinance the property at 80% LTV and pull out $40,000 in equity to purchase the next investment property.
Buying a fourplex has provided the investor with some flexibility. We assumed that the investor lived in a 1 bedroom unit. If the investor gets a roommate or marries, they could move to one of the two bedroom units without having to buy something else.
If our first-time buyer needs to relocate, the property should have enough income to pay all property expenses when fully rented. Our first-time buyer can safely transfer to another city without worrying about selling a home first.
The fourplex purchase allows our hypothetical buyer a financially fit decision and a level of freedom that a SFR does not allow. It appears that an investment property, is far superior to the single family home purchase for our first time buyer. (Please do not construe this as a hard and fast rule or investment advice.)
Call me at (925) 385-8798 to see if we can find a duplex or fourplex that fits your investment needs.
Adrian Paras says
Very good post Peter! Good job, very informative!
But you mentioned that the expenses for property taxes and insurance will be $612 per month. And my understanding is that ONLY in property taxes you have to pay 3% of the property value which in this case would be $11,250 per year or $937.5 per month. And this is ONLY property taxes. Am I wrong? Also, for how many years is this loan that we are talking about in this example?
Peter Maclennan says
I can only speak from my experience here in California. Generally, property taxes run between 1%-2% of the purchase price of a property in California. In other parts of the country or world, these amounts may be higher or lower. You would have to perform the analysis based on where you are purchasing a property. California offsets the lower property taxes with higher sales tax and income tax.
It’s difficult to find knowledgeable people on this subject, however, you sound like you know what
you’re talking about! Thanks