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Build a rental unit, buy a duplex, or sell?

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Money Talk > Real Estate

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plush
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Build a rental unit, buy a duplex, or sell?  Reply with quote  

Hello,

I am a 32 year old Realtor who earns a variable income. My wife (31) and I spent a year abroad (Aug 2017 - Aug 2018) and thus made next to nothing in real estate while we were away, but the year before we earned about $140,000. We are both Realtors and are aiming for a gross commission of $200,000 in 2019, which should NET us about $10,000 - $11,000 per month after taxes and brokerage splits/advertising/business expenses/etc. It is doable and likely.

We own two homes. One is a 3 bedroom rancher leased at $1495. Rent control was just enacted two days ago in my state (Oregon), so the most I can raise it to is $1599 (7% annual increase). Market rent is about $1650-$1700 currently. We have about $115,000 in equity in this house (it is worth about $295k now). We can sell it before July of this year and pay no gains since we occupied it for ~2 of the past 5 years. I have concerns about condition (built in 78 and lightly remodeled within the past 15 yrs, but with old furnace/AC/decrepit fence). Currently we cashflow about $200/mo, but can get this up to $375 ish with an appraisal to get PMI off, and by raising the rents modestly. Emotionally, I have no ties to this house.

Our primary residence is in a historic neighborhood in a rapidly growing and desirable downtown--walking distance to multiple restaurants, breweries, cafes and schools. We purchased this in 2016 for $250k. It is now worth about $320k Our equity position is about $100k in this one, too. It is a turn of the century craftsman that was completely overhauled about 10 years ago -- roof, plumbing, electrical, studs-out remodel. Needs no repairs. We're very attached to this home.

We have an opportunity to build an Accessory Dwelling Unit (ADU)/1 bedroom apartment/guesthouse with attached garage in our backyard for about $80,000. We think we could rent it for about $900 - $1000 per month. We would pay cash to build it later this year or early next, especially since we think a HELOC is out of the question with our recent 1-yr gap in income.

My wife and I are playing with a few different ideas. Currently our house has no off-street parking, which is a bummer. If we built the ADU, we would have both a driveway and a garage, which would solve a majority of our usability problems and storage issues. We love living here and don't want to move, but also want our decisions to make good financial sense and set us up for a secure future. I like the ADU idea because the structure itself would likely be "free and clear." However, recouping our investment would still take about 7 years assuming no repairs and minimal vacancy.

On one hand, it's very attractive to build the ADU and have immediate cash-flow in exchange for capital. We could probably stay comfortably in our current home for the next 5-10+ years if we did that, and would use the rental income to fund share purchases in mutual funds/retirement (of which we have NONE). When/if we decided to move, we could hold the property and generate a present-value cashflow of about $1100 per month on top of the mortgage between the main structure and the guest home). Combined we'd be bringing in about $1500 in rental income/mo between all 3 doors.

On the other hand, it's attractive to take that $80k or so and purchase a duplex instead. The cash flow would be less, but the equity gain over the long haul would probably put us in a different financial position come retirement. If we did this, we'd still have a driveway cut and build either a carport or garage without ADU. Costs would be a fraction of the ADU/garage, but overall we'd spend more between the new duplex and the off-street parking/storage solutions in our primary.

Considering a third option--we could sell our current primary and use the equity to springboard us into a home that doesn't have the deficiencies our current home does (storage, parking, layout). This is the hardest sell for us since the replacement home would have to be nearby to keep our walking lifestyle the same.

What would you do in this situation? What questions should we be asking ourselves or considering before making a decision?
Post Sat Mar 02, 2019 11:18 pm
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oldguy
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If you opt for the $80k ADU, I sure wouldn't own it 'free & clear". The US mortgage provides some of the cheapest capital in the world - where else can you walk into a bank, ask for $300k, demand a fixed loan for 30 years, about a 4% rate? Better to put that $80k to work for you, rule of 72, double it about every 7 years, about $640,000 in 21 years?

But, from a landlording standpoint, I would not do it. The first law of landlording is - never rent to an acquaintance, a coworker, a friend, and never-ever to a relative, always have a formal, arms length agreement with a stranger. (You need to be able to demand late rent, be able to evict, be able to avoid "I'll work off the rent" - you can't do that with your sisters' son, he'll stay forever.). As for proximity, I never live close to my renters, you don't want to see every time their car leaves, and you don't want them to watch your car come & go. Plus, when you tie two structures together on the same property, you cannot sell one of them. Same with a duplex, better to have 2 houses, a mile apart.

But I would add the garage and driveway to your primary. And after the garage is built I would refi the house/garage, pull an extra $100k out of the equity, get a new 30 yr, FR 4% loan, and keep it forever.

""most I can raise it to is $1599 (7% annual increase). Market rent is about $1650-$1700 currently. we cashflow about $200/mo, but can get this up to $375 ish with an appraisal to get PMI off, and by raising the rents modestly.""[quote]

Good, if you max'd the 7%, your rent would be about $3200/m in 10 years. I might not do it that way, remember that extra $1600/m is fully taxable - will you want more taxable income? Or would you rather have more going into investments? You can keep that $200/m down by refi'ing every 10 years or so and investing the equity elsewhere.[/i]
Post Wed Mar 06, 2019 8:02 pm
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plush
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Thanks Oldguy! I was hoping you would be commenting on this post. Great to receive your wisdom again.

I hear ya on keeping the equity low in the rental but.... how can one extract equity in a non-owner occupied home? I haven't found anyone who will do cash out refis on NOO homes. Any recommendations on that front?

I also hear ya on the backyard rental vs equity boosters. I'm not super crazy about having a tenant live that close (I think of 2am knocks at the door due to problems, too close for comfort contact, etc. I already feel a little awkward driving through my old neighborhood to check on how my renters are keeping up the property, etc). But I sure would like a driveway and garage, and could then refi the primary.

What do you do for your rentals to extract equity without selling, if you're not occupying? Who do you use for the loan?
Post Thu Mar 07, 2019 9:29 pm
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oldguy
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My most recent refi's were with Chase - the last 3 I believe. All were 30 years, fixed rate. The Non-Owner Occupied premium was 1% or 1.13%. And the required DP is typically a little higher, bankers understand that if you get financial trouble you will direct money to your home - and let your rentals go into foreclosure. (After the 2008 'crisis' the banks and credit unions were terrified to lend money, the NonOO premium was about 3%, if you could even get a loan. I didn't refi anything at that point).

I used Chase simply because the loans were already there with a good payment history. But other than that, most major banks and credit unions are fine. You might want to go where your residence is financed.
Post Fri Mar 08, 2019 2:37 am
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franklee
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Post Fri Mar 22, 2019 2:58 pm
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Garson
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You are happy people I would say! I also want to buy a new house but in my case, I have to take a loan on https://cashcat.ph/ Now I don't have a place where I can live and it hurts. I hope one day I will live with dignity... Now I am just a loser.
Post Sun Apr 14, 2019 12:37 pm
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