Is it time to buy a rental property?

January 23rd, 2009, 3:00 am · 27 Comments · posted by Mathew Padilla

Randy Johnson, president of Independence Mortgage Co. in Newport Beach, author of “How to Save Thousands of Dollars on Your Home Mortgage” and a mortgage broker since 1983, answers questions. This week he tackles two questions about real estate investing.

Hopeful Investor in Trabuco Canyon asks:
Q. My question is whether I could qualify for a mortgage for a second house. I would suggest that the bottom of the housing market should occur in the next 12 months or so and I thought it may be a good idea to purchase a second home to use as a rental property and hold onto it as an investment. Overall, what do you think of this suggestion? I realize speculators drove the market to tremendous highs and bad mortgages drove the market to dramatic lows. My FICO should be 725 to 775, and I have approximately $155,000 in a 401K, $55,000 in an IRA, and $25,000 in a six-month CD. My gross monthly income is $9,000. My mortgage payment is $1,900 a month.

A. I would certainly consider buying an investment property in this market. We may not have reached the bottom yet, but you won’t be able to tell where the bottom was until well after things are on the upswing. If you find a property that appeals to you at an attractive price, I would move now rather than wait. The good news is that you will be more likely to get a good cash flow as rents haven’t fallen as much as property values.

On another note, the pricing structure for non-owner occupied loans has worsened. The best pricing is for buyers putting down more than 30% and with your $25,000 CD, you are a bit away from that. So I would save as much as I could every month. As to raiding your retirement accounts, I am not in favor of that for complex reasons that are beyond the scope of this venue. Get a personal finance book and read that for more guidance before you do that.

Stu in Seal Beach asks:
Q. I have the cash to buy a rental property, but wonder if there are enough advantages for me to borrow some of the money. And if I do borrow against the property, should I buy with a mortgage, or pay cash and then borrow later? I wouldn’t want to borrow more than 50% of the purchase price. I am looking for a way to invest cash long term, avoiding the stock market. I have a dependable renter, which is why I am looking for one good rental investment.

A. I certainly would finance it at time of purchase. If you finance it afterwards it will be treated as a cash-out refinance with stricter terms and higher rates than a purchase loan.

Most income property that someone else owns – your competitors – is financed at rates greater than 6% and you will be under 5%. That’s a competitive advantage that will make you more money than they will make during the same period.

We are really excited about the market opportunities and have several deals in escrow right now that are similar to yours.

That’s it. If you want Johnson to answer a question, email it to Mathew Padilla at mapadilla(at)ocregister.com. Include your name or nickname and the city you live in — that information will be published with your question.

Johnson will answer up to three questions each week, so keep checking back for a response. If many questions are submitted, it could take a while to get a response, or he may never get to it. Also, readers keep submitting variations on the same question, which has already been answered: what to do when you can no longer afford your mortgage. I have decided not to publish most of those questions, because they are repetitive, although I appreciate the difficult situation many homeowners are in these days.

Read prior questions and answers by clicking on the headlines below…

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Buy Houses Now! says:

January 23, 2009 at 6:13 am

It’s always a good time to buy real estate!

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Whatflavorisyourkoolaid says:

January 23, 2009 at 6:31 am

Blasphemy! I heard you can rent for 1/3 the cost of owning. These guys are realtors trying to fool us. Holding properties for investment? What kind of ridiculous idea is that?

no_vaseline says:

January 23, 2009 at 7:47 am

There’s no “I heard” about it’

My rent is about half what it would cost me to own my Orange SFR. Every time I put a pencil to it, rental properties are losers with negative cap rates.

SOMEDAY rental properties will make sense. Consider we need another 40% reduction in prices/sf to even get close in all but the worst neighborhoods, and even there, it’s razor thin.

January 23, 2009 at 7:50 am

The last guy is trying to avoid getting stuck in the stock market and blowing off his principal.

What is the difference if he loses 30-40% of his principal in RE instead of stocks? The address! He’s still stuck!

And he’s going to get stuck in RE.

Whats wrong with cash?

dafox says:

January 23, 2009 at 8:00 am

it just depends on where you are. downtown huntington a house rents for ~$3500-3800/mo. Same homes are listed for $1.2-1.5M. Its significantly cheaper to rent, and no where near possible to buy a rental prop.
In Santa Ana or San Bernardino it might be possible (I dont know the numbers.. I havent been watching there)

DonS says:

January 23, 2009 at 8:21 am

Good idea. Just keep paying off someone elses property for them and pounding rent money down a rat hole. Try writing it off your taxes this April.
Good idea.

Chris says:

January 23, 2009 at 8:35 am

Whether or not you get a positive cash flow from renting out a property all depends on what your mortgage payment is. For example if I put 30% down on a SFR that costs $400k my mortgage payment would be roughly $1500 and I would be able to rent this property out for ~$2k a month. It all depends on how much money you put down, it’s never going to be possible to put 0 down and have your mortgage payment be equal to rents, if it was then everyone would buy a house.

TH says:

January 23, 2009 at 8:45 am

It will eventually be cheaper to buy a house than rent in many places, but most people won’t buy because “everyone knows housing prices only go down.” Then rental properties will start to pay off. I think that should be around 2010-2011.

January 23, 2009 at 10:32 am

What do you think this can rent for?

http://www.realtor.com/realestateandhomes-detail/1245-W-Sycamore-Ave_Orange_CA_92868_1094589764

meltdown says:

January 23, 2009 at 10:34 am

CASH is a position in the market.

January 23, 2009 at 10:35 am

How about an apartment for $2025?

http://www.forrent.com/apartment-community-profile/1005803.php

January 23, 2009 at 10:50 am

And how does that apartment compare to this condo?

http://www.realtor.com/realestateandhomes-detail/444-S-Tustin-Unit-C3_Orange_CA_92866_1106219351

The cost to own this condo with 20% down is $842.50 PI, $165.83 T, $50 I, $300 HOA or a grand total before tax deduction of $1358.30.

It can rent for $2,000+.

Walt says:

January 23, 2009 at 11:01 am

Erm, do you guys all think that there are no costs to maintaining and managing a rental?

Even if we assume none of those costs, in Chris’ example you’ve spent $120k to make $500 a month profit (assuming you have the place rented 100% of the time). That’s 5% ROI in an *ideal* situation.

It’s pretty safe to assume you’ll spend $5k a year on managing and maintaining a property unless it’s deep in the ghetto, and it’s also safe to assume it will only be occupied 80-90% of the time as renters come and go, which will drive your ROI into negative territory pretty quickly.

Second point is that being a landlord is a TON of annoying work. I’ve been there, I was a landlord for almost a decade. Problems constantly crop up, even with good renters, and you’ve got to pay yourself for your time, unless you’re going to hire a management company (which takes 15-20% of your monthly income away).

Houses aren’t useful as an inflation hedge just now, so I personally wouldn’t go looking for rental properties just yet. Give the market another 20-30% and it will make sense.

-Walt

Louis says:

January 23, 2009 at 11:07 am

……”and you will be under 5%”….Does this guy have an clue on what mortgage rates are???, no way you can get a 5% non-owner occupied loan….EVEN if it were on a 15 year fixed rate.

Liar Loan says:

January 23, 2009 at 11:10 am

Whatflavor-

I think your analysis is exactly correct. Renters are paying a premium because they are unable (or unwilling) to save 20% down. Anybody that buys now will do very well over the long run, even if things continue to slide in the short run.

However, I believe anyone that buys 2 years from now will do even better. December 2010 will be the ideal time with the post-Option ARMeggedon having laid waste to local real estate.

January 23, 2009 at 11:12 am

My example were in reply to the guy (?) who said his rent was half of what it would cost to own. Maybe he’s got some kind of great deal on a high end home. Otherwise, it’s just smoke.

January 23, 2009 at 11:19 am

Questioner #1 could use the IRA to purchase real estate as a tax free retirement investment. There are books on this subject, and I wish Randy would have mentioned that in his answer.

Here’s a site on the subject:

http://www.realtor.org/archives/featuresept03ira

401k’s are more rigid and it wouldn’t be smart to take the 10% tax penalty for withdrawing funds to invest in real estate.

Dina says:

January 23, 2009 at 12:10 pm

Increased numbers of rentals increase crime. Tenants do not have a vested interest in the community. I have rental properties. its not a profitable as you think. It is subject to the quality of the tenant. If you hire a management company they they try to rip you off. No more management companies for me.

January 23, 2009 at 12:32 pm

Keep pounding that rent and paying off someone elses property. Good idea!

Rule of thumb: Rental property expenses will approximate 35% of income not including mortgage. Don’t forget that part of your profit is principle pay down along with depreciation write off of other income.

BOGEY says:

January 23, 2009 at 12:48 pm

LOLLLL at all of the RE agents still thinking “the old way”

It’s no wonder the industry is imploding

shadow735 says:

January 23, 2009 at 2:49 pm

Dina can you please explain your reasoning behind your statement, unless your rental is in a ghetto I really dont see how renters dont have a interest in the community.
My sister and I and a roommate have been renters for the last 10+years, 2 1/2 years in our current house we rent and 8 years in the previous one, in our previous house the landlord decided to sell the home. Which forced us to move, of course he wasn’t able to sell it and asked us to move back but by that time we had already signed the lease on our current place.
My roommate maintained the property on both houses, this covered most common repairs and landscaping (he is a green thumb) in exchange for $100 credit each month. He actually added value to the home because the landscaping on both properties looked fantastic to what is was prior.

As renters we knew our neighbors and watched out for each other so I disagree with you that renters don’t have any interest in the neighborhood. I cant see why they couldn’t unless they are dodging bullets and replacing windows on their vehicles.

they are down says:

January 23, 2009 at 2:58 pm

Whatflavorisyourkoolaid Says:
January 23rd, 2009 at 10:50 am
And how does that apartment compare to this condo?

I’m a renter and live in Mission Viejo. I would NEVER pay $2000+ to rent an 1100 sq ft condo in Tustin. Your dreaming on that rent!

January 23, 2009 at 3:48 pm

I think the idea that most people have on buying a rental property is not so much making a second income off of the rent but being able to hold on to that property for many years by renting it out in the hopes that someday (maybe in 10 years) that that property will have increased in value by a good amount. In some areas of OC, especially among the lower-end condos and homes, I would say it’s a good bet as the price declines have considerably slowed down. The $500k+ market….well, I definitely wouldn’t buy into that.

fcprop says:

February 2, 2009 at 9:21 am

If you do buy a rental. Make sure you look for an area with low taxes, no HOA, no mello-roos, and stick with a SFR.

sgprop says:

February 7, 2009 at 5:45 pm

I pay a premium in operating cost ie; HOA’s ,taxes, some Mello-Roos and commisions. All five of my rentals are South O.C. and people love the area and will pay more and are GREAT tenants too. But all my rents are down 10-20% and HOA’s are climbing. Most of my mortgages are paid in rent but operating costs are kiling me!

PlanetboundGazerGeezer says:

March 17, 2009 at 5:40 pm

Rentals - have you thought about how difficult it is to find a decent renter nowdays? There are plenty of families and others looking for a place who are unable to pay the rent. Even in good times too. It is tough to find a good renter(s).
Even good renters suddenly go bad, for a variety of reasons. I know, I have had to go through the long, expensive, and emotionally trying process of eviction, and they don’t leave until well after the Sheriff arrives.
One 90-120 day Eviction leaves your profits in negative territory for quite awhile.

March 17, 2009 at 5:57 pm

To Liar Loan - “Anybody that buys now will do very well over the long run, even if things continue to slide in the short run.”
Assuming things get better. They may not. Maybe in 10-15 years?
Reasons: Jobs are gone. Almost all MFG jobs. Gone offshore. ENGG jobs along with them.
Service jobs, many of them are gone too, except those that require locality like health care. And those jobs are not coming back any time soon.
Thus we have fewer good renters, and renters are packing many people into one rental unit.
Look at all the cars on the street, too many cars, too many people for the units. Major problem all over the OC. Illegal often but no solution.
Jobs that remain in the USA are often much lower pay.
People I’ve talked to have said OC properties have gone up constantly since WWII-except now. We have a new situation as never before - nobody knows what to do about it, indeed if anything at all CAN be done, local nor national, even all the best talent cannot help this meltdown.
I’ve lost $600,000 in 2 years in housing and rental values. Wish I could see a light at the end of the black hole. Trust and hope is all.

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