tenants versus "flipping" continued

If you have read the last post, I would assume that you can see why we have a sour spot right now for renting versus "flipping". But, even though we ate sour grapes earlier, some properties are just asking to be kept. The first question that you ask yourself when you look at a property is: what is my goal for this particular property? Is my goal to keep this property, generating cash flow every month, and not incurring tax liabilities, or am I going to sell this property as soon as I can, making instant profit, but incurring capital gains tax that will have to be paid the following April 15th? Just a word for your perusal, if you decide to keep the property, rent it out, and generate cash flow every month, then you will be eligible to refinance the property, using other people's money (the bank's), have an 80% LTV, still holding 20% equity in the property. When you do decide to sell the property, you will be paying capital gains on the profit only. Because you have a mortgage lien on the property, even though you received cash from the refinance, you will still be paying only on the profit, not the cash that you received from the bank. Let's do an example for ease of comprehension.
Let's say theoretically, that you purchase a 2-unit property for $60K. With closing costs, the total acquisition cost to you would be somewhere around $66K depending on many factors including transfer taxes, real estate taxes, insurance, etc. So, now you just settled on the property, paid the $66K, and are looking to do some cosmetic repairs to the property. If you keep your taste modest (and depending on how much work the property needs) you could get away with less than 20K including labor and carrying costs. Now, you are up to $86K in total costs on the property. Let's assume that the property is now worth $120K completed. In this scenario, if you decided to sell the property, then with realtor fees, transfer taxes, and possibly closing cost assistance of, let's say 3%, plus misc. closing costs to the seller, you will have a total expense of somewhere close to $12K. This will reduce your net to 108K. So, doing the math, at 108K minus the total costs of 86K on the property, then your profit will be $22K. This figure is what you will be paying income taxes on, and not the total sales price.
Now, let's take this same scenario, and turn it into a refinance. You will be getting an 80% LTV when you refinance, and based on the above value of $120K, you will have an $96K loan now on this property. Assuming that you are not living in one of the units, and also assuming that you have good credit, the principal and interest payments at 7% interest will be $638.69. Now, you need to add in your monthly real estate taxes, and your monthly fire and liability insurance. In our area, these would probably total about $200.00 a month. So, assuming a $838.69 payment is what you are going to pay on this property every month, you will need to rent both units out for at least $420. to break even. In my area in Pennsylvania, rents are going for at least $600.00 for 2 bedroom units.
Based on this fictitious scenario, you will have paid yourself back for the $86K that you have spent on the property, received about $4K in cash (don't forget closing costs for the refi), and if you would be in my area, then you will rent these out for $600/per unit, and receive $1200.00 a month to pay the mortgage payment of $839.00 Since the tenants are paying the utilities, you will be receiving $361.00 per month for your troubles. Now, you can wait out the market, and wait until the property appreciates in value, having your monthly payments made for you, and generating a couple hundred dollars in cash flow every month!
Let's think about the property now, in 5 years. Let's assume that appreciation is somewhere around 3% a year (very slow market). The value at that time, will be somewhere around $139K. Your loan balance will be $90,366.00 according to your amortization schedule. So, your taxable profit at that time will be $139,000 minus 90,366. minus closing costs, seller assistance, and marketing fees, which will equal something close to $31K. Or, you could refinance again if you wanted to.
Does any other investment do this well even in a slow market? What is stopping you from making real estate your investment vehicle of choice?
Let's touch on this next time. Talk to you then.