Business Model Work ?
Hi all, first time poster so please be gentle. I am a new investor who would like to have feedback on whether my model works. I started visiting this site a few montsh back and love it ! There are a lot of smart people out here.
Background
I work full time (like most) and am doing this in my spare time. I do not need the rental income at present and simply trying to do this as a means to build future retirement funds.
I live in an area where avg homes prices are $150K, averaging 3-4% increase annually. I am buying all new homes or nothing more than 5 yrs old and we plan to buy 4-5 homes this year. In this area, new homes are generally less (or equal)per SF than older homes in established neighborhoods. And, all come with warranty.....so my maintenance cost should be minimal. I also try to get into early phase of a new development. so as it builds out I am seeing solid increases in value as the developer increases their home prices.
I'm using an equity line (personal residence) for downpayments. I am buying properties with 10% down (from equity line) and doing 80/10 loans for the balance. All loans are 10yr interest only (exc. rates), except for home 1. I am then using the rent income to pay minimal 1st & 2nd, with remainder going to pay off equity line (EL). Once EL is paid off (approx 5yr), I then plan to apply this money to 2nd mtg (if applicable).
I plan to keep homes 5-7 yrs, then do a 1031 exchange, again looking for new (er) homes.
Homes
1st home REO: Paid $76k (plus repairs), 5yr old home, $96k appraisal, and $8k in repairs. (I completely renovated the home, except HVAC). I am renting this out for $750. As mentioned above this home is standard loan @ 5.25%.
2nd home: New, paid $143k, appraised for $160k at closing. This will rent for $990.
3rd home: New, paid $143k, appraised for $150k. Rent $1045.
Here's the summary. In doing the math in Excel, I am making at least $200-300+ mo per property, after paying minimum (int only) payment, taxes, ins., etc.. Again, the extra money will go to pay off equity line (EL). In essence I am financing 100%. Based on the numbers, paying off the EL in 5 yrs, I should have at least 10-15% (figuring value increase) equity per home at that time.
Am I doing the math right ? Does this model make sense ? I considered the no money down schemes mentioned on this (and other) sites, but I just don't have time to deal with all the extra work. Since I have the available credit it was the easiest solution for me.
I also built a website, advertising my homes and offering ad postings for other local investors. Investor ads should pay for cost of website. So, my only cost for advertising is $30-40 month for small ad in local paper, usually generic & pointing them to my website. ? rentlakenorman. com
BTW, most of the REO's around here go for 90-95% FMV (after repairs).....so that's what drove me to new homes.
Any feedback would be appreciated.
Nice website, good plan. Maintain some available funds in the home equity line incase you need cash for reapairs and you should do fine.
Oh, and after the HEL is paid down (or perhaps even before) think about where your most expensive money is. If you have any credit cards carrying cash ballances at a higher rate than the Home equity loan you might want to think about applying the cash there first.
it looks and sounds like you have a working model.
if its not broke dont fix it
DDENT01 - I found your model interesting as I to have been considering a similar model for my area in South Florida. I'm curious to know if your model has panned out the way you thought a few months ago and what lessons you might be able to pass on to someone who is getting ready to take the plunge. Any feedback would be appreciated and I hope you have found your plan to be all that you hoped for in the beginning. :-D
Thanks all for the feedback. Being new to the business it's always good to get feedback from the pro's.
I am maintaining a fund reserve to handle emergencies. I have also started getting good traffic on the website and a few inquiries for ad postings there.
I'll follow up in a few months and let everyone know how it's going.
Interesting, almost the same model my neighbor has been using for the last year. He's up to 9 new houses, 8 are rented. 2 of them are really sold on L/O with a 3-yr balloon. He added 3 yrs worth of appreciation to the price on the L/O sales so his backend looks pretty good.
He's seen 5-15% appreciation from the time he buys the lot to the time he closes on the finished house. And the cashflow is a couple hundred per month on each at minimum using the I-O loans.
There is risk, but really, if the market tanks or the subdivision doesn't look good, you can not close and walk away from your $1-2K deposit.
Good luck
Peter
Have you run some simulations to validate your model? What were new development home prices five years ago? What will they be five years from now?
If you purchase one property today for $150K, then in five years it may be worth about $187.5K (and about $225K in ten years with 3% to 4% average appreciation). If you sell at or near maket value in five years, what will you 1031 into -- a replacement property costing $187.5K? You have not increased your net worth at all with this exchange.
Just keeping your original property will get you to the same point. How is your business model accelerating the increase in your wealth (net worth)? This is what I am missing.
DaveT, thanks for asking some good questions. As they don't show me your post while typing a reply I have to rely on my old memory.
Yes, I have run simulations on the model and it appears to show a 12-20% return after taxe considerations. We live in an area where homes are averaging a 3-4% annual value increase, but I have found new developments here tend to increase about 5-7% annually while it is being built. For safety sake I am still only factoring in 3% on my model.
Not sure I understand your comment regarding 1031 exchange not increasing my net worth. If I pay down the principle with profits from rent and then exchange for another home of the same as selling price how would I not be gaining net worth ? I would only have to borrow what I owe on the balance of my current loans (minus closing cost) and I would be continuing to upgrade to newer homes. Example: I purchase a home for $150k and pay down the loan over 5 yrs to $125k. I then sell the home for $175k (after closing cost), buy another for $175k, and borrow $125k, would I not have $50k in increased net worth ?
Forgive my ignorance, but I thought that was what this REI program was all about. I am obtaining properties with the least amount of out of pocket money, letting someone else (renter) pay the mortgage, and building equity in the home by reducing principle while increasing the value of the home. Can you help me understand what I'm missing ?
Thanks in advance!
ddent01
Quote:Not sure I understand your comment regarding 1031 exchange not increasing my net worth. If I pay down the principle with profits from rent and then exchange for another home of the same as selling price how would I not be gaining net worth ? I would only have to borrow what I owe on the balance of my current loans (minus closing cost) and I would be continuing to upgrade to newer homes.
Example: I purchase a home for $150k and pay down the loan over 5 yrs to $125k. I then sell the home for $175k (after closing cost).In your example, appreciation has pushed the value of your relinquished property up to $175K. Subtracting your $125K mortgage balance, gives you $50K equity in the property. If you don't sell, you still have $50K of equity contributing to your net worth.
Quote:I then .... buy another for $175k, and borrow $125k, would I not have $50k in increased net worth?No. Your replacement property value is $175K and has a mortgage balance of $125K. Your equity in this property is $50K, the same as the equity you had in the relinquished property.
The exchange did not increase your net worth -- just maintained it if you ignore transaction costs. Because selling costs, closing costs, and exchange fees take cash out of your equity or reduce your cash on hand, the exchange will actually reduce your net worth a little in this example.
There are situations where an exchange is not appropriate. Your example is one. Unless you have another compelling reason to exchange out of your "relinquished" property, this exchange will cost you more than you will gain.[ Edited by DaveT on Date 04/22/2004 ]