A Little Bit of Background
A little over a year ago I took my first plunge into real estate investing. Terra and I found a house that we could “house hack” — live in one side/floor and rent out the other to lower or eliminate our monthly living expenses. We were so excited–well, I was… Terra was a little nervous about my new venture.
It didn’t work out due to co-signing problems and we ended up paying for the appraisal, which was around $450. That’s quite a lot of money for a poor college student couple. Since then, things have changed completely and I’m happy to share what I’ve learned so far. (Read more about my first failure here)
To read why I got involved in real estate in the first place read here.
The Power of Networking and Mentorship
If you’ve been following my blog posts, you know a little bit about the group of investors that I’ve been working with. We are a group of 10-15 investors led by two awesome mentors. More about that here.
Due to this mentorship and education I’ve gotten through Renatus, I’ve found a smart way to start building a portfolio of rental properties, the first of which is Terra’s and my first house ever! It’s exciting to think about decorating and improving our new home, which we will live in while renting it out at the same time.
Owning vs. Renting
There will always be discussions about whether it’s more financially wise to own a home or rent one. Usually, if you are living somewhere for a short time (1 – 2 years), and plan on selling your home when you leave, then it makes sense to rent. As a renter you don’t have to worry much about home improvement, closing costs, or selling costs. As a home buyer, it’s important to note that it can costs quite a bit to buy a home. You need to determine for yourself and your situation which makes more financial sense.
Now, with that being said, I am biased toward owning instead of renting in my situation. Here’s why:
1) We plan on keeping the house and renting it out for 5+ years.
2) I consider the experience of landlording and managing property valuable for my future.
3) We will be paying ourselves each month instead of paying someone else (our mortgage, not someone else’s).
4) In this specific case, it will allow us to live for $200 or $400 a month, depending on whether we live in the basement.
Here’s a useful calculator I found that while help you compare buying and renting.
Right now we are renting for $700/month. In our new house we would be paying just $200/month for the same conditions. (1 bed, 1 bath).
You may be thinking, “Well okay, you’re saving $500 a month, but what about the costs of buying and selling the house?”. If that’s what you’re thinking, then you are asking the right questions.
We are using an FHA loan, so we will pay about $6,000 down. We also pay for the inspection, which was $369. The cost of the mortgage broker is built into the loan, and the seller is paying the closing costs (including the realtor’s commission).
I may be forgetting something else, so let’s say in total we are paying $7,000 up front to buy this house. Our monthly expenses, including taxes, insurance, principal and interest mortgage payments is about $1100. We can rent the top of the house for $900/month. That leaves $200 in expenses each month.
Now let’s take the difference between our would-be rent and our expenses of owning this house.
$700 – $200 = $500. We save $500 every month. But how long will it take for it to break even with our cost of renting from someone else?
$7000 (cost of purchase) / $500 (monthly savings) = 14 months. It will take 14 months for “buying to be better than renting” in this case.
Edit: A good friend pointed out that we need to take into account the “time value” of money in this case. Here’s what he said about the time value of money…
“Basically, it means that $10 now is worth more than $10 a year from now. Like you said, this is partially because of opportunity cost. Say you have $10 now. If you invest that money, you could maybe have $11 a year from now. Also, because of inflation, the $10 now is worth more than $10 a year from now.
This concept can start having a huge impact once you’re dealing with larger amounts of money. You wrote that you had to make about a $7000 down payment for your current house and that you would save $500 each month because you were renting out part of your house. Even though 14 months of saving $500 is a total of $7000, you’re not actually saving that full amount of money. You’re maybe only saving $6000 or $6500.”
He’s right, we definitely need to take into consideration what we could do with that $7000 now that could grow our money, and we need to account for inflation too. Make sure you keep these factors in mind when you are comparing owning and renting.
14 months isn’t very long in my opinion, but the best part is that downpayment we made upfront doesn’t go to someone else. So the 14 months doesn’t mean anything. The money doesn’t go our landlord–it goes to us! We ARE the landlords. So really, aside from the inspection and closing costs, we get all our upfront money back PLUS the principal payments we made each month (minus selling costs) when we sell the house. (or take a home equity loan out on the house)
Try this: Multiply your current rent by the amount of months you have been renting from someone else. (if your rent has changed, adjust accordingly) Under the right conditions, that is how much money you have been giving to someone else that you could have kept for yourself while owning your own home.
Note that these calculations are rough and don’t apply to all situations. The interest that is built into the mortgage IS money that doesn’t come back to you. In our case, the tenant is paying for that interest–we don’t pay it.
I’ve given a lot of reasons why buying is a great idea, but don’t go out and buy a home until you sit down and go over the numbers. If you aren’t renting out part of your house while you live in it, it will take a lot longer for “buying to be better than renting”.
There are some really cool ways to pay down your mortgage in 5-7 years instead of 15 or 30. This will make owning a home more appealing than renting. I won’t go over it here, but we have meetups all around Utah where we talk about how to do this without using any extra money. It’s all about changing your way of thinking. Learn about local events on my meetup group here if you’re interested.
The First of Many
It’s hard to start new things. Even though I don’t know much yet, it’s been hard to learn the lessons that have gotten me to this point. (But totally worth it) This house is the first of many properties. By finding creative ways to finance our investments, (read this book about how to invest with no money down) we will continue to buy 1 or 2 properties a year, producing passive income that will compound on itself with time.
The next property we are looking to buy this year will cash flow $700/month. The deals are always around; you just have to be consistent and confident that you can find them.