Help me give facts to a friend looking to invest in a second house in Scottsdale, AZ.

February 20, 2009 2:52 PM

A friend of mine owns a house in Phoenix proper. He wants to rent it for nearly his mortgage amount and purchase a bigger house in Scottsdale, intending to have his money in property investment as opposed to sitting in the bank. Help me give him facts that may support or prove inauspicious his idea...

He says his mentality is that of Warren Buffet's - when all the money is being pushed in one direction, put yours in the opposite direction. He can make a few thousand by letting a big chunk of money sit in the bank, or he can put that big chunk into a down housing market and let it grow with his investment. He has and will have a well-paying steady job in a field relatively unaffected by the current crisis (at this point). But he seems to think the curve is within 6 months of the bottom, and I very much disagree. Please help me give him solid data and weblinks that show him why this time, everything's different, and now is definitely not the time to invest in property in Scottsdale, AZ.
So far I've gathered:
RealEstateDecline.com
Marketwatch
Financial Sense
and a few news stories from the AZ papers.

posted by blastrid to work & money (9 comments total)

Well, this is only anecdotal but he should check out the rental listings on Craigslist here in Phoenix. People are renting out 3-bedrooms in decent parts of town for a fraction of the market rent and I assume, a fraction of their mortgages. It's a renter's market here.

My parents have several properties they are themselves renting and people have shown up to view the properties fully expecting to haggle on the posted rental prices.

Just FYI.
posted by notjustfoxybrown at 2:57 PM on February 20

This is exactly what small real estate investors do, so you could find out a lot of details in books related to real estate investing. There's a lot of hype books out there though that were written before the bubble collapsed. Make sure he gets a book that is factual and sober, rather than books about making no-risk millions by flipping houses.

From my perspecitve, the relevant issues are:

1) Will the rent equal his mortgage payment? As you point out, rents can be pretty cheap these days, so he may not be able to make the whole payment, and he'd have to supplement out of pocket. This is not necessarily a bad thing, it just means that he has to be prepared to do it, and hope that the value of the house will increase over time so he can recoup his expenses.

2) Does he mind being a landlord? Will he be ok with making repairs, or will he need a relationship with a contractor/manager type person to fix things? He needs to figure that the house will need repairs from time to time, and he should have a budget for that. Also involved with being a landlord is dealing with difficult clients. Not sure what tenant's rights are in Phoenix, but he should learn about leases and evictions and all that.

3) Can he sustain the mortgage during times the rent isn't coming in? The house may be vacant for periods of time or the tenants may not pay for some reason. He'll have to have a budget to tide him over during those times.

4) Tax and insurance issues. The tax writeoffs for owner occupied homes are fairly straight forward. They are entirely different for rental property. His insurance premiums will also likely be different if he's not living in the place.
posted by jasper411 at 3:20 PM on February 20

How much would he put down on the house in Scottsdale and how big is the mortgage on the house he currently owns in Phoenix?

If he's talking about a 20% downpayment for the house in Scottsdale and still has a sizable mortgage on the house in Phoenix, this is a risky strategy. For example, if he loses his renter in Phoenix, he'll have to cover both mortgage payments himself. If he can't afford both mortgage payments and the market doesn't improve, he might not be able to sell one of the homes or refinance his way out of trouble. Then he might find himself losing the investment house.

That is definitely NOT a situation Warren Buffett would get himself into. Buffett isn't merely a contrarian, he's a master of finding investments where he can control or minimize his downside.

Now, if he has the cash to purchase the new home with very little debt, that's another thing. If he can absorb the cost of losing his renter in Phoenix and still maintain both houses, his exposure to the mortgage and housing markets is minimized. In other words, it won't matter to him whether housing bottoms in 6 months or 2 years because he can hold his assets indefinitely. That is closer to a Buffett-like approach*.

* I don't mean that as an endorsement of this idea; I'm just creating an example that better fits the value investing philosophy.
posted by mullacc at 3:37 PM on February 20 [1 favorite has favorites]

Now is a bad time of year to be trying to find renters. The rental market is seasonal because of the snow birds. Lots of people will be moving back to cooler climates in the coming months and there will be an increasing number of competing rental properties. There will be a peak of openings in the summer, and then then things will return to normal when the snow birds start coming back in the fall.
posted by TungstenChef at 4:23 PM on February 20

If he has the stability and personality characteristics mentioned above, it seems like it is a good investment strategy actually. I think there is a good chance that we will have an inflationary situation within a year, and in that kind of situation real estate is definitely better than having money in dollars.
posted by peter_meta_kbd at 6:29 PM on February 20

An important question is how much money he has to put down on the second home. Will he even qualify for a second mortgage? The new lender is going to look at his debt and monthly expenses as being both mortgages combined. He will need monthly income that is at least three times both mortgages. You can't count income from a renter until you have actually rented the first home.

As others said, he needs income to support both mortgages when the first isn't rented, which may be more often than he thinks. Otherwise he could get into a squeeze where he is forced to sell one or the other in a down market for a loss. He could end up losing both homes. I wouldn't expect the housing market in Phoenix to recover for at least five years.

Another factor to consider is that renting out his first home is likely a violation of the terms of his mortgage. They may or may not make a fuss depending on the current appraisal and his equity.
posted by JackFlash at 8:39 PM on February 20

If his mortgage amount is more than what market rates are for rents, he won´t be able to rent it for that much.

If he thinks that he will rent it and have money coming in every single month, he´s wrong.

Maintenance costs will be higher with renters than while he was living there. Insurance might be higher, or not -- something to check on.
posted by yohko at 9:25 AM on February 21

A friend of mine rented her house last year when she had to relocate for work and couldn't sell. Her tenant decided to stop paying rent and the eviction process here (in PA) took so long long she almost lost her new house and her rental house. After that, she quickly sold her first house for a small loss. I would make sure your friend is considering the worst case scenario.
posted by bda1972 at 1:57 PM on February 21

Please help me give him solid data and weblinks that show him why this time, everything's different, and now is definitely not the time to invest in property in Scottsdale, AZ.

No can do. Property values have fallen tremendously, and may yet fall more, but you can't time a market precisely. This is a great time to buy real estate (even if you move into what you buy). Bargains galore. In that sense your friend could not have a better strategy.

He may, however, have trouble renting due to the extremely unusual market conditions. There are lots of foreclosed homes out there for rent, and houses that people who need to move can't sell, and so forth. It would be a dicey first couple of years to make sure he had a tenant.

And generally you need a much more hands-on mentality with landlording than with other investments. I would recommend he read The New No-Nonsense Landlord as it gives a good overview of the business with some advice including that not everyone is suited for it.

But yes, if your friend has cash reserves to weather the current economy, this is a great time to buy. I just don't know when the market will stabilize in Arizona and wouldn't hazard a guess.
posted by dhartung at 11:52 PM on February 21