Property's cheap, people need rentals - how can I make money?
July 23, 2012 9:13 AM   Subscribe

Is it possible to purchase a home with an FHA loan, rehabilitate it, and then rent it out? Also - what's it like to make an independent entry into the rental home market?

I recently found out that there are a number of homes in my area that are eligible for some very competitive FHA loans - so competitive in fact, that I could probably afford a mortgage on one or two of these homes in addition to the rent payment on my principal residence.

Is it possible, or wise, to use an FHA loan to purchase a property and then use it as a rental property? I've Googled around a bit and seen time periods between 90 days and 1 year in which the home must be occupied by the loan holder, but most of what I've found is out of date or doesn't seem credible. The FHA website seems reticent to talk about this possibility. I'm not interested in "flipping" the homes.

This would be in a working class neighborhood in Denver, Colorado. Judging by what I pay for my house and what a mortgage payment + rehab costs would be, it seems like I could make between $400-800/mo on these homes. Has anyone else made an independent foray into the rental property business - and what have your experiences been?

In a more general sense, I'm interested in this because it seems like a *relatively* easy way to make money if you've got a bit of capital behind you. When I say easy, I don't mean I'm not devoting my life to it - just that profitability is more than just a pipe dream. My girlfriend wants to start her own coffee shop (and I know she'd be good at it, she's worked every position and has managed a shop for years with extreme business acumen) but it seems like an awful lot of work for extremely uncertain returns, whereas the rental business is still hard work, but the uncertainties seem to be much more limited ("known unknowns") and the break-even point looks to come much sooner in real estate.
posted by speedgraphic to Work & Money (14 answers total) 2 users marked this as a favorite
In general, FHA loans require residency. The exception is if you have a "Good Neighbor" type loan or if you rent out only part of the home.

As a practical matter, I know of people that violate this requirement and I am under the impression it is rarely, if ever, enforced.
posted by saeculorum at 9:18 AM on July 23, 2012 [2 favorites]

I know this is probably not what you want to hear, but this is a riskier venture than it seems.

Maintaining a rental house is expensive. There will be months when you can't find a tenant and you will have to pay the mortgage out of pocket. Tenants may move out at any time, leaving you scrambling to find replacements. Tenants may not pay rent for months, leaving you with costly and stressful eviction proceedings (it's almost impossible to get back the money you're owed, too). Tenants may trash the place, leaving you with costly repairs and remodeling after they ruin the carpets/break the windows/punch holes in doors/burn out the wiring, etc. Unforeseen events like flooded basements, spider infestations, mold infestations, falling trees, etc, can totally bankrupt you.

Basically, with earnings of just $400 to $800 a month, your margins for profit are way, way too thin. You could end up sinking tons of time and effort into the project and only making an extra grand or two a year. Or you could end up losing money. Worst case, you get totally over extended and in debt, and end up losing not just the rental house, but your primary residence. I've seen it happen.

It's not impossible, but it's hard, and you need a lot of capital behind you to make it a safe venture.
posted by crackingdes at 9:25 AM on July 23, 2012 [1 favorite]

There may be other adventageous loans for you to take advantage of, but FHA requires residency (as Saeculorum notes.)

You are leveraging debt, and personal debt at that. It's not such a hot idea. (as many, many people discovered in the crash of 2008).

If you can get a duplex, and rent out half, and live in the other half, that would be a good way to start.
posted by Ruthless Bunny at 9:28 AM on July 23, 2012 [1 favorite]

If you're renting now and you're cashflow is such that you can take on the risk of owning a house or two to rent out, why not just buy a house to live in yourself?

It's WAY lower risk and you're not really giving up anything. By being a renter you don't have to worry about maintenance. As a landlord, you'd be giving that up. Instead of getting $400-$800/month in profits that you put into your savings account, the money that you no longer have to pay in rent goes into the equity of the home.

It just seems silly to buy a house to rent out when you don't own the property you live in now. By a house for yourself first and then maybe worry about buying something else to rent out (or do the duplex thing that Ruthless Bunny suggests).
posted by VTX at 9:43 AM on July 23, 2012

It just seems silly to buy a house to rent out when you don't own the property you live in now.

Given the tax breaks you receive for home ownership, this actually does make sense, assuming all the other financials work out right.

If you can get a duplex, and rent out half, and live in the other half, that would be a good way to start.

Duplex or triplex, but yes, this is the best way to go. There are mortgage benefits to doing it this way, too (you can buy one building with one mortgage, rather than having to get multiple mortgages for multiple units). As was noted above, FHA loans require residency, and I really wouldn't screw with that, especially if you're using them as an investment and have people living there. (It's a different type of foolish if this was just your second home.)
posted by NotMyselfRightNow at 9:49 AM on July 23, 2012 [1 favorite]

Interesting - I hadn't considered duplexes, but that makes a lot of sense. I've heard a lot of talk about multi-unit complexes and "live in one, rent the other, live for free"... but how feasible is that? I ran the numbers on a $300k duplex and it looks to be a $1,200-1,500 mortgage payment... doesn't seem likely that I'd be able to live "for free" in the other unit, even though the rented unit would pay the bulk of the mortgage.
posted by speedgraphic at 9:54 AM on July 23, 2012

You don't "live for free" but you live for half of the mortgage, and you build up equity in the home. You also get a decent tax deduction.

Also, this gives you a chance to dip your toe in the landlord water. Being on-site is a bonus because you know what your tenants are doing or not doing to the property.

Also, don't be fooled by "mortgage payment" in addition to the Principle and Interest, you'll be escrowing for property taxes, Private Mortgage Insurance and homeowners insurance. Tack on another $400-$500 on a $1,200 to $1,500 mortgage payment.
posted by Ruthless Bunny at 10:14 AM on July 23, 2012

Yeah, the "mortgage payment" I was referencing is really more like the total payment. A $1,500 total payment on a 30 year loan @ ~3% + PMI + taxes + insurance seems reasonable, unless I'm completely off?
posted by speedgraphic at 10:26 AM on July 23, 2012

edit: that's for a $300k property.
posted by speedgraphic at 10:27 AM on July 23, 2012

Expect a rate of 3.75%, not 3%; in my neck of the woods (MA), I'm paying close to $2.5k/month on a modest home via FHA loan for ~$350k.

That figure drops if you live in an area with lower taxes (I pay ~$7k/year) or can put a significant amount down (20%, vs, say, 5%).
posted by ellF at 11:04 AM on July 23, 2012

Another point about owning a duplex and renting the other half:
You are an on-site landlord, as opposed to an absentee landlord. The latter is rarely welcomed by the neighborhood. But since you would actually live in the house, it shows you're invested in the neighborhood, in both senses of the word. Not to mention better for prospective tenants, to have "Mr. Fix-it" right next door.
posted by BostonTerrier at 11:17 AM on July 23, 2012

crackingdes has some good points and I urge you to consider them. Landlording is not exactly a way to easy money, something all too many "investors" learned to their chagrin during the housing crisis and the bubble burst.

That said, this is an excellent time to buy with one caveat: if you can get/afford a competitive mortgage. As you guessed, this may not be an FHA mortgage, but then there is the option of a duplex or two-flat building. The combination of relatively low home prices and relatively low borrowing costs is really hard to pass up if you have the capability. Landlording can be fun and rewarding too, and you can reduce the risks with good background checks, references, finding tenants through a network, and other means, not to mention being on-site as with a multi-unit you live in keeps it from turning into a meth lab or whatnot.

I really don't think it makes sense to buy a building when you're renting, though, so I would want to sit down with a real estate attorney and CPA and work out various strategies that are within your means, find out the tax consequences and benefits, and have a realistic business plan. Then you can know exactly what you need to buy and wait for the right opportunity to come along, without falling in love with an unaffordable property or one with too many problems requiring repairs to code (a good home inspector would be invaluable).

Landlord finances are much more than just the mortgage vs. the rent. There are property taxes; insurance; maintenance; appliance replacement; and the odd disaster. You had better factor these into your math.

That said, there are different ways to approach this (aside from the flipping that you wisely dismiss). One popular way is the tax loss where you have a rental business that loses money on paper (after depreciation/deductions) to offset income you have with a tax rate that's too high. So see what this scenario would do. The other (and these aren't necessarily exclusive of each other) is "cash flow" investing, which is what you're thinking of mostly -- the cash flow pays for the expenses, and you have an asset that's appreciating. The thing is that cash flow isn't going to make you rich in and of itself at this level (10 to 100 units, on the other hand, may). So you're hoping for equity and appreciation. Both of those are going to be a long time coming in this economy. If you have patience for that....
posted by dhartung at 12:30 PM on July 23, 2012

Landlord finances are much more than just the mortgage vs. the rent. There are property taxes; insurance; maintenance; appliance replacement; and the odd disaster. You had better factor these into your math.

If you have only ever renter, you likely don't appreciate these costs. For example, I bought a house this year. I've spent nearly $20k mitigating radon, replacing the oil boiler, and doing general repairs. I'll spend another $10-$15k before the year is out replacing appliances, painting, and doing various smaller jobs that require me to run to Home Depot or Lowes and drop a few hundred dollars on supplies and tools.

Roofs fail. Electrical systems need to be upgraded or replaced. Plumbing fails dramatically. Roofs start leaking. Will all of it happen to you? Probably not. Will some of it? Probably. You can lower your risk by getting an amazing inspection, being thorough, and not letting emotion play into your purchase. But it's only a lowering of risk; things will go awry, and it's on you (and your bank account) to make them right.
posted by ellF at 3:24 PM on July 23, 2012

I mostly wanted to comment on the rehab aspect, but I will say that, as others have noted, FHA does require a 12 month primary occupancy period. They're not going to come around and check that you're living there, but if your loan gets pulled for audit (and they do audit a significant number) and there is ANY indication in the file that you didn't really intend to occupy, they will hold your lender accountable, which means your lender may well call your loan due and payable. I would not do it unless you truly intend to occupy for at least 12 months. Note also that you can pretty much only do this once - you can't get a 2nd FHA loan while the first is outstanding unless you meet certain extenuating circumstances, so this isn't a way to build up a rental portfolio.

Re: the rehab: I'm not sure what kind of condition the houses you're looking at are in, but if they need fix-up in order to be acceptable rentals, it's likely they won't meet FHA property standards without some work being done--which means that work has to be done before closing. If the work required is extensive, you could take a 203(k) rehab loan and finance the repairs but that's going to add to your loan and monthly payment. Seconding get a really thorough inspection - even if you don't have to fix it all up front, you'll know what's coming out you down the line.

The multi-unit idea is the best way to go about this, but if you do, you should probably have a minimum of 3 months mortgage payments in reserve (more if the rehab is going to prevent you from renting it right away) - that's in addition to your down payment. Note also in calculating your income that FHA assumes the rental unit is going to be vacant 25% of the year - that's probably a little conservative, but if you can successfully budget (for repairs, maintenance etc) based on only 9 months rent, you're a lot more likely to be successful. Good luck!
posted by tinymojo at 7:55 PM on July 23, 2012

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