Dipping Our Toes Into Real Estate
February 12, 2013 9:04 PM Subscribe
My brother and I would like to buy a four-bedroom house, furnish it, have him live in one room and rent the other three rooms. Neither of us have any experience with real estate, renting rooms, or being in business with one another. We're looking for advice as to how to fairly structure this investment, advisers we should consult, issues that we need to consider up front, and so on. More details inside...
I'm not entirely sure which details are relevant, so I may include too much or too little. I live in New York, my brother lives in the Phoenix area. The house to be purchased would be in the suburbs of Phoenix. I have money, excellent credit, and a high-paying job - particularly by Arizona standards. My contemplated contribution would be mainly the down-payment and my credit. My brother has some money, decent credit, and a low-paying, though solid job. His contemplated contribution would be getting the tenants, collecting the rent, doing the actual work to furnish the place, perhaps paying rent himself on his room, perhaps contributing some money up front, and handling any ongoing maintenance, etc. In the area where we wish to buy, a reasonable 4-bedroom house would go for around $170-200k, then we'd need to furnish it, and rent out the 3 other rooms.
The main reason we think this investment makes sense is that my brother very reasonably believes he has the means to consistently rent out each of the rooms for about $350 per month (he already has the first set of tenants lined up if we go forward with this). For purposes of this question, please assume that's the case. The rentals would likely be short term - 3 months is probably the commitment we could get from each individual, though many people would stay longer on a month to month basis, and if one person moves out there are a host of others that will be ready to move in soon thereafter. Again, please assume that's the case.
Also, I can readily afford this investment and readily afford to lose it all - my brother is far more important to me than $200k and so even if I somehow lost that amount our relationship would be fine. We want to do this together as a team, think it would be a good experience, and get along very well and are both quite practically minded. My thought is to put up around $50k-$70k in cash for the down-payment, fees and furnishing and for a fund for repairs/maintenance, but I could do up to the full purchase price without issue if that makes more sense from a financial perspective, or put up less.
If we can work this out for one house, we might do this for another one or two houses as well after the first house is up and running.
With all those details in mind, my many questions are:
(1) How should we think about structuring this so that the investment is one we are both making and that we are both getting a fair return? I'll be putting up the downpayment and the money for furnishing the place, but he'll be doing all the work to find tenants/collect rent/etc. Unless there are tax or other reasons not to do it, we'd both like to be on the mortgage and both end up owning a share of the house. I'm really having a lot of trouble even thinking how best to structure this - I don't want to get the better deal, just something that is fair and leaves us both invested in this property. Would it make sense to form some sort of formal business arrangement (LLC, etc) and have that buy the house? Can't imagine mortgage companies would like that as much, assuming we go the mortgage route.
(2) What advisers should we be consulting? Broker? Real estate attorney? Tax attorney? Any book recommendations to get us more up to speed on buying/renting?
(3) We'd like to make sure however this is structured we get all the tax benefits available. I currently rent and neither of us own a place. From some quick research online, it appears that if we rent most of the house we wouldn't qualify for a mortgage interest deduction against regular income, but could deduct the mortgage interest as an expense against any rental income, etc. Is that right? Is this something a broker would know or do we need an accountant/tax attorney? Am I right that a mortgage makes sense here instead of paying the full purchase price upfront?
(4) Are there any legal issues with renting 3 bedrooms out of a four bedroom house in a residential neighborhood? Would this be governed by the HOA agreement? Any state/city laws? Or is this always going to be legal?
(5) Will we have to outline our plans for this house to a bank when we seek a mortgage? Or if I know I can get approved for a mortgage to buy myself a house quite readily, can we just present my and his information (income, savings, etc.) and get a regular mortgage without disclosing any additional details?
(6) What else should we be considering? What other issues may arise that we should be prepared for?
Thanks in advance for any advice/thoughts!
I'm not entirely sure which details are relevant, so I may include too much or too little. I live in New York, my brother lives in the Phoenix area. The house to be purchased would be in the suburbs of Phoenix. I have money, excellent credit, and a high-paying job - particularly by Arizona standards. My contemplated contribution would be mainly the down-payment and my credit. My brother has some money, decent credit, and a low-paying, though solid job. His contemplated contribution would be getting the tenants, collecting the rent, doing the actual work to furnish the place, perhaps paying rent himself on his room, perhaps contributing some money up front, and handling any ongoing maintenance, etc. In the area where we wish to buy, a reasonable 4-bedroom house would go for around $170-200k, then we'd need to furnish it, and rent out the 3 other rooms.
The main reason we think this investment makes sense is that my brother very reasonably believes he has the means to consistently rent out each of the rooms for about $350 per month (he already has the first set of tenants lined up if we go forward with this). For purposes of this question, please assume that's the case. The rentals would likely be short term - 3 months is probably the commitment we could get from each individual, though many people would stay longer on a month to month basis, and if one person moves out there are a host of others that will be ready to move in soon thereafter. Again, please assume that's the case.
Also, I can readily afford this investment and readily afford to lose it all - my brother is far more important to me than $200k and so even if I somehow lost that amount our relationship would be fine. We want to do this together as a team, think it would be a good experience, and get along very well and are both quite practically minded. My thought is to put up around $50k-$70k in cash for the down-payment, fees and furnishing and for a fund for repairs/maintenance, but I could do up to the full purchase price without issue if that makes more sense from a financial perspective, or put up less.
If we can work this out for one house, we might do this for another one or two houses as well after the first house is up and running.
With all those details in mind, my many questions are:
(1) How should we think about structuring this so that the investment is one we are both making and that we are both getting a fair return? I'll be putting up the downpayment and the money for furnishing the place, but he'll be doing all the work to find tenants/collect rent/etc. Unless there are tax or other reasons not to do it, we'd both like to be on the mortgage and both end up owning a share of the house. I'm really having a lot of trouble even thinking how best to structure this - I don't want to get the better deal, just something that is fair and leaves us both invested in this property. Would it make sense to form some sort of formal business arrangement (LLC, etc) and have that buy the house? Can't imagine mortgage companies would like that as much, assuming we go the mortgage route.
(2) What advisers should we be consulting? Broker? Real estate attorney? Tax attorney? Any book recommendations to get us more up to speed on buying/renting?
(3) We'd like to make sure however this is structured we get all the tax benefits available. I currently rent and neither of us own a place. From some quick research online, it appears that if we rent most of the house we wouldn't qualify for a mortgage interest deduction against regular income, but could deduct the mortgage interest as an expense against any rental income, etc. Is that right? Is this something a broker would know or do we need an accountant/tax attorney? Am I right that a mortgage makes sense here instead of paying the full purchase price upfront?
(4) Are there any legal issues with renting 3 bedrooms out of a four bedroom house in a residential neighborhood? Would this be governed by the HOA agreement? Any state/city laws? Or is this always going to be legal?
(5) Will we have to outline our plans for this house to a bank when we seek a mortgage? Or if I know I can get approved for a mortgage to buy myself a house quite readily, can we just present my and his information (income, savings, etc.) and get a regular mortgage without disclosing any additional details?
(6) What else should we be considering? What other issues may arise that we should be prepared for?
Thanks in advance for any advice/thoughts!
I wrote you a big explanation that my computer ate - my bottom line was that you have a lack of planning for what to do with trouble applicants or trouble tenants with a lease.... Your brother is not qualified to choose good rommates/tenants... This won't end well unless you have an awesome attorney in place advising you, or similar landlord with longterm experience in Arizona....
In short, this is a bad idea unless you lock down the tenancy issues. At this point, you don't indicate what protections tenants or applicants have that might make your lives difficult should things go south. With multiple tenants, things will go south, especially if you are dealing in short-term leases.
This plan is folly. Stop. Rethink it.
posted by jbenben at 9:41 PM on February 12, 2013 [2 favorites]
In short, this is a bad idea unless you lock down the tenancy issues. At this point, you don't indicate what protections tenants or applicants have that might make your lives difficult should things go south. With multiple tenants, things will go south, especially if you are dealing in short-term leases.
This plan is folly. Stop. Rethink it.
posted by jbenben at 9:41 PM on February 12, 2013 [2 favorites]
I've read this through a couple of times, and in your position my question would be 'Why would I want to do this?' rather than 'Should I do this?'
With all due respect, I think you're looking at this with rose-tinted glasses. You might have a 'host' of people lined up for shortp-term leases with strangers, but how's that going to work out in reality? What about when your brother gets tired of the revolving roster of tenants, or they get tired of each other?
Honestly, I think there are better ways to do something with your brother. Buy a smaller place (say, 2 bedroom), you pay 50% straight up as the deposit, he pays the other 50% as a mortgage, rent out the second room if you want. Or you pay for the place straight-up, and he pays off 50% to you, so that he comes out of it with some equity. Or you buy a one-bedroom as an investment property and rent it directly to him.
My brother means more to me than 200 grand as well, but that doesn't mean that I want to throw money away, or put either of us in an unnecessarily stressful living situation.
posted by Salamander at 11:10 PM on February 12, 2013 [2 favorites]
With all due respect, I think you're looking at this with rose-tinted glasses. You might have a 'host' of people lined up for shortp-term leases with strangers, but how's that going to work out in reality? What about when your brother gets tired of the revolving roster of tenants, or they get tired of each other?
Honestly, I think there are better ways to do something with your brother. Buy a smaller place (say, 2 bedroom), you pay 50% straight up as the deposit, he pays the other 50% as a mortgage, rent out the second room if you want. Or you pay for the place straight-up, and he pays off 50% to you, so that he comes out of it with some equity. Or you buy a one-bedroom as an investment property and rent it directly to him.
My brother means more to me than 200 grand as well, but that doesn't mean that I want to throw money away, or put either of us in an unnecessarily stressful living situation.
posted by Salamander at 11:10 PM on February 12, 2013 [2 favorites]
No offense to Mefites who are responsible renters, but managing rental property, putting up with possibly 'unusua' tenants who might not share your values, or take care of your property, is a challenging job. It is a job, and you and your brother already have jobs.
Visualize the guy who removed the window screens so that he could shoot BBs at the resulting flies. Visualize the unmarried couple who broke up leaving the unemployed woman in the apartment. Can you visualize your brother coping with that kind of drama in his spare time?
posted by Cranberry at 11:55 PM on February 12, 2013
Visualize the guy who removed the window screens so that he could shoot BBs at the resulting flies. Visualize the unmarried couple who broke up leaving the unemployed woman in the apartment. Can you visualize your brother coping with that kind of drama in his spare time?
posted by Cranberry at 11:55 PM on February 12, 2013
Best answer: (1) By getting a lawyer. You're talking about what amounts to a business deal involving real property. You need to set up a contract that clearly sets forth all relevant rights and duties. Also, since this is a contract involving ownership rights in land, it should probably be in writing.
(2) Doing this without a real estate agent seems like a bad idea. And you're going to want a lawyer too, probably one in general practice. You've got real estate, business tax, individual tax, and contract issues here.
(3) That's what you talk to a lawyer about.
(4) Quite probably. But the thing to realize here is that you're not talking about your brother taking on three tenants, you're talking about taking on three roommates. Your brother will be living with these people and sharing living space with them. This is a far, far more complicated arrangement than simply renting out the entire house at a go.
(5) Again, quite probably. Residential mortgages are an entirely different class of financial instrument than commercial lending, even for the purchase of real property. Filling out your application as if you were in one category while actually being in the other could constitute mortgage fraud, which is a felony. Consult your attorney.
(6) The idea that you can consistently keep three bedrooms in a house occupied is even less realistic than thinking you can consistently keep three individual apartments occupied. There's an active, thriving market in the latter, but not so much of one in the former. Most people don't like sharing living space with people they don't already know.
Not to put too fine a point on it, but this is a terrible idea. If your brother wants to find a way of buying a house, there's probably a way you can make this work. If he can find a roommate to help with the rent, that'd be awesome. But doing this as some kind of investment is a bad idea for everyone involved.
posted by valkyryn at 12:16 AM on February 13, 2013
(2) Doing this without a real estate agent seems like a bad idea. And you're going to want a lawyer too, probably one in general practice. You've got real estate, business tax, individual tax, and contract issues here.
(3) That's what you talk to a lawyer about.
(4) Quite probably. But the thing to realize here is that you're not talking about your brother taking on three tenants, you're talking about taking on three roommates. Your brother will be living with these people and sharing living space with them. This is a far, far more complicated arrangement than simply renting out the entire house at a go.
(5) Again, quite probably. Residential mortgages are an entirely different class of financial instrument than commercial lending, even for the purchase of real property. Filling out your application as if you were in one category while actually being in the other could constitute mortgage fraud, which is a felony. Consult your attorney.
(6) The idea that you can consistently keep three bedrooms in a house occupied is even less realistic than thinking you can consistently keep three individual apartments occupied. There's an active, thriving market in the latter, but not so much of one in the former. Most people don't like sharing living space with people they don't already know.
Not to put too fine a point on it, but this is a terrible idea. If your brother wants to find a way of buying a house, there's probably a way you can make this work. If he can find a roommate to help with the rent, that'd be awesome. But doing this as some kind of investment is a bad idea for everyone involved.
posted by valkyryn at 12:16 AM on February 13, 2013
Owning rental real estate can be a great thing, and I can certainly say for some people it works out well. But it certainly isn't for everyone.
Agree with others here that there are better ideas to achieve the same ends.
Buying a smaller place outright (suitable for your brother and say one optional renter-of-a-room), then having him responsible to you for a 50% agreed-upon 'private' mortgage (where you are the lender to your brother, and his monthly payment to you is something he can handle on his own without the optional renter) would meet a lot of your goals. Your brother can accelerate his payback to you as he shows his ability / responsibility in finding a good tenant, and once that place has worked well (say he puts in sweat equity, also he is good with making payments etc.) you have full control to rent that place out, and put your brother (with another agreement) to manage that rental for a market-rate. (Something like 8-10% of the monthly rent is the usual.)
At that point, your brother has rented out the first place, the rent would apply to your brother's existing mortgage to you, but now the arrangement includes his managing the rental at that point. Your brother basically becomes a landlord - you hold the note, he pays the existing mortgage with the rental income and his management fee, and he's free to live in a second place.
The second place could then well be another 2nd rental place, you do very similar to what you did the first time, where he lives in it, puts in some sweat equity to fix it up, makes a regular payment to you, and gets to the point where he rents it out and manages that 2nd place for you (for a fee of course).
This is basically how people get started in real estate investing, with the benefit that you are acting in place of a bank.
posted by scooterdog at 3:01 AM on February 13, 2013
Agree with others here that there are better ideas to achieve the same ends.
Buying a smaller place outright (suitable for your brother and say one optional renter-of-a-room), then having him responsible to you for a 50% agreed-upon 'private' mortgage (where you are the lender to your brother, and his monthly payment to you is something he can handle on his own without the optional renter) would meet a lot of your goals. Your brother can accelerate his payback to you as he shows his ability / responsibility in finding a good tenant, and once that place has worked well (say he puts in sweat equity, also he is good with making payments etc.) you have full control to rent that place out, and put your brother (with another agreement) to manage that rental for a market-rate. (Something like 8-10% of the monthly rent is the usual.)
At that point, your brother has rented out the first place, the rent would apply to your brother's existing mortgage to you, but now the arrangement includes his managing the rental at that point. Your brother basically becomes a landlord - you hold the note, he pays the existing mortgage with the rental income and his management fee, and he's free to live in a second place.
The second place could then well be another 2nd rental place, you do very similar to what you did the first time, where he lives in it, puts in some sweat equity to fix it up, makes a regular payment to you, and gets to the point where he rents it out and manages that 2nd place for you (for a fee of course).
This is basically how people get started in real estate investing, with the benefit that you are acting in place of a bank.
posted by scooterdog at 3:01 AM on February 13, 2013
slide: "The rentals would likely be short term - 3 months is probably the commitment we could get from each individual, though many people would stay longer on a month to month basis, and if one person moves out there are a host of others that will be ready to move in soon thereafter. Again, please assume that's the case."
I think you're being wildly optimistic about being able to maintain a pipeline of tenants on an ongoing basis. Remember, when owning property you need to think about things in terms of years down the road.
Also, short-term tenants have pretty much zero personal stake in maintaining the property. People who float through your house on a 3-month stint are probably not going to give a crap about dinging up the furniture, staining the carpet, etc. And moving in and out in general creates a lot of wear and tear. I think you're severely underestimating the amount of upkeep you (financially) and your brother (in labor) will have to put into the house.
I think you're going in way over your head here. Simplify!
posted by mkultra at 3:50 AM on February 13, 2013
I think you're being wildly optimistic about being able to maintain a pipeline of tenants on an ongoing basis. Remember, when owning property you need to think about things in terms of years down the road.
Also, short-term tenants have pretty much zero personal stake in maintaining the property. People who float through your house on a 3-month stint are probably not going to give a crap about dinging up the furniture, staining the carpet, etc. And moving in and out in general creates a lot of wear and tear. I think you're severely underestimating the amount of upkeep you (financially) and your brother (in labor) will have to put into the house.
I think you're going in way over your head here. Simplify!
posted by mkultra at 3:50 AM on February 13, 2013
Best answer: Consult a landlord/tenant attorney who practices in the same area you are buying and find out about roommate laws, HOAs, evictions, leases and anything else you can think of. Talk to an accountant or tax lawyer about the tax consequences.
There are a lot of laws specifically designed to keep roommates/college students out of "family" neighborhoods. I'm not sure how this is permitted under fair housing law but it is.
Also find out what the code enforcement is like there. Where I manage properties, tenants can call codes to inspect the property and the owner is given a list of violations they must fix in 15 days or get fined. That is true even if the tenant caused the damage.
There's probably an investor/landlord club in the area, they are a good resource if you can find one.
Roommate tenants have to be evicted if they don't pay, and eviction can drag on for a while. It's got to be pretty awful to live with someone who you're evicting!
posted by Melsky at 4:04 AM on February 13, 2013
There are a lot of laws specifically designed to keep roommates/college students out of "family" neighborhoods. I'm not sure how this is permitted under fair housing law but it is.
Also find out what the code enforcement is like there. Where I manage properties, tenants can call codes to inspect the property and the owner is given a list of violations they must fix in 15 days or get fined. That is true even if the tenant caused the damage.
There's probably an investor/landlord club in the area, they are a good resource if you can find one.
Roommate tenants have to be evicted if they don't pay, and eviction can drag on for a while. It's got to be pretty awful to live with someone who you're evicting!
posted by Melsky at 4:04 AM on February 13, 2013
In almost every locality there are zoning ordinances that either completely prohibit renting rooms in a home zoned for single family use or that sharply curtail the number of renters you can have. For instance in Mesa (you didn't say which suburb), the rules apparently just changed to allow renting up to 30% of the space. You need to consult an attorney in Arizona.
posted by Lame_username at 4:32 AM on February 13, 2013 [2 favorites]
posted by Lame_username at 4:32 AM on February 13, 2013 [2 favorites]
Let's accept all of your optimistic assumptions at face value and also assume that your brother will pay rent.
Do you consider a gross income of $1400/month ($350 x 4) versus a $170-200k obligation to be a good investment? I think that's the only way you can look at this deal.
The numbers don't work for me. Therefore, in my opinion, this does not sound like a good situation for you.
posted by 99percentfake at 7:32 AM on February 13, 2013 [2 favorites]
Do you consider a gross income of $1400/month ($350 x 4) versus a $170-200k obligation to be a good investment? I think that's the only way you can look at this deal.
The numbers don't work for me. Therefore, in my opinion, this does not sound like a good situation for you.
posted by 99percentfake at 7:32 AM on February 13, 2013 [2 favorites]
How long has your brother lived with roommates? Has he ever lived with three roommates before? For how long? Did/does he like it? How much does he like it?
Someone I know rented the same house for about 10 years, himself staying in one room and the three other rooms sublet to other folks. Often the people in the other rooms were relatives or good friends before they moved in, and on the grand scale of roommate drama, the place was always drama-free. Nonetheless, by the end of those 10 years, my friend was so sick of roommates he couldn't wait to get out of there.
How sure is your brother that he will really be ok with this living arrangement in the long term? Short term renters really do not give a shit about your house--they will not clean or maintain it well--so if your brother moves out, the house will be in trouble. And I think your brother will, eventually, want to move out.
posted by snorkmaiden at 8:14 AM on February 13, 2013
Someone I know rented the same house for about 10 years, himself staying in one room and the three other rooms sublet to other folks. Often the people in the other rooms were relatives or good friends before they moved in, and on the grand scale of roommate drama, the place was always drama-free. Nonetheless, by the end of those 10 years, my friend was so sick of roommates he couldn't wait to get out of there.
How sure is your brother that he will really be ok with this living arrangement in the long term? Short term renters really do not give a shit about your house--they will not clean or maintain it well--so if your brother moves out, the house will be in trouble. And I think your brother will, eventually, want to move out.
posted by snorkmaiden at 8:14 AM on February 13, 2013
I too HATE this idea. With a white-hot passion.
It's all fun and games until the roof leaks, or the hot water heater dies, or a tenant trashes his room and departs in the dead of night leaving you with nothing but his fleas and rubber check.
This is a uniformily terrible idea.
posted by Ruthless Bunny at 11:50 AM on February 13, 2013 [1 favorite]
It's all fun and games until the roof leaks, or the hot water heater dies, or a tenant trashes his room and departs in the dead of night leaving you with nothing but his fleas and rubber check.
This is a uniformily terrible idea.
posted by Ruthless Bunny at 11:50 AM on February 13, 2013 [1 favorite]
Response by poster: I truly appreciate all the responses and advice, as does my brother. I'll admit I particularly appreciate the point by point responses, but the reality checks from everyone who explained why they thought this was a terrible idea are good to hear and consider as well. Nothing we've read has scared us away from the idea, believe it or not, but our next step will be to consult with an attorney and a real estate broker so there will be another level of sanity check and as the details emerge who knows...
posted by slide at 8:33 PM on February 13, 2013
posted by slide at 8:33 PM on February 13, 2013
our next step will be to consult with an attorney and a real estate broker so there will be another level of sanity check and as the details emerge who knows...
This is a good idea.
I am very confident that once you make these consultations you're going to find that this is simply not going to work the way you seem to want it to.
But you may also find that there is a different way of making it work that works for you and your brother. It may not be what you originally had in mind, but flexibility is an important part of doing business, any kind of business. See what you can figure out.
posted by valkyryn at 4:13 AM on February 15, 2013
This is a good idea.
I am very confident that once you make these consultations you're going to find that this is simply not going to work the way you seem to want it to.
But you may also find that there is a different way of making it work that works for you and your brother. It may not be what you originally had in mind, but flexibility is an important part of doing business, any kind of business. See what you can figure out.
posted by valkyryn at 4:13 AM on February 15, 2013
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2) All of those, I should think. I'd seek out a real estate broker who specializes in investment properties --- in Phoenix you should be beating them off with sticks. They should be able to advise on some of the next steps and regs you'll need to know for an investment property.
3) I believe you're right about the mortgage, but consult a tax advisor on that to be sure.
4) Yes, quite possibly. It depends on the local jurisdiction, and I'm not in Phoenix so can't advise on that. But I know that in my own location renting to more than 4 people in a residential neighborhood is illegal without a hotel/boarding house license and that many HOA flat-out ban subletting/renting. And also that the majority of newer developments in Arizona and Cali come with HOAs. So this could definitely be an issue and you should check thoroughly before purchase --- one busybody neighbor on the HOA board could put you up shit creek.
5) Buying a home that will be your first home purchase but which will not be your primary residence, and with a co-signer who may or may not be contributing to the payment, is a very unusual situation, mortgage-wise. I don't think you would qualify for a standard residential loans under current underwriting guidelines, which are quite strict. This is not to say I think you'll have trouble finding someone to lend to you; it sounds like you have sufficient cash on hand to make you a safe bet. But given the amount of documentation you'll be asked to provide, I don't think you'll be able to just purchase the house without mentioning your plans for it, especially if you want your brother to be on the documents as co-owner. You should talk to a broker and/or attorney about this.
6) As i said, I don't live anywhere near Phoenix. But I do follow the industry, and from everything I hear the Phoenix market is saturated with investors right now who are snapping up properties quite quickly, often for 100% cash. It's a bit volatile. I wouldn't be surprised if house I bought for $170K today was worth $185K in six months --- or $150K. I think a weird loan/partnership situation such as yours will place you at a disadvantage if you end up in a multiple bid situation against people who can put up full cash purchase price. It's worth thinking about under what conditions the finances here stop making sense for either you or your brother --- if, by the time you get your ownership structure sorted out, you can't get the right size/type of house for less than $225K, does that still work? What if the Phoenix market dips again and the house goes underwater and you can't sell out for a couple of years --- are you going to need that down payment money again?
posted by Diablevert at 9:40 PM on February 12, 2013