In my 1996 book, Stop Renting Now!, I advised, "To increase borrowing power, let tenants pay your mortgage. Choose a two- to four-unit rental property and live in one unit for a few years. Collect rent from the other units." Anyone who followed this advice would have multiplied their original investment many times over. Although Secret #4 introduced this topic, let's revisit this possibility.
Should You Buy a Two- to Four-Family Home (or Larger)?
"I'm trying to buy my first home, but without success," writes Lorrain Stark to real estate columnist and investor Robert Brass. "My problem is that I do not earn enough to qualify for a mortgage. [Do you think] I should buy a two- or three-unit rental property ...to provide income to help pay the mortgage?"
Bob Brass responds that he thinks it's an excellent idea. In fact, that's how he got started in real estate. "My first [home]," Bob answers, "was a triplex where I lived in one unit. . . . The rental income provided the money for my mortgage payments. . . . My triplex wasn't my dream house . . . [but] few of us can afford to buy our dream home when we start out. Eventually, though, we can build equity and then move up to the home we really like." (As mentioned earlier, I got my start in real estate with a multi-unit property/home. That partly explains my enthusiasm for this approach.)
How to Finance a Two- to Four-Family (or Larger) Home
Every property financing technique you will learn throughout Mortgage Secrets is available for two- to four-family, owner-occupied properties. You can finance these multi-unit properties through FHA, VA, conventional (Fannie/Freddie), portfolio lenders, or seller-assisted financing. In fact, sellers help finance rental properties more readily than single-family homes. You can buy a two- to four-unit property with five percent down or less. If you can't pull the needed up-front cash from your bank account, bring in a co-investor as a partner. Investigate this alternative. You may find it easier to finance a two- to four-unit property than a single-family house.
Most five-unit (or larger) properties, however, and some non-conforming two- to four-unit properties can prove difficult to finance through a typical mortgage lender. If you locate a tough-to-finance property, the fact that lenders shy away from it—or maybe require a 20 to 30 percent down payment—could work to your advantage. The more difficult it is to finance a property through a financial institution, the greater the chance that the owner will offer seller-assisted financing.
If you live in Berkeley, Queens, or Georgetown, a well-kept fourplex might cost $1,000,000 or more. In Pittsburgh, Peoria, or Paducah, you can buy small multifamily investment properties for $200,000 or less. As to the relationship between rents and price, these, too, vary significantly by city and neighborhood. In Detroit, $100,000 multi-unit properties might generate $1,000 a month in rents. In Miami, a four-family unit that generates $2,500 a month in rents might sell for upwards of $500,000.
Nonetheless, no matter where you live, a two-, three-, or four-unit (or larger) investment permits you to venture into real estate at a much higher price than you could otherwise afford. You will build wealth faster through both amortization (paying down the mortgage balance) and price appreciation.
An income property can boost your power to build equity in another way. Even though you may pay a higher price for a two- to four-family or larger property, you may pay less out-of-pocket for your own housing expense. To illustrate: Say a four-unit property costs $2,300 a month for principal, interest, property taxes, insurance, and upkeep. If you give up $750 a month from your building's rent collections of $2,750 a month because you move into one of the four units, the other three units will still pay you $2,000 a month.
Subtract that $2,000 of rental income from your outgo for mortgage payments and operating costs of $2,300 a month. You personally spend just $300 each month. You save $650 a month as compared to the $950 a month you would spend on a single-family house. Over five years, these monthly savings would total close to $40,000. If you raised rents each year and banked your housing cost savings, you could probably accumulate more than $50,000 over five years. Add these savings to your equity build-up. In many instances, you will have multiplied your original down payment three to five times over.
"My biggest accomplishment in Washington, D.C.," writes Doreen Bierbrier, "was buying a house and creating a management system for it that worked." Doreen describes her experiences in her book, Living with Tenants: How to happily share your house with renters for profit and security (McGraw-Hill, 1986).
"When I bought my first home," Doreen explains, "I was earning a modest salary. . . . I decided that the only way I could buy a house in a good neighborhood was to find one large enough to accommodate a couple of housemates who paid rent. If everything worked out, the rental income would cover more than half of my house payment and two-thirds of my utilities. Adding in tax advantage and appreciation, I figured buying a home would actually make me money. Even better, some time later when the house was paid off, I would own a valuable asset free and clear. . . . It's amazing how things fall into place [even when you think] you have no choice."
As Doreen points out, you can generate income from a house even if you choose to pass up a two- to four-family property in favor of a single-family. This sharing technique has been popularized in a dozen or more books with titles such as Homesharing and Other Lifestyle Options; Housemates: A Practical Guide for Living with Others; and The Complete Roommate Handbook. The latest U.S. Census reports that 8.3 million homeowners now share their homes with non-family members.
This idea worked so profitably for Doreen Bierbrier that she quit her modestly paying job and, within a year and a half, bought three more houses that she organized as houseshare room rentals. In fact, Doreen bought her second property using a VA assumable mortgage and borrowed the down payment from her father. Unfortunately, today, most lenders won't permit housemate rents to count as qualifying income, so, you may have to talk to a savvy mortgage broker who could find a willing lender. (Or you can use a co-borrower.)
John Walker jumped over the qualifying income problem. He asked his mother to come in as a co-borrower on his mortgage. That got him past the lender's scrutiny. After moving into his property, he found two housemates to pick up over half of his monthly mortgage payments. John's mother never paid anything.
Realtor Mary Rodriguez tells of one of her buyers who bought a house that was then rented by three women. Instead of evicting these tenants, the new buyer moved in with them. "He didn't even ask for the master bedroom," Rodriguez recalled. Although few lenders like to count housemate income in your qualifying ratios, many will count rent generated by a leased house (or condo)—if you can provide the lender a copy of the lease. So, you could buy and finance such a house and then, after you close, move in and share as did Mary Rodriguez's buyer. That could navigate you around the co-borrower issue.
If a houseshare could work as part of your investment strategy, buy a property that adapts itself well to roommate living. Privacy, security, location of entrances, noise, parking, as well as kitchen and bathroom access greatly influence appeal and livability. Before you buy, pose as a potential tenant and meet with other homeowners who advertise for housemates. Identify those house features that would appeal to you if you were to live as a roommate in someone else's property.
Also, size up the rental market to learn which features and locations pull the highest demand and rental rates. In expensive cities, room rents often range between $400 and $800 a month. Houseshare income can add $5,000 to $20,000 to your yearly income.
I've seen this housesharing strategy work well firsthand. During the time I taught at the University of Virginia, I spent many weekends in Washington, D.C. To avoid hotels when in D.C., I participated in a houseshare. The fellow who was buying the house collected enough from me, his girlfriend, and one other housemate to cover two-thirds of his mortgage. And this house was no slouch—a $300,000 (16 years later, $1.3 million) Georgetown three-story townhouse. Although skeptical at first, I found the experience fun.
Likewise, Doreen Bierbrier enjoyed the personal side ofhousesharing. "For me," Doreen explains, "the advantages of sharing my house with tenants overwhelmingly outweighed the disadvantages. Housemates [not only] made it possible for me to buy and maintain a house at a time when most people told me my salary was too low to consider buying, [but also] tenants provided countless hours of companionship, laughter, and insights into everything from Republican fund-raising to Vietnamese cuisine— things I never would have discovered had I lived alone."
Maybe you prefer not to share with housemates or buy a two- to four-unit property, but you do need more income to stretch your borrowing power. Then buy a house with an accessory apartment. These units are commonly known as a granny flat, garage apartment, carriage house, studio, efficiency, in-law quarters, or basement suite. In Vancouver, British Columbia, more than 100,000 single-family houses include basement suites. These so-called suites not only add to owner borrowing power, they somewhat ease the tight rental housing market in Vancouver.
An accessory rental allows you to share a house without disturbing your life. And it won't require the same level of management and upkeep that some multi-unit properties require. An accessory apartment can add $4,000 to $10,000 to your yearly income.
Create Your Own Accessory Apartment
If you can't find the property you want already equipped with a rental unit, create your own. That's what freelance artist Andrea Pogue did.
Andrea bought a three-story fixer-upper and converted the lowest floor into an accessory apartment that she rented to two sisters for $550 a month. When Andrea realized the income potential of her house, she carried her idea further. After the tenant sisters moved out, Andrea moved up to the third floor. She renovated the lower floors into two private units and rented each one for $750 a month.
"I don't earn much," says Andrea, "and I doubt that I'll ever become another Andy Warhol and make a fortune. So it's great to receive the rent checks. I'm now taking in $1,500 a month. That's enough to pay my mortgage and cover part of the property taxes and homeowners insurance."
If you intend to add an accessory apartment, find out whether zoning or building regulations might restrict your rights to operate the property as you have planned. Likewise, just as some houses work much better than others for houseshares, so, too, do some properties adapt more readily to apartment conversions. As you evaluate properties, visualize how well they might work for the rent-producing use you have in mind.
SECRET # 14
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