Which is a better investment?

[cyamaoka]

I'm 28 years old, renting an apartment in San Francisco, but I'm in the process of purchasing an investment property in Sonoma County.  I'm trying to determine whether I want to lock in a 15-yr. or a 30-yr. fixed mortgage.  My initial plan was to go with the 15-yr. since my interest rate would only be about 4.3%.  My monthly mortgage payments would be approximately $2,300 and I could probably rent the property for $1,800/mo.  My boyfriend pointed out, however, that with a 30-yr. loan at 5%, my monthly mortgage payments would only be about $1,700, so I'd be $100 cash-flow positive each month.  I know being "cash-flow positive" is something you always hear as being the smart investment choice, but I'm not sure how to factor in the fact that the difference in total interest paid on a 15-yr. versus a 30-yr. is about $130K.

Ideally, I'd want to acquire several investment properties over the next 10-20 years so that when I retire, I could support myself with rental income.  Would you say that paying the extra $130K in interest for a 30-yr. mortgage term is worth while since I would be cash-flow positive and could use the cash that I'd otherwise apply towards a mortgage payment (for a 15-yr. mortgage) to save for another investment property?  I know there must be some sort of finance formula out there, but I'm not quite sure where to begin.  Any thoughts would be appreciated!

[yrush2000]

Well if you buy this property with a 15 or 30yr mortgage either way do not plan on buying another property for quite sometime.  You said it yourself, You know about cashflow.  Where is the cashflow on either terms.  Stay away from this deal.  There is no deal, even with equity there is no deal.  If you can not clear $300+ a month on a duplex, do not bother.  And if the mortgage is $1800 a month, you need about $3400-$3600 a month in rental.    You have taxes, ins, upkeep, vacanies, evictions, tenants not paying, filing taxes, plumbing issues, pest control, landscaping, water, unpaid utilities, your time is worth money, etc.   

Its good to buy properties, a few a year and you can have a great retirement.  You can do 30yr mortgages and pay more each month to principal.  Rates are always better on 15, but its good to have alittle extra each month for emergencies if you need.  A good rule is to see if property will CF with 15yr term.  Also make sure you get a fixed loan, not interest only or ARMS...  but most importantly....CASH FLOW to pay for all this....

[justin0419]

As yrush said, you won't buy too many properties if under the BEST case scenario you would be paying out AT LEAST $500/mo to have an "investment" property.  How many properties could you support at $500 or more each?  These are called alligators.  They will eat you alive financially.  Your cash flow positive calculation sounds like something you'd hear from a Realtor with no investment experience trying to sell you the property.  Even if your property taxes and insurance are rolled into the $1700 or $2300/mo mortgage payments, you'll still end up on the bad side of things.  You're hoping nothing ever goes wrong, there's never any vacancy, property taxes and insurance never go up, etc.  Find a better deal and be careful before you strap yourself to something that could take your money for many years.

[tatertot]

Cyamaoka, in San Francisco and nearby areas it is not going to be possible to buy a cash flow property. If you want to retire on your real estate in that area, you must use a different strategy from rentals to build your wealth.

Shop hard until you can buy a nice property for substantially under what it is worth, and I mean under what it is worth today, not what it was worth 2 years ago.  You buy that property. Then you hold it long enough to qualify it to do a 1031 exchange.

You will have it rented out while you hold it, and that will help with the expenses, but you must be able to pay a lot of the costs out of your own pocket while you hold it. That means you MUST have the income to pay those expenses.

Then you sell it at the retail level, which should give you a big chunk of money because, if you bought it right, you will have a lot of equity. (I buy properties for about $100,000 under their fair market value, about 1/3 off, and you can to, if you are a good shopper. Closer to SF, 1/3 off should be more than a $100k discount)

When you sell that property, you 1031 into another property that you have purchased for a substantial discount. So say, you made $100k on the first one and you find the next one at $100k off the value, you will have $200k equity in that new property.

Hold it until you can 1031 it into another discount property. It depends upon the figures, but when you have enough equity in a property that it isn't taking it's expenses out of your pocket, you can split that equity and 1031 one sale into two purchases.

The end game is to end up with several that are fully paid for by the time you are ready to retire. Then you can live on the rents for as long as you want to, and you can sell each house to obtain a substantial chunk of money, if you want to move away, or you find something else you want to invest in.

The above is very simplified. You must read and understand the rules for 1031 exchange, you must study your local market until you know it well, and you must have patience. Also, for the first few years, you must have enough income to support your real estate. After a few years, you will be playing with no cash out of your own pocket.

If you want to buy properties that cash flow, you will be looking in other parts of the country, not close to San Francisco. If you do that, shop with local prices in your head. Do not compare to SF prices. Every cycle, a whole bunch of Californians lose their shirt in the Oregon real estate market, because they come up to Oregon saying, "oh my gosh, it's so cheap. That would cost me 3 times as much back home". Well, they are not back home. They aren't going to sell it for back home prices, and it's cheap for a reason.

[Bluemoon06]

Real estate in California is like selling ice in Alaska.  People do it but it isn’t making them rich.  People buy land in Califorina but it is not making them rich.

I don’t know how to make money in real estate in California.  I don’t know anybody that knows how.  I think what people do is make money and put that money into real estate there.  I would look at buying real estate in the part of the country that you can actually make money.  You should never buy a piece of property that does not pay for itself.  That is why raw land doesn’t work. 

Find sombody that is in California and is making money and do whatever it is that they do. 

[Dave T]

I agree with the others that this property and this price with the market rent you could expect would be a negative cash flow deal.

I do want to comment on your reluctance to pay any more interest than you need to.  If your property is generating a positive cash flow, then YOUR TENANTS are paying your mortgage payments for you.  Your tenants are paying that interest expense, but you get the income tax deduction for it.

Rental property ownership is a slow road to wealth.  It is a retirement plan with a long horizon.  Your plan should be to invest now so you have a few free and clear properties generating the passive income you need to support your lifestyle in retirement.  If it takes you more than 30 years to reach that point in life where you want to retire, then you should not be adverse to 30 year mortgages.

[cyamaoka]

Thanks to everyone who responded!  I appreciate all of the advice.  I wanted to clarify a few points, however, in case it changes how you all perceive this transaction.

First of all, this is a single-family house that I'm interested in purchasing and while, ideally, I'd like to have rentals and live off of that income in retirement, right now I see this purchase more as an opportunity to build some equity and get into the housing market while prices and interest rates are low.  Even though my total monthly expenses may exceed what I'd be getting in rental income, my hopes are that within the next 3-5 years this property will have appreciated enough to yield an ROI greater than what I'm receiving now in my savings and CDs.  I'm not sure if it matters, but this house is a short-sale (already approved by the bank) and is selling for about $50K less than comparable homes in that neighborhood.  With that all said, does everyone still believe this investment to be a poor choice?

[Dave T]

No matter which financing alternative you choose, this property is a negative cash flow deal.  The negative is just greater with a 15 year loan.

Yes, you are building equity faster with a 15 year loan vs a 30 year loan but you are paying $500 out of pocket each month to do it.  Equity does not put food on the table.  If you lose your job or your income gets downsized, you can't eat equity. 

Cash flow is not just the difference between your monthly rent and your loan payment.  There are other costs of ownership such as property taxes, hazard insurance, repairs, preventive maintenance, utilities, just to name a few.   There are rental operation costs such as advertising, legal fees, and property management, and when you have a vacancy, you still have all the expenses with no rental income to pay them.

As far as appreciation is concerned, you get the same appreciation with a 30 year loan as with a 15 year loan.  If you are looking at ROI as cash flow plus appreciation, then the longer loan term with the smaller negative cash flow will give you a higher ROI over the next five years.