Advice Needed - Real Estate/Investments

[mnsharon]

8-year YM lurker (and very grateful for all of the knowledge I gained)and very infequent poster - Thanks for the new boards!

My husband (54) and I (49) have a question that we would appreciate some input on.

Our primary residence - worth approximately $240,000.00 - has a mortgage of $22,800.00 at 5.375% - 15 -year fixed. I have been prepaying $250.00 per mont, and have less than 3 years left on that mortgage. We own a lake cabin - worth around $90,000.00 - outright - about 8 miles from our primary residence. We purchased a small 2-bedroom single family home 1-1/2 years ago and remodeled it. It is currently rented, and we have a HELOC on our primary residence on it for $28,000.00 at a variable rate, currently 4%. I have been paying $250.00 per month, with a minimum due of $181.00. It is worth about $50,000.00. We live in rural Minnesota.

We have a 401(k) of $200,000.00 +, an EF of $28,000.00 and no other debt. I have been considering combining the 2 loans - from different lenders - together and taking out a 15-year fixed mortgage for around $60,000.00. We need new shingles on our primary home and I would like to do some work on our kitchen/living room. We save about $2,100.00 between the 401(k) and general savings per month on a net take-home of about $7,000.00 per month.

Our credit scores are both over 800.

Any input - Phil? - would be appreciated. Also - investing $40k or so in our lake cabin property would probably increase the value to $200k. (Mobile home to cabin - OLD mobile home.) The rental home is a little gem - no work possibly needed.

[2kids10horses]

In a nutshell, I gather you want to refi the two loans you currently have that total about $50K, and get a new loan of about $60K to pay for $10K of home improvements?

I see no real problem with that, however, you state that your little 2BR investment house is a "little gem"...

If you are going to go thru the bother of refinancing, why not get enough to buy another "little gem"?

That way, you would be getting a owner-occupant loan (which is at a low interest rate) to purchase investment property.

Just a thought.

[mnsharon]

2kids, good point - and a bit scary. Single family homes are very reasonable here, and rents are high in comparison. I'll discuss this with my husband, but it's definitely worth considering. Although - do we have too much tied up in real estate and not enough in investments?

[Deleted]

Sharon,

It looks like you have over 50% of your NW in real estate with the balance in 401k (funds???) + cash. So, yeah it looks like you have too much equity in real estate. For your age maybe 60%-70% in equities (split between stocks and real estate) 20%-25% in bonds and 5%-10% in cash (EF + opportunity fund?). Keep in mind this is the pot calling the kettle black as we're over 50% invested in real estate ourselves.

I think you really need to step back and say what's your plan at this point? When are you planning on retiring? How do you plan on replacing your current income; e.g. pension, rental income, ? Do you have a goal to live in a mortgage-free house? Will you plan on moving from your current house to something smaller or closer to town?

I see a lot of consumer spending, not necessarily investment spending proposed. I don't finance kitchen remodels because they are usually outdated in about 10 years. So you don't want to finance a 10 year "improvement" with a 15 year loan.

As to the cabin, if you spend $40k to turn it into a house, would the plan be to rent it? How much would it rent for? Have you ever built a new house before? 40k sounds pretty cheap. What would you be building?

[phil5185]

bonnap made some very good points. The two appreciating assets are real estate and equities - you have a $650k NW and only about $200k of it is invested in equities. Heavy on RE, light on investments.

And much of the real estate is non-income producing - rentals are profitable largely because someone else is paying the mortgage for you while the house appreciates. By that same measure, 2nd homes are major expenses - lots of costs and no returns.

And usually a remodel or upgrade adds only 25% to 50% of the expense to a property appraisal - ie, spending $40,000 on a place mght add $20,000 to the appraisal. Your plan indicates that you can add way more? Maybe, but that would be unusual.

As for financing the 3 places, you will get the best interest rate on the owner-occupied house. I woud clear the 2 loans ($50k) that are short term & VAR - and put a new $100k to $150k loan on the home, a full 30 yr loan, fixed rate <5%. That would remove $50k to $100k of equity from your RE and move it to cash. (So your $650k would be better balanced). And then direct that extra cash, plus the extra income stream to build up your $200k portfolio (stop prepaying the mortgage).

It will be more important for you, 10 yrs from now, to have over $500,000 in your investments than to be free of a $550/m or $775/m loan payment.

[2kids10horses]

Phil and I agree on this one.

But then again, we're both landlords. Here's the thing... it does take some work to be a landlord. There are ways to make it easier, you have to go thru a learning curve to get it down, and it takes a while to find the right handimen, suppliers, heating and A/C companies, etc. who know how to work with you and your tenants.

So, my advice for new landlord wannabes is to set a goal for 5 units. The advantages of having 5 is that the first one or two you're learning how to do it. By the time you do numbers 3 and 4, you've already been tested, so it goes easier. Number 5 (and more) you just follow your formula. It might take you 2 or 3 years to get to number 5. Plan on 2 a year.

Then evaluate if you like landlording or not. Believe me, the first one or two are hard! It gets easier as you go.

More to the mnsharon situation:

I would not look at the lake property as an investment. Sure, it's real estate, but I don't think you purchased that with the goal of making money on it. So, I didn't consider it in your investment portfolio.

Your house... Lot's of people like having a paid off principal house/home. But then, they'll borrow to aquire rentals. That's OK, but loans on investment properties are more expensive than loans on owner-occupied properties. Right now, you have the opportunity to get some cheap money to go shopping for rentals houses.

And, the kinds of houses that make great rentals are plentiful right now! The prices are WAY down due to all the foreclosures, and there are a lot of potential tenants.

One more point about landlording... you can get positive cash flow. If you buy the rental house cheap enough, you can rent it out so that the rent you receive exceeds the combined cost of the mortgage, insurance, taxes and maintenance/repairs/reserve.

I view each of my rental houses as being a little cash cow. Each month it pays for it's feeding, and pays me, too.

Phil's strategy is to extract the equity out, and reinvest it into stocks. Another strategy is to pull the equity out, and reinvest into more real estate. I did this at the beginning. Until I had about 25 houses, then I cut back to about 10.

Don't get me wrong... I love stocks, too. I let my old 401(k) grow and compound. And I have a little trading account. But, I LIVE off my real estate.

[debtheaven]

I'm very conservative, I would not borrow on my home. Phil advocates doing so, but if you push him just a little, he will tell you that his wife won't let him do it anymore, and hasn't for many years LOL. You just never know what life could bring. We never prepaid our mortgage (only once, 2.5K) but it was an amazing feeling to know that our home was fully-paid off and we could hopefully weather whatever life could bring, financially.

However, I would also stop pre-paying everything, and use that money to save up for more rentals and pay cash for whatever work you need / want to do in your own home (keeping things reasonable of course. It doesn't sound like you are aspiring to gold taps LOL.)

I'm in Europe and things work differently here. Although Bonnap always cautions about not being over-invested in RE, she is (*waving to Bonnap LOL*), and so are we. We would never be at the net worth we are today if we weren't. We have done MUCH MUCH better by putting our discretionary income towards RE than we have by putting it into the market. She definitely has a "nose" for RE, so do I. Sounds like maybe you do too ...

IMO you have to work towards your strengths, and if your strengths are in RE, then go for it. But, I would advise you to stop pre-paying and try to add more rentals to your portfolio.

Lastly, your home is your home. Not every upgrade is for resale value, some of it is for you *GASP* and that's OK too, especially if you are planning on staying put for a while. So again, be moderate, but it sounds like you can afford the modest upgrades you are aspiring to.

I would definitely redirect the extra cash towards more rentals and whatever reasonable upgrades you want.

Best of luck!

ETA: To clarify, we are still in the market too, but when we have "extra" money, it goes into RE, not into extra stocks.

[phil5185]

I would not borrow on my home. Phil advocates doing so, but if you push him just a little, he will tell you that his wife won't let him do it anymore, and hasn't for many years LOL.

LOL - true enough. We borrowed against our home multiple times to finance some of the rentals yrs ago - later we refi'd rentals and paid off the home with the cash-outs. Later still, we refi'd the rentals and invested the cash-outs in stock. And when rates dropped to the 5% range a few yrs ago I would have willingly put a new loan on our home. But the other half of the marriage vetoed it - and after 42 yrs of marriage, I knew better than to "die taking that hill".

[debtheaven]

LOL Phil! I am SO GLAD that you made your way over here, and I know I'm not the only one!

[Deleted]

"Although Bonnap always cautions about not being over-invested in RE, she is"

Umm yeah and that's in my first post... ( DH)

The reason I asked the OP to outline a plan is that we do have a plan to divest ourselves of our real estate to bring us back into balance.

Plan A is to sell 2 of the 5 houses within 5 years of retiring (in 18 months). We are likely to move in for 2 years, do some fix-up and take advantage of the capital gains exclusion of up to $500k. That will free up close to $1M in equities to be reinvested in the market.

Plan B would be to pay off the mortgages and live on that income but that means drawing down our cash reserves to a years EF, increasing our real estate exposure to 2/3 rds and we'd have close to 25% of our NW in one house. That makes me nervous to have so much NW in one investment. We have plenty of cushion so if we had another 20% devaluation we could handle it but why take the risk if we don't have to?

Plan C would be some kind of combination of A or B. It's likely to be driven by a need to spend an extended time in one of the houses due to a parental illness-a real possibility with DH's mom. Our properties are scattered through SF Bay Area, So Cal and Phoenix. MIL is in Portland OR and my father is in San Diego County. I want to live within an hour's plane ride or a day's drive of either of them.

[Peace77]

I have a different approach.

Stop paying extra on the mortgage and HELOC.

Use the HELOC to fund the roof repairs, instead of paying for the costs of a new mortgage.

Save the $319 per month you were sending in additional payments to fund your home improvements.

If the $319 per month isn't enough, consider renting out the lake house for a week or weekend.

Or, just be patient. The mortgage will be paid off soon and you will have the funds that were going to pay the mortgage to fund the home improvements.

If you do decide to pay extra -- focus on the mortgage only and get it paid off. It has both the smaller amount and the higher interest rate.