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Encumber His Home to Invest in Phoenix Real Estate?

Posted by Keith on April 24, 2007 at 2:56 pm  


Love your show, and have a question: I’ve been thinking about tapping the equity in my home or 401-k to purchase a couple of new homes in the Phoenix Metro area. I’m 54 years old. My home is worth approximately $265,000 [$210,000 equity].

Does it make sense at my age to encumber my personal residence further for investment purposes ???

Thanks in advance for your response and smooth sailing.



First, please see my April 12 response to Debra regarding the math underlying the “should I encumber my home” part of your question.

Second, I would NOT raid your 401(k). It’s a suckers bet. Deducting the interest you pay is always tricky, and that money could be working independently for you in the markets. Leave your 401(k) money alone!

Third, about Phoenix real estate: Larger-tract land speculation continues unabated in Arizona, particularly on the far east and west sides of Maricopa County. The price of raw land is holding its own. However, generally, single family homes continue to lose value in the market, and will probably continue to do so through at least the end of the year.

Because the Phoenix market has not yet bottomed, you may not enjoy the discounted prices today you may enjoy around year-end or at the beginning of next year. Phoenix real estate prices appreciated very rapidly during the housing “boom”, relative to other parts of the country, so it is not surprising that we may be hit harder than some areas as the market adjusts.

My suggestion, if you invest in single family homes at all, is to do so after the first of the year. Use a deductible home loan to finance your down payments, and to provide you with some working capital in case of emergencies. I’d seriously consider a five-year ARM, but only after you have located the properties you will attempt to buy. Then plan on flipping those homes before the home mortgage loan balloons or is called, and pay OFF the loan. This should give your properties plenty of time to appreciate.

Use some leverage. The banks will probably not permit you to put less than 30% of the purchase price into each investment property, but as long as you have sufficient cash flow from rents, keeping your leverage to between 50-70% can provide you with a very respectable rate of total return. This leveraged rate of return should be — but cannot be guaranteed as being — well in excess of the net-after-tax cost of the mortgage you will take on your primary residence to produce your down payments.

Keep in mind that you are contemplating considerable debt: Say a $200,000 mortgage on your home, and then perhaps $200-300,000 of additional debt on the investment properties. Do the math. Check fair-market-value rents. Don’t pull a “California” where investors routinely purchase properties at prices and rates well in excess of what rents can support. Shoot for a slightly positive PRE-TAX cash flow. With luck, after the tax benefit of depreciation, but after the inevitable maintenance and repair surprises you’ll encounter, you MAY achieve an after-tax break-even cash flow. That is definately the goal: “Don’t go broke while you’re getting rich.”

Remember, investing in, and holding, single family residences takes a lot of work. You much watch the properties like a hawk — and most of all, you must be very, very careful in your selection of renters.

Finally, in addition to taking out a large umbrella liability policy, I strongly suggest you consider keeping each property in its own LLC. That way, if someone is hurt on the property due to a hazard there, the worst that can happen is that you’ll lose that property. But you won’t have your life savings sued out from under you.

Good luck! Hope this helps.



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