Putting my money where my mouth is…

You know how I keep saying Seattle real estate is in a bubble? Girl Ninja and I haven’t walked through a single house in over two months, we’ve virtually given up on the house hunting process. So we decided to do what any logical couple would do… buy a house.

Wait, what?

Allow me to explain.

If you’ve been reading along for a while now, you’ll know that I’m a big fan of short-term investing. Saving for retirement is great, but that only puts money in my pocket for when I’m old and wrinkly. If I want to have financial freedom before my 60’s I’m going to have to start investing outside of my 401k and Roth IRA. What better way to do that than to invest in an income producing asset.

A few weeks ago, I got a text from my long time best friend. He wanted to know if I would be interested in buying an investment property with him. I told him no. We chatted more about it. I told him no again. But after a few weeks of continued dialogue, and coming to the realization that Girl Ninja and I will probably not buy a house in the next year or two (because we love renting so much), I’m warming up to the idea.

We are going to look at a house on Sunday that hasn’t yet come on the market (it’s due to be listed on Tuesday, but through a connection were able to reach out to the sellers and get a viewing before it lists). It’s an 1,850sqft, 3b/2.5bth, that will list at $359,000. The house was built in 2012 and the owners are moving to cash out on the 20% YOY return on investment they’ve made. Well, that and they want to upgrade their home.

The house is in suburbia, which means it’s cookie-cutter, across the street from a large park, and in a solid performing school district. I personally wouldn’t buy this house for Girl Ninja and I, the layout isn’t my style, but it is shaping up to be the perfect candidate to make a rental property.

Here is how things would go down if we decided to move on the property.

  • My friend and I each put $55,000 in to a house fund ($110k total).
  • We buy the property for full list (we expect it will go pending the same day it lists due to the market).
  • We put 25% down, $90,000.
  • Another $5,000 each ($10k total) towards closing costs if necessary
  • And another $5,000 each ($10k total) for a maintenance/reserve fund.
  • Exact models of this house in the area are renting for around $2,300/mo, but we budget for $2,100/mo.
  • Our PITI payment would be $1,700/month.
  • Take discretionary rent income and build house reserve fund.
  • Let someone else pay off our mortgage.

Seems like a pretty good plan, eh? Obviously the scenario above seems pretty legit, but of course there are some concerns as well. Such as…

  • Finding tenants that don’t suck.
  • Knowing the market will cool off at some point and the house might not appreciate much above current price point for a few years.
  • Partnerships, by nature, bring an element of risk.

Still, no matter what way my buddy and I run the numbers (and believe me they’ve been ran), it seems that this house is smart buy. I don’t say that lightly, my friend is an investment banker who makes a crapload more than me, and knows Excel like Lindsay Lohan knows the inside of a courtroom. I trust the dude more than I trust myself (he’s actually the guy that got me to sign up for a Roth IRA 6 years ago!).

It seems like Girl Ninja and I are in the perfect position to take something like this on. Here is the way I see things:

  • We have had a ton of money sitting in a bank account for years now, earning virtually nothing.
  • We have no desire to buy a personal residence in the next 12 months, possibly longer (possibly ever).
  • I know that short-term investing is important to me, and at some point I have to stop talking about it, and start doing it.
  • I know all investments come with risk.
  • Having someone else pay off a house I partially own would be sweet.
  • Girl Ninja and I could always move in to the property if needed.
  • We aren’t buying for the short-term, minimum 10 year hold.
  • Never have to put another penny in to the house after the initial investment.

Who knows what will actually happen after we look at the house Sunday morning, but it should be an eventful weekend nonetheless. I’ll let y’all know how things went on Monday πŸ™‚

p.s. I’m obviously leaving out a lot of information, if I didn’t, this post would have been triple the length. If you have more questions about the property or our assumptions don’t hesitate to ask. We want to be very diligent in the process and think of all the potential benefits and concerns.

47 thoughts on “Putting my money where my mouth is…

  1. “Never have to put another penny in to the house after the initial investment”
    Will you be making regular deposits from the rental income to shore up the maintenance fund? Or will you only replenish the fund as withdrawls occur? Is $10,000 enough to replace the roof? Will you be making the mortgage payments from that account if the tenants don’t pay or if the house is empty for a few months?

    • Bingo. This sentence leapt off the screen and slapped me across the face. There will ALWAYS be more money to be spent. The washer will break. The ice maker in the fridge will slowly leak, trashing the flooring and subfloor in the kitchen. The A/C will die on the hottest day of the summer necessitating an emergency call-out at premium rates from a repair dude. And don’t think the tenants will pay for this. Or landscaping. Or other upkeep. Houses, even brand spanking new ones, cost money to keep up and running, brother!

      • I say AMEN to what Bret is saying. and the sub floor damage doesn’t always happen just in the kitchen. I had to replace the floor and sub-floor in the bathroom in one of my homes! What a MESS, and there was no one to assist me with the cost of the repair and replacement of the floor, linoleum, stool, etc. WHAT A MESS, physically, emotionally and financially!

      • The same maintenance concerns would exist if we lived in the house, no? House has a 3 year warranty for everything and a 10year on the major things, so that helps mitigate the water heater exploding or roof caving in. But these are things we would have to deal with on our own place as well. Plus, remember I said we would have a $10,000 joint savings account opened up for the rental property beginning day one. It’s part of the $55k buy in.

    • Yeah, since neither of us our cash poor we actually wont draw from the rental profits. They would continue to build in our maintenance/reserve fund until we had a very healthy amount of around $25,000+. Obviously the roof could spontaneously combust or the water heater could go out, but on a one year old house with a ten year warrant, we have a lot of time before those are likely scenarios. Possible, sure and we will plan for it.

      Our spreadsheet also accounts for one month rental vacancy each year. Could it be two months of vacancy some years? Sure, but it also could be no vacancy others.

      If we were putting a smaller amount of capital in to the investment then these concerns would be exponentially more important, but with $110,000 going in to a $350k dollar house we are at least making sure the numbers work.

  2. Danger, Ninja! Stay away from partnerships. You want to buy a rental property on your own and follow the same general plan you have on the post- my hat’s off to you! But don’t go halfsies on anything that you can’t literally split in half. Bad idea…

  3. Get a lawyer involved and make sure your partnership is set up in a way you can both live with. Granted I don’t know you or your friend, but it would be a damn shame to lose a friend over something as silly as a business decision gone bad. Personally I don’t mix friends and business but that’s just me.

    Good luck! I look forward to hearing your progress!

    • Definitely will have a solid partnership agreement. We can’t buy the house as an LLC, but we will buy as individuals and then immediately put the property in an LLC that clearly explains how the partnership works. Death, divorce, forced sale, etc. Lots to go over, but well worth the cost to get it done right.

  4. I would be leary about entering into a partnership with a friend. To me it wouldn’t be worth a potential loss to the friendship if something went bad. I’m sure there are tons of examples out their of successful business partnerships with friends, but the bad stories are enough to make me things twice (no, three times).

    Good luck in whatever you decide. It sounds like a great opportunity other than that.

    • Yeah definitely leary, praying and seeking guidance from people. Partnerships can be either terribly successful or just terrible. I wouldn’t consider this with just any of my friends. My wife’s dad started a company with a business partner 6 years ago, and here they are executives of a 1,000 employee company that they created.

      Partnerships that go south are typically partnerships that weren’t well thought out. Kinda like Jesse and I started MANteresting over skype with no official operating agreement. We’ve survived thus far, even when we’ve disagreed about business decisions at times.

  5. “he’s actually the guy that got me to sign up for a Roth IRA 6 years ago!”
    And we know what you think about Roths right now.

    I echo the concerns about the partnership. I have to wonder what his motivation is for bringing this up to you, and why he can’t or won’t buy the house entirely on his own. It may be that you’re being manipulated here for undisclosed reasons.

    Back in about 1960, my own father founded an engineering business with two partners from the company where he was then working. The business grew to about 100 employees at peak and was successful, but there was a quarrel with one partner who eventually left. Disputes between partners are almost inevitable, and just as a legally binding pre-nuptial agreement is a good idea before marriage, so is a legally binding pre-house-buying agreement if you decide to go ahead with this. Meanwhile I would consider either buying a property on your own or looking into other streams of income.

    • Ah come on Larry. Signing up for the Roth has been great for me. It’s what sparked my PF love affair and I’ve actually had pretty decent returns too πŸ™‚

      Definitely agree with everything you said about partnerships. If we choose to do this, we have to have a very clear operating agreement that explains what is to happen in a bunch of different scenarios, divorce, death, etc.

      It’s funny to me that everyone keeps suggesting I should buy a rental property on my own. To me that is just as (if not more) risky than this scenario, but I guess it just depends on what one’s priorities are.

  6. If you trust your friend a lot, I wouldn’t have any problem entering into a partnership with someone close to you. My friend commercial real-estate, and we’ve been talking about buying a property together. The only thing I’d be worried about is the tax situation. It might be best to see the same accountant, to figure out how to use the depreciation shield and figure out other rental income stuff. Best of luck!

  7. Go for it. Even though a few have said partnerships are tough, it does lesson risk by half. You know me and risk ;P. I think I know where you are coming from in regards to risk by now. Look at Manteresting, so far great investment, right? Real estate would be a good way to diversify. Like Seattle, Las Vegas real estate is on fire and I’m fearful to get in. But I’m going to take that risk anyhow and go big. Hopefully we both get lucky πŸ™‚

  8. Will you guys be forming an LLC together to be the legal owner of the property? I’m not actually sure that that’s the right thing to do, but it seems like it would make sense. It would provide you each with legal protection and would protect you personally from liability issues. Maybe someone with more experience can elaborate on whether or not this would be the smart thing to do…

  9. Shocking, most people think it’s a bad idea…

    I think you should go for it. Clearly you’ve done your research. Rental properties, when done right, can be a great investment. Think about the long term income you could achieve from this, especially once the mortgage is paid off. As to having a partnership I think this situation is a little less risky than partnering with someone in business. Oh wait, you’ve already done that successfully!

    Exciting opportunity! Good luck πŸ™‚

    • Here’s the thing — you have to be willing to sacrifice the friendship on the altar of business. If not, then don’t do it. Because if the business goes south, for any reason, there’s a good chance that the friendship will go with it. Friendships and business deals just don’t mix.

  10. Talk about scenarios where things go bad with your friend, make sure that you guys touch ground on every kind of scenario so that the friendship is protected the best possible. It is a risky thing to go into business with your close friend but then again who else do you trust better than your friend? Make sure you hold each other accountable for the success or failure of your endeavor.

  11. Honestly, I would avoid mixing business with pleasure.

    Good friends are hard to make.. the money.. you can replace it.

  12. Personally, I do not like partnerships and particularly with friends. You need to write down an agreement to cover things like when you will sell or other major decisions.

  13. As long as you take the appropriate precautions before forming your partnership, I see no problem here. I can’t wait to hear more about this idea from you. Owning rental properties is something I would LOVE to do one day. It’s a great residual income, as long as you’re educated about what you’re doing.

  14. What happens if one of you wants to sell your share? Say, what if you decided you wanted to cash out so you could have more money to put down on a house you’ll actually occupy? You may have to sell, even if the other doesn’t want to. And you may not make much of a profit depending on how early you’d sell, with realtor fees and whatnot.

    I think it could just get too messy, and too much money is at stake here. It’s probably better to buy a rental on your own, rather than sharing ownership.

    • The simplest solution to having a disagreement (IMO) about having one person wanting to sell their share in the partnership would be to have an agreed upon plan prearranged. Ninja, would you two consider having the party who wishes to remain invested buy out the other investor’s share? Or possibly have the person who wishes to sell their share find a new investor(s) to buy them out?

    • Gotta say, I totally agree; you and GN would be better off buying an investment property yourselves. I wouldn’t mix business and friendship either, especially when it comes to such large amounts of money. Whatever you decide, good luck!! πŸ™‚

  15. My in laws buy houses with another couple that they completely trust. They flip the houses and share the profits 50/50. Both parties put the same amount into the investments and split everything in half, that way no one is investing more than the other. If you trust the guy, I wouldn’t worry about taking the risk. Better than you money sitting in a savings account.

  16. Just curious about the investment of time for the two of you. It sounds like the money is all worked out, but who will be responsible for advertising for and interviewing potential tenants, handling regular maintenance, any issues that arise etc. In my (admittedly limited) experience with partnerships, it’s not just the money you have to work out (a biggie obviously) but if one person feels they are putting a lot more time into it, the “equitable” finances may not seem so equitable. Being a landlord does come with responsibilities and those require some time put in to the equation. These may have been the details you’ve left out of your post, but I just thought I’d ask.

  17. Just about everyone hates the idea of a partnership, but as long as you are willing to front the money to pay for a lawyer and get all the “what-ifs?” figured out then I say go for it. I’m a big fan of non-bank and non-stock market investments.

  18. And wait…all this for a $300/month profit if all goes to plan? So the hope then is for the house to jump in value and you can turn around and sell it? Or what’s the long-term plan with this? How does this jive with you buying a house to occupy?

    • Turning a $300/month profit from day one is appealing. But what’s more appealing is having someone else pay off an asset that we own. And historically house prices rise over time. So we have a positive cash flow investment, that’s mortgage is being paid down, while the property is increasing in value. Doesn’t seem that crazy to me.

      And as I mentioned in the post I realize this will limit GN and my ability to buy a primary residence until we have a proven rental income track record. But reality is we may not want to buy in next year or two anyways.

      Biggest risk is partnership risk. Divorce, death, forced sale. Would definitely have to hammer these details out in an agreement before we bought the place.

      That said there would also be a tremendous risk if I bought my own investment property sans partner. Like more required liquidity up front. Same issue of not being able to qualify for second property. Etc.

      Give and take. There is risk with any investing decision. The risk here doesn’t seem to be as much financial as it is relational. That’s what I’m trying to wrap my brain around.

  19. I would recommend an iron-clad agreement for the running of this partnership. Things can go south in an heartbeat and one person will be on the chain for the house. While I think the rental property might be a good idea, I think the partnership might be a bad idea, especially with a close friend.

  20. Hey Ninja-
    You said “If I want to have financial freedom before my 60β€²s I’m going to have to start investing outside of my 401k and Roth IRA”. I totally agree with this statement, but suggest that there are much better choices available than the real estate partnership you’re considering. You don’t want to get in on the real estate market when you’d be “buying high”, and I certainly wouldn’t do it with a partner.

    I suggest you do some low cost investing in the stock market via index funds. Check out Vanguard.com for some excellent options- they’re low cost and you can build wealth without waiting until you’re a wizened old man. πŸ™‚

  21. I think Mr money mustache posted a while ago about a real estate partnership with a friend. In that case (according to him, anyway), MMM put in a ton more work into the place, and it wasn’t a great deal for him in the end. I think they were doing a flip, not a long-term partnership, but it’s worth talking about how you account for the time you each dedicate to the project. Houses don’t run themselves, unfortunately, and your tenants won’t be responsible for everything!

    Also I didn’t see you account for bills like water and trash (not sure your tenants have to pay that or if you do). ALSO also, you said you and GN could live in the house if it came down to it – if you at all meant that, that angle should be covered in your business plan as well. Many cities offer landlord classes – you might want to look into that.

    good luck! should make good blog fodder no matter what.

  22. Unlike every other commenter, I actually own rental property, so allow me to weigh in. I see a few things wrong with your calculations, at least with what you’ve mentioned. You said you left stuff out, so I don’t know if you’ve thought of them or not.

    1. Your $400 per month cash flow includes nothing for repairs and maintenance and nothing for vacancy. You need to set aside at least 10% of your rent for this, which cuts your cash flow in half.

    2. Even if you make $400 a month in cash flow, it’s barely more than a 10% return on your invested capital. That doesn’t excite me, but there are people who are willing to take it.

    3. Look at the return from the perspective of paying cash for the house. A $359,000 house renting for $2100 per month only grosses a 7% return. By the time you pay taxes, insurance, repairs and vacancy (Seattle won’t be booming forever) you’re looking at a 4-5% net return. A collection of corporate bonds would do about the same, and require zero work.

    4. Are you hiring a property manager? You can manage it yourself, but take it from me, it ain’t easy.

    5. And finally, the point I think is most important, why would you buy an investment property in a market that you think is in a bubble?

    Look, I don’t want to discourage you or anything, but being a landlord isn’t easy. Adding a partner to the mix would just add to your headaches. Want to make money at real estate? Buy when everyone thinks the market is crap.

    Anyway, my two cents. Good luck in whatever you decide.

    • Good to have you chime in!

      1. We have accounted for 8% vacancy rent, or one month a year. Some years it could be 20%, other’s 0%. We have definitely factored in this cost. Not to mention we would prefund a $10,000 savings account for things like maintenance and no-rent months. The $500 will be added to this amount until we have about $25,000 in a reserve fund.

      2. The numbers indicate my $55,000 investment turns in to $150,000 in 10 years. With home prices appreciating over that time, our mortgage being paid down by renters, and about $25,000 in rental income over the years. Works out to 13% YOY.

      3. You’re forgetting tax deductions/depriciation benefits. Not to mention the fact that our mortgage will be paid down by renters for 10 years, and rent prices will increase over that time. And the $1,700 monthly payment is PITI meaning taxes and insurance are part of the math already.

      4. Not a property manager, no doubt we would learn a thing or two. The house is half a mile from my friends current home. I live about 15 minutes away and work from home, meaning I have a ton of flexibility in my work schedule. We’ll probably make mistakes along the way, but our spreadsheet even accounted for an 8% property management fee should we choose to go that route.

      5. There is no denying real estate has bubbled, 20% YOY is not sustainable. That said, I don’t think the pop will be like the 2006 pop. The Feds have gotten themselves too involved, lending has become significantly more tight (meaning the people that have bought homes in the last four years could probably actually afford them), and we are still 20% less than 2006 prices. We have ran the numbers at 1%, 3%, and 5% annual appreciation over a 10 year time frame. They all make sense. Not to mention even if the market remains completely stagnant for 10 years (extremely unlikely), we’ve still had someone else pay down our loan for us.

      Buying a rental property and buying a personal home are completely different, and since you own an investment property like you mentioned I’m a little surprised you are making them an apples to apples comparison.

      Is there risk? Sure. But there’s also risk in the stock market, if we bought our own home, started a business, etc. People have different risk tolerances and should only do what they are comfortable with. If the spreadsheet didn’t show the numbers it showed, and I didn’t have 100% confidence in my personal/business relationship with my friend, we wouldn’t think twice.

  23. Investing for a return and buying for a need are two different things. You need a house, why not buy it when you can afford it πŸ™‚

    • I don’t want a house for myself. No desire to commit to living in one place for a long period of time at this stage in my life. I do like the idea of someone else paying for an appreciating asset for me though.

  24. Umm, not loving the partnership aspect of this deal. There are so many things that go wrong. The only partner that I trust would be your wife πŸ™‚ at least you live together and know what’s going on with one another. Good luck!

  25. Curious- what is the cap rate you’re looking at for the house? In the area we’re usually looking for 6 or greater

    • My sentence made zero sense. In the particular area we purchase rental properties we’re looking for a minimum of a cap rate of 6 – but obvs hopefully greater. I’ve seen some areas with as much as 14 but not in WA πŸ™‚

      • Cap rate per the spreadsheet is 5.9%. What’s more important to us is the spread between the cap rate and and the interest rate on the loan. With a 6% cap and a 3.6% loan, we like the 2%+ spread.

  26. Ok, I hardly EVER comment, but this time I had to. I’m 55 years old and I’ve had 3 rentals over my life. I don’t have any now. Why? Because honestly, I thought they were more trouble than they are worth. I never had tenents that took care of the places like I would have. However, having said that, I did make money over time on them all since the renters paid down my mortgage for me. But then I had to pay taxes on the gains. So in the end, would I do it again? No. And I certainly would not go into partnership with someone on a rental house.

  27. Even though it’s new construction, make sure to get a home inspection. Not a place to cut corners.

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