Salud received a Facebook message a couple of days ago. A client shared that her and husband currently own 2 properties and would like to buy a 3rd, preferably a duplex (2 units). She asked, “What will a down payment have to be for the purchase and what do you suggest in moving forward?” We thought it would be best to schedule a 15 min. call with them to ask what their goals are, how their financials look, and gather information about their current properties to best answer their questions.
Q&A From Our Conversation
Us : Where do you own the 2 properties and what are the property specs?
Clients: We own a primary residence in Azusa that we purchased with a 5% down payment conventional loan and a property that is now rented. We originally bought that property in Baldwin Park with an FHA loan. The properties are both 3 bedrooms and 2 baths. Baldwin Park is about 1200 SF and Azusa, our primary residence, is 1400 SF.
* The size of the primary home plays a role here if they plan to buy an owner occupied 3rd property and want to keep their down payment low (below 20%). The lender would like to see a compelling reason why they are buying another home (i.e. going to to a bigger property, bigger backyard with a swimming pool, for example…etc ).
Us: What is the goal with the new purchase/Why are you moving?
Clients: We would like to buy in Pasadena or Altadena as our children want to play in a HS that has better sports and is more competitive. We also want to buy in an area that could have the potential for higher equity.
* This answer is important because it tells us the potential price point and that will dictate the potential down payment. 10% for a property that you can buy for $700K in Azusa is different from 10% for a property in Pasadena or Altadena that could be over $1 million to $1.4 million.
Us: Would you be interested in a comparative market analysis of your 2 homes to see what they can sell for, and also very important, an analysis of the return on your equity in each? The CMA for value is important to understand what your profit could be and what you can buy with that profit elsewhere. The ‘return on equity’ analysis is important because it tells you what your true returns are and if your current asset is doing well or if trading the asset for a better one would be most beneficial. Many people have over $500K sitting in a property as equity and after paying the mortgage every month, the rent collected is only $400 per month or $4,800 per year. That’s not even a 1% return on on investment on that equity. You could choose to explore looking for a property where you can deploy the $500K and in many cases cash flow about $1500 to $4,000 per month or $48K per year by simply buying a better asset!
Client: Yes! Thank you for offering that!
Us: How much money do you have saved for this purchase?
Client: We have about $30K saved.
As you can tell from the info above, the clients have assets that they can refinance or sell to gather more funds to buy that 3rd property. $30K won’t take them far, as they would like a duplex in Pasadena and Altadena. That new property could be for sale for about $1.2 to $1.5 million and they will need about 20% down payment for it, assuming that their debt to income rations based on income and debt will allow it. This is why I suggested that they look at the 2 homes they own now. They could choose to sell one of them and use the proceeds from the sale to purchase the next property. The home in Baldwin Park will take a long time to reach a value of $1 million dollars (maybe between 15 to 25 years depending on the market and condition).
They will break even with the rents coming in, so it doesn’t make sense to keep it at this point. They can use that equity and go buy a property for $800K that will be worth about $1.5M in the next 10 years.
Our suggestion for now, was to put them in contact with a lender so that they could tell them exactly how much they would qualify for and how much they will need for a down payment.
We also suggested that they speak to a tax professional in order to understand their tax liability if they choose to sell one or both properties. They will avoid paying capital gains on the primary home in Azusa but will have to pay them for the Baldwin Park property since that home is an investment for them. They could do a 1031 exchange to sell and purchase another investment of equal or greater value. That process is a bit more complicated and they would not be able to live in the new investment property.
There is more information that will be uncovered as we continue on the investigative portion of this conversation with them. It is important to know as much as possible and ask the appropriate professionals for help in their given field to better guide these clients and anyone else!
Thank you for reading!
Looking for more?
