As some readers may know, we sold our rental home and 4plex earlier this year. Of course, I’m addicted to investing so I couldn’t leave well enough alone and invested in a duplex soon after. I’m a bit reluctant to talk about the duplex investment because it’s definitely not the best investment we could have made. First let’s go over why I decided to invest in a duplex, then see the pros and cons, and lastly crunch the numbers.
Why invest in a duplex
So I’ve complained in the past that I’m not cut out to be a landlord. So why would I invest in a duplex? Well, I have my reasons. Mrs. RB40 doesn’t really like it, but she’s going along with it for now. (She’s being a really good sport).
All right, let me tell you a bit about the duplex. It’s an old Victorian home that was converted to a duplex in the 70s. The upper level unit is 580 sq ft with one bedroom and one bathroom. The lower unit is about 900 sq ft with one bedroom, one bath, and a study. The unfinished basement is about 1,000 sq ft. The property is in a great location with many amenities within walking distance (walk score = 97). The public transportation access is also very good. It is also in a good public school district in Portland and that’s important for us because we’re not sending our kid to a private school. Most owners in the area are long term owners and properties rarely go on sale. The last owner had this home for 35 years. We plan to rent this property out for 2-5 years and move into it at some point.
1. We need more room
Currently we live in a 960 sq ft, 2 bed/2 bath condo. It works really well for the 3 of us and our cat. The condo is centrally located and we love it here. Mrs. RB40 absolutely does not want to move. However, my mom is staying with us for 6 to 9 months at a stretch and it’s too small when you add one more person. She is sharing a room with RB40 Jr. right now, but he’ll need his own space when he’s older. My dad is also coming to visit for about 4 weeks starting in October and it will be really tight then.
To me, a small duplex is an ideal solution to our problem. My mom can live in one unit when she’s here. When she’s not, we can rent out the unit to tourists and professionals with short term stays. My dad is 70 so he might also move in with us at some point. Having their own unit would really lower our stress level. I love my dad, but he is a disruptive presence. My parents live in Chiang Mai, Thailand when they’re not in the US.
Rental properties are great, but you’ll have to pay a ton of tax when you sell. I ran the numbers through Turbo Tax to gauge how much tax we’d pay and I was shocked. We’d have to pay about $45,000 in tax just for the rental home alone. That’s long term capital gain plus 25% tax on any depreciation we took. Yeap, the tax write off was great, but you have to pay for it when you sell.
The way to defer paying $45,000 is to do a 1031 exchange. We took all the money generated from the rental home sale and roll it into a replacement property (duplex). This way we’ll put off paying $45,000 to the IRS. If it all works out like I envision, we won’t have to pay part of this tax. We’d have to keep the duplex as a rental for at least 2 years, move into the duplex, and then live there for at least 5 years. At that point, it will be considered a primary residence and we won’t have to pay capital gain tax (up to $500,000.) I think we still need to pay the 25% depreciation recapture when we sell, though.
3. Less management headache
The problem with the old rental home and 4-plex is that they were too far way. Whenever there was an issue, I’d need to drive over 30 minutes to get there. We had a property manager for the 4-plex, but they don’t manage it like an owner would. I like to keep an eye on my properties so I know the condition of the place. For example, when one of our tenants decided to build an unauthorized tree house, we didn’t find out from the management company. A grouchy neighbor looked up our address and sent us a complaint instead. The duplex is only a few minutes away and I’m in that neighborhood pretty often, so that’s not a problem anymore. The tenants are also more financially secure because the rent is higher in this location. I envision a lot less management hassle, but we’ll see how it turns out.
So those are the main reasons why I invested in another rental property. Let’s go over the pros and cons list.
- Separate living area. My parents can have their own space. Mrs. RB40 is a saint, but she can’t deal with having her in-laws here all the time.
- Location is amazing. I lived in that area when I first moved to Portland so I’m familiar with it.
- Schools are good.
- Cheapest house on the street. According to Zillow, other homes in the immediate vicinity are valued 20-100% more. Of course, they are bigger and more updated so we’ll have to take that with a grain of salt. It’s better to own the least expensive house on the block than the most expensive, right?
- Possible expansion. The basement has its own entrance and good headroom. One possibility is to add another unit in the basement at some point.
- Lower monthly housing cost. Our monthly housing bill would decrease when we move in. We currently pay $470/month just for the HOA at our condo. It’s great not to deal with exterior maintenance, but that’s a lot of money every single month. The mortgage would be lower as well.
- Rent is below market. The current rent is cheaper than usual. We could raise the rent a bit to help with the cash flow.
- Need repairs and updating. The kitchens were installed in the 70’s. The electrical and plumbing are not up to code. The roof is at the end of life. There is a little leak in the basement after a heavy pour down. The carpet probably needs to be replaced soon. At least, the hardwood floor still looks good. Basically, there is a long list of items that need to be updated. The previous owner is an architect so he took care of the place pretty well and the materials are good quality. But he also added a few unusual “architectural elements.”
- No Parking. The duplex does not have a garage so there is only on-street parking. The parking is really tough in this neighborhood and many people enjoy a car-free lifestyle.
- A study is not a bedroom. RB40 Jr. would get his own room – the study. There are no doors so he won’t have that much privacy. We can put up sliding curtains or something.
- Only one bathroom on the lower unit. This is going to be a problem. We’ll have to figure something out.
- Not the perfect house. It would have been perfect if the lower unit is a 2 bed/2 bath. We should have purchased a multi-unit in this area during the housing market crash. It would have been tough, though. There weren’t many properties on sale and we probably couldn’t get a loan at the time.
- The duplex was expensive… See the numbers below.
Crunch the numbers
All right, I warned you at the beginning that the duplex isn’t a great investment. Many of our readers are real estate investor and I’m a bit embarrassed to talk about the details. The numbers don’t make sense from an investment standpoint. The location is great, but the price went up years ago. We could have purchased a home in an up and coming area and that would have a much better investment. However, the schools in the up and coming areas are not very good. That’s a big concern for us so we went with a suboptimal investment. All the numbers are rounded for simplicity.
- 1031 exchange rental home: $260,000
- Cash from 4-plex: $135,000. Reserve $15,000 for tax so we have about $120,000 to work with.
- Seller asking $650,000 in February 2014.
- Reduced to $599,000 in April.
- We offered $560,000 at the end of June.
- We rolled $260,000 from the rental home and added $100,000 cash.
- We got a $200,000 mortgage from our credit union. 30 years FRM at 4.25%.
Monthly Cash flow
|Rent upper unit||$820|
|Rent lower unit||$1,200|
|Water and trash||$100|
*oops. I forgot to factor in vacancy. It’ll probably be less than 5%.
So you can see why I told you this isn’t a great investment. We put a lot of money into the place and the estimated cash flow is under $100/month. I plan to raise the rent a bit to bring it up over $100. There is actually more headroom, but the tenants are good and I want to keep them.
From a financial standpoint, keeping the old rental home would be better. However, it doesn’t fit in with our long term goals. Another option is to wait for the next housing market crash, but I guess I’m not patient enough to do that. Anyway, our family is a bit unusual so we have to make some sacrifices. Well, what do you think?