Housing Situation

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Housing Situation

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It’s only three posts in, and we have already covered a lot of ground on the subject of houses and housing … you should also be able to see that this blog is unusual; it’s like an iceberg: only 10% can be seen ‘above the ground’ (i.e. in the post, itself) … 90% of the value is ‘hidden’ in the comments below the water line. So, do yourself a favor, go back and read the posts over the last few days and scroll down to the comments …

When you’re done reading, add one of your own!

elephant-stampNow, our intrepid hounds have tracked Mark down to one of his secret global locations (Mark: will you let us in on the secret … and, send the requisite photos??!), to find that he is the poster-child for the 20% Equity and 25% Income rules … both now, and planned.

What do you think? Does Mark get an elephant stamp?


The real estate market has been on the news a lot; be it housing starts, mortgage rates, foreclosure rates, refinancing activity and so forth. While at the macro level it seems like it is affecting everyone, we should zoom in on our own situation to assess where we are at in the current situation. Using some numbers from networthiq.

Basic numbers:

Current home value (according to zillow): $140,000 (Range: $133,000 – $152,000)

Current mortgage: $109,600 ($92,600 first mortgage and $17,000 HELOC).

Current mortgage payment: $515.39 (first mortgage) + $216 (HELOC) + $100 (Taxes) + $146 (HOA dues) = $977.39 (I’m including taxes and HOA dues).

% of after tax income per month: 15.6% (($977.39 / $6241) x 100)  using 70% of gross income.

20% Rule

Now let’s look at the details for the 20% rule:

The current equity for the home is $140,000 – $92,600 – $17,000 = $30,400

This approximately (($30,400 / $181,900) x 100) = 16.7%

20% Rule – check.

25% Income Rule

Based on the 25% Income Rule:

I’m currently spending about 15.6% of my net income on mortgage, taxes, and HOA dues.

25% Income Rule – check.

But wait, the 20% Rule and 25% Income Rule is a general rule of thumb. What if the number is significantly below the threshold? Are we not investing enough in our primary residence? Are we missing out on tax breaks on the mortgage interest?

Some of these questions got me thinking and I’m currently in the market to upgrade my current residence and convert my existing home to a rental. It is definitely a great time to buy, if you can afford it. Mortgage rates are at multi-year low and housing prices are declining. It is a buyer’s market.

As for my current residence, I don’t foresee it being a good rental because it does not cash flow with the high HOA dues and the HELOC payments. I dont’ think I will get rid of the HELOC since it is at 2.25%.  The main reason for me to keep it as a rental is to ride out of the current market and sell it later when the housing market picks up again.

Let’s run some numbers for the upgrade:

Home value according to zillow: $210,000 ($190,000 – $220,000). I believe I can get a $210,000 market value home at $200,000 given the current market. Not a lot of discount but I’m not looking at foreclosures or HUD homes since I want to live in it for about 3-5 years and upgrade again.

Current home value: $210,000 (purchase value at $200,000)

Current mortgage: $180,000 (after $20,000 down payment)

Current mortgage: $1,216.82 (PITI)

% of after tax income per month: 19.5% (($1,216.82 / $6241) x 100)

Great! This is still within the 25% Income Rule. How about the 20% Rule?

The current equity for the home is $210,000 – $180,000 = $30,000

This approximately (($30,000 / $186,900) x 100) = 16.1% (Assuming equity gain at $10,000 – $5,000 closing cost). The rental is now an income producing asset (if we consider taxes and depreciation).

Nice. Let’s hope I find a good one.

Mark is traveling again – where?

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Reader Comments

Very well-written and organized, Mark!

Great Post Mark. I especially liked the explanation of why you are going to keep your current home as a rental ONLY UNTIL it appreciates and you have a great rate on your mortgage. Many people keep their home as a rental only because they hear it’s a good idea to do so. They pay no attention to the geographic location (close to a college, public transportation, etc.), the cashflow situation, or anything else business related.

If you didn’t buy the home to be a rental, there’s a great chance that it will never be a good rental property. It’s the old “if you can’t be with the one you love, love the one you’re with” scenario.

Nice work Mark. Keeping your home so far under those golden rules should work very well in your favor to build wealth.

@Diane – Thanks! Not back in town yet. I’m at +8GMT time zone 🙂

@Ryan – Yes, there are a lot of factors to evaluate a property. Some might be too emotionally attached (to the value of their home). Some cited good schools or nice upgrades and neighborhoods. But, in the end, it all boil down to raw numbers. From what my discussions with various people and some reading on the real estate market, properties that cash flow nicely are not really the ones you want to live in. Same for properties obtained through tax liens as well.

@Scott – The rules are “golden”. Great guidelines for all of us to follow with a few exceptions. We all could be case studies for these rules.

@ Mark – You’ve stated in one place that your current home is not a good rental and in another that it cashflows positive. Can you tell us what rental you expect (and, how confident you are to achieve it)?

Something to consider:

You have a current home that you feel is undervalued, hence you wish to rent it out to ‘ride’ the current market.

It’s possible that other real-estate in a similar price range may rent better for you AND be similarly undervalued due to current conditions …

… is it possible that you can do an exchange (whether tax-deferred or not), and would it be worthwhile (closing / changeover costs considered)? Or, would that trigger the closing (or interest rate change) in your currently VERY keenly priced HELOC?

Questions … questions … questions …

@ Mark – Congrats on being within the recommendations of both rules.

With regards to finding value in homes and rentals. I’m a big believer in trying to find rentals in areas that I could see (or could have seen) myself living in at some point in my life.

My “valuable” home criteria has changed as I’ve grown older. One piece I did not adequately understand before I had children was the importance of a good public school system and the specifics of the schools that the home feeds. Good schools means that homeowners don’t have to shell out for private school. That adds value to any home, whether it’s your home or a rental. Tenants with children are just as interested in schools as are homeowners with children.

Cash flow is great, but I’m finding that trying to max it out is bringing me to properties that will never appreciate (or very little) and will always be at risk for collecting the rent and preserving the property. That’s a hassle (and a “slum lord” image) that I don’t want.

I think there is a balance point where you can still benefit from cash flow in the near term while setting yourself up for long term appreciation. Finding that balance is the tricky part.

Above you asked “But wait, the 20% Rule and 25% Income Rule is a general rule of thumb. What if the number is significantly below the threshold? Are we not investing enough in our primary residence? Are we missing out on tax breaks on the mortgage interest?”

I’ll be interested to hear Adrian’s views on these points. For me, I “invest” as little of my own money as possible in a home. My track record so far reflects this with “home investments” of 0% of my money used in Florida, 0% in Virginia, and 5% in Massachusetts. Bottom line, I want to invest as little as possible while still being able to control the mortgage on a monthly basis.

The only way to get increasing tax breaks on the mortgage is to pay MORE interest throughout the year. Putting more of your own money into the deal lowers the interest as does seeking lower financing rates. I personally do not own a home, nor do I look for rentals based upon the potential tax break.

That’s icing on the cake for me, not the fundamentals of a business.

Good luck

@ Jeff – You move a lot, so for you a home is more a house/investment, I would guess. I’m nervous about 3 year appreciation strategies …. by the same token, I agree that looking for higher rents at the ‘expense’ of appreciation should ONLY be a MM301 strategy.

I think the wisest two options for you are:

(a) rent – and, reinvest the difference b/w the rental and ownership costs (if you owned the same property) …. after all, what’s the difference b/w 1. owning a home and 2. owning a rental and renting another home? or,

(b) go for a real ‘flipper’: one where you add value along the way to ‘guarantee’ at least some of the appreciation (e.g. add a room; add a deck; repaint; change use; etc.)

BTW: It NEVER makes sense to increase one expense (e.g. interest) to reduce a lesser expense (e.g. tax) … that’s always just the ‘gravy’ on a deal for me:

The reason why we DO want to put in as little as possible into an appreciating asset like RE is for the leverage. If we own 100% of a property and it doubles, we double our money (and, earn some rent along the way). If we own 50% of TWO such properties and they double, we TRIPLE our money TWICE (but ‘pay’ for some of it in lesser income because of mortgage payments … straight math will tell you this is usually a GREAT trade-off). If we own 25% of FOUR properties, what do you think happens? Then try 0% of all of Manhattan 😉

@Adrian – It will rent out cash flow positive without the HELOC but then again, too much equity will be tied into that property and I think it is not ideal. The equity can be used in other better performing properties. It is not that easy to switch properties as you mentioned due to closing costs, interest rates, etc. It can probably rent out for $900 and that’s below the current “cost” for me, not including maintenance, vacancies, etc. I will have a small negative cash flow. I did consider tax implications as well but the numbers are not ideal. A good calculator to use is here:

A general rule of thumb is that the rental rate is about 1% of the property value. The property is valued at $140,000 and will not be able to generate a $1,400 rental income yet. The property will appreciate since it is in a good neighborhood with good schools. My goal at this point is to wait 3 years just like Jeff to “profit” from appreciation and avoid the tax consequences by rolling over to another property.

I think you will find multi-family units or properties obtained at a huge discount, foreclosures, short sales, tax lien or other means to be a really good rental. Maybe I’m not looking hard enough.

@Jeff – Thanks! I agree with you on the lower end properties vs middle class and above properties. I don’t want to be a slum lord either 🙂 I’m also looking at properties that I think I can live in which is what I’m looking for currently. Point taken on considering tax breaks – it should not be the main factor.

@ Mark – Is that 1% p.m. or 12% p.a. … one is WAAAY too small (in any market) and the other is WAAAY too large (in most markets) – but nice, if you can get it!

@Adrian – It is 1% p.m. I read about this guideline in one of the real estate investing book that I have. I think most would agree that for real estate, you generate profits, whether for appreciation or rental, when you buy at a discount. Not at ‘retail’.

@ Mark – Burn the book … if you can find a property – residential or commercial – that generates 12% p.a., or even much more than half that, I’ll buy 100 🙂

But, you are right, you can trade-off current income for future capital appreciation … unless you are MM301, I think you need to find a balance …

Anyone want to throw their hat into the ring on this one?

@Adrian – I think it is possible but it will be low end homes or multi-unit buildings. These properties will not appreciate much but generate good cash flow. I actually did came across some decent ones but was not prepared to go ahead with the deal. I’ll not burn the book yet since it contains advice on negotiation and other parts and puzzle of real estate investing.

@ Mark – Check the book out on John T Reed’s “picks ‘n’ pans”; he tends to be overly critical, but I have certainly appreciated some of his recommendations:


… and, I will feel that I’ve ‘made it’ when John reviews me (with whatever color he chooses) and puts me on this list of ‘gurus’:


BTW: We need to talk about rents v. appreciation v. value-add … what combination/s will get you the required Annual Compound Growth Rate? Not necessarily a question to be answered here, but certainly something to be explored …

@Adrian – Yes, I’ve read about John T Reed. He is definitely overly critical and even hates the publishing industry. That’s why he prints his own books and sell. He is also very critical about Robert Kiyosaki which I agree to some degree. There is always a fine balance of things and they are on both ends of the spectrum.

Adrian, I had also read and heard about the 1% of the purchase price that Mark cited and the other being that many go by .8% of that same purchase price. What is the 12% p.a. that you mention?

Mark, are you planning to hire a Property Manager or do that yourself? How do you account for the other costs (maint, primarily) associated with the property as a rental as well?

This has been a good discussion. Tell more about the reed v kiyosaki spectrum as well.

@ Diane – It means: 1% p.m. = 12% p.a. 🙂

@Diane – I’m planning to manage the property myself first so I know what to look for when hiring a Property Manager later.

Mark – Even though I normally suggest that you outsource property management, I agree that handling it on your first property as a learning experience is a great idea … you can always outsource later.

BUT: make sure that you ‘pay yourself’ i.e. include an allowance for property mgt when you first analyze the deal … do the financials still ‘stack up’ when you add property mgt charges of 6% to 10% into the equation?

@Adrian – The “pay yourself” idea is a great idea. I will consider it in my analysis for the property as well.

@All – Update on the housing situation. I did find a property recently from a builder. I don’t believe I bought at the bottom but I paid $20K less compared to the average. I bought the last house from this subdivision and paid the least among similar size houses. Will be closing end of this month!

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