Why That Foreclosed House May Not Be A Good Investment

With the bargain basement prices on single family home foreclosures in the marketplace, I’ve been getting calls from homeowners who, seeing the cheap house down the street, are thinking about becoming first time real estate investors.

I like that they’re thinking like that. Real estate offers investors growth in equity, an annual passive income stream that grows with the cost of living, appreciation, leverage, and the opportunity to use depreciation as a tax shield from other income.

However, most of these novice investors are thinking of single family home ownership as a path to wealth. What they don’t realize is more often than not, single family homes as rental properties do not cash flow.

In other words, the investor will have to reach into her pocket every month for money to pay the bills the rent doesn’t cover.

A duplex, on the other hand, will pull its own weight.

Surprised?

For the first time in decades, small multi-unit properties like duplexes are actually breaking even or producing positive, spendable cash flows.

To illustrate this point, this morning I pulled two properties from the Nokomis neighborhood from the MLS. The first is the least expensive home listed in the area of 42nd and Cedar.  It’s a short sale, built in 1949 with two bedrooms and two bathrooms, listed at $149,900.

Just a couple of blocks away is a 1947 built duplex, priced at $145,000. It has two bedrooms on each side, appears to be in reasonable condition,  and is a bank owned property.

Both require similar down payments, and will have mortgages at the same amortization and interest rates.

Assuming rent of $950 per month on the single family home, with the tenants paying all utilites, and the investor responsible for insurance and property taxes, this home actually has a negative cash flow of $1149.54 per year. In other words, every month, the owner has to reach into her pocket for cash in order to make up a shortfall of $95.80.

Duplex living may not be as desirable to prospective residents as a single family home. So, in order to entice tenants, I assumed lower rent; in this case, $850 per month for each of the two bedroom units.

In this case, I assumed the investor would be responsible for paying the water bill, as well as taxes and insurance. And still, the property has a positive cash flow of $4383.87 per year.

Unlike the single family home, this property actually puts money in the pocket of the investor every month; $365.32 to be precise.

Why? Well, in part because the duplex will never be 100 percent vacant. And I always consider the vacancy rate when analyzing potential investments.

Not to mention that when fully occupied, the property is generating two monthly rents.

This is an historical anomaly in the Minneapolis/St Paul duplex market. Duplexes have not cashed flowed like this upon purchase for investors in decades.

Of course, we haven’t even counted the other benefits of real estate investment, regardless of property type. Those include appreciation, equity growth, depreciation, a growing passive income stream and the ability to borrow against the equity you gain.

There probably won’t be a better time to invest in real estate in any of our lifetimes.