John is not a real estate investor. He is a real estate watcher. Nothing wrong with that but many people enter the New Year with aspirations of buying an investment property and never do. The New Year’s Resolution has no mercy.

Every investor has a different strategy. For us, it is the single family unit in close-in neighborhoods. Our goal is to find a home that needs little or no work to be in “renter condition.” Something around a B, B- on the scale of livability- we have no interest in being slum lords. When it comes time to sell it, we’ll remodel it to A condition.

If you buy a trashed house to put a renter in, you’re going to have to spend a lot to place the tenant and then through wear and tear (if not outright damage) you’re going to have to do a lot of the work again when it comes time to sell. If the house is not in solid shape, you’re going to have to make repairs on the tenant’s schedule. You can’t just leave the door unlocked for the contractor to take their time to get over there.

Buy a solid house, in a market where the neighborhood has good appreciation possibilities and that is not to inconvenient to you.

We’re selling NE Ivy St. as an investment property. The price difference of what we bought it for in 2001 and the selling price now would be taxable as a capital gain on our income taxes. The 1031 Exchange allows us to reinvest the money in another property (or multiple properties) without paying capital gains.

Wikipedia has a great synopsis of the way it works.

In a nutshell, we have 45 days from the day NE Ivy closes to identify the property, or properties, we are going to purchase. We have a total of 180 days from the closing date on NE Ivy to close on the new property.

We will never touch the money. It goes from the buyer of NE Ivy to a Qualified Intermediary (also known as an Accommodator). The QI holds the proceeds from the sale until they are transferred to the seller of our new property. Anything that finds its way into our bank account is taxable as a capital gain.

So, the burning question is what to buy? Don’t know the answer. I do know that we are not going to take on any more rentals as a landlord. We will hire a property manager to do that for the foreseeable future.

Putting the three together determines if you have a good investment. Not all three have to be favorable to have a good investment.

Let’s say we buy a $200,000 house. We put $20,000 down (10%) and have a loan calculated over 30 years at 6%. That’s a monthly principle and interest payment of $1079. Add $221/ month for taxes and insurance (all these numbers are fictional). Our monthly payment is $1300.

The property closes and now we have two different rental scenarios. First, the renter moves in and happily pays $1500/mo. Gross cash flow, providing there were no other expenses is nearly $200 per month. The other is that it only rents for $1100. Now we’re writing a check for $200/mo. Not so fun!

If we had put more money down, say 30%, our payment drops by $240. Now we’re making money on a monthly basis. Sounds great but we have lost our leverage. Now were using our money instead of someone else’s.

After five years, we sell the property for $255,000. It has appreciated 5% per year. Let’s say the loan cost you $4,000 and it cost you another $13,000 to sell the property in commissions, escrow & title fees, and minor repairs the buyer asked for. You’ve made only a small dent in the principle so you pay off the $180,000 loan and are left with approximately $60,000 on your $20,000 investment. This assumes the whole time we were cash flow neutral. If we’ve made a payment for $200/mo for the last 60 months, we’re out $12,000. Now we’ve “only” got $48,000 on our $20,000 investment. If the same $20,000 had sat in the bank earning 5% interest, we’d be sitting on $25,525.

Again, all these numbers are fictional on one cup of coffee. There are so many other variables that need to be considered in the overall picture but this is a good primer on the basics. we don’t have to have positive cash flow to have a good investment (but it sure is nice). We’ve always got to consider what we could have done with the money for another use.