Ep.64- The Ins and Outs of Buying a Rental Property In L.A.
Read Time: 5 Minutes.
Disclaimer: this article only reflects my personal opinion and experience on rental property investments in Los Angeles.
Three years after we bought our first home in L.A, we bought our second property in 2018. If you are curious, here's our strategy and how we executed on it.
YOU MAY NOT BE ABLE TO BREAK EVEN ON CASH FLOW IN LOS ANGELES
Typically, there are two ways of profiting from an investment property, either through cash flow or asset appreciation. Cash flow is the difference between how much you bring in every month (typically rent) and how much you pay out (mortgage + property tax + insurance + HOA + repair/maintenance + rental income tax).
Cash flow can be positive or negative. In the case of Los Angeles, it is likely to be negative if you buy in 2018 and onward, because the cost of buying is simply too high already.
- For example, this 2bd/2bath condo in Fox Hills was recently sold for $650k with an HOA of $483/month. In terms of expenses, it comes out to be a monthly payment of $3,972, pretty much $4k. If you bought it and then rented it out, you can expect to collect $3,300/month, as you can see a comparable listing here. As a result, you would take a loss of at least $700/month. Realistically, the monthly loss is $800-$900/month, once we budget for repair and maintenance.
REAL RENTAL STRATEGY: CASH FLOW LOSS IS MADE UP WITH RAPID ASSET APPRECIATION
Fast house appreciation is what makes it worth it to take on the cash flow loss in Los Angeles. Location is everything, because it determines how fast the property appreciates. In the context of Los Angeles, there are many neighborhoods that can return +10% annually, which translates into tens of thousands of dollars annually.
- For example, if one had invested in a $650k property in Brentwood in 2017, one would've experienced flat or negative appreciation in the last 12 months. Why? Because of the spillover effect. Potential buyers find it so expensive in Brentwood nowadays (easily +$1 million for a small bungalow) , they started looking at the neighborhood over. Alternatively, if one had invested 5 miles east, in a $650k property in Inglewood, Ladera Heights or Mid- Los Angeles, he/she would've experienced +10% appreciation.
WHAT DOES IT TAKE TO BUY A RENTAL PROPERTY IN L.A.
In my experience, compared to my first home, I learned to expect a larger down payment, a higher interest rate, and a more stringent debt to income ratio.
- Down Payment: Expect to have at least 20% down. If possible, put down 25%, because you will get the best rate.
- Interest Rate: Expect the interest rate to be at least 1 whole point higher than a conventional 30-year fixed mortgage on a primary home. For example, if the current mortgage rate on a primary home is 4.75%, expect your the rate on your investment property to be 5.75%.
- Debt-to-Income Ratio: On the first home, you may be able to stretch your debt-to-income ratio to 43% or maybe even 45%. On the rental property, it typically stops at a hardline of 38%.
HOW WE MADE IT WORK
My personal favorite in 2018 is Inglewood, because there are many things making it more attractive every day.
- RAMS Stadium (2020):
- NFL stadium for the Rams and Chargers in 2020.
- Super Bowl venue in 2022.
- FIFA World Cup Venue in 2026.
- Olympics venue in 2028.
- RAMS Stadium Surrounding Development (2020): When the stadium opens in 2020, it will include a ton of business developments beyond the stadium alone
- 70,000 seat open air stadium, expandable up to 100,000 seats
- 6,000-seat performing arts venue
- 780,000 square feet of office space
- 890,000 square feet of retail space
- 300 hotel rooms
- 2,500 modern residences
- Approximately 25 acres of public parks, open space, pedestrian walkways and bicycle paths
- Revamped Casino
- LAX- Crenshaw Line (2019): The 8.5 mile line will connect people to the Expo line into the Westside, and the Green line into South Bay in 2019. In other words, it can take people from Santa Monica to Inglewood, and then to Redondo Beach.
- LAX People Mover (2023): This automated transit line will further connect to the LAX-Crenshaw line, taking people from the airport terminal to Inglewood and beyond. Scheduled to be finished in 2023.
- Possible Clippers Arena (TBD): It is uncertain if this project will be approved. But if it does, it will boost the home value further more.
LOAN: 20% DOWN
Typically, to come up with the 20% down payment on a rental property, people either save themselves, borrow from family/friends, or take out a home equity loan from the first house. I went with the third option. As I have owned my home for 3 years now, I was able to cash out enough to cover the entire down payment on the new investment property.
There is one catch: debt-to-income ratio. Home equity comes out in a form of debt, which is factored into the overall debt-to-income ratio on the investment property. For that reason, I made sure to take out just the right amount of equity to I meet dual goals: enough cash to cover the down payment, and not excessive so that it would not disqualify me from the 38% threshold.
I went with a Redfin agent, which turned out to be one smooth experience. You may want to consider a Redfin agent for the following three reasons, based on my personal experience (not sponsored).
- Technology: If you've ever used Uber or Lyft, you'd understand exactly why I like Redfin, as it does a fine job of streamlining communication, without all the cumbersome human interaction. Specifically, the Redfin website/app makes it easy to communicate to the realtor without getting on the phone. For example, I can save all my favorite properties with comments within Redfin. Without calling, my agent see them all on his end, and schedules appointments accordingly.
- Prompt Agent Communication: I had a great experience with Joe Roylds, who was prompt in his communication. I've always received a response from him within one hour.
- Refund: With Redfin, we received credit back toward closing. It is transparent as it's posted on the listing of each property before you buy it. It helped quite a bit to cut down on our total closing costs.
OFFER: AS CLEAN AS POSSIBLE
It's a competitive market in LA, which mean you will be competing against many other offers on any given property. My experience is to keep it clean.
We kept our offer clean with 20% down, and only 3 contingencies: inspection, financing and financing. Nothing else. As a matter of fact, the feedback we received was that our offer was picked out of the top 2, was because our offer was cleaner than the other one, which happened to be slightly above our offer.
My strategy of investing in a rental property in Los Angeles is to knowingly taking on a cash flow loss, but betting on the neighborhood of Inglewood for rapid asset appreciation in the upcoming years. To get a loan for a rental property, I learned to put down at least 20%, expect a higher interest rate, and a tight debt-to-income ratio of 38%. To make your experience a smooth one and your offer competitive, I'd recommend considering a Redfin agent, and make your offer as clean as possible.
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