A lot of first-time home-buyers buy what’s called a starter home, which is exactly what it sounds like: a home to start a person on the path of homeownership. A starter home is smaller and less expensive than a “forever home,” if you will, and it puts a new buyer on the first rung of the equity growth ladder.
There’s a way that you can use this purchase to supercharge your financial position. Why settle for the first rung on the equity ladder when you could catapult yourself right up to the fourth or fifth?
Let’s dig into the math and look at real examples with real home listings to demonstrate how you can use your first home purchase to best prepare yourself financially for your forever home purchase.
I should also point out that our examples will be in Los Angeles, where I live and own homes. If you’re in Southern California, great! If not, just take all the prices and profits and divide them by four. Or six. Maybe eight! Point is, LA is an expensive, tough market. If this strategy works here, it will work anywhere.
Your Starter Home Should Be a Duplex
My thesis is this: your starter home should be a duplex. Stop shopping for that Joanna Gaines-inspired two-one dripping with ship lap, and set your search criteria for a duplex. Live in one side and rent the other. Why? Because it’s going to put you in a much better financial position when it’s time to buy the forever home. How much better? You will be amazed.
And isn’t that the point of a starter home? You’ve saved diligently for years for a down payment. You’re ready to quit wasting money on rent and start building equity. So its time to buy, but you don’t really need the family house yet. You don’t have kids yet, or the kids are still infants, so this purchase it really about setting you up for the next one. If that’s the case, and you want to make the smartest purchase you can, you should buy a duplex.
We’re gonna get to the numbers to show you exactly why buying a duplex is so advantageous, but first we have to deal with the objections. Many people understand intuitively that owning rental property creates income and equity and options – but being a landlord? Dealing with tenants?
Not everybody can easily wrap their head around what owning and living in a duplex might actually be like. So we’re going to tackle the top four objections that people have when considering it.
Objection #1: “I don’t want to be a landlord!”
I don’t want to deal with tenants or their toilets or late rent or anything. I don’t want to do it.
Well, I have good news for you: you don’t have to. There’s a service out there called property management, and a property management company does everything you don’t want to. Property management will collect rent whether its on-time or late, they’ll take your tenant’s phone calls, they’ll send the plumber to deal with the broken toilet – they’ll even handle an eviction were one to happen, and we’ll get to evictions in a moment.
And you can hire a property management company to handle just one unit, the other unit in your duplex. The fee that the property management company collects for their services is based on the unit’s rental income. In Los Angeles, you can find a 6% fee. In lower-rent markets in the Midwest or Southeast, you’re more likely to find a 10% fee.
And if you think 6 or 10% of rental income is a bit steep, there are less expensive alternatives, like the company Hemlane. Now, I’m not affiliated with Hemlane at all, I just think they offer a very cool service. They’re basically a web portal and call center for your tenant. Your tenant pays rent to Hemlane. If there are any problems with the unit, your tenant calls Hemlane or submits a repair request online, and Hemlane finds a serviceperson and handles all the scheduling. It’s like property management lite, which is probably all you need if you’re living next door to your unit. And it’s cheap! One unit would cost just $58 per month. That’s less than your phone bill!
And finally, option three is to just be a landlord. I’m a landlord. I live in a duplex; my tenants live downstairs. They’ve never called me in the middle of the night, and the only toilet I’ve had to unclog was my own.
But seriously, being a landlord is not that difficult. What’s most important is to have someone with experience help you get started. Once the ball is rolling, it’s really not a big deal. And it’s worth it for the financial benefits – which we will get to shortly.
Objection #2: “How do I buy a duplex?”
Buying a house is hard enough; how in the world am I supposed to figure out how to buy a duplex? A duplex is like two houses under one roof, so it must be twice as cumbersome a process, right? Fortunately, the answer is no. Buying a duplex is exactly like buying a house. Let me explain.
Condos, houses, duplexes, triplexes, and fourplexes are all classified together as residential real estate. Apartment buildings with five units or more are considered commercial real estate, along with strip malls and office buildings and everything else that isn’t residential.
Buying anything from a condo to a duplex to a fourplex is the exact same process. You would use the same agent to buy a house or a duplex. You would use the same bank or mortgage broker and get the same 30-year fixed-rate loan product on a house or a duplex. You’d use the same insurance company and get the same homeowner’s insurance policy. You can even get the same home warranty. From tip to tail, it’s the same process.
The only additional detail is confirming any rent that’s being paid. So word of advice: buying a duplex is the same process, but you want to do it with an agent who specializes in buying duplexes and other multifamily properties.
Objection #3: “I don’t want to lose privacy!”
I want my privacy. I don’t want to hear somebody on the other side of the wall. This really depends on where you live, but if you live in any city, please take my word that the privacy afforded by a house isn’t as impenetrable as you may think.
I myself owned and lived in two houses in Los Angeles before moving into my duplex. Both homes were in a quieter, hilly neighborhood, and in both cases, I was really looking forward to the quiet that the home would afford me.
At my first house, my neighbors on one side were a couple of nice guys who, in their free time, hosted their moped gang for beers and moped repair in the driveway. My neighbor on the other side was a nice, quiet elderly gentleman who cleaned his driveway with a gas-powered leaf blower every other morning.
My second home was better, but I would have really appreciated it if my neighbor on one side would have closed his window while having sex and my neighbor on the other side would have closed his window while watching German football at full volume.
My point here is, if you live in a city, it’s hard to escape your neighbors. The way I see it, I’d rather have a choice over who my neighbors are. And if they are going to occasionally disrupt my peace and quiet, at least they’re paying me for the privilege.
Objection #4: “What if I have to evict someone?”
And finally, objection number four: what happens if I have to do an eviction? This is an especially worrisome question in Los Angeles and other tenant-friendly markets. Evictions can drag on for months and get quite costly. No one, neither tenant nor landlord nor property management company, wants to see an eviction, so the question is how you can avoid and then cope if one were to happen.
Firstly, preventing an eviction begins with finding the right tenant. The great news is that you’re going to buy a duplex in a place where you want to live. That means that other people like you are going to want to live there, too. If you’re reading this, it means you’re not the kind of person who’s trying to skip out on rent and scam a landlord. You’re the kind of person who thinks about your financial future and doesn’t want to ruin your credit report with an eviction. So you should expect that somebody just like you, somebody who cares about their FICO score, is going to be interested in the unit for rent in your duplex.
And when you have applicants for your unit, there are a bunch of websites that make qualifying them a breeze. I use cozy.com, and they have this automated credit check thing that is great. I would also recommend, again, working with an agent who focuses on multifamily properties and can get you started. Once you know the three steps to qualify an applicant, it’s a cake walk.
But! But! What if you buy a duplex that has a tenant in place, and that tenant is terrible and stops paying rent and you have to do an eviction? Well, this may sound callous, but in a market like Los Angeles, you’re actually the winner in that scenario. Let me explain.
Los Angeles has rent control, so the longer a tenant has been living in an apartment, the lower their rent is relative to market rent, which is what a vacant apartment would rent for on the open market. So if you inherit a long-term tenant who stops paying rent or otherwise necessitates an eviction, once the eviction occurs and you clean up the unit, you’ll be able to rent it for more money. So while it seems like an eviction equals financial ruin, so long as you have some reserves saved, going through an eviction will actually make your property more profitable and more valuable.
If you’re in or around Los Angeles and you think you might want to consider buying a duplex as your starter home, please get in touch, I’d love to help you.