Landlord Takes a Risk
With His New Property

Jeff Jones bought his second Seattle investment property in 2004 just days after Thanksgiving. Despite the many hours he logged driving to see listings, the hundreds of dollars he paid for professional research and frequent Internet searches for properties, Mr. Jones found the 1909 Craftsman-style house in Seattle's Leschi neighborhood by chance. In fact, he saw the for-sale sign for the three-bedroom, one-bath home while driving to another listing. He made an offer on November 6 and closed three weeks later.

Listed at $399,000 -- low for the area -- Mr. Jones says he couldn't resist taking a look, even though the house is small. Most single-family homes in the upscale Leschi area are larger and priced above $1 million; this house has less square footage but offers partial lake views. Nestled on a hilly bank along Lake Washington, Leschi offers waterfront-apartment rentals but few single-family homes for lease, which makes Mr. Jones think this house is a good investment. It's also located near Leschi's winding waterfront boulevard, with its restaurants, cafés and wide sidewalks for waterside jogs. Another perk: It's only 15 minutes from Mr. Jones's house.

Sealing the Deal

Deciding to buy the cottage wasn't easy. It had been on the market for several months. The owner initially listed the home for $549,000, dropped it to $519,000 two months later, then hired a real-estate agent who convinced her she had overpriced it. When Mr. Jones found the house, it was priced at $368,000. He secured a 10% down-payment loan and offered $350,000 for the property, but the seller wanted $360,000. He decided he'd ask the seller to pay closing costs and commission -- a risk, because he didn't know if she had the cash. However, he did some homework and discovered the seller and her partner were trading up to a larger home and had to sell this one to purchase their new place.

They settled in the middle: Mr. Jones paid $366,000, but the seller paid $8,500 in closing costs and commission -- a deal that suits him because neither of those costs is tax-deductible, whereas his higher mortgage payment will be.

Apart from price negotiations, Mr. Jones hesitated on the deal when he learned about the home's physical condition. On the positive side, the house's basement had been waterproofed, and the electrical and plumbing systems were in good shape. On the down side, the house's foundation is showing signs of settling, initially a major concern for Mr. Jones. However, the seller told him the settling occurred before she moved in 10 years ago. And some of Mr. Jones's friends who know the Leschi area assured him that settling is widespread there and not necessarily problematic.

However, the house has a more urgent problem: a 25-year-old roof. "My inspector almost fell through the roof when he was inspecting it," Mr. Jones says. He tried to negotiate down for the roof, but there were restrictions on what he could ask in the contract. "After the inspection I deliberated whether I really wanted to go through with it," he says.

The roof will need to be replaced within four months. Mr. Jones says that he decided to purchase the house nonetheless. The benefit of a small house, he says, is that repairs are sometimes less costly. The roof, for instance, will cost $3,000 to replace, he says. If he chooses to repair the settling foundation, it will cost from $7,000 to $20,000, but the need isn't immediate.

The Risks

Mr. Jones, who intends to keep his first investment property in nearby Lakeridge until he pays off its 30-year mortgage, plans to use another approach with the Leschi property. To get a lower down payment, he chose an adjustable-rate mortgage with an interest rate that increases after seven years. Mr. Jones says this works for him because he'd like to sell the Leschi home within five to seven years, using the profits from the sale for additional real-estate investments.

In the short term, he'll take some major losses on the property. At his Lakeridge property, the rental income currently covers about 75% to 80% of the mortgage, allowing him to nearly break even in the short term after he takes tax deductions; he expects profits within three years. But at Leschi, the rent will cover only 50% to 60% of the mortgage. He plans to rent the house at $1,495 a month -- a figure he chose after making "mystery shopper" phone calls to other rentals in the area.

"I have every expectation that I'll contribute to the rent," Mr. Jones says. "I can sustain the difference [between rental income and the mortgage expense]."

Mr. Jones believes he'll profit from this house when he resells it, rather than incrementally through rental income. He knows it's a risky strategy: Mr. Jones is calm considering the bulk of his income from his job as a corporate-sales executive at Microsoft Corp. will go to his primary-residence and investment-property mortgages.

The new deal puts him under more pressure to keep the tenant in his Lakeridge home in South Seattle and to swiftly locate renters for the second home, which he's already begun advertising.

"It's that anxiety that'll drive me to get tenants in no matter what," Mr. Jones says.

Fast Learner

Mr. Jones also has grown more sophisticated in discussing his real-estate investing. He talks about "eating the delta" between what an income property can fetch in rent and what the mortgage costs. He refers to land with water views as a "nice piece of dirt." He buys research to see how professionals run the numbers on investment properties.

"I now know real estate really well," he says. "A lot of new income that comes in for me, I'm going to put that into real estate."

Sitting in a Starbucks in West Seattle, a section of the city where he made two near-miss offers on multifamily buildings, Mr. Jones is tired but upbeat. Despite the new level of personal risk he's assumed with a second investment purchase, he's still bullish on real estate. He's investigating forming a limited-liability corporation to shield his personal and investment properties from lawsuits.

"Compared to the last one, I'm cautiously optimistic. I didn't expect to buy in Leschi," he says. "I think I'll do this again in six to 12 months."

-- Ms. Hodges is a free-lance writer in Seattle and writes the Investor Profile and Landlord Chronicles columns for RealEstateJournal.com.

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