The Money Mustache Community
Learning, Sharing, and Teaching => Real Estate and Landlording => Topic started by: iamlindoro on May 19, 2015, 05:47:50 PM
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I am still learning, just like everyone else. Relative to several of the veteran landlords here, I am a rank amateur. However, I've done a few deals now, made a few mistakes, and hopefully learned something from them. I have a few cash flowing properties, and each has been more successful than the last as I raise my standards, learn how to anticipate some of the trouble areas, and most of all, have greater confidence in my ability to oversee all aspects of a deal. I figured I would share how I am currently evaluating deals and it may help some people. Discussion of my analysis may also help me to learn some things and get even better outcomes in the future.
On this forum, we frequently get questions about whether or not a given property is a "good rental." Though this is a highly subjective question, many rentals people consider are virtually guaranteed losers. This is usually because people fail to consider all the possible costs of buying and owning a rental, and/or because they are overly optimistic about vacancies, repairs, etc.
And now for some assumptions: My own real estate investment strategy is buy and hold for cash flow. The goal is to build a steady stream of income that compliments the safe withdrawal rate from my stock and bond portfolio. Thus, my analysis makes bottom-line cash ROI the most important factor versus appreciation. That is not to say that quality of neighborhood, tenant, and prospects for the city aren't just as important-- they're just things that I consider before I ever get to evaluating the raw numbers. I'm a California resident and have found that the best deals in my price range are out of state, even after accounting for property management.
My analysis spreadsheet is based on the J Scott Single Family Home analysis spreadsheet on biggerpockets. Here's a link to that:
http://www.biggerpockets.com/files/user/JasonScott/file/20-sfh-rental-analysis
I've uploaded my modified version, which corrects a few Excel issues with the original, and enhances it somewhat to allow for evaluating duplex/triplex/small multifamily units. I've put it on Google Sheets and all the formulas seem to have made the leap properly. The version I put there contains real numbers for a property I'm in contract on in the city of Cleveland, Ohio. This version also has some tweaks that are specific to the area/property management but if you decide to use my copy as a basis for your own, it should be pretty easy to figure out.
https://docs.google.com/spreadsheets/d/10XGrJTyn-xDbPulj9t3STtshNd3Clx-2Ck1XQbLwd0w/edit?usp=sharing (https://docs.google.com/spreadsheets/d/10XGrJTyn-xDbPulj9t3STtshNd3Clx-2Ck1XQbLwd0w/edit?usp=sharing)
The sale price is $65,000. It's a 2/1-per-unit duplex located in a C+ neighborhood with somewhat below standard schools. The average household income for this part of the ZIP code is approximately $40K. The unit was priced too low for the market and was pending within 24 hours of being on the market. That deal fell through and I moved on it quickly. The duplex is in above-average condition for the neighborhood and will rent for approximately 650 per unit.
Now, let's start plugging in numbers I feel comfortable with. Again, these are my actual numbers. You could do better/worse/differently with more exotic financing, but these are fairly standard, which may help those with no idea what to expect.
The Numbers
Downpayment %: Because this will be an investor mortgage on a multifamily, I will need to put down 25%. Fannie Mae requires that investor + multifamily be 25% through the first five financed properties. It's 20% on single family for investors. Thus, my downpayment amount is $16,250.
Interest Rate: Also because it is a investor mortgage, the interest rates are slightly higher than consumer. The rate I'm getting on this property is 4.65%. Roughly in the same ballpark I've gotten on my last few properties. My middle credit score is a 750 or so.
Improvements: Any improvement needed to get the property ready for rental. Remember, the goal is to be in good, safe, and clean condition, with amenities appropriate for the neighborhood, not amenities which you would demand for your own home. Initial forecasts for improvements were conservatively $1000. After the inspection, I learned that there are some electrical issues needing repair (missing grounds and a few knob-and-tube issues) so that has been revised to $2500. This is an up front cost that I will incur shortly after closing.
Closing Costs: I paid $349 for the inspection, and the expected costs to close the financing are currently $2966, which includes the escrow of the first few months of taxes and insurance. This property's taxes are lower than originally expected, so this number will come down slightly.
Per-unit market rent: This will be $650 per unit. This is on the medium-high end of average for the neighborhood, which is justified by the extremely good condition of the property. Median rent in the area is about $612. Don't delude yourself about rents if you don't know the area! At *least* use rentometer, check Zillow and Craigslist for rentals, and get somewhere in the ballpark. I'm satisfied that $650 should be possible, but the numbers are still good enough if I have to go to $625. $615 is the bottom I would be happy with and shouldn't be necessary. Try the whole range of possible rents and make sure it still works. A unit in the same floorplan two doors down is on the market for $750 a month right now.
Vacancy/Loss Rate: Set at 10%. Average vacancy for the area is 4-5%, but I prefer to estimate high and use any extra income from low vacancy to fill reserves quicker. This is one of the areas that I consistently see people underestimate. There are always hand-wavy arguments about how "the market is really tight in the area" or "it seems like everything fills up quick around here." It costs you nothing to estimate conservatively. At worst, you might pass on a deal that could be good but falls on the wrong side of the bubble because of being too conservative. At best, you only pick the cream of the crop because of high (but not unrealistically high) standards.
Property Taxes: $1551 per year currently for this unit. Cleveland taxes are normally very high, but this area has ~25% lower taxes than some of the others I have considered.
Insurance: $904/year. This is 1 million in liability coverage, full replacement value, DF1 insurance. The deductibles on repair/replace are $2500. I knew about what I wanted to spend on insurance, so went back to the insurance broker 4 times to get adequate liability (first quote was 300K), adequate property value (first was 53K) and a higher deductible (first was the lowest/most profitable for the company). The DF1 policy covers fire/wind/smoke, but excludes things like flood, war, etc.
Maintenance and Repairs: 1% of property value for year is my estimate, so $650. This is one area where I may not be conservative enough, but I hope for my conservative estimates elsewhere to help provide some margin for error. I also have income from other properties that can help compensate for unexpected high expenses.
Property Management: The property management is 10%. You may want to manage your own property, but for a variety of reasons I believe it's best to build it into the budget anyway. You may want/need to move. You may want to travel long term in retirement. You may become disabled. Again, the only risk in being too conservative is that you pass on a deal that might otherwise have been profitable. Don't be a motivated buyer.
Annual re-leasing fee/tenant placement: This is another critical element to consider if you will be using property management. Many/most property managers charge you something, often half or all of the first month's rent, to place a tenant. This is a large percentage of your cash flow if you turn over tenants too frequently. As our friend NoNonsenseLandlord consistently reminds us, the most important thing you can do is place quality tenants. If you're turning over tenants every year, or more often, something is wrong and it's going to eat even the best profitable-on-paper deal alive. This property manager charges the full first month's rent to place a tenant. I am wary of this as I pay half a month elsewhere, but I have been frank about my expectations and made it clear that if I see a pattern of poor tenants, they will lose my business quickly. $1300 for the first year, with an expected one turnover per year after that. This should be an overly conservative estimate with good tenants (and being a good landlord).
Annual Inspection: Read your property management agreement! You need to account for every cost. The PM offers an optional annual service to change air filters, inspect appliances, smoke detectors, radon detectors, change batteries, and do some light maintenance. I'll probably use it, so it's on the budget. $130.
Sewer Service: What utilities is the landlord obliged to pay? How much do they cost on average? Cleveland landlords must pay water and sewer, though there is some gray area about whether they can charge them if the amount is "excessive." $800 per year per unit for water and sewer is average. If it's too much beyond this, I'll bill the tenant. I will be putting this in the lease.
Water Service: See above, same deal.
Lawn Care: Code enforcement requires trimmed lawns and at a duplex, the landlord is responsible. Lawn service twice a month for seven months out of the year will run $66.
Putting It All Together
Let's see how it stacks up against the 1%/2% rule:
65000 (purchase price) + 2500 (improvements) + 3315 (financing/inspection costs) = $70,815 Total Cost
(1300 rent * 12) * .9 (estimated vacancy) = 14040
(($14040/12) / 70815) * 100 = 1.652%
Nice! Now let's do a more detailed analysis.
Accounting for all these costs, which are quite a bit higher than some areas, the total annual expenses in year 1 are $8000 even. Accounting for vacancy, the rents are $14040. Thus, the Net Operating Income (NOI) is $6040. After mortgage ($3008), the cash flow is $3032, for a cash ROI of 13.74% with a fairly conservative analysis. Throw in the equity gained and the total ROI is 17.23%.
The Cash Flow
The monthly cash flow with all of these assumptions is $253. I'm personally looking for about $100 per month in cashflow per $10,000 of my own money invested, which this meets. I'm very happy with this deal. If any one of the very conservative variables tips in my favor, I'll fill my reserves that much faster.
What if it all goes right?
The temptation would be high to see greater than the $253 "safe" cash flow coming in and to use it for something. Resist! Vacancy will come. A roof replacement will come. There will come a day when I have filled my reserves so much that I can start to skim off a little more cash flow, but that day is still far off.
My current plan reinvests all the cash flow in future properties. I'm buying 2-3 a year for the next 5 years. This will be a serious pull-up for the first two years, after which the cash flow starts buying properties for me almost as fast as I can on my own.
What if it all goes wrong?
Hopefully my conservative estimates give me breathing room if it does, but if not, I have 6 months of PITI for each property just in case right from closing.
Anyway, just thought I would throw this out there. Maybe it will help people to think of some of the variables that don't immediately occur to them when considering getting into Real Estate Investment. I continue to learn as I go, but feel like I'm starting to have some confidence and I'm having a lot of fun-- all while making money. :)
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Thanks for your thoughtful and informative post.
I, too, believe in being a bit conservative on the estimates. That way, when I find out I actually wasn't conservative enough, it doesn't hurt so much!
I only have one serious disagreement with you. It has to do with this statement:
"Remember, the goal is to be in good condition for the neighborhood, not a condition which you yourself would live in."
If, by that statement, you mean "I would not live in a house with less than 2 bathrooms and this only has one." I have no problem with your statement.
If, however, you mean, "The rest of the properties for rent in the area have holes in the floor and rats living in the basement that come up thru the floors, so it's ok for me to rent another house just like that." then we are in very serious disagreement.
Any house you rent should be safe and properly maintained regardless of how many scum-sucking soul-less slumlords you have as competitors.
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If, by that statement, you mean "I would not live in a house with less than 2 bathrooms and this only has one." I have no problem with your statement.
If, however, you mean, "The rest of the properties for rent in the area have holes in the floor and rats living in the basement that come up thru the floors, so it's ok for me to rent another house just like that." then we are in very serious disagreement.
Neither was what I meant, exactly. If the standard of the home/area you live in amenity-wise is granite countertops, stainless appliances, hardwood floors, double-paned windows or any other convenience/aesthetic disguised as "must have," there's not reason that you have to demand those same amenities of a rental in a working class neighborhood.
You're right, though-- using the words "aesthetic" or "conveniences" rather than "condition" might have been wiser. I absolutely agree that it's the obligation of the landlord to provide safe and clean housing. That said, there are some places where the lines are blurred somewhat. I might not want a fridge that had turned from white to yellow, but I would absolutely leave it in a rental if it was in good working condition. I might not want to live with stains in my countertop, but I wouldn't replace the counters in a rental for this issue alone.
(The above are theoretical as neither would bother me in my own home-- just driving home the point of not having to have the exact same threshold for replacement of something on a rental as for your own home-- safety/security/basic cleanliness are non-negotiable for me).
Edit to add: The same goes for selection of the property itself. I live in a B/B+ neighborhood. That doesn't mean I am committed to buying rentals in B/B+ neighborhoods or better. It's okay for me to buy a C property, and it's okay for it to offer the amenities common in a C neighborhood.
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Great post! Stickied!
I will have more to add later, but I agree with about 98% of this. It's a great primer/guide for newbies.
Thanks for taking the time to type it up.
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Replying to follow. Thanks for the detailed analysis. All of our investments so far are retirement, but we are considering pulling out some Roth principal (penalty free, of course) to purchase a rental property.
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Great post! Stickied!
I will have more to add later, but I agree with about 98% of this. It's a great primer/guide for newbies.
Thanks for taking the time to type it up.
Thanks! I was/am a little hesitant since I don't have the same experience you, Another Reader, NoNonsenseLandlord, etc. do, but figured we respond to enough variations on the same question that maybe it could be a neat discussion and that I'm bound to learn something.
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"Remember, the goal is to be in good condition for the neighborhood, not a condition which you yourself would live in."
If, by that statement, you mean "I would not live in a house with less than 2 bathrooms and this only has one." I have no problem with your statement.
If, however, you mean, "The rest of the properties for rent in the area have holes in the floor and rats living in the basement that come up thru the floors, so it's ok for me to rent another house just like that." then we are in very serious disagreement.
Any house you rent should be safe and properly maintained regardless of how many scum-sucking soul-less slumlords you have as competitors.
On re-reading, I changed the wording to (hopefully) more accurately reflect what I was trying to say. I hope it's clearer now.
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In case anyone was curious about this specific deal, the inspection yielded no real issues that I didn't expect to repair, but gave me an opportunity to push the seller for cash back at closing. $500 credit towards the closing costs puts the year 1 cash ROI at 14.08%, which jumps up to 17.79% in year two.
Just a little, but always good to preserve up-front cash for use in the next one.
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This is an amazing write up, and am very thankful you took the time to write it up Robert. Thank you so so much for the detailed emails regarding this too. Good luck with the closing and finding a tenant!
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Great post! Real numbers and the spreadsheet are really helpful.
I have come across a spreadsheet which shows return as CAGR over duration of mortgage (30 years, I am going for). I suspect CAGR is not the best when it comes to evaluating a rental property because all the cash flow is not really 'reinvested' and hence it does not compound like in stocks.
So my question is - what is your baseline number that you look at to evaluate a property - ROI? Also, have you ever tried to evaluate if a particular deal is better than just investing with total market fund?
Thanks in advance.
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So my question is - what is your baseline number that you look at to evaluate a property - ROI? Also, have you ever tried to evaluate if a particular deal is better than just investing with total market fund?
I am sure there are a lot of reasonable answers to the first question, but for me the top priority is the Cash ROI. Since I'm trying to create an income stream, getting the most dollars-per-month-per-dollar-invested is key to me. Secondary for me would be factors like total ROI and purchase value compared to market value (if I can get the property below market, then that's an instant increase in potential equity).
I suppose you could say I evaluate if a particular deal is better than investing with a total market fund in the sense that my minimum for an acceptable property for me is ~4-5% higher ROI per year than the long term average market return. If I'm looking at a property and it's merely matching the return of the market, there's little motivation to take on the additional risk of Real Estate. The ROI has to handily beat the long term average stock market performance to make it worthwhile.
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I am still learning, just like everyone else. Relative to several of the veteran landlords here, I am a rank amateur. However, I've done a few deals now, made a few mistakes, and hopefully learned something from them. I have a few cash flowing properties, and each has been more successful than the last as I raise my standards, learn how to anticipate some of the trouble areas, and most of all, have greater confidence in my ability to oversee all aspects of a deal. I figured I would share how I am currently evaluating deals and it may help some people. Discussion of my analysis may also help me to learn some things and get even better outcomes in the future.
On this forum, we frequently get questions about whether or not a given property is a "good rental." Though this is a highly subjective question, many rentals people consider are virtually guaranteed losers. This is usually because people fail to consider all the possible costs of buying and owning a rental, and/or because they are overly optimistic about vacancies, repairs, etc.
And now for some assumptions: My own real estate investment strategy is buy and hold for cash flow. The goal is to build a steady stream of income that compliments the safe withdrawal rate from my stock and bond portfolio. Thus, my analysis makes bottom-line cash ROI the most important factor versus appreciation. That is not to say that quality of neighborhood, tenant, and prospects for the city aren't just as important-- they're just things that I consider before I ever get to evaluating the raw numbers. I'm a California resident and have found that the best deals in my price range are out of state, even after accounting for property management.
My analysis spreadsheet is based on the J Scott Single Family Home analysis spreadsheet on biggerpockets. Here's a link to that:
http://www.biggerpockets.com/files/user/JasonScott/file/20-sfh-rental-analysis
I've uploaded my modified version, which corrects a few Excel issues with the original, and enhances it somewhat to allow for evaluating duplex/triplex/small multifamily units. I've put it on Google Sheets and all the formulas seem to have made the leap properly. The version I put there contains real numbers for a property I'm in contract on in the city of Cleveland, Ohio. This version also has some tweaks that are specific to the area/property management but if you decide to use my copy as a basis for your own, it should be pretty easy to figure out.
https://docs.google.com/spreadsheets/d/10XGrJTyn-xDbPulj9t3STtshNd3Clx-2Ck1XQbLwd0w/edit?usp=sharing (https://docs.google.com/spreadsheets/d/10XGrJTyn-xDbPulj9t3STtshNd3Clx-2Ck1XQbLwd0w/edit?usp=sharing)
The sale price is $65,000. It's a 2/1-per-unit duplex located in a C+ neighborhood with somewhat below standard schools. The average household income for this part of the ZIP code is approximately $40K. The unit was priced too low for the market and was pending within 24 hours of being on the market. That deal fell through and I moved on it quickly. The duplex is in above-average condition for the neighborhood and will rent for approximately 650 per unit.
Now, let's start plugging in numbers I feel comfortable with. Again, these are my actual numbers. You could do better/worse/differently with more exotic financing, but these are fairly standard, which may help those with no idea what to expect.
The Numbers
Downpayment %: Because this will be an investor mortgage on a multifamily, I will need to put down 25%. Fannie Mae requires that investor + multifamily be 25% through the first five financed properties. It's 20% on single family for investors. Thus, my downpayment amount is $16,250.
Interest Rate: Also because it is a investor mortgage, the interest rates are slightly higher than consumer. The rate I'm getting on this property is 4.65%. Roughly in the same ballpark I've gotten on my last few properties. My middle credit score is a 750 or so.
Improvements: Any improvement needed to get the property ready for rental. Remember, the goal is to be in good, safe, and clean condition, with amenities appropriate for the neighborhood, not amenities which you would demand for your own home. Initial forecasts for improvements were conservatively $1000. After the inspection, I learned that there are some electrical issues needing repair (missing grounds and a few knob-and-tube issues) so that has been revised to $2500. This is an up front cost that I will incur shortly after closing.
Closing Costs: I paid $349 for the inspection, and the expected costs to close the financing are currently $2966, which includes the escrow of the first few months of taxes and insurance. This property's taxes are lower than originally expected, so this number will come down slightly.
Per-unit market rent: This will be $650 per unit. This is on the medium-high end of average for the neighborhood, which is justified by the extremely good condition of the property. Median rent in the area is about $612. Don't delude yourself about rents if you don't know the area! At *least* use rentometer, check Zillow and Craigslist for rentals, and get somewhere in the ballpark. I'm satisfied that $650 should be possible, but the numbers are still good enough if I have to go to $625. $615 is the bottom I would be happy with and shouldn't be necessary. Try the whole range of possible rents and make sure it still works. A unit in the same floorplan two doors down is on the market for $750 a month right now.
Vacancy/Loss Rate: Set at 10%. Average vacancy for the area is 4-5%, but I prefer to estimate high and use any extra income from low vacancy to fill reserves quicker. This is one of the areas that I consistently see people underestimate. There are always hand-wavy arguments about how "the market is really tight in the area" or "it seems like everything fills up quick around here." It costs you nothing to estimate conservatively. At worst, you might pass on a deal that could be good but falls on the wrong side of the bubble because of being too conservative. At best, you only pick the cream of the crop because of high (but not unrealistically high) standards.
Property Taxes: $1551 per year currently for this unit. Cleveland taxes are normally very high, but this area has ~25% lower taxes than some of the others I have considered.
Insurance: $904/year. This is 1 million in liability coverage, full replacement value, DF1 insurance. The deductibles on repair/replace are $2500. I knew about what I wanted to spend on insurance, so went back to the insurance broker 4 times to get adequate liability (first quote was 300K), adequate property value (first was 53K) and a higher deductible (first was the lowest/most profitable for the company). The DF1 policy covers fire/wind/smoke, but excludes things like flood, war, etc.
Maintenance and Repairs: 1% of property value for year is my estimate, so $650. This is one area where I may not be conservative enough, but I hope for my conservative estimates elsewhere to help provide some margin for error. I also have income from other properties that can help compensate for unexpected high expenses.
Property Management: The property management is 10%. You may want to manage your own property, but for a variety of reasons I believe it's best to build it into the budget anyway. You may want/need to move. You may want to travel long term in retirement. You may become disabled. Again, the only risk in being too conservative is that you pass on a deal that might otherwise have been profitable. Don't be a motivated buyer.
Annual re-leasing fee/tenant placement: This is another critical element to consider if you will be using property management. Many/most property managers charge you something, often half or all of the first month's rent, to place a tenant. This is a large percentage of your cash flow if you turn over tenants too frequently. As our friend NoNonsenseLandlord consistently reminds us, the most important thing you can do is place quality tenants. If you're turning over tenants every year, or more often, something is wrong and it's going to eat even the best profitable-on-paper deal alive. This property manager charges the full first month's rent to place a tenant. I am wary of this as I pay half a month elsewhere, but I have been frank about my expectations and made it clear that if I see a pattern of poor tenants, they will lose my business quickly. $1300 for the first year, with an expected one turnover per year after that. This should be an overly conservative estimate with good tenants (and being a good landlord).
Annual Inspection: Read your property management agreement! You need to account for every cost. The PM offers an optional annual service to change air filters, inspect appliances, smoke detectors, radon detectors, change batteries, and do some light maintenance. I'll probably use it, so it's on the budget. $130.
Sewer Service: What utilities is the landlord obliged to pay? How much do they cost on average? Cleveland landlords must pay water and sewer, though there is some gray area about whether they can charge them if the amount is "excessive." $800 per year per unit for water and sewer is average. If it's too much beyond this, I'll bill the tenant. I will be putting this in the lease.
Water Service: See above, same deal.
Lawn Care: Code enforcement requires trimmed lawns and at a duplex, the landlord is responsible. Lawn service twice a month for seven months out of the year will run $66.
Putting It All Together
Let's see how it stacks up against the 1%/2% rule:
65000 (purchase price) + 2500 (improvements) + 3315 (financing/inspection costs) = $70,815 Total Cost
(1300 rent * 12) * .9 (estimated vacancy) = 14040
(($14040/12) / 70815) * 100 = 1.652%
Nice! Now let's do a more detailed analysis.
Accounting for all these costs, which are quite a bit higher than some areas, the total annual expenses in year 1 are $8000 even. Accounting for vacancy, the rents are $14040. Thus, the Net Operating Income (NOI) is $6040. After mortgage ($3008), the cash flow is $3032, for a cash ROI of 13.74% with a fairly conservative analysis. Throw in the equity gained and the total ROI is 17.23%.
The Cash Flow
The monthly cash flow with all of these assumptions is $253. I'm personally looking for about $100 per month in cashflow per $10,000 of my own money invested, which this meets. I'm very happy with this deal. If any one of the very conservative variables tips in my favor, I'll fill my reserves that much faster.
What if it all goes right?
The temptation would be high to see greater than the $253 "safe" cash flow coming in and to use it for something. Resist! Vacancy will come. A roof replacement will come. There will come a day when I have filled my reserves so much that I can start to skim off a little more cash flow, but that day is still far off.
My current plan reinvests all the cash flow in future properties. I'm buying 2-3 a year for the next 5 years. This will be a serious pull-up for the first two years, after which the cash flow starts buying properties for me almost as fast as I can on my own.
What if it all goes wrong?
Hopefully my conservative estimates give me breathing room if it does, but if not, I have 6 months of PITI for each property just in case right from closing.
Anyway, just thought I would throw this out there. Maybe it will help people to think of some of the variables that don't immediately occur to them when considering getting into Real Estate Investment. I continue to learn as I go, but feel like I'm starting to have some confidence and I'm having a lot of fun-- all while making money. :)
Thanks for an informative post.
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Updated the spreadsheet with all the final numbers. Closed on the property on the 22nd. A little late, but none the worse for wear. Was a little concerned about the limited time to try to get a tenant in for July, but found a good one at an open house last Friday, and they're moving in on the 1st. Also got the existing tenant onto a new 1 year lease (had been month to month) and upped the rent to market rates. That saved me the first-month cost of placing a new tenant, so my cash ROI increases a bit for year one.
All things considered, pretty happy with how this one has turned out.
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This is a great post!
I'm considering getting into rentals and your post and spreadsheet answered a lot of questions. I still have some more questions though. I'd like to learn more about the annual re-leasing fee, the annual tuneup, maintenance and repairs, and insurance. I can see the formulas you used, but I'd like to know more about the reasoning behind the formulas. Have these been discussed anywhere?
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This is a great post!
I'm considering getting into rentals and your post and spreadsheet answered a lot of questions. I still have some more questions though. I'd like to learn more about the annual re-leasing fee, the annual tuneup, maintenance and repairs, and insurance. I can see the formulas you used, but I'd like to know more about the reasoning behind the formulas. Have these been discussed anywhere?
Most of the fields you're asking about are specific to the Property Manager I've hired. I can discuss what they are/how they ended up in the spreadsheet, though, since at least lease renewals and tenant placement are charged by every PM I know. It might cost you less or more to place or retain tenants, but if you use a PM or realtor to do it, odds are these line items will be a cost you incur.
Annual re-leasing fee: Cost paid to the PM to place a tenant. The PMs I work with all cost *something* to place a new tenant. In one case it's the first month's rent, in the other it's half the first month's rent. The spreadsheet is currently set up to assume that a tenant will stay on average two years, so in a given year (again on average over the longer term) I will have to place one tenant in the duplex, and renew one lease, which also has a (lower) cost. Since I've closed on the property, we placed a tenant in the empty unit (+1 Annual re-leasing fee, just updated the spreadsheet to more accurately call it "tenant placement fee") and renewed the lease on the other (+1 Lease Renewal Fee), so my first year costs to obtain/keep tenants (assuming no deadbeats/evictions/etc) are $650 (first month's rent) + $195 (lease renewal). Maybe my tenants stay longer than two years on average, but if that's the case, then the excess still stays in the reserve to cover unexpected repairs and if something like an eviction is someday needed.
Annual Tuneup: Flat-fee service offered by the PM to visit the property, replace all AC and Heating filters, replace all batteries in smoke and CO detectors, perform some light maintenance/inspection on appliances and furnaces. Their charge is $80 per unit, or $80 + $50 per additional unit at multi-unit properties.
Maintenance and Repairs: Probably estimated a tiny bit low (General consensus I've seen is to reserve 5-10% of rents for repairs and capital expenses, I use 1% of property value which is about 4.7% of expected gross rents), but I also estimate everywhere else a little high, so it may end up a wash. The property was just inspected, and I did some initial repairs, so the expectation is that most of the maintenance issues are already resolved. Any money not spent on repairs just remains in the capital budget for future roof replacements, hot water heater replacements, other minor or major maintenance.
Insurance: No real equation followed here, this is just what it cost. $904 is what I'm paying. This varies a lot by coverage and region. This $904 annual policy is $1,000,000 in liability, full replacement value on the property, with a $2500 deductible. No flood, rent replacement, or other non-standard coverage. There are some unused fields on the spreadsheet that I used to guess at insurance cost in another market, so you can ignore the tax fields in "Unit Assumptions."
Hope this helps, and if you have any specific questions, let me know and I'll answer (or tell you when/if I'm guessing/spitballing a number).
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Great post!
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...jumped the gun a bit on that last one. Curious which tools you use to evaluate out of state properties/neighborhoods? How did you settle on Cleveland versus other locations?
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...jumped the gun a bit on that last one. Curious which tools you use to evaluate out of state properties/neighborhoods? How did you settle on Cleveland versus other locations?
I read BiggerPockets, particularly the marketplace and REI-specific subforums. I take notice of the Property Managers/brokers who are helpful and knowledgeable, and who contribute meaningfully to the community there. I pay attention to who among those people posts decent deals in the marketplace, and their endorsements on BP. I start running numbers using the analysis spreadsheet and trends of who is posting worthwhile investments emerge.
By following the above process, I found a PM and broker in Cleveland who seemed to pretty consistently post deals that left enough on the bone for an investor, who also engaged in helpful dialogue with investors to help address issues, offer advice, etc., which IMO gives you some insight into the kind of PM they're going to be. Knowing that often the BP marketplace is a dumping ground for bad or marginal deals, I got in touch and got on an MLS feed for the ZIP codes that matched the kind of property I was looking for. I discounted a lot of properties, and they advised me to pass up others (another plus in my book). Eventually (within a few weeks) one that was both a good price, in a decent working-class neighborhood, in excellent condition, and which would attract decent tenants came on the market, and I made an offer immediately.
I wish there was more of a "data-driven" approach that I could offer you on this, but identifying a good team seems to be equal parts soft and hard skills. Run numbers. Run them again. Then run them again. You'll see which markets and agents and PMs are worth a deeper look. Who is just trying to dump stinkers, and who is offering consistently good (or at least moderate) properties? Bear in mind that BP marketplace deals usually won't be the best, but who is at least making sure to offer property that won't end up costing you money out of the gate? Now go and talk to the promising candidates. Who has reasonable and not overly rosy answers to your questions? Who isn't afraid to respond when you challenge why you should pay them a certain fee? Who gives you a general sense of integrity? Can they offer references, and does a basic background search on them not turn up anything that gives you pause?
To start, though, you just have to consider a lot of markets and analyze, analyze, analyze. It's often very easy to tell who is pumping up the numbers as they'll often use unrealistically low figures for repairs, vacancy, and other unavoidable costs (or omit them entirely from their analysis). I'd say about 20-30% of the time when I look at a deal posted to the BP marketplace, with my more harsh analysis, the properties would be cash flow negative under less-than-ideal conditions.
Hope this helps somewhat.
Edit to clarify: I've never actually bought a property listed on the BP marketplace, by the way-- it's just a decent barometer to see who is pump-and-dumping and who is offering properties that are actually worth something. Then I start looking closer at the market and identify my own candidates.
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Very interesting that doing it right requires a combination of qualitative, human connections and quantitative analysis. Thanks for the thoughtful posts here.
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What changes to the sheet would you recommend if it were for a multi-family (3) but owner occupied?
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What changes to the sheet would you recommend if it were for a multi-family (3) but owner occupied?
I started to create a variation based on this question, but I realize it's probably just to individual-- even the original sheet is based on the specific property and property manager. It shouldn't be too hard to find the items in the budget that won't apply and adjust them, though. If you adjust a number of calculation in the "year one" column, it will adjust the following years. Off the top of my head:
Property Taxes: Should be the same.
Insurance: Will probably differ, but I'm not sure by how much as I'm not sure how the insuring breaks down in this situation.
Property Management, tenant placement, annual tuneup, lease renewal, lawn care: Will be either half as much or 0 depending on whether you plan to self manage.
You should be able to adjust the spreadsheet to your specific situation pretty easily, though. The calculations are all really simple, and you should only really need to get year one right, then everything else should adjust automatically. Sorry to not be more helpful.
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What changes to the sheet would you recommend if it were for a multi-family (3) but owner occupied?
I started to create a variation based on this question, but I realize it's probably just to individual-- even the original sheet is based on the specific property and property manager. It shouldn't be too hard to find the items in the budget that won't apply and adjust them, though. If you adjust a number of calculation in the "year one" column, it will adjust the following years. Off the top of my head:
Property Taxes: Should be the same.
Insurance: Will probably differ, but I'm not sure by how much as I'm not sure how the insuring breaks down in this situation.
Property Management, tenant placement, annual tuneup, lease renewal, lawn care: Will be either half as much or 0 depending on whether you plan to self manage.
You should be able to adjust the spreadsheet to your specific situation pretty easily, though. The calculations are all really simple, and you should only really need to get year one right, then everything else should adjust automatically. Sorry to not be more helpful.
No no, helpful enough. Starting the education and planning phase for the future so I'm trying to understand more about the tools that others use. Thanks :)
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I'm also in California. If your bid on an income property pencils greater than a 3.0% cap, the sellers will laugh at you. There are just too many all-cash investors, at least in CA coastal properties or inland Los Angeles and San Diego. Everybody and their brother wants to diversify; if you are a small player, it's really hard to compete. This is a great time to be a seller.
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What a great post! I've been wanting to get into rental property for quite some time. I made a huge mistake by investing in a condo here in CA for my son to live in. When I bought it I thought the market was at the bottom and I paid all cash for it, then spent ~$10K to fix it up. My son just wasn't ready for the responsibility yet and it's in a complex that already has too many rentals and has a cap on it so my only option is to have family in it. Had my SIL and my nephew there for a bit, but they couldn't afford it and I did not want to lose money. I was finally able to move my mom into it, but now she can't afford it so she only pays the bills and no rent. I consider it something that someday I will sell and get my money back, but I hate that all that cash is tied up. I'd like to invest in something that won't cost too much out of pocket cash, but need to know which states/areas seem to be good for the 2% rule. Also what do you look for in a PM company?
I agree with the previous poster that CA is not the place to be investing in right now. Better to be a seller here.
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I'm just getting interested in rental properties, so I really appreciate this post. It brought up a lot of things I hadn't thought about. Thanks for taking the time to write it up!
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I'm just getting interested in rental properties, so I really appreciate this post. It brought up a lot of things I hadn't thought about. Thanks for taking the time to write it up!
You are very welcome! Thank you for reading! Let me know if anything comes up that wasn't covered, I'm interested in improving the post to catch other important considerations.
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Greetings, I have a property that was purchased last year.
I am thinking it is a bad investment, but I bought I thought that I might use it as a retirement home. It's a nice place, on a lake and and is historic. Old people and hipsters live there right now and the place is immaculate.
This is a condo in Florida. It did not need any improvements and rented the same week as it was assigned by the property manager. I had to pay 1/2 of the 1st months rent to the property manager and my fee is 100 dollars a month.
Price: 60000 (cash)
Monthly HOA = 404
Rents for 1000 a month.
Property manager 100 a month.
math=
60, 000 (purchase price) Plus 500 (property manager) and 250 dollars initial inspection = 60, 750.00
(1000 rent *12) *.9 (estimated Vacancy) = 10, 800
10,800 Income a year minus 404 HOA fee a month(4848.00 a year) minus 1044.00 a year property tax.
(4908.00/ 60, 750.00)
= 0.080 ???
Am I doing this wrong?
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Hi RothnRoll,
Your calculation isn't quite right here. You don't use the monthly costs like HOA and property management to evaluate whether the property meets the 1%/2% rules, only the monthly rents, minus vacancy, divided by the total costs of acquisition. You don't mention what your total closing costs were, but let's assume 3000 including the inspection for a second. That would make the % profit calculation:
1000 * .9 = 900 (average monthly rent after vacancy)
900 / 63000 (total cost to acquire the property) = 1.42%
So what you see here is that the expenses are not taken into account in deriving the % profit. That's why it's only useful as a general rule of thumb-- to really know whether the property is a good one, you have to factor in all the expenses and look at the cash and total ROI. 1.42% profit is definitely decent, generally speaking, but I don't have enough information to say whether this is a good property, because you didn't mention whether you financed, insurance, tenant placement, any utilities or landscaping, etc. You also didn't factor in maintenance and repairs.
If we assume you pay at least 600 in insurance a year, that you only keep 5% of rents for repairs, that you only pay PM when the unit is occupied, and that you financed it with 20% down and a rate of 4.5%, then it's the HOA fee that kills you. You end up paying 19 out of pocket every month with those assumptions. If you pay half a months rent to place a tenant, then your property costs you 61 a month just to hold it.
If you paid cash on the property, you would probably cash flow a little bit, but then (in my opinion) you would have missed the opportunity to own 3-4 profitable properties which would cash flow more for the same investment.
I have no idea whether the assumptions above are close to reality, just an illustration that with a high HOA fee, it can be very very hard to get a good property to cash flow.
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Hi RothnRoll,
Your calculation isn't quite right here. You don't use the monthly costs like HOA and property management to evaluate whether the property meets the 1%/2% rules, only the monthly rents, minus vacancy, divided by the total costs of acquisition. You don't mention what your total closing costs were, but let's assume 3000 including the inspection for a second. That would make the % profit calculation:
1000 * .9 = 900 (average monthly rent after vacancy)
900 / 63000 (total cost to acquire the property) = 1.42%
So what you see here is that the expenses are not taken into account in deriving the % profit. That's why it's only useful as a general rule of thumb-- to really know whether the property is a good one, you have to factor in all the expenses and look at the cash and total ROI. 1.42% profit is definitely decent, generally speaking, but I don't have enough information to say whether this is a good property, because you didn't mention whether you financed, insurance, tenant placement, any utilities or landscaping, etc. You also didn't factor in maintenance and repairs.
If we assume you pay at least 600 in insurance a year, that you only keep 5% of rents for repairs, that you only pay PM when the unit is occupied, and that you financed it with 20% down and a rate of 4.5%, then it's the HOA fee that kills you. You end up paying 19 out of pocket every month with those assumptions. If you pay half a months rent to place a tenant, then your property costs you 61 a month just to hold it.
If you paid cash on the property, you would probably cash flow a little bit, but then (in my opinion) you would have missed the opportunity to own 3-4 profitable properties which would cash flow more for the same investment.
I have no idea whether the assumptions above are close to reality, just an illustration that with a high HOA fee, it can be very very hard to get a good property to cash flow.
Hello, shockingly I do not pay insurance. It's a condo in Florida and I checked with USAA and a few other insurance companies and they will not insure it.
I paid cash for the condo. My monthly HOA fee is 404 a month and that includes lawn, water, and all maintenance outside of the building. I pay the PM 100 a month when it's occupied. Honestly, where it is located it's very desirable and the property manager told me that she could rent it within 2-3 days. It's next to a hospital and there are a bunch of professionals there. I paid 1/2 a months rent to place the tenet.
I think it's impossible for me to make money off this property. I make 400 a month before repairs to anything.
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What reason did the insurance companies give for not being willing to insure it? You *definitely* need to get it insured, as all it will take is an accident and a litigious tenant to sue you, and with no liability coverage, you could have a serious problem on your hands.
If you get it insured (and let's assume for a moment that it costs you about 6-700 a year), then by my calculations, after 5% of rents for interior maintenance, you would cash flow about $175 safely per month. It's not stellar, but it's at least cash flowing.
Now there's a further question as to whether this was a wise use of cash-- this will vary by personality and willingness to use leverage, but with 60K cash I would have bought 3 ~75K properties with 25% down, which would cash flow at minimum 600-800 per month after all expenses. You would have the same amount invested, but the risk diversified a bit, and tons and tons more cash flow. You would be carrying three mortgages, but they would be paid by your tenants, and with three units, a single vacancy would mean you would still be cash flowing and covering all the mortgages. Just an illustration- you didn't necessarily do the wrong thing here, it's just not quite what I would have done.
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rothnroll: where do other people in the complex get their insurance? Who does the property manager recommend? Florida is an unusual market for insurance, but there are Florida-based insurance companies who have done the risk analysis. You really do need insurance.
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Awesome post man , that was such a great read. I've been trying to learn more about real estate ...I enjoyed reading what you wrote :)
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Good read. Thanks for sharing.
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Does your end plan for the property affect your numbers.
I'm looking at a semi-rural property right now. 3 acres on the edge of town. The best I can hit is 0.7% which puts it awful tight on cashflow. Rents would put the monthly income at about $400 over the ownership costs. Risk is high though, since its only a single unit rental plus storage space. Lose 1 tenant, lose all income. Storage space will generate a pittance as far as income goes.
BUT - semi rural on the edge of town will be great as a retirement property 10 years out. The plan would be to tear down the existing structure and build our retirement home on the lot. FWIW, the property is selling for less than vacant properties in town, but its also on a well/septic. Not sure about the liability of a well with a rental property.
Since I don't have a contract on the property I don't want to type up a load of details, but I'd appreciate your thoughts.
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My experience with a well for irrigation on a rental property is: The drought caused the water table to drop below the pump. Bright renter didn't notice that no water was coming out of the sprinklers and the lawn had died (absentee owner). Result was that the pump welded itself to the pipe and the well is no longer useable. Had to hook up to city water to water the lawn.
A friend is building a storage facility on his excess land. Will rent for good money down here, and he will have enough cash flow to retire on, when it is finished.
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Good ideas, but the storage space is a 3-bay drive shed without power, so I doubt I could retire on it. In the spend-more make more, It may be possible to build a studio apt over the shed, or rebuild the shed with apartment as a kit (something like this: http://beaverhomesandcottages.ca/Model/Whistler-I ) but I wouldn't want to take on the debt.
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This analysis is mostly focused on evaluating a property for cash flow (since that's really the only one you can control right off the bat). For complicated scenarios like a mixed-use rental or a future retirement property, I think you need to do a more customized analysis. In the end, you'll need to determine what level of cash flow is alright with you in the intervening years, what amount of improvements you want to make, etc. Evaluating the property on cash flow alone, .7% would be a poor investment-- but perhaps that's acceptable to you since you also intend to use it for personal use in the future. Since most of our request for help with rental property analysis are for investment only, that's really who this post is aimed at.
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This is a great post. I am interested in investing in real estate and have thought through a lot of these concepts, but it's extremely helpful to see it on a spreadsheet. I'm a numbers person by trade so that really helps bring it to life for me. I do just have a couple of questions, more generally, about real estate investing:
1 - The "market" for duplexes, tri-plexes, etc. is clearly investors. Real estate doesn't really seem as much like a business to me in the sense that if it's a good investment, it's a good investment (e.g. hard to screw it up, you just have to do your homework). My question is are you cautious about purchasing an investment property from someone that is most likely another investor? In other words, if it's a good investment why is the original investor selling. I understand that there are reasons you may want to cash out on appreciation or built up principal, but generally if it's a cash positive investment those investors are going to hold rather than sell. Maybe I'm being too paranoid since in real estate investing the numbers are what they are, but I just can't figure out why an investor would sell a good investment unless it's to ride off to the sunset for retirement.
2 - I live in Florida so thought of buying something on or close to the water and using airbnb is appealing to me. I was curious if anyone has experience with that model and if, in the long run, it could net higher returns. On its face, it seems you could get pretty high weekly/weekend revenue or even turn it in to something quasi-longterm with snowbirds, but I do realize the constant changeover would drastically increase expenses as well.
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1 - The "market" for duplexes, tri-plexes, etc. is clearly investors. Real estate doesn't really seem as much like a business to me in the sense that if it's a good investment, it's a good investment (e.g. hard to screw it up, you just have to do your homework). My question is are you cautious about purchasing an investment property from someone that is most likely another investor? In other words, if it's a good investment why is the original investor selling. I understand that there are reasons you may want to cash out on appreciation or built up principal, but generally if it's a cash positive investment those investors are going to hold rather than sell. Maybe I'm being too paranoid since in real estate investing the numbers are what they are, but I just can't figure out why an investor would sell a good investment unless it's to ride off to the sunset for retirement.
There are lots of reasons someone would sell their investment, but the important thing to remember is that the seller having a problem is not necessarily a problem for you, but an opportunity. For example, there are a *lot* of rentals out there with deferred maintenance issues. The seller has let them slide for so long that they no longer have the capital to fix issues. Many (but not all) of these sellers realize that a buyer will want to buy the property at a discounted price relative to the repaired value. I'm in the midst of buying a property right now with an ARV (After Repair Value) of about $95K. I'm buying it for $77.5K and putting about $5K of work into it. I'll gain $12.5K in equity because I have the $5K in capital that the seller lacks. In the deal evaluated in the OP here, the seller was a restaurant owner and needed to pay for renovations to expand the business. I have looked at a lot of properties where sellers have self-managed for many years and want to retire or don't want the hassle any more. Since I pay a PM to manage my properties, this isn't a point I expect to reach.
Basically, you should only worry if you feel the seller is deceiving you in their reason for selling, and it's always ok to ask-- I always do. This is also a great reason to do all of your due diligence- learn all about the neighborhood, have a good investor-oriented agent, have an inspector you trust, bring in a contractor to estimate repairs, etc.
2 - I live in Florida so thought of buying something on or close to the water and using airbnb is appealing to me. I was curious if anyone has experience with that model and if, in the long run, it could net higher returns. On its face, it seems you could get pretty high weekly/weekend revenue or even turn it in to something quasi-longterm with snowbirds, but I do realize the constant changeover would drastically increase expenses as well.
Take what I say with a grain of salt, since I don't use the AirBnB model. In Florida, taxes and insurance are very high, making low vacancy important. There's also huge competition from hotels and other AirBnB hosts. With Snowbirds/longer stays, you are getting into territory where you would have to evict someone if they refuse to leave, and without the protections of any sort of lease. As you mention, there is a lot of cost in cleaning AirBnB properties, and you're on the hook for all the utilities, which guests will not be shy about using. There's definitely money to be had in AirBnB, I just know that for me, it's too much of a gamble with too many variables I can't control.
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Thank you SOOOO much for all the time you spent to share this information!!!
I was wondering, is there an advantage to spreading the mortgage over 30-yrs vs 15-yrs? I noticed one pays ~almost double the real estate value by paying interest over 30 yrs vs 15 yrs.
I'm a newbie, zero real estate assets, and super-ready to pull trigger this year so now educating myself!
I've been living/working in the Bay Area, pretty clueless about real estate investing and was focusing on just affording a home here b/c I like it so much here. Finally wising up that a goal like that will keep me working til my mid-60s!
Which areas in the US for 2016 do you recommend I start looking? Any forums/networking sites to start connecting with real estate agents, property managers, inspectors in these areas?
My situation is: age 38, I have $70K in cash (afraid to put in current market and was holding out to buy a house) and $40K in stocks + $80K in an IRA(rolled over fr 401K) + $50K in a Roth IRA. I hadn't been maximizing earnings but this year will have a $90K/yr new job so thinking best to lower those taxes and buy a property pronto (if favorable #s).
THANK YOU!!!
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You are very welcome. I'm still learning too, but I get more confident with each deal.
15 vs. 30 year mortgage really comes down to what your goals are. If your goal is simply to accumulate equity quickly, a 15 year mortgage might make sense because, as you mention, you pay far less in interest over the life of the loan. The problem with doing that for *me* is that it increases the monthly mortgage payment and reduces bottom-line cashflow. I'm looking to FIRE in 3-4 years, and the property cashflow will account for about 60% of our early retirement monthly income. I need cash flow to be as high as possible, because then I need to buy fewer properties to hit our retirement spending amount, and thus our time to FIRE is reduced. I'm sure that there are good reasons that someone could give you for a 15 year mortgage on a rental, but my assessment is that for my situation (and probably most very early retirement scenarios) it doesn't make sense.
We (my fiancé and I) also live in the Bay Area. We grew up here and have a lot of connections to the area, but our plan is to hit our retirement numbers and get out. The upside is that Bay Area salaries allow one to buy great cashflowing properties in many of the cheaper parts of the US with a relatively short savings period.
I wrote a bit recently about finding rental properties that addresses some of your questions, maybe this will help:
http://frugalvagabond.com/2015/12/23/finding-great-rental-properties/
The short answer is BiggerPockets to find people to work with, as well as to learn about various markets. I own properties in Tennessee and Ohio. I'm buying my next property in Ohio, and may actually buy three there this year.
I hope that this gets you started, at least!
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WOW $70,000 total cost and $1,300 a month rent not bad at all I wish I had deals like that around here. but all in all a very good post and very informative
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WOW $70,000 total cost and $1,300 a month rent not bad at all I wish I had deals like that around here. but all in all a very good post and very informative
If it's any consolation, this property is 2,500 miles away from where I live (and that makes it the closest property I own!). It's totally doable!
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What a splendid post you put up there.
I, like everyone else on the planet, have been "thinking" about the rental market. I've been leaning toward higher education to increase my income, but I've run into several people who just keep buying properties...mainly in lower middle neighborhoods...whether they be duplexes or quads, just to get skin into the game and get their units up and running.
One guy makes his whole living off of these units and now has enough capital to build them himself, then rent them out.
Another just started 8 months ago, used his 401k to make the d/p for a duplex, then wrote dozens of letters to owners of different properties, hoping to get a personal contract to buy their property while they carry the loan. Anyway, eight months in and he's got six units. Five were occupied when he bought them, the empty was updated and rented out quickly. He's making on average 150 per unit in rent more than the mortgage payments. His plan is to get to 25 or 30 units and then quit his job to manage them full time.
I met a lady while hiking in the mountains who purchased a home in Bend, OR, and then fixed it up. She rents it as a vacation rental because the tenant rights favor the landlord, not the tenant.
So I'm thinking instead of suffering in school I might search for my first rental and start on the journey you've begun so well yourself. Like you, I want income streams and would use a PM if at all possible. I live in CA now and have no plans to buy here, so I'll have to look elsewhere and have little idea how to go about it. Until your post, which gives me at least some idea of how to start. Thanks!
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Thank you for all the info, it makes a great read!
We have a rental in California and are looking to invest in another, but it's SOOOOO expensive. How do you invest out of state, do you travel to each location personally?I wouldn't even know where to begin, any pointers?
Thanks :)
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Thank you for all the info, it makes a great read!
We have a rental in California and are looking to invest in another, but it's SOOOOO expensive. How do you invest out of state, do you travel to each location personally?I wouldn't even know where to begin, any pointers?
Thanks :)
Thanks! Well, first off (and maybe arebelspy will see this and chime in, as he has funded his FIRE off of this same approach): try to believe that it is less daunting than you expect it will be. Most months my properties run themselves with little to no intervention. ARS even self manages (some for sure, but I think maybe not all any more?) from afar with little trouble.
One of the best pieces of advice/reassurance I got on this forum when I was considering getting into REI was that unless you are a contractor or other tradesperson, it is likely that you know less about how to evaluate a property's condition than a team you can put in place remotely. In my opinion, the most important members of your team are (in order you'll need them): a good agent to know the neighborhoods in your market, an objective and independent home inspector to find the major physical defects and causes for concern, and a good property manager.
For the agent, you can get referrals from someone you trust, or you can spend some time on BiggerPockets researching your market. Just sitting and absorbing the posts written by people in the market you've chosen will tell you a lot about them, and a lot about the market. It's a great way to learn. I found the agent I'm working with in Ohio this way. I am very satisfied with him.
For the home inspector, I have been fortunate to find inspectors who are landlords themselves, and who have been willing to share a lot of sample inspections so that I can verify the level of detail I'm looking for. I can't stress enough that even if it costs you a few hundred bucks to get an inspection that causes you to back out of a deal, the inspector can save you from making a huge, huge (and expensive) mistake. I always spend an hour or two talking to my inspector after he delivers the report, and this gives me a chance to get his subjective view on the property. The condition of the place is just one part of the puzzle-- you have to know how much it would cost to fix, what's not worth fixing right now, and how the condition of the property fits into the neighborhood and renter type you're looking for. Don't be overwhelmed when dozens of small items are found.
When it comes to finding a PM, I follow the same process as I describe in looking for an agent, but I'm batting about .600 on that right now. I'm actually changing out my property manager in one market because they're too inflexible (not enough services offered, communication not good enough, make it too hard to seek repair bids outside of their in-house maintenance, unwilling to bill for utilities). I guess my most current advice here is to be willing to fire them and seek someone who manages the property the way you want them to. It's a hassle but it looks like it's going to be worth it.
I wrote recently on this topic, maybe some of this will help: http://frugalvagabond.com/2015/12/23/finding-great-rental-properties/
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This is great! Thank you so much, I have some investigating to do. Biggerpockets.com here I come...
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Thanks! Well, first off (and maybe arebelspy will see this and chime in, as he has funded his FIRE off of this same approach): try to believe that it is less daunting than you expect it will be. Most months my properties run themselves with little to no intervention. ARS even self manages (some for sure, but I think maybe not all any more?) from afar with little trouble.
Can confirm.
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Do either of you have any experience with turnkey real estate companies?
Thanks!
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My first rental was purchased turnkey. I don't regret that I did it, but *for me, at this time*, I'm not purchasing any more. There are definitely people who buy that way exclusively (Ali Boone on the BiggerPockets blog, and CashFlowDiaries here and on his own blog (www.cashflowdiaries.com)). They have a lot of good content on why turnkeys work for them, so check out those sites.
My experience comparing the reputable turnkey provider that I worked with and doing it myself is that turnkey is low stress and the purchase and onboarding process was very smooth and approachable. For that reason, it was a helpful exercise to me as a first time RE investor. I learned a lot, and my experience was positive. The downside to turnkey that I experienced was that there is a lot more cash flow per dollar invested if you can develop the knowledge needed to purchase non-turnkey properties. The downside to DIY is that each step along the way when purchasing and "digesting" the property needs more of your input and attention (but it's really not *that* bad, a lot of the anxiety goes away with experience). For me, doing it myself and the higher cashflow that comes with that is what is best for me at this time. I would need to buy a lot more turnkeys to hit my FIRE numbers.
So, that's a long way of saying that both are good depending on your needs, and that there's no shame however you go, and that you should do your due diligence no matter which way is more appealing to you.
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It looks like finding a trustworthy turnkey company would be the way to go for us, definitely more appealing than the CA market.
Thanks so much :)
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Do either of you have any experience with turnkey real estate companies?
Thanks!
Run a search on the real estate part of the forum for turnkey and you'll find plenty :)
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This question is a peripherally related to the rental market. I was wondering whether OP or the other REI folks here typically run their rentals through an LLC, several LLC's for each property, or simply insuring each property adequately? For those of you with an LLC, do you operate it out of the state you have your rental or in your home state?
Fascinating topic. Thanks @iamlindoro for spending the time to write up your experiences. Did you ever travel to your property before purchase?
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Florida--Anna Maria Island. Did major reno on a house 7 houses from the Gulf. Put online and got bookings for over 30k in two weeks. The island gets bookings year round. House should get 60k per year and I use it for approx. one month.
Investors are flocking there like crazy!
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Hi! Awesome post, thank you! Where do you find your data for neighborhood ratings and average income for certain parts of a zip code? Thank you!
MouseBandit
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Hi! Awesome post, thank you! Where do you find your data for neighborhood ratings and average income for certain parts of a zip code? Thank you!
MouseBandit
Thanks! Most demographic data, including income, education level, median rent, etc. is available at:
http://www.city-data.com/
You can search for a ZIP code and see a report on a lot of these items, including visualizing data on a map at the neighborhood level, which is more granular than the ZIP code level. Neighborhood "letter" grades are subjective, but they should theoretically be a combination of the above data. Remember too that neighborhood letter grading should scale according to the surrounding community. What I mean is, a $50K median income in Columbus, Ohio is very different from a $50K median income in San Francisco. Whereas in one community it might be middle to upper middle class, in the other it might represent practically living in poverty.
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Excellent!! Thank you!!
MouseBandit
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Soooo...there's a home we're thinking about buying and living in for a few years at least, then maybe trying to rent out. Home costs ~$148k including closing costs and inspections. $4k/year property taxes, $1k/year insurance. It's right across the street from a university so would probably be easy to rent to college professors or maybe students (4 bedrooms total). Looks like comparable properties in the area rent for $1500/mo or slightly less. What else would I need to know to determine if this is an okay prospect for a future rental? Or can you already tell looking at the above information?
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Soooo...there's a home we're thinking about buying and living in for a few years at least, then maybe trying to rent out. Home costs ~$148k including closing costs and inspections. $4k/year property taxes, $1k/year insurance. It's right across the street from a university so would probably be easy to rent to college professors or maybe students (4 bedrooms total). Looks like comparable properties in the area rent for $1500/mo or slightly less. What else would I need to know to determine if this is an okay prospect for a future rental? Or can you already tell looking at the above information?
Those numbers are a good start towards what you need to know, but the original post has many of the common items you ought to consider under the heading "The Numbers," with each item to consider in bold (need to figure in vacancy, repairs, etc). You can make a copy of the spreadsheet linked in the first post and plug in your numbers to see what cash flow you could expect. Go through the analysis described in the OP and you should be able to determine whether this property would be an acceptable rental to you.
Based on what you've said so far, though, I'd anticipate that it would cash flow very poorly, if at all, so if you're hoping for cash flow, this one isn't likely to work very well.
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Cell P8 refers to the annual cash flow in regards to doing your own PM. It takes the annual cash flow calculated with paid PM but subtracts cells F30 and F31 which are Sewer Service (per year) and Lease Renewal Fee. Why isn't this just subtracting the Variable cost PM (cell F27)??
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Cell P8 refers to the annual cash flow in regards to doing your own PM. It takes the annual cash flow calculated with paid PM but subtracts cells F30 and F31 which are Sewer Service (per year) and Lease Renewal Fee. Why isn't this just subtracting the Variable cost PM (cell F27)??
Good catch (though I think you mean adding it back rather than subtracting as we're talking cash flow). Seems to have been an artifact of some of the additions I made to the sheet when I made it multi-unit. Thanks!
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iamlindoro - I'm considering buying a home in the Denver area in a specific neighborhood because of my son's school location. We will live in the house for now, then I am thinking to rent it later. I want to run the numbers now to see if it's a good decision. However, in reading through this thread, I am struggling to translate the numbers to a much different home value. What we're talking about here is a home price in the mid 400k range (with rental prices around 2$500).
Do you have a standard formula that will still hold up at those higher numbers? Thanks.
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iamlindoro - I'm considering buying a home in the Denver area in a specific neighborhood because of my son's school location. We will live in the house for now, then I am thinking to rent it later. I want to run the numbers now to see if it's a good decision. However, in reading through this thread, I am struggling to translate the numbers to a much different home value. What we're talking about here is a home price in the mid 400k range (with rental prices around 2$500).
Do you have a standard formula that will still hold up at those higher numbers? Thanks.
When the price/rent ratios don't hold up to the formula, the right answer probably isn't to find a new formula :)
A 400K purchase price with 2,500 is rents is a bad rental for cash flow. There may be other mitigating factors (like your family situation, or banking on appreciation, which is purely speculative) but as a cash flowing rental, it doesn't sound like a good one.
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Can anyone share examples of how the statement below works with actual numbers?
My current plan reinvests all the cash flow in future properties. I'm buying 2-3 a year for the next 5 years. This will be a serious pull-up for the first two years, after which the cash flow starts buying properties for me almost as fast as I can on my own.
Also, what's a "serious pull up for the first 2 years" mean?
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Hi! Awesome post, thank you! Where do you find your data for neighborhood ratings and average income for certain parts of a zip code? Thank you!
MouseBandit
Thanks! Most demographic data, including income, education level, median rent, etc. is available at:
http://www.city-data.com/
You can search for a ZIP code and see a report on a lot of these items, including visualizing data on a map at the neighborhood level, which is more granular than the ZIP code level. Neighborhood "letter" grades are subjective, but they should theoretically be a combination of the above data. Remember too that neighborhood letter grading should scale according to the surrounding community. What I mean is, a $50K median income in Columbus, Ohio is very different from a $50K median income in San Francisco. Whereas in one community it might be middle to upper middle class, in the other it might represent practically living in poverty.
Note also that this does not make SF the better place to buy into! certainly, making 5% on a $850,000 property is a lot better than making 5% on a $50,000 place - but the opposite holds true if you lose. Also, finding renters at each price point is no different and one may be easier to finance than the other. Price can only be the beginning of your search. Many secondary markets are overlooked and offer great opportunities - both from a LL perspective and as LCOL retirement options (our plan).
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Two things that you may want to look at.
1. Normally 1-4 unit buildings are considered single family dwellings for mortgage purposes. I don't think you need investor financing up to five units after that you will need the investor financing.
2. The law generally says you must have the intent to occupy the dwelling to get owner occupied financing. In practicality you can either move in for six months, or have the intention to do so but change your mind later. You need to look at the wording of the mortgage, some say you have to live there for a minimum time period and others say intent.
If you are single or have a wife willing to move you will do much better by living in one side while fixing the place up and then moving to your next investment.
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Helpful spreadsheet, thanks!
Question on your purple boxes at the top. You break out Cash Flow & ROI between doing your own Property Management and outsourcing PM.
If doing your own PM, wouldn't that cover your listed costs for Tenant Placement, Annual Tuneup/Inspection, and Lease Renewal Fee? Or would you still be hiring out those servicing while doing your own PM? I guess I'm not sure what PM is actually DOING at that point...help me out here.
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Helpful spreadsheet, thanks!
Question on your purple boxes at the top. You break out Cash Flow & ROI between doing your own Property Management and outsourcing PM.
If doing your own PM, wouldn't that cover your listed costs for Tenant Placement, Annual Tuneup/Inspection, and Lease Renewal Fee? Or would you still be hiring out those servicing while doing your own PM? I guess I'm not sure what PM is actually DOING at that point...help me out here.
The idea is to change the line-item values as necessary to suit your situation. The unmodified spreadsheet just happens to have been configured for the specific additional charges that I factored in for this property. Easiest way to handle it is to just save your own copy and then adjust the line items to suit you (I ignored the non-PM price completely in this scenario since the property is far out of state and I preferred not to attempt to manage it from afar).
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Helpful spreadsheet, thanks!
Question on your purple boxes at the top. You break out Cash Flow & ROI between doing your own Property Management and outsourcing PM.
If doing your own PM, wouldn't that cover your listed costs for Tenant Placement, Annual Tuneup/Inspection, and Lease Renewal Fee? Or would you still be hiring out those servicing while doing your own PM? I guess I'm not sure what PM is actually DOING at that point...help me out here.
The idea is to change the line-item values as necessary to suit your situation. The unmodified spreadsheet just happens to have been configured for the specific additional charges that I factored in for this property. Easiest way to handle it is to just save your own copy and then adjust the line items to suit you (I ignored the non-PM price completely in this scenario since the property is far out of state and I preferred not to attempt to manage it from afar).
Thanks. However, my question pertains to the formulas/assumptions behind L8 / P8 and not to the "line-item values".
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Of course I read this only *after* making a calculator from scratchish XD
I'm definitely going to look over this spreadsheet and make some changes, though...Iamlindoro (or anyone else who's interested), I'd love feedback :)
https://fetchingfinancialfreedom.com/calculator-rental-property/ (https://fetchingfinancialfreedom.com/calculator-rental-property/) I would link back to this thread/the share sheet as a reference source, of course. (Feedback thread for calculator here: http://forum.mrmoneymustache.com/real-estate-and-landlording/i-made-a-calculator-for-real-estate-newbs-feedback-please-d/ (http://forum.mrmoneymustache.com/real-estate-and-landlording/i-made-a-calculator-for-real-estate-newbs-feedback-please-d/))
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Bigger Pockets just had a webinar on this very subject. The actual numbers start min 45. Anything before that is just hype.
https://www.youtube.com/watch?v=l1u2qPXBadc&feature=youtu.be
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Helpful spreadsheet, thanks!
Question on your purple boxes at the top. You break out Cash Flow & ROI between doing your own Property Management and outsourcing PM.
If doing your own PM, wouldn't that cover your listed costs for Tenant Placement, Annual Tuneup/Inspection, and Lease Renewal Fee? Or would you still be hiring out those servicing while doing your own PM? I guess I'm not sure what PM is actually DOING at that point...help me out here.
I would say that you are doing the job of the PM and should be paid accordingly. Ditto if you are doing your own repairs. That income is above and beyond the profit you are making from renting the property out.
I think it's important to look at it in that manner for several reasons:
1) You might decide you don't want to do that work anymore, but you might be stuck with it if you can't afford to hire it out.
2) You might not be able to do that work anymore, but you might start losing properties because you can't at least break even on the ones you have.
In other words, as long as you're doing the work, it's bonus income from working a side-gig as a PM.
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Your post will definitely help a lot of people who have just entered into the real estate business.
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I often feel like the most important thing to do while searching is to find the right property in the right neighborhood. When you are looking to buy a rental property, there are four considerations which can help you make the best choice. they are:
Evaluate the Location of the Property
Evaluate the Property's Financials
Evaluate What Repairs Are Necessary
The Investment Compared to the Current Market
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Updated the spreadsheet with all the final numbers. Closed on the property on the 22nd. A little late, but none the worse for wear. Was a little concerned about the limited time to try to get a tenant in for July, but found a good one at an open house last Friday, and they're moving in on the 1st. Also got the existing tenant onto a new 1 year lease (had been month to month) and upped the rent to market rates. That saved me the first-month cost of placing a new tenant, so my cash ROI increases a bit for year one.
All things considered, pretty happy with how this one has turned out.
Thanks for the great post. Did the management take care of/help with these tenant issues for you (setting up the open house, negotiating the new lease) or did you do some/most of that yourself, especially considering you live in CA?
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Thanks for the great post. Did the management take care of/help with these tenant issues for you (setting up the open house, negotiating the new lease) or did you do some/most of that yourself, especially considering you live in CA?
All the grunt work was done by the PM (all tenant contact and leg work), with me providing direction (ie, telling them what I wanted done).
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Hey, Folks:
I'm looking for some advice/information. I'm considering investing in a rental property. I've run some numbers and I'm not impressed with what I've found:
Assuming a monthly rental income, after expenses, of $1000. And a total investment (mortgage, down payment, taxes, interest, etc.) of roughly $189,000. It will take about 15 years to break even. After 15 years, I'll have an asset value of $424,000 (assuming a 6% annual appreciation, which, frankly seems highly unlikely) generating a monthly income of $1000 (assuming there are no vacancies).
If I took that $189,000 and invested it ($1,080.00/month for 15 years) in a low cost index fund earning 6%, the total value of the fund after 15 years would be about $300,000 and it would generate about $1500/month.
Investing the money in stocks seems (at least on paper) like a better deal. Am I missing something?
Regards,
Dimetri
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Hey, Folks:
I'm looking for some advice/information. I'm considering investing in a rental property. I've run some numbers and I'm not impressed with what I've found:
Assuming a monthly rental income, after expenses, of $1000. And a total investment (mortgage, down payment, taxes, interest, etc.) of roughly $189,000. It will take about 15 years to break even. After 15 years, I'll have an asset value of $424,000 (assuming a 6% annual appreciation, which, frankly seems highly unlikely) generating a monthly income of $1000 (assuming there are no vacancies).
If I took that $189,000 and invested it ($1,080.00/month for 15 years) in a low cost index fund earning 6%, the total value of the fund after 15 years would be about $300,000 and it would generate about $1500/month.
Investing the money in stocks seems (at least on paper) like a better deal. Am I missing something?
Regards,
Dimetri
Ooof... where to begin. You're oversimplifying how to compare two different types of investments. Given that you should take the advice in the post below and apply it (arebelspy's post about researching both forms of investment and understanding it and what to do in the meantime).
https://forum.mrmoneymustache.com/real-estate-and-landlording/real-estate-vs-just-investing-in-index-funds/msg638966/#msg638966