Author Topic: Target return rate for a rental  (Read 495 times)

mavendrill

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Target return rate for a rental
« on: February 03, 2019, 09:20:13 PM »
We are quite unexpectedly looking into buying our first rental (the owner of the worst house in our neighborhood died, house was in foreclosure, estate forfeited it to the bank on friday).  We are planning on making an offer.

The house is trashed, so we are planning on somewhat extensive rehabilitation.  We are putting together an offer (it won't be contingent on financing, which will be necessary for this property we think).

I am confused by the way most people seem to evaluate deals, because they look at purchase price as a fixed quantity instead of something that is negotiated.
The house we are looking at is a 2b2br, 1k sf, roughly the same blueprint has 3 other houses on its block that are rentals for 800-900.  The area sees lots of shorter-term rentals (college and military near by).
My calculations were as follows:
850 rent
210 Property Taxes
85 vacancy
75 insurance
55 repairs (1% of property)
25 water
25 sewer
40 bug abatement and lawn care
85 property management
These costs add to:
600 / month.

So rent would have $250/month remaining for cashflow and mortgage (we would plan to take out a mortgage after renovation, so our cash can work harder).

That seems to imply to me that if purchase and rehab costs added up to 50k, we would end up with 15k cash spent (10k in equity in the house, 5k on loan fees/inspections/closing costs).  That would leave a mortgage of ~200/mon, meaning cashflow of ~50/.  So it would turn a profit of ~600/yr, for a 4% return.  Obviously this doesn't account for growing equity (and deliberately so).  Regardless, 4% would seem a pretty mediocre return.  So then it seems to me the best thing to do is just adjust offer until the money makes sense (since costs of 40k bump cash flow to 8% return).

I have three questions:
Is this just the worst way to think about a rental purchase, is this genius, or somewhere inbetween?
What rate of return on your investment would you set as a minimum threshold before you became interested in a property?
One consideration for us, is that currently I have side-gig time free, so would manage the property ourselves (similarly, I am fairly handy, and most repair money would end up going to me).  How much would you let that affect your choice on minimum return rate?

Any comments appreciated, as while I have been reading up and thinking about rentals for over a year, none of it has been really serious (and this is a time-limited opportunity).

waltworks

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Re: Target return rate for a rental
« Reply #1 on: February 03, 2019, 10:01:59 PM »
Nominal returns need to beat historical stock returns. So 10%, give or take.

That's just me, though. Some people go for way better than that and turn their noses up otherwise.

Your place is probably not a great rental if it's a standalone structure, btw, because the "1% of purchase price for maintenance" idea breaks down horribly for both really cheap (yours) and really expensive houses. Roofs have to be replaced even if the house is cheap, likewise carpet, paint, etc. You're going to spend a lot more to maintain it than 1% of $55k. If you have a $2 million house that's the same size/configuration/spec but located in Malibu, on the other hand, you aren't going to have to pay $20k a year to maintain it (though if you're hiring out the work, it'll be at least somewhat more expensive just because of higher labor costs). Make sense?

I'd assume no less than $2000/year for maintenance and capex on any SFH unless it's made of cinderblocks with a metal roof or something. If you're talking post/beam/asphalt shingle, it's going to cost real money to keep it in decent shape. So bump your number up there, and you're probably going to be in a negative cashflow situation with a mortgage. With no mortgage/paying cash you're going to make $1800/year on your $55k investment, which is pretty horrible.

-W

jpdx

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Re: Target return rate for a rental
« Reply #2 on: February 04, 2019, 01:22:31 AM »
Yeah, $55/mo for maintenance seems really, really low. Even after you rehab the house, things will happen to inside and out that will require more than $600/year to fix.

Jon Bon

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Re: Target return rate for a rental
« Reply #3 on: February 04, 2019, 05:31:43 AM »
I have three questions:
Is this just the worst way to think about a rental purchase, is this genius, or somewhere inbetween?
This is a fine process to start with
What rate of return on your investment would you set as a minimum threshold before you became interested in a property?
My personal target is +-25% cash on cash return after mortgage, taxes and insurance
One consideration for us, is that currently I have side-gig time free, so would manage the property ourselves (similarly, I am fairly handy, and most repair money would end up going to me).  How much would you let that affect your choice on minimum return rate?
I do my own management. I like being able to "know" the property. I dont trust property managers to 1. Do a good job. 2. Keep me informed. 3. Tackle preventative maintenance before its an expensive headache YMMV



My thoughts on this house is it is way to small potatoes to get involved with. As walt says small hosues still need the same expensive things big hosues need. And that is NOT reflected in rent. Run the numbers for a flip and get back to us.


waltworks

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Re: Target return rate for a rental
« Reply #4 on: February 04, 2019, 08:30:06 AM »
Almost didn't notice the last part of your question, OP. If you are managing and maintaining yourself, you should pay yourself your going hourly rate (assuming you're employed, you can use that number) and subtract that from your returns.

If you already work full time and using your weekend to fix plumbing is going to make your life suck a lot more, of course, this calculation won't really reflect the "cost" to you correctly.

The easiest thing to do is to just assume you'll hire everything out. Then if you *want* to save yourself the $75 call-out fee for the plumber or whatever, you can call it a side gig/part time job.

Lots of people just set management and repairs to zero since they plan to do the work themselves and then calculate the return with zeros in those categories. That's a really dumb way to look at it, since you'd need at least 20-30 of these rentals for full FIRE income, and at that point if you self-managed and did all repairs, you'd just have a full time job, right?

-W