Author Topic: How much to invest into rental property?  (Read 8319 times)

Arbor33

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How much to invest into rental property?
« on: March 07, 2012, 05:18:02 AM »
Here's my scoop:
I'm 24.
2 years out of college with $0 in student loans.
Current salary $60-$70k.
I owe about $5k on a truck at 3%.
Currently living with my parents for cheap.
Closing on a duplex at the end of the month - $60k at ~3.5% ($10k down)

It's a little funny the way I'm doing the financing for the property. The home wouldn't qualify for a mortgage due to peeling paint (interior and exterior) and the homeowner wasn't capable of devoting the money to fixing it. So my father offered to fund some of the costs from his home equity so that I could make it a cash deal. As soon as I have the deed I can take out a LOC on the property and pay him back (assuming it gets assessed accordingly).

All that being said, one side of the duplex is in stellar shape and ready to rent. I plan on moving into the other side temporarily where I'll live and work on the property until I can afford to purchase another multi-unit home and do it all over again.

My family and I have been building houses since the early 90's so I'm fairly well suited to swing a hammer. My problem is I don't quite know how much capital I should really throw at this project.

The bathroom is lacking a shower and could use some remodeling so that is priority #1 (so that I can shower vs soak in a tub while living there).
The entire house could use some replacement windows.
I should really get gutters all around to protect the foundation.
There's some plaster work that needs doing.
The exterior needs some paint and my half needs a lot of it on the inside.
The hardwood floors could really use some refinishing.
The brick could stand to be sand blasted and repointed.
There's various other small things that'd obviously add up.

I can do 90%+ of what's listed above so the costs will mostly be materials and renting tools like drum sanders, scaffolding, etc. The most I could see the house selling for in pristine shape would be about $115-$120k. The problem is I don't want to sell it so I wouldn't be recouping my investment instantaneously like that. I'd like to keep the property as long as I can unless it stops making me money. I'm aiming for more almost passive income streams.

I know it'd be tough to estimate having not seen the property first hand, but how much is too much to invest into a rental unit like this? Is there any rule of thumb I could base some decisions off of?

Thanks guys!

Mike Key

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Re: How much to invest into rental property?
« Reply #1 on: March 07, 2012, 05:39:51 AM »
The amount you want to invest is dependent on how long you want to keep the property. If it's a rental property you don't want to go fixing it up like you would your own home, making things the way "you" want them to look. You want to fix it, so it's habitable and rentable. That's the different mindset between a home-owner and investor.

Some people get caught up replacing fixtures that don't need replaced and updating things. And some updates can help you charge a higher rent, but you need to think those thru. Will this help me charge more in my area or not.

Just do some math, if you spend 10K on repairs, how long will it take to recoupe?

Dave

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Re: How much to invest into rental property?
« Reply #2 on: March 07, 2012, 05:48:56 AM »
It might be useful to compare it with what you could do with the money otherwise.

This is what I did, to try and figure out whether to buy to let at all. Flats like ours currently rent for around 1/300th of the property cost, or 4% annual return. That's 2% taking into account MMM's 50% rule of thumb, or a negative real return (inflation here is 3.5%), and not smart compared with investing the money elsewhere.

Hence, I don't own any buy-to-let. For you the equation will be different, hopefully! but you can still do the same math (what would I get if I invested the money instead, vs the extra rent it would generate).

arebelspy

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Re: How much to invest into rental property?
« Reply #3 on: March 07, 2012, 08:34:21 AM »
It might be useful to compare it with what you could do with the money otherwise.

This is what I did, to try and figure out whether to buy to let at all. Flats like ours currently rent for around 1/300th of the property cost, or 4% annual return. That's 2% taking into account MMM's 50% rule of thumb, or a negative real return (inflation here is 3.5%), and not smart compared with investing the money elsewhere.

Hence, I don't own any buy-to-let. For you the equation will be different, hopefully! but you can still do the same math (what would I get if I invested the money instead, vs the extra rent it would generate).

The difference is this is a duplex, meaning he can live in one side and rent the other.  And then when he moves, rent both.

Plus real estate is very local.  I'm picking up things in the 70k range and renting for ~1-1.1k.  Latest purchase (closed two weeks ago, still putting in paint and carpet) was for 58k, should rent for 900-1k.  It turns out to be a nice return (using the 50% rule).  So we can't say, based on your scenario or mine, that he should.  Like you said, do the math. 

I'm assuming (hopefully correctly) that he has, since he's going forward with this and it's closing at the end of the month.

Going back to the OPs question...

My problem is I don't quite know how much capital I should really throw at this project.

The bathroom is lacking a shower and could use some remodeling so that is priority #1 (so that I can shower vs soak in a tub while living there).
The entire house could use some replacement windows.
I should really get gutters all around to protect the foundation.
There's some plaster work that needs doing.
The exterior needs some paint and my half needs a lot of it on the inside.
The hardwood floors could really use some refinishing.
The brick could stand to be sand blasted and repointed.
There's various other small things that'd obviously add up.

Here's the thing.. if this is a long term buy and hold (for years and years).. do it right. The first time. Right now.  It will pay off.

This article (posted two days ago on BiggerPockets), says a similar thing in a case study: http://www.biggerpockets.com/renewsblog/2012/03/05/first-real-estate-deal-of-the-year-a-case-study/

From the article: "As a buy and hold investor it usually pays to do the correct long term thing the first time, instead of limping along."

I know it'd be tough to estimate having not seen the property first hand, but how much is too much to invest into a rental unit like this? Is there any rule of thumb I could base some decisions off of?

Not really a rule of thumb, but it's something you'll want to consider when running your calculations to determine if it's worth it to purchase the property at all.  Like Dave said, do the math.

Assume that you fix everything AND pay someone to do it.  What will your total all-in costs be?  Then determine ARV with comps & cap rate, ROI, etc.

(Then, when you do the work yourself, you pay yourself in equity for it as an extra side job via sweat equity, but don't count that "free work" as not costing you anything.)

A property that needs a ton of work may not be worth it, so to do apples to apples comparison, calculate what it would cost to get everything fixed up perfectly, then run your numbers based on that.
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chrish

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Re: How much to invest into rental property?
« Reply #4 on: March 07, 2012, 09:11:43 AM »
I'm picking up things in the 70k range and renting for ~1-1.1k.  Latest purchase (closed two weeks ago, still putting in paint and carpet) was for 58k, should rent for 900-1k. 

Speaking from a UK perspective that is an unbelievable rate of return! I make that a gross rental yield of over 20%. In the UK, the average is around 5-6% and 10% is generally considered very good.

What I can't understand is why anyone would rent when buying a place is so cheap? Surely it makes no sense for anyone who plans on being there for more than a year or so. Or am I missing something here?

Mike Key

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Re: How much to invest into rental property?
« Reply #5 on: March 07, 2012, 11:57:53 AM »
I'm picking up things in the 70k range and renting for ~1-1.1k.  Latest purchase (closed two weeks ago, still putting in paint and carpet) was for 58k, should rent for 900-1k. 

Speaking from a UK perspective that is an unbelievable rate of return! I make that a gross rental yield of over 20%. In the UK, the average is around 5-6% and 10% is generally considered very good.

What I can't understand is why anyone would rent when buying a place is so cheap? Surely it makes no sense for anyone who plans on being there for more than a year or so. Or am I missing something here?

Because in the US a vast majority of people bought homes already they couldn't afford and where forced into renting because of their poor decisions. After that whole mess, getting loans has become more difficult, people generally need excellent credit and a good 20% down payment for most banks to assume the risk now a days. And we already know that Mustachian know how is a rare thing.

And or someone isn't in a place to own yet, ie, college, starting out in life, etc.

AJ

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Re: How much to invest into rental property?
« Reply #6 on: March 07, 2012, 12:43:25 PM »
I'm picking up things in the 70k range and renting for ~1-1.1k.  Latest purchase (closed two weeks ago, still putting in paint and carpet) was for 58k, should rent for 900-1k. 

Speaking from a UK perspective that is an unbelievable rate of return! I make that a gross rental yield of over 20%. In the UK, the average is around 5-6% and 10% is generally considered very good.

What I can't understand is why anyone would rent when buying a place is so cheap? Surely it makes no sense for anyone who plans on being there for more than a year or so. Or am I missing something here?

Because in the US a vast majority of people bought homes already they couldn't afford and where forced into renting because of their poor decisions. After that whole mess, getting loans has become more difficult, people generally need excellent credit and a good 20% down payment for most banks to assume the risk now a days. And we already know that Mustachian know how is a rare thing.

And or someone isn't in a place to own yet, ie, college, starting out in life, etc.

In addition to this, unemployment is still high. Most folks can't pay cash for a home, and no one will give you a loan if you are unemployed. Even after getting a job, banks want to see two years of steady work history. Also, you have to have somewhat decent credit and if you are just starting out (or have been recently unemployed or divorced) your credit may not be good enough. Basically, yes, with real estate so cheap most people would *rather* own than rent, but many are not in a position to do so.

arebelspy

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Re: How much to invest into rental property?
« Reply #7 on: March 07, 2012, 08:47:46 PM »
Exactly what the two previous posters said.  I'll also add: people are scared.  They heard housing was amazing in the mid-2000s, and they bought (often making a poor decision in doing so), and got burned.

Now they're scared, due to both their own experience(s) and the media, saying housing is terrible.  So they can't buy (as people said above), or else they're scared to.

You're correct though, in many, many areas in the States right now the numbers make much more sense to buy than rent.  And likely will for the foreseeable future.
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chrish

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Re: How much to invest into rental property?
« Reply #8 on: March 08, 2012, 02:27:01 AM »
We had a lot of the same issues in the UK: a housing boom from 2000-2007 fueled by easy credit (125% mortgages were available with no downpayment), followed by a severe recession, and a tightening of credit availability.

House prices haven't fallen as far I don't think though (~15%). The high population density, plus strict planning regulations means that demand for housing outstrips supply, and this is keeping prices high. Also, during the boom, many buy to let landlords were prepared to accept negative real yields, because the capital gains they were making massively out-weighed their losses. So I think rents started from a low base, and although they have climbed somewhat, they are still relatively much lower.

My personal opinion is that it will only be possible to make a decent profit in rental property in our market if house prices start to rise again. Using the 50% rule, it is barely possible to break even on rental income alone.

Having said that, if/when the economy starts growing again, I think house prices will start to rise again due to the high levels of demand, and the power of leverage should then make rental property a good investment again.

Arbor33

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Re: How much to invest into rental property?
« Reply #9 on: March 08, 2012, 04:29:14 AM »
All good input, thanks!

I know the finshed side can pull in around 700+ because it was getting that with the previous owner. That alone will be 12% of the house value per year. Since the only difference between the finished side and the unfinished side is the presence of a shower and cosmetics, it should be relatively cheap to bring it all up to an even keel. I've got to assume at that point that my number will double for a total of ~24% of the houses value after maybe $3-$5k in updates.

While windows are a definite in the future, they're not an immediate necessity. Nor is repointing or the gutters. Being that that sort of work is more fun to do in the summer, I'd  be better off waiting anyhow. That'll be a bigger chunk of cash as well.

I'm pretty sure my current plan is to pretty-up the inside first, making sure any functional issues I run across get addressed. Exterior work (aside from the peeling paint) can be done within the next 6 months.

In my experience, limited as it may be, many people prefer renting because it takes all of the responsibility off of their shoulders. If a hot water tank goes they call and it magically gets replaced at no cost to them. If it's a water tank or a loose screw, they call the same guy. Doesn't make any financial sense to me, but that's why I'm not taking the path of a renter. In my area, it just doesn't pay to rent and have nothing to show for it in the end.

arebelspy

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Re: How much to invest into rental property?
« Reply #10 on: March 08, 2012, 07:32:52 AM »
My personal opinion is that it will only be possible to make a decent profit in rental property in our market if house prices start to rise again. Using the 50% rule, it is barely possible to break even on rental income alone.


Break even is good.  Cash flow is better, but as long as it's not negative cash flow, the inevitable appreciation, rise in rents, and principal paydown will give you a good return.  Don't buy negative cash flow, but if you can break even with leverage and the 50% rule, it's likely an okay investment, and if that's the environment an experienced investor can find gems that will beat that and cash flow.

Having said that, if/when the economy starts growing again, I think house prices will start to rise again due to the high levels of demand, and the power of leverage should then make rental property a good investment again.

That seems like the opposite time it's a good investment, or at least sub optimal.  Buying when they're rising means more competition and higher prices.  Waiting to buy when everyone is is the opposite of what you want to do.  Be a contrarian.  ;)
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chrish

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Re: How much to invest into rental property?
« Reply #11 on: March 08, 2012, 07:59:52 AM »
Yeah, I take your point, but actually, I think break even is quite hard to do in this market. £100000 properties rent for around £500-£600 per month here. A £75000 mortgage at 5% is approx £430 per month. So using the 50% rule, you have negative cashflow of at least £130 ppm.

If I was going to jump into buy to let, I would probably go with an interest only mortgage, that should take you to about even cash flow, but then you are totally reliant on capital appreciation to make money, and that is far from a certainty, I'm not 100% convinced we have hit the bottom yet. I certainly don't think I'm going to miss out on any big gains by waiting a year.

arebelspy

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Re: How much to invest into rental property?
« Reply #12 on: March 08, 2012, 08:30:59 AM »
Yeah, I take your point, but actually, I think break even is quite hard to do in this market. £100000 properties rent for around £500-£600 per month here. A £75000 mortgage at 5% is approx £430 per month. So using the 50% rule, you have negative cashflow of at least £130 ppm.

If I was going to jump into buy to let, I would probably go with an interest only mortgage, that should take you to about even cash flow, but then you are totally reliant on capital appreciation to make money, and that is far from a certainty, I'm not 100% convinced we have hit the bottom yet. I certainly don't think I'm going to miss out on any big gains by waiting a year.

No, interest only payment doesn't give you cash flow, but just the false sense of cash flow.

http://www.johntreed.com/positive.html

I was basing my statement on your comment that break even was possible in your location.  It may not be, as you seem to indicate now. 

You're right, a £100000 property renting for £500-£600 is not a good investment.  At all.  The price would need to be about half that.
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Mr Mark

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Re: How much to invest into rental property?
« Reply #13 on: March 08, 2012, 08:55:01 AM »

Be very wary of buying property with no net cash flow, hoping to make the money on 'capital appreciation'.

You're just speculating and trying to time the market.



chrish

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Re: How much to invest into rental property?
« Reply #14 on: March 08, 2012, 08:59:53 AM »
No, interest only payment doesn't give you cash flow, but just the false sense of cash flow.

http://www.johntreed.com/positive.html

I can't see any reference to interest only mortgages in the article. What I meant was that an interest only mortgage would bring the payments down to around £300 per month. If rent is £600, then using the 50% rule, you can just about break even. You then rely on rising property prices to make a profit. It is risky though!


Be very wary of buying property with no net cash flow, hoping to make the money on 'capital appreciation'.

You're just speculating and trying to time the market.




Absolutely right - I will not be investing in property until either prices fall, or rents rise. Although a lot of people made a lot of money doing exactly that over the last ten years!

arebelspy

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Re: How much to invest into rental property?
« Reply #15 on: March 08, 2012, 04:35:21 PM »

Be very wary of buying property with no net cash flow, hoping to make the money on 'capital appreciation'.

You're just speculating and trying to time the market.

That's not necessarily true.  It is if you're buying cash flow negative, but if it's at least break even with realistic assumptions (50% rule), you can still make money in 3 ways:
Principal Paydown
Appreciation (inevitable simply due to inflation, but it will match the inflation rate, not beat it, as some have claimed)
Tax shelter

You will also start to cash flow later due to your rents rising, but your mortgage payments remaining the same.

So cash flow neutral (assuming it actually is, and you're not doing something ridiculous and saying rent - PITI = cash flow) can still make you money, even without assuming any appreciation.

No, interest only payment doesn't give you cash flow, but just the false sense of cash flow.

http://www.johntreed.com/positive.html

I can't see any reference to interest only mortgages in the article. What I meant was that an interest only mortgage would bring the payments down to around £300 per month. If rent is £600, then using the 50% rule, you can just about break even. You then rely on rising property prices to make a profit. It is risky though!

He specifically talks about how you should cashflow with a 30 year fixed loan at a normal loan to value ratio (70-80%, i.e. a down payment of 20-30%).

Having it be interest only clearly breaks that criteria, and you are trading equity paydown for "cash flow" (forced cash flow is not real cash flow, thus the quotes).  That is not break even, that's cash flow negative, you're just making your payment lower by giving up principal paydown.  It's not just risky, but a downright poor decision.
I am a former teacher who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and am now settled with three kids.
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