Author Topic: Buying a rental just doesn't seem to add up, why not?  (Read 2706 times)

embwbam

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Buying a rental just doesn't seem to add up, why not?
« on: October 25, 2020, 07:45:20 AM »
So I read MMM's recent article. I've long had an itch to diversify into real estate and take advantage of low interest rates. But I can't get the numbers to add up. Am I making a mistake or are home prices too high in my area (Salt Lake City)?

A hypothetical 3 BR house in a part of town I would want to live in might go for $400k. Assuming I get $2400/mo in rent, 20% down, a 3% 30y mortgage, and $4000/y in repairs, my cash flows are only $340 per year. Obviously it looks better if you factor in principal repayment, but you canít eat equity.

What am I missing here?

More about my situation if it's relevant: 38, FI (stocks/bonds), Salt Lake City, UT. I live in a van and don't own any real estate at the moment.

norajean

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #1 on: October 25, 2020, 09:04:17 AM »
The 1% rule says you need $4K/mo for a $400K unit.   Sounds like SLC is not a good rental market.

Read more here
https://www.biggerpockets.com/forums/763/topics/837036-best-places-to-invest-in-salt-lake-city

YttriumNitrate

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #2 on: October 25, 2020, 09:26:33 AM »
In general, the higher the price of the unit the lower the returns will be, but the amount of work needed per dollar earned will also be less. Consider looking at less desirable areas nearby.

lhamo

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #3 on: October 25, 2020, 09:39:32 AM »
Have a look at what the houses you like were selling for back in 2010-11.  At those prices, they would have made better rentals.  In most larger cities in the US, the quick rate that prices have gone back up over the last decade means that there are very few, if any, properties that meet the 1% rule.  If you really want to get into rental real estate, you might want to save your money and wait until the next market crash.  In the meantime, look for a property you can live in yourself and rent out any extra rooms to generate extra income.

waltworks

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #4 on: October 25, 2020, 12:17:03 PM »
SLC was a great place to buy rentals around 2010-12. I owned a couple of rentals there that I sold a few years ago.

Now it's not. In fact, you could make a good argument that selling your house and renting would be a good move in some places.

There is no law that says your local RE market makes sense to invest in.

-W

Fishindude

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #5 on: October 26, 2020, 07:02:18 AM »
Owning a rental at those figures makes absolutely no sense at all.   I'm not a fan of single family rentals like that anyway.   
You can do much better with a multi-unit building or a commercial property.

Paper Chaser

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #6 on: October 26, 2020, 08:40:57 AM »
Owning a rental at those figures makes absolutely no sense at all.   I'm not a fan of single family rentals like that anyway.   
You can do much better with a multi-unit building or a commercial property.

Maybe I'm ill-informed but I'd have a hard time pulling the trigger on a commercial property right now too with so many small businesses struggling and large corporations reconsidering their real estate footprints. I'd guess that there may be very specific types of commercial or specific locations that continue to do well, but it definitely feels like commercial rents in general will probably see some downward pressure in the coming months/years.

belly05

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #7 on: October 26, 2020, 08:41:58 AM »
It does seem like home prices in your area, or at least the ones you have seen so far, are too $$

Things make a lot more since where I live here in the Midwest (although over the past 3 years the market is definitely trending up quickly).  The last house I purchased was in 2018 for 112,000 and it can be rented for 1100 - 1200/month.  This is a single family house but I agree with Fishindude, I've enjoyed much better success with multi family properties.

A couple things that have helped me along the way:
  • Don't be afraid to find a place that looks like it needs work and contact the owner.  Just use the cities website and lookup contact information for who pays taxes.  We've bought 2 houses this way.
  • Don't rush in if the numbers don't add up, its totally fine to wait until housing prices come down in your area.
  • If you are going to manage the maintenance and tenants yourself, try to find something close to you. I've had great success keeping everything within 3 miles of my primary residence.  This also makes periodic drive by inspections much easier as well. 

embwbam

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #8 on: October 26, 2020, 10:56:57 AM »
Thanks everyone for the information. I'll cast a wider net with my realtor and wait for the bubble to pop. Who knows, maybe I'll get lucky and the stock market won't pop at the same time and interest rates will remain low.

I wasn't aware of the 1% rule. That's very helpful. Is there a real-estate investing 101 somewhere you'd recommend I read?


vand

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #10 on: October 28, 2020, 06:36:10 AM »
So I read MMM's recent article. I've long had an itch to diversify into real estate and take advantage of low interest rates. But I can't get the numbers to add up. Am I making a mistake or are home prices too high in my area (Salt Lake City)?

A hypothetical 3 BR house in a part of town I would want to live in might go for $400k. Assuming I get $2400/mo in rent, 20% down, a 3% 30y mortgage, and $4000/y in repairs, my cash flows are only $340 per year. Obviously it looks better if you factor in principal repayment, but you canít eat equity.

What am I missing here?

More about my situation if it's relevant: 38, FI (stocks/bonds), Salt Lake City, UT. I live in a van and don't own any real estate at the moment.

What don't you get?
A 320k repayment mortgage @3% is $1392/mo
You have a positive cashflow AND you're owning a little more of the entire house each month. This is hidden because you don't see it in the monthly cashflow, but each month you are paying off a little more capital and a little less interest.
After 30 years the mortgage is completely repaid, you own the house and and your cashflow is then $2400/mo.


waltworks

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #11 on: October 28, 2020, 07:32:02 AM »
Property taxes are a problem with your analysis, @vand. Not to mention insurance, maintenance/capex, management costs, and occasional vacancies.

I actually know the tax rates and insurance costs in SLC having landlorded there, so here's a rough breakdown of how I'd analyze this place:

Gross Rent $2400

P&I $1392
Taxes $350-400 - though this may have gone up a bit due to school bonds/etc
Management $200
Maintenance/Capex $200 if it's newer. If it's like a lot of SLC SFH (Avenues, Sugarhouse, etc), $300 because it's 120 years old.
Insurance $150
Vacancy $100

So you're going to lose $200+ a month here. Now, rents will rise some with inflation (presumably) and you've got a fixed cost with your P&I. So after a while you'll probably be breaking even. And indeed, you'll end up owning the house at the end. So you will probably have a positive return when all is said and done in 30 years when you're 68... but you'd almost certainly have been better off with some other investment.

-W

vand

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #12 on: October 28, 2020, 10:16:26 AM »
@waltworks OK yes, I was trying to simplify it, and as you say tax and other costs will need to be accounted for.

However if you it were easily possible to put your money to work in real estate at x5 leverage and have it all self-funding & managed then don't you think everyone would be doing it?

IMO the 1% per month return is mythical as a passive real estate investment. That's 12% a year gross yield. Maybe you could get that back in 1982 when interest rates were 10-15%, but no way today, Jose. Here in the UK you'd be lucky to get half that in even the most reasonably priced areas. A 12% yield is effectively a price to earnings ratio 8. What other income producing assets are trading at a P/E of 8?


waltworks

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #13 on: October 28, 2020, 10:43:55 AM »
The 1% rule debate(s) have been hashed out here lots of times, Vand. Those properties were easy to find from 2010-2015 or so in lots of places, and prior to 2003 or so as well. There was a long period pre-bubbles (ie 90s and earlier) that RE was boring and 1% rule properties were a thing then too. There are still a few US markets where you can find them right now. There will be again, when interest rates or some other factor depress housing prices for a while. There's a reason it's a "rule" among RE investors. Lots of us did indeed jump on the opportunities available (and will again) during the last cycle.

Leverage via gov't sponsored cheap money is a huge advantage. As is the ability to find local deals/use local knowledge. RE lends itself to "active" investing because it's not a very efficient/large market, but rather a collection of micro-markets that you can, with some effort, have an information advantage in.

As to why "everyone" doesn't do it... well, you need to work hard and be smart, and you need capital up front. I'm sure you're just as aware as I am how cash-poor most people are, even wealthy people, and how bad they are at saving/investing. The barrier to entry to RE is just too high for 95+% .

-W
« Last Edit: October 28, 2020, 10:50:39 AM by waltworks »

vand

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #14 on: October 29, 2020, 02:26:14 AM »
The 1% rule debate(s) have been hashed out here lots of times, Vand. Those properties were easy to find from 2010-2015 or so in lots of places, and prior to 2003 or so as well. There was a long period pre-bubbles (ie 90s and earlier) that RE was boring and 1% rule properties were a thing then too. There are still a few US markets where you can find them right now. There will be again, when interest rates or some other factor depress housing prices for a while. There's a reason it's a "rule" among RE investors. Lots of us did indeed jump on the opportunities available (and will again) during the last cycle.

Leverage via gov't sponsored cheap money is a huge advantage. As is the ability to find local deals/use local knowledge. RE lends itself to "active" investing because it's not a very efficient/large market, but rather a collection of micro-markets that you can, with some effort, have an information advantage in.

As to why "everyone" doesn't do it... well, you need to work hard and be smart, and you need capital up front. I'm sure you're just as aware as I am how cash-poor most people are, even wealthy people, and how bad they are at saving/investing. The barrier to entry to RE is just too high for 95+% .

-W

Sure, I get all that. I'm just pointing out how everyone has to live and make decisions with the world as it is today.  Low interest rates and cheap money has pushxup valuations of all other risky assets by design. Stock market investors mostly understand that valuations are well above long term average and they are paying more per dollar of income that companies are making; exactly the same is true in real estate.

theoverlook

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #15 on: October 29, 2020, 07:35:03 AM »
Vand, at $80,000 down on a $2400/mo rental, you're really earning a quite a paltry sum on your investment even with all the risks of leverage. 30 years is a long time, and at a (conservative) 8% return of an index fund you'd have $805,000 after that long period. You could easily get $2400/mo in cashflow from an $805,000 liquid investment, without the risks and effort involved in owning real estate. Even at just 6% average return you have $459,000 at the end of 30 years. Compounding and time are a powerful force. There's no special magic in a rental that just pays for itself.

The 1% rule only exists to see if real estate is worth owning. If it doesn't meet the 1% rule it's a good bet that the return will not be high enough to justify the risks and effort. I'm not going to go buy real estate to under-perform an easily purchased liquid investment.

SwordGuy

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #16 on: October 29, 2020, 09:42:02 AM »
Thanks everyone for the information. I'll cast a wider net with my realtor and wait for the bubble to pop. Who knows, maybe I'll get lucky and the stock market won't pop at the same time and interest rates will remain low.

I wasn't aware of the 1% rule. That's very helpful. Is there a real-estate investing 101 somewhere you'd recommend I read?

The sticky thread in this very sub-forum has a list of things to read.  I like Gallinelli's book on Cash Flow and other measures for a great lesson on how to run the numbers the right way.

vand

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #17 on: October 29, 2020, 01:55:31 PM »
Vand, at $80,000 down on a $2400/mo rental, you're really earning a quite a paltry sum on your investment even with all the risks of leverage. 30 years is a long time, and at a (conservative) 8% return of an index fund you'd have $805,000 after that long period. You could easily get $2400/mo in cashflow from an $805,000 liquid investment, without the risks and effort involved in owning real estate. Even at just 6% average return you have $459,000 at the end of 30 years. Compounding and time are a powerful force. There's no special magic in a rental that just pays for itself.

The 1% rule only exists to see if real estate is worth owning. If it doesn't meet the 1% rule it's a good bet that the return will not be high enough to justify the risks and effort. I'm not going to go buy real estate to under-perform an easily purchased liquid investment.

The point is RE is leveraged. So if you use 80k to buy a 400k house you're compounding off a yr 1 base of 400k, not 80k. At 6% pa you'll end up with $2.23m

theoverlook

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #18 on: October 29, 2020, 02:10:49 PM »

The point is RE is leveraged. So if you use 80k to buy a 400k house you're compounding off a yr 1 base of 400k, not 80k. At 6% pa you'll end up with $2.23m
Where did you come up with a 6% appreciation rate on real estate? I said 6% on equities - that's a very conservative rate, and would be post inflation. Real estate tends to track with inflation pretty well other than in exceptional markets that tend to not even be cashflow neutral.

almcclur

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #19 on: October 29, 2020, 02:42:33 PM »
I think a lot of people look at buying a house they would want to live in, but for us it has been more practical to buy a house that the median local income can afford to rent. So in our market if the median income is $40k, then 30% of that is about $1000 per month. If you try to buy something that can bring in that amount you'll have the largest market of tenants to choose from. At that rental amount I wouldn't want to spend more that $100k or so. If those numbers don't work where you are, maybe consider investing in another area. I know it's a little more intimidating but people buy turnkey rentals all the time.

vand

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #20 on: October 29, 2020, 03:13:44 PM »

The point is RE is leveraged. So if you use 80k to buy a 400k house you're compounding off a yr 1 base of 400k, not 80k. At 6% pa you'll end up with $2.23m
Where did you come up with a 6% appreciation rate on real estate? I said 6% on equities - that's a very conservative rate, and would be post inflation. Real estate tends to track with inflation pretty well other than in exceptional markets that tend to not even be cashflow neutral.

I'm working with your numbers, not mine. You went with 8% return in equities and 6% RE.
It doesnt have to be 6% capital appreciation, the rental income is what will get you most of the way there.

clarkfan1979

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #21 on: October 29, 2020, 07:28:26 PM »
I tend to buy rentals in the path of progress. I buy ugly houses that need mostly cosmetic work. After repairs, I get them 10% to 15% under market value. My cash flow isn't great in the beginning. However, I get higher than normal appreciation on rents and home value during the first 5 years. After 5 years, appreciation on rents and home value start to track closer to inflation. For example, rental #2 will probably average 2-3% appreciation per year over the next 5 years even though it has averaged 10% over the previous 5 years.

Rental #1: Purchased for 182K in 2007 + 10K of repairs: Now worth 410K, which is 6% appreciation

Rental #2: Purchased for 95K in 2012 + 16K of repairs: Now worth 250K, which is 10% appreciation

Rental #3: Purchased for 603K in 2018 + 60K in repairs: Now worth 800K, which is 9% appreciation

Current Primary Home: Purchased for 280K in November 2019. No repairs! Now worth 305K, which is 9% appreciation
« Last Edit: October 29, 2020, 07:30:31 PM by clarkfan1979 »

former player

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #22 on: October 29, 2020, 09:23:52 PM »
If you want to get into real estate, how about buying a house that you live in and rent out rooms?  How would that compare for value?  Or a duplex?

Archipelago

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #23 on: October 29, 2020, 09:56:07 PM »
Not a lot of good rental properties hit the market these days. It's a classic example of the 80/20 rule. People don't tend to just sell off good 1% rule properties. Why would they? You may need to try looking harder, off market and without a realtor. Not paying that 5-6% broker's commission makes for good reason to sell.

If you need some more ideas on this line of thinking, feel free to check out my journal or PM me.

SwordGuy

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #24 on: October 30, 2020, 08:42:29 AM »
Let's say I put $100,000 in a CD at 3% interest.  In a year I have $103,000.

Let's say I put $100,000 on a $400,000 house and it appreciates 3% a year.  We'll assume rent = costs for now.

In a year the house is worth $412,000 that requires no repairs.    That's $12,000 in appreciation because I earn appreciation on the part of the house I own but haven't yet paid for.

If I'm making a profit on the rent my return is even higher.   I also get depreciation on $400,000 - land value worth of depreciation on the house which will shelter some of my rental income from taxes.  (I'm not positive on the mortgage interest and depreciation, that part confuses me.)

Now, if I sold by owner in the first year I would lose money in realtor commissions and fees.   But if I hang onto it for a number of years, I'll keep most of the appreciation gains and, of course, collect more rent.   

CDs have many advantages over rental property as a storage of wealth, but rental property has many advantages over CDs as a way to make money.

vand

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #25 on: October 31, 2020, 12:57:50 AM »
A more complete way of estimating your return in RE:
https://mymoneywizard.com/high-annual-returns-through-real-estate/

This is why, empirically, far more people have built significant wealth in RE than have in paper assets.

Paper Chaser

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #26 on: November 01, 2020, 04:38:19 AM »
A more complete way of estimating your return in RE:
https://mymoneywizard.com/high-annual-returns-through-real-estate/

This is why, empirically, far more people have built significant wealth in RE than have in paper assets.

Now subtract from their numbers: Maintenance, vacancy, insurance, ongoing repairs/cap ex, etc

vand

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #27 on: November 01, 2020, 06:54:29 PM »
A more complete way of estimating your return in RE:
https://mymoneywizard.com/high-annual-returns-through-real-estate/

This is why, empirically, far more people have built significant wealth in RE than have in paper assets.

Now subtract from their numbers: Maintenance, vacancy, insurance, ongoing repairs/cap ex, etc

That would be that item he's labelled "annual expenses" then

Paper Chaser

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #28 on: November 02, 2020, 06:53:19 AM »
A more complete way of estimating your return in RE:
https://mymoneywizard.com/high-annual-returns-through-real-estate/

This is why, empirically, far more people have built significant wealth in RE than have in paper assets.

Now subtract from their numbers: Maintenance, vacancy, insurance, ongoing repairs/cap ex, etc

That would be that item he's labelled "annual expenses" then

Wouldn't it be nice to actually see those numbers if they make the argument more compelling?
I'm a novice when it comes to real estate but I have been trying to do my homework and learn. Feel free to correct me, but here's what I see: Looks like a 160k mortgage @ 4% results in PITI around $1200/mo (obviously insurance and taxes will vary). That's $14,400 annually in PITI. He's got $16,000 listed under annual expenses. $16k expenses - 14.4k PITI = an extra $1600 annually for all non PITI expenses. That breaks down to just $133/mo (or 7-8% of monthly rent) to cover vacancy, cap ex, maintenance, etc. That seems...low to my untrained eye. IF the property is in a particularly high tax area, and/or insurance is expensive, then there might be $0 outside of PITI in that "Annual expenses" category.
« Last Edit: November 02, 2020, 06:55:26 AM by Paper Chaser »

waltworks

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #29 on: November 02, 2020, 07:44:39 AM »
Yes, that is extremely low.

Easy rule of thumb is to just say that 50% of your gross rents to go overhead *before paying the mortgage*. Like the 1% rule, it's not always true (you might have low property taxes, or have a metal roof/cinderblock house that doesn't cost much to maintain, or whatever). It can serve as a good guide, though.

For the blog author's place, that would mean:
Gross rent $20k
Net rent $10k
Mortgage payment (P&I only) $9,600
Annual income $400

Not so attractive anymore. If you assume 3-4% annual home price appreciation then it totally works as a (risky) investment but that is not the historical norm.

-W

theoverlook

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #30 on: November 02, 2020, 09:18:49 AM »

The point is RE is leveraged. So if you use 80k to buy a 400k house you're compounding off a yr 1 base of 400k, not 80k. At 6% pa you'll end up with $2.23m
Where did you come up with a 6% appreciation rate on real estate? I said 6% on equities - that's a very conservative rate, and would be post inflation. Real estate tends to track with inflation pretty well other than in exceptional markets that tend to not even be cashflow neutral.

I'm working with your numbers, not mine. You went with 8% return in equities and 6% RE.
It doesnt have to be 6% capital appreciation, the rental income is what will get you most of the way there.
I never said anything about 6% appreciation rate in RE; nothing at all about appreciation. I was comparing 6% and 8% return in equities to the return you get in RE.

Archipelago

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Re: Buying a rental just doesn't seem to add up, why not?
« Reply #31 on: November 03, 2020, 04:58:58 AM »
A more complete way of estimating your return in RE:
https://mymoneywizard.com/high-annual-returns-through-real-estate/

This is why, empirically, far more people have built significant wealth in RE than have in paper assets.

Now subtract from their numbers: Maintenance, vacancy, insurance, ongoing repairs/cap ex, etc

That would be that item he's labelled "annual expenses" then

Wouldn't it be nice to actually see those numbers if they make the argument more compelling?
I'm a novice when it comes to real estate but I have been trying to do my homework and learn. Feel free to correct me, but here's what I see: Looks like a 160k mortgage @ 4% results in PITI around $1200/mo (obviously insurance and taxes will vary). That's $14,400 annually in PITI. He's got $16,000 listed under annual expenses. $16k expenses - 14.4k PITI = an extra $1600 annually for all non PITI expenses. That breaks down to just $133/mo (or 7-8% of monthly rent) to cover vacancy, cap ex, maintenance, etc. That seems...low to my untrained eye. IF the property is in a particularly high tax area, and/or insurance is expensive, then there might be $0 outside of PITI in that "Annual expenses" category.

Novice or not, you are thinking about this exactly the right way. Nicely done.