Author Topic: first-time real-estate investor -- do my #s and strategy make sense?  (Read 4685 times)

calcsam

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Hello fellow Mustachians!

I'm a 25yo recent graduate, trying to get to FIRE in 10yrs, considering my first investment property. A bit about me: I grew up in the Detroit suburbs, but moved to CA for college and now live & work in the SF Bay Area as a software engineer.

My parents, who still live in MI, recently decided to get into real estate investment by buying a newbuild condo in Ann Arbor. I took a look at their #s, and was pretty impressed.

I am planning to duplicate their investment by this summer when I accumulate the money (there's still a couple buildings under construction).

My main aims:

(1) This should not be time-intensive. I'm fine with putting in time upfront, but don't want to do so on an ongoing basis (hence newbuild, mgmt company, etc). My field has high-returns-to-skill, so I have high ROI from time spent on professional development (earning 100k; could get 10-15%/yr raises for next 4-5yrs).
(2) I preferred Ann Arbor over other locations in MI -- my hometown, Livonia, has one of the lowest price-to-rent ratios in the country, but I plan to hold forever, and risk in Ann Arbor is lower due to the University of Michigan.
(3) Assuming this works, I'm going to do it maybe 4x over the next five years.

My main questions:

1) Do the numbers below look reasonable?
2) If #1, any reason why I should just put my $ in an index fund instead of this?
3) If I looked harder for other properties (keep in mind I'm out of state), could I expect to find properties with substantially better #s?

My parents' #s:

Condo: $152,000 cost, 25% down (38,000), at 3.8% interest for a 15yr loan

Cashflow:
$1500 rent
less
-$450 principal payment
-$360 interest payment
-$360 property tax, insurance, etc
-$150 monthly payment to management company
-$210 HOA fee

net:
-$30 monthly cashflow

Income
$450 principal
$380 appreciation (= 3%/yr = 0.25%/mo * 152,000)
$150 tax savings from depreciation = ((152,000 / 27.5) / 12) * 30% rate; I plan to hold forever.
less
-$30 monthly cashflow
-$100 budgeted for tenant turnover (first month new tenant rent to prop. management  = $1500/12, so $128/mo if change every yr)
-$60 budgeted for repairs (4% x 1500 -- remember, new construction)
-$105 budgeted for vacancy (7% x 1500)

net:
$685 monthly = $8,220 yearly

...for a $8,220 / $38,000 = 21.6% annual return.
« Last Edit: December 31, 2013, 10:32:47 AM by calcsam »

Johnny Aloha

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Re: first-time real-estate investor -- do my #s and strategy make sense?
« Reply #1 on: December 31, 2013, 12:30:30 PM »
I wouldn't do this deal.

It is a condo (with an HOA), which means you won't be able to control/time maintenance and could have a heavy assessment with no warning.

Before you invest in real estate, you need to read about the 50% rule and other rules of thumb/guidelines.  Biggerpockets is an excellent resource, and they have a lot of great podcasts (hour long interviews with successful investors).

A quick and dirty analysis shows $1500 * 50% = $750/month income.  Then subtract debt ($810) and HOA ($250) and you are cash flow NEGATIVE $360/month.  This is a back-of-the-napkin analysis, but you get the hint.  You need to account for vacancy, maintenance (even though it's a condo), etc.  Maybe the HOA fee would cover the big stuff (roof, windows, etc) but you will still be on the hook for paint, carpet, appliances, etc.

Also, are you sure you want to bet on 3% appreciation?  What is the historical trend for that area?

To answer your questions:
1) No vacancy or maintenance is included.
2) Yes, I'd prefer an index fund over this for 3 reasons: liquidity, (probably) better returns, definitely less work.
3) You can find much better deals in MI, and other areas of the country in general.  There have been some threads on this forum, and lots on BP.

Another Reader

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Re: first-time real-estate investor -- do my #s and strategy make sense?
« Reply #2 on: December 31, 2013, 12:39:37 PM »
The numbers appear to be an attempt to sell a deal.  Their author is not properly defining income and expense.  Appreciation is not income.  Tax savings is not income.

I would not consider this property as an investment.  It's a money loser from the get-go.  Please, before you even consider investing in real estate, read some of the books on Arebelsy's book list.  It's pinned to the top of the Real Estate and Landlording category.  Check out the Bigger Pockets real estate investing website.  Attend some real estate investors association meetings in your local area.  Do not buy this property or any other property until you have a better understanding of how the numbers work.

_JT

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Re: first-time real-estate investor -- do my #s and strategy make sense?
« Reply #3 on: December 31, 2013, 12:40:17 PM »
There are many far more experienced RE investors here than I, but given the reading I've done and the deals I've analyzed over the past few years, my answers to your questions are:

1) No. You're getting less than 1%, which, in my opinion, is pretty mediocre. Your cashflow is negligible, your expenses are high, and you're betting on appreciation and tax breaks, which a lot of experienced investors advise against.
2) Until you get a much better understanding of what a deal looks like, I would invest in index funds.
3) Yes.

I would go over to biggerpockets.com and read their beginner's guide to RE investing (it's free). It does a good job of explaining some of the guidelines you'll want to familiarize yourself with, like the 50% rule, 2% rule, and some demonstrations with numbers. Now, once you understand the thinking behind them you may decide a lower return in a stable area with new construction is acceptable, but I don't think you have all the information at hand now that you need to make that decision.

You say you're familiar with the Detroit suburbs. My understanding is that there are some fantastic deals to be had there if you know which areas are good.

golfer44

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Re: first-time real-estate investor -- do my #s and strategy make sense?
« Reply #4 on: December 31, 2013, 01:15:19 PM »
My parents' #s:

Condo: $152,000 cost, 25% down (38,000), at 3.8% interest for a 15yr loan

Cashflow:
$1500 rent
less
-$450 principal payment
-$360 interest payment
-$360 property tax, insurance, etc
-$150 monthly payment to management company
-$210 HOA fee

net:
-$30 monthly cashflow

Income
$450 principal
$380 appreciation (= 3%/yr = 0.25%/mo * 152,000)
$150 tax savings from depreciation = ((152,000 / 27.5) / 12) * 30% rate; I plan to hold forever.
less
-$30 monthly cashflow
-$100 budgeted for tenant turnover (first month new tenant rent to prop. management  = $1500/12, so $128/mo if change every yr)
-$60 budgeted for repairs (4% x 1500 -- remember, new construction)
-$105 budgeted for vacancy (7% x 1500)

net:
$685 monthly = $8,220 yearly

...for a $8,220 / $38,000 = 21.6% annual return.

These numbers simply do not fly. They might get lucky and have no vacancies, and very little maintenance, but you absolutely should not count principle payoff and appreciation as "income", it simply isn't. Rental properties should cash flow here and now, not on a promise of future performance.

The only cash flow you should expect is your rent roll, minus your P+I payment, minus expenses. Expenses include taxes, insurance, condo dues, vacancies, repairs.

Rent roll: $1500
P+I payment: $810
Taxes/insurance: $360
Management fee: $150
HOA fee: $210
Turnover: $100
Repairs: $60
Vacancies: $105
Cash flow: -$295/month

It's refreshing to see that they were realistic about the expenses related to owning a rental property (including management), but their rent to purchase price simply doesn't work.

Eventually, rent will go up, they'll pay the place off, and then they'll cash flow, but purely as an investment property - it's a no go for me.

$1500 rent for a $152,000 purchase price isn't terrible, but the taxes and condo fees kill it.

calcsam

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Re: first-time real-estate investor -- do my #s and strategy make sense?
« Reply #5 on: December 31, 2013, 02:05:13 PM »
I appreciate the feedback. A lot.

Responses below. I'll put my next question up top though: time is my limiting factor. If I take all of your advice (which I'm inclined to) and hold off on this deal, and I still want to invest in real estate, I'll have to scope out a new place. So how long does it typically take you to find a property that meets your criteria?*

-----

The 50% rule seems around what I'm budgeting for the expenses. I included that on the income, but you guys are right, it belongs in cashflow. It's a newbuild, so I assume maintenance will be less, but perhaps that is optimistic.

Correct, I am banking on appreciation and tax breaks for the income. I get the sense from you guys that is a bad idea. That's really good to know.

Real estate appreciation since 2000 in Ann Arbor is 2.6%. The most reasonable advice I've seen says to estimate is at around the rate of inflation.

@Another Reader my parents bought one property and have rented it out already. Took the numbers from what they are paying.

@JT thanks. I will cruise over to BiggerPockets and read around.

@Johnny Aloha and @JT thanks. My thinking on this is that my family & some HS friends are in MI; it seems that some of the best price-to-rent ratios in the country are there: http://trends.truliablog.com/vis/rentvsbuy-spr2012/. (The Warren-Troy-Farmington Hills, MI area in particular is where I grew up.)

*This is an honest question, though it may lead you to characterize me as "wanting results without wanting to exercise." More accurately, I have a busy job and a fiancee, and am trying to get a handle on whether to invest my already-limited time into real estate investing or professional development :) If the latter, I can always put my money in index funds for a while until I do have the time.
« Last Edit: December 31, 2013, 02:07:13 PM by calcsam »

_JT

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Re: first-time real-estate investor -- do my #s and strategy make sense?
« Reply #6 on: December 31, 2013, 06:22:14 PM »
I think it's basically impossible to estimate how long it'll take your find a deal. But I commend you for listening to the advice in this thread and seriously estimating your available time.

Why do you want to invest in real estate? With your income and free time, it really seems like you might be better off investing in index funds, at least for the foreseeable future, while you do some research about real estate.

The other thing is that, due to the magic of compound interest, I really think the investment strategy I would recommend to anyone your age is dump money in your 401(k) and index funds throughout your 20s, and then just back down to company match (for anyone still working at that time). For an earner like you, you'd still be able to do RE investing along with that, say 6 months to a year from now (after the wedding?).

KingCoin

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Re: first-time real-estate investor -- do my #s and strategy make sense?
« Reply #7 on: January 02, 2014, 08:32:04 AM »
Yeah, I don't think this is the train wreck everyone is making it out to be, especially if you're able to place studens with solid guarantors, but paying out over 25% of your revenue in HOA and management fees would be a deal breaker for me. The problem is that the condo HOA and property management company provide somewhat overlapping services, so you're effectively double paying for management.

You can investigate what services the condo provides. If the dishwasher breaks, is there an in-house handyman who can take care of it for a fee? If so, you may be able to dispense with the property manager and just have a real estate agent place a tenant (or handle it yourself).

A 30yr rather than 15yr mortgage would also help this property cash-flow better. You can always pay down the principle at an accelerated rate if you choose.

As always, you also have to consider what happens if a tenant stops paying and it takes a few months to evict and place a new tenant. Are you prepared to take a $10k hit due to vacancies and legal expenses?
« Last Edit: January 02, 2014, 10:29:00 AM by KingCoin »

Daleth

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Re: first-time real-estate investor -- do my #s and strategy make sense?
« Reply #8 on: January 02, 2014, 09:01:57 AM »
Another thing to think about is that Ann Arbor is not the only college town in the area--there's also EMU a few miles down the road in Ypsilanti, and real estate costs distinctly less there. I completely agree that colleges are gold mines for the landlord, but when there's more than one college town in your target area, definitely consider them both.

I also would avoid HOA's like the plague and instead find a good property manager.

sdp

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Re: first-time real-estate investor -- do my #s and strategy make sense?
« Reply #9 on: January 02, 2014, 10:47:05 AM »

"I also would avoid HOA's like the plague and instead find a good property manager."

HOA fees for an absentee REI isn't such a bad thing, as long as they are reasonable.  is that 210/month or 210/year?  Living in a community with an HOA might warrant a premium on the rents as it might make it a more desireable place to live.
When I was looking to buy my latest rental, I started out avoiding hoa fees, but in the end I bought a house with a 225/yr fee and the monthly premium in rents in that neighborhood vs, surrounding neighborhoods are about 100/mo.  Its all part of the big picture

Another Reader

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Re: first-time real-estate investor -- do my #s and strategy make sense?
« Reply #10 on: January 02, 2014, 10:56:53 AM »
In general, HOA's hate tenants and may single them out for rule enforcement.  Tenants are not always motivated to follow the HOA rules.  My leases call for the tenant to pay fines as part of the rent, so they can be evicted for non-payment.  Over the years, they have paid a lot of fines for ignoring the HOA warning letters.

Being in a college town gives you a larger pool of potential tenants nut not necessarily a larger pool of good tenants.  I own rentals in Tempe, home to ASU, and we do not rent to undergrads in room mate situations.  Those situations are disasters waiting to happen.  Fortunately they never meet the income requirements, so turning them down is not a problem.  Grad students and post docs with full time employment have been fine.

brandino29

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Re: first-time real-estate investor -- do my #s and strategy make sense?
« Reply #11 on: January 02, 2014, 11:02:15 AM »

Responses below. I'll put my next question up top though: time is my limiting factor. If I take all of your advice (which I'm inclined to) and hold off on this deal, and I still want to invest in real estate, I'll have to scope out a new place. So how long does it typically take you to find a property that meets your criteria?*


Setting a time limit runs the risk of clouding your judgement on potential properties.  More importantly, set your criteria and then get prepared financially to jump when an opportunity arises.  But be picky, especially as you are first getting into it.  We only have one rental property right now (looking to add more) but we were able to get the one because we had set money aside for the down payment and spent a while learning about real estate investing, studying the market and potential properties in our area, and looking at a number of places.  In fact, we had decided to wait a while longer after nothing met our criteria and we hadn't even been looking for several months when the place we have now opened up, but we were fortunate because we knew immediately that it was a good deal and we had the resources ready to go. 

It's important to remember that there are, and will always be, good deals down the road, so there's no need to rush it today for fear of missing the mythical 'once in a lifetime' opportunity.  Sure, you might miss a good deal or two, but as long as you are stashing your cash in tax-advantaged accounts and index funds, you are doing right.

calcsam

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Re: first-time real-estate investor -- do my #s and strategy make sense?
« Reply #12 on: January 02, 2014, 06:32:18 PM »
Thanks for the first-hand experience Brandino. That makes sense.

I was referring to time more as "processing time" (100 hours of work investigating opportunities) rather than "waiting time" (6 months, 12 years). I have lots of waiting time (I'm 25!) but little processing time (impending marriage, opportunities for professional development).

sdp

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Re: first-time real-estate investor -- do my #s and strategy make sense?
« Reply #13 on: January 02, 2014, 08:35:18 PM »
I think the upfront time commitment for us was the learning phase.  As Brandino stated, if you are ready financially and well edjucated, then you will know a good deal when you see it.  It sook myself many hours of reading and learning, and then many hours of evaluating my local market to really get a grasp on what was good and what was great.  But there is no deadline so it doesn't matter if you get swamped with other commitments for a while.  Once we felt competent to really start looking and listening, there wasn't as much time involved, just a little bit of time in the morning and spreading the word to the right people so if they hear of anything they will let you know.  You can gather a committee of folks to help you out and keep you sane with reality checks.  Then when you are in the right place at the right time, you will know.
The extra amount of time you invest in getting truly competent is going to be WAY less than the amount of extra time at your day job you will have to work to offset a 'bad deal' that might cost you 100 grand and several years of mistakes.  Not to mention less stressfull to boot!
Cheers,
Scott