Author Topic: Getting into the rental market...understanding ROI  (Read 2666 times)

TGod

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Getting into the rental market...understanding ROI
« on: September 28, 2015, 12:22:14 PM »
We are looking at purchasing a rental property. The property is in a fairly popular area, close to schools, downtown, rec center. It's not a beautiful home, but split level, 3-4 bedrooms, updated bathrooms, fenced yard. They are asking 259,000, so maybe we could scoop for 245K as it is a foreclosure. Vacancy rate here is under 2%. We are thinking we could rent out for $1600 (utilities not included) maybe more, because vacancies are very tight for family homes and the area has a lot of short term employees. I don't think this would take much in the way of cash output to get it up on the market. Property taxes are $2800, insurance would be about $800 and there are probably some miscellaneous costs as well.
We have 10K in cash and the rest of the 20% down payment would come from LOC. We would be looking long term, essentially creating an income source for 25 years down the road.

So like a good little mustachian I ran the #s through a rental property calculator...2 in fact, and I'm not sure if this would be good or not.  This is showing that I would be in the negative cash balance for the first 3 years to pay off my cash investment.  But it is showing my average annual rate as 17.25% I don't think this is right??? I must have put in a number wrong I think. Can someone review this and tell me if my calculations are completely out to lunch.



mathstache

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Re: Getting into the rental market...understanding ROI
« Reply #1 on: September 30, 2015, 09:27:07 AM »
Can't say I'm an expert but I've run some numbers on some situations and been surprised how good it can look. I was thinking of a few things in your example. Do you have PMI involved in mortgage rate? I think unless you have 20% down your going to need to pay PMI until you have 20% equity in the house. What is your house appreciating by in your calculation? Houses don't always appreciate. In the calculation, I think you are assuming that you are putting all extra income into the mortgage balance beyond interest. In effect, your tied into the investment of the house (unless you sell), this isn't money that you are putting wherever you please (stock market).

Then there is the 50% Land-lording rule where you assume half your income will actually be used to cover expenses (this seems high to me but people go by this).This last piece alone might cut your rate in half. Is 8.75% in an investment that you are constantly putting all money back into something you want to do? Is 7% a good enough rate if your house doesn't appreciate(didn't actually run numbers guestimation)?

Maybe you already thought of these things. Totally not looking to squash a good buy, these are just things I might consider. By the way, when I've got a stash built up I am looking to try to do a similar rental property so good luck!

TGod

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Re: Getting into the rental market...understanding ROI
« Reply #2 on: September 30, 2015, 11:23:33 AM »
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Do you have PMI involved in mortgage rate? I think unless you have 20% down your going to need to pay PMI until you have 20% equity in the house

I'm in Canada so no PMI. I don't have a big enough stash to put down the 20% down payment, so would end up using equity on my main house via my HELOC  to do that.  After 5 years of payments on the rental house, I could remortgage and pull out the cash to pay off the LOC. Until that time I would be having to make interest payments on the HELOC.

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Then there is the 50% Land-lording rule where you assume half your income will actually be used to cover expenses
Based on the numbers I ran last night, I would be looking at 85-90% of my rental income from this property going to expenses once I factored in interest costs on the HELOC, for the first 5 years.

 I guess my confusion around all of this as discussed in this forum is that right off the bat you should be making 1-2% of the home value in rent (doesn't happen here although rental prices are higher than many small communities in the area), and getting cash flow right away. I would basically be breaking even on income vs expenses for the first while and realistically I would not have much equity in the house until after year 10. But at the end of 25 years I would have good equity in the house. So even if house prices didn't go up, for my paltry 10K cash investment I would have $250K in equity for this house and after year 5, I would be making a couple hundred $ in profit each month.

Is it always about maximizing the regular income coming in on a monthly basis?

DaveR

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Re: Getting into the rental market...understanding ROI
« Reply #3 on: September 30, 2015, 11:56:38 AM »
for my paltry 10K cash investment

Whoa, this is not a $10k investment. It is a $259,000 * 20% = $51,800 investment! Actually, it's even more than that, because you are pulling equity out via a HELOC so have to pay interest on that extra $41,800.

And since you are talking about 5, 10, 25yr of holding the rental, your expenses will be higher than you are laying out. Think you'll need to put a roof on sometime in the next 25 years? How about a new water heater? Maybe a plumbing problem costs you $1200 and suddenly 6 months of cash flow...poof.

Honestly, you have a few more things to learn (check out your local library for some good RE investing books and biggerpockets.com) before jumping into the RE game.

Ricky

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Re: Getting into the rental market...understanding ROI
« Reply #4 on: October 01, 2015, 07:04:11 AM »
I'd skip on this one. Even with leverage, you're better off throwing money at an index fund rather than deal with the headache of owning this less than ideal rental over the long term. You don't have to invest in your city, or even your country. Find a place where the numbers make sense and go from there, but don't get discouraged from RE just because this one particular house doesn't sound good.

NoNonsenseLandlord

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Re: Getting into the rental market...understanding ROI
« Reply #5 on: October 03, 2015, 08:14:37 AM »
I would NEVER get into an investment that I could not afford the down payment, the fix-up and carrying costs until it was rented on my own money.

This is WAY risky.  What are you going to do if the numbers do not work?  Or you get a bad tenant that requires and eviction and $10K to fix back to the state it was in before the renter?

chesebert

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Re: Getting into the rental market...understanding ROI
« Reply #6 on: October 03, 2015, 08:57:47 AM »
for my paltry 10K cash investment

Whoa, this is not a $10k investment. It is a $259,000 * 20% = $51,800 investment! Actually, it's even more than that, because you are pulling equity out via a HELOC so have to pay interest on that extra $41,800.

And since you are talking about 5, 10, 25yr of holding the rental, your expenses will be higher than you are laying out. Think you'll need to put a roof on sometime in the next 25 years? How about a new water heater? Maybe a plumbing problem costs you $1200 and suddenly 6 months of cash flow...poof.

Honestly, you have a few more things to learn (check out your local library for some good RE investing books and biggerpockets.com) before jumping into the RE game.

I agree, my calculator says you are already at 1642/month in your total projected monthly expenses, without taking into account any remodeling that will be needed when you purchase a foreclosure property (you will need to spend money, no question about that). When you throw in the minimum 5% vacancy rate, you are underwater. Also, I used 20% down payment, 1.5% property tax and 4.7% interest rate for rental, among other assumptions. I also on purpose did not take into account opportunity cost for the down payment amount.

In addition to the primary analysis, you also need to review the rental history of the area and do a sensitivity analysis on the effects of vacancy rate vis-a-vis rental amount, projected maintenance cost vis-a-vis rental amount and property appreciation rate vis-a-vis rental amount.
« Last Edit: October 03, 2015, 09:00:22 AM by chesebert »

thd7t

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Re: Getting into the rental market...understanding ROI
« Reply #7 on: October 05, 2015, 08:51:20 AM »
I haven't pulled the trigger on any rentals, but starting with rules of thumb, this one fails the 1% rule with rent being $1600 and total cost being about $250,000.

Setters-r-Better

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Re: Getting into the rental market...understanding ROI
« Reply #8 on: October 12, 2015, 02:40:15 PM »
Yeah, some things are wrong with your calculations. This is not a good rental for you unless market rents are closer to $3,000/month.
And, as pointed out, your investment is more than $10,000...its the whole downpayment.