Author Topic: Help With Investment Math  (Read 1987 times)

Jalapeno

  • 5 O'Clock Shadow
  • *
  • Posts: 12
Help With Investment Math
« on: December 05, 2016, 04:36:29 PM »
Hi all, super long time lurker, first time poster! I have found that I like this forum much better than BiggerPockets just because of how it's organized so I'm going to try and hang out here more and hopefully contribute some valuable information.

A little background first: My wife and I have been wanting to get into real estate investing and put together a plan a year ago to get to the point where we were comfortable buying our first property. We are almost there! We have read a ton of real estate books, put together a business plan, and have enough money to buy our first property cash. We are getting to the point where we will soon be looking for a realtor that can help us get into REO's and short sales as well as driving for dollars on our own.

What I'm really struggling with is the investment returns and identifying a good deal. I would greatly appreciate it if you guys could look at my sample deal below and tell me if it makes sense or if I'm doing something wrong. I put together a nice spreadsheet that takes everything into account and automatically calculates my mortgage payment and my returns. I'm confused because when I calculate my returns with an imaginary property that cash flows at 2% cap rate the returns are still not that good. My goal is to purchase properties that give me at least a 15% CoC return to justify buying it instead of throwing money in an index fund.

Here are my assumptions:
Home: 3 bd/1 ba
Area: C+/B- (Nice older neighborhood with nice normal houses, schools suck, I would gladly live there without kids because of the schools)
Asking Price: $56,000
Purchase Price: $50,000 (it's been on the market for a long time)
Improvements: $0 (to keep the example simple)
ARV: Ignoring for now (no improvements, no ARV)
Closing Costs: 3%
Finance Amount: $37,500
Cash Outlay: $14,000 (down payment + closing costs)
Interest Rate: 5%
Mortgage Duration: 30 years

Income: $1,000 a month (Similar properties rent for $1,100 but I'm being conservative)

Expenses:
Vacancy Rate: 10% (conservative for SFH I think)
Maintenance Rate: 5% of rent
Property Taxes: $2,373/year
Insurance: 50/month (guess)
Property Management: 10% (I would self manage but I still gotta pay myself)
Capex: 220/ month (based on biggerpockets articles and making a table of capex and dividing by useful life)

Total expenses: $7293/year
Gross Income: $10,800/year
NOI: $3,507/year
Mortgage: $2,416/year
Total Cash Flow: $1,091 on year 1
CoC ROI: 7.80%
Total ROI: 11.75% (assume no appreciation, added return over CoC is from mortgage paydown)

Based on these numbers this is what I see, a property that meets the 2% rule (wow amazing!) that doesn't beat the market by a significant enough margin to warrant acquiring it. However, people on BP buy properties like this all the time and post about the great deal they got and how they're going to make a ton of money. What am I missing? Am I shooting myself in the foot with numbers that are too conservative?

I could remove the property management expense and my CoC goes to 15.5% but I'm just tricking myself because I'm not paying myself and what happens when I do hire a property manager?

I could also leave PM but remove my Capex for the first year and my first year's CoC return goes to 26.7% return. Again, I'm just tricking myself because my $220 number is a long term average so even if I pocket it the first year I will have to shell it out at some point in the future.

Thanks for reading and I appreciate any and all feedback!


waltworks

  • Magnum Stache
  • ******
  • Posts: 3444
Re: Help With Investment Math
« Reply #1 on: December 05, 2016, 08:21:59 PM »
Property taxes are killing you here. That's the main issue, really - the property is otherwise awesome, but I've never heard of a $50k house with ~$2.5k/year property tax - property taxes roughly equal to mortgage payments?!? That's what I pay on my house, roughly, and mine is worth *almost 20 times as much*. Where the heck is it?

This is a great example of the rules of thumb being just that - rules of thumb. With more normal property taxes (say, something like 2%/year/$1000), you'd be doing quite well.

I would still maybe buy it. You're being really conservative on everything and still making a decent, though not spectacular return. If you do a little better on any of those assumptions, you'll do quite well.

-W
« Last Edit: December 05, 2016, 10:06:13 PM by waltworks »

Jalapeno

  • 5 O'Clock Shadow
  • *
  • Posts: 12
Re: Help With Investment Math
« Reply #2 on: December 06, 2016, 03:35:31 PM »
Property taxes are killing you here. That's the main issue, really - the property is otherwise awesome, but I've never heard of a $50k house with ~$2.5k/year property tax - property taxes roughly equal to mortgage payments?!? That's what I pay on my house, roughly, and mine is worth *almost 20 times as much*. Where the heck is it?

This is a great example of the rules of thumb being just that - rules of thumb. With more normal property taxes (say, something like 2%/year/$1000), you'd be doing quite well.

I would still maybe buy it. You're being really conservative on everything and still making a decent, though not spectacular return. If you do a little better on any of those assumptions, you'll do quite well.

-W

Hi waltworks! Thanks for the thoughtful reply. This is what taxes are in Garden City, MI which is where I'm thinking my farm area will be. The millage rate according to the most recent information I could find on it is 68.2 and the properties are usually assessed between 30k and 40k. Keep in mind this is a fictitious property that I made up which is sort of similar to what's available but not quite. There are no $50k properties on the market that don't need any work (unfortunately).

I like to find properties on Zillow and run an analysis on them and then play around with the numbers. My plan is to buy the first property in cash to get a good deal and refinance a year later. I'm not sure realistically how good of a deal I may be able to find once I actually start talking to people.

How do you find your deals? I was planning on driving for dollars and getting a realtor that can buy REO's.

waltworks

  • Magnum Stache
  • ******
  • Posts: 3444
Re: Help With Investment Math
« Reply #3 on: December 06, 2016, 04:03:36 PM »
I sold 2 out of 3 of my rentals last year, but kept one that is in a place I might want to move to at some point. Appreciation was just nuts over the last 4 or 5 years.

Values are way out of line with rents in most places now, so I got out and will wait for things to sort themselves out before jumping back into RE in any significant way (though I'm building an apartment in my basement).

If property taxes are really 5% in your desired area... IMO it is going to be next to impossible to find worthy rentals. That is just going to absolutely kill your returns.

-W

Jalapeno

  • 5 O'Clock Shadow
  • *
  • Posts: 12
Re: Help With Investment Math
« Reply #4 on: December 06, 2016, 04:21:15 PM »
I sold 2 out of 3 of my rentals last year, but kept one that is in a place I might want to move to at some point. Appreciation was just nuts over the last 4 or 5 years.

Values are way out of line with rents in most places now, so I got out and will wait for things to sort themselves out before jumping back into RE in any significant way (though I'm building an apartment in my basement).

If property taxes are really 5% in your desired area... IMO it is going to be next to impossible to find worthy rentals. That is just going to absolutely kill your returns.

-W

I guess here's another question that I have had in mind recently which kind of ties in to a new topic that I just started. If you pull out of RE what do you do with the cash? Do you invest it in stocks until real estate becomes feasible again or do you keep it in cash? It kills me that right now we have a ton of cash laying around because we want to get into RE. At the same time, because I want to invest in RE it doesn't seem like a wise idea to keep that money in the market because I wouldn't sell at a loss to buy a deal.

It took us a year to save up what we have right now and I'm wondering if it would have been smarter to put it all into the stock market until we were ready to buy a deal.

waltworks

  • Magnum Stache
  • ******
  • Posts: 3444
Re: Help With Investment Math
« Reply #5 on: December 06, 2016, 04:31:08 PM »
Personally, I just dump money in the market. If I find a smoking RE deal, I'd sell some stock if needed to buy it.

IMO with the US RE market the way it is right now, there is no point in holding cash looking for deals. Just invest in other stuff. If there's an RE crash of some kind, or you stumble on something great, you can jump on it, but otherwise, I wouldn't make any long term plans involving residential RE.

-W

Another Reader

  • Walrus Stache
  • *******
  • Posts: 5149
Re: Help With Investment Math
« Reply #6 on: December 07, 2016, 05:21:25 AM »
Waltworks is correct.  There are no deals in most markets now.  If there are, the vultures will will beat you to them or if they go on the open market, they will be bid up to market value.  You can keep the cash, but you may be waiting for awhile until the market turns.  In the last crash, all assets dropped in value at the same time, i.e. real estate correlated with paper assets.  A lot of people that wanted to buy could not raise capital in 2009-2012.  IMO, correlation will continue because of the nature of demand in the real estate market today.  My guess is we will see the cycle turn in the next 5 to 10 years. 

Those $50k houses with 5 percent property taxes?  There's no investor market for those properties.  The prices are low because of the taxes.  Neither owner-occupants nor investors want to buy because of the property tax burden.

Jalapeno

  • 5 O'Clock Shadow
  • *
  • Posts: 12
Re: Help With Investment Math
« Reply #7 on: December 08, 2016, 04:22:10 AM »
Waltworks is correct.  There are no deals in most markets now.  If there are, the vultures will will beat you to them or if they go on the open market, they will be bid up to market value.  You can keep the cash, but you may be waiting for awhile until the market turns.  In the last crash, all assets dropped in value at the same time, i.e. real estate correlated with paper assets.  A lot of people that wanted to buy could not raise capital in 2009-2012.  IMO, correlation will continue because of the nature of demand in the real estate market today.  My guess is we will see the cycle turn in the next 5 to 10 years. 

Those $50k houses with 5 percent property taxes?  There's no investor market for those properties.  The prices are low because of the taxes.  Neither owner-occupants nor investors want to buy because of the property tax burden.

Doesn't this just mean that I have to find a better deal? I know this varies from person to person, but what is your ROI criteria to determine whether to invest in RE or invest in the stock market? I was aiming for a CoC of 15% plus which I would get with my imaginary property above if I self manage which I plan to do anyways.

My goals with my first property other than to make a decent return are also to learn how to become a landlord and get all my systems in place. So with that in mind I think it's still worth it to find a good deal right now so that I can have the necessary experience and systems in place so that when the next crash comes around I can scale up quickly without struggling with the mechanics. What do you think?

Another Reader

  • Walrus Stache
  • *******
  • Posts: 5149
Re: Help With Investment Math
« Reply #8 on: December 08, 2016, 06:46:59 AM »
If you can find a real deal, sure.  Just make sure you understand what a real deal is and you have the capacity to get the property up and running.

waltworks

  • Magnum Stache
  • ******
  • Posts: 3444
Re: Help With Investment Math
« Reply #9 on: December 08, 2016, 08:03:55 AM »
Of course if you can find a good deal you should buy it. But what you posted *probably* isn't due to the tax burden and you've said that actually this price/condition of property doesn't exist where you're looking. So...

Don't include your labor in the CoC return. Not sure why you're changing your mind about that now when you initially posted that you weren't including it. Don't talk yourself into something by fudging the numbers!

-W

Cwadda

  • Handlebar Stache
  • *****
  • Posts: 2181
  • Age: 25
Re: Help With Investment Math
« Reply #10 on: December 08, 2016, 08:34:38 AM »
I'd avoid an area that has a 68.2 mill rate. Tougher tenants, higher vacancies, paying out the nose for taxes, etc. Try to find a better area.

Jalapeno

  • 5 O'Clock Shadow
  • *
  • Posts: 12
Re: Help With Investment Math
« Reply #11 on: December 08, 2016, 06:28:11 PM »
Of course if you can find a good deal you should buy it. But what you posted *probably* isn't due to the tax burden and you've said that actually this price/condition of property doesn't exist where you're looking. So...

Don't include your labor in the CoC return. Not sure why you're changing your mind about that now when you initially posted that you weren't including it. Don't talk yourself into something by fudging the numbers!

-W

Thanks for the advice Waltworks, I definitely don't want to fudge the numbers. Just to clarify, a deal like my imaginary deal above doesn't exist on the MLS, but this makes sense because any easy deals are going to get snapped up immediately. However, there are deals that are in the ballpark which makes me believe that if I can find a motivated seller I can then get a real deal that looks like my imaginary deal.

Cwadda, in my area specifically all millage rates are about that high unless I go to the really nice areas but then it doesn't make any sense to rent out property there. I think that if I want to be in the rental business here then that is something that I can't get away from.