Author Topic: I was face-punched over idea of buying my first rental property  (Read 24088 times)

MorningCoffee

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Ugh. Here to vent and gather some feedback.

We're looking at buying our first rental property. We have no debt and a solid net worth for our age (35 and 37). I first looked into rental properties about 1 year ago but the Math didn't add up for our city, so I dropped the idea.

Our hometown is about 1 hour away and the Math does work there. We're considering buying a rental there. Our parents and many friends still live there and we have a good understanding of the area, real estate there, etc. We plan on hiring a property management company.

Well, we have a property in mind and before making the trip to see it, we decided to ask FIL, who's handy and lives minutes away, to drive by and give us an opinion. He had nothing bad to say about the property per say once he saw it, but I wasn't ready for the face-punch. You know it's not going to be goo when it starts with "You didn't ask my opinion but..." He ranted about bad tenants, we're too far away to keep an eye on it, the place will be trashed, he wouldn't do it, invest in anything but real estate, and on and on. And on.

I refuse to let an emotional response (FIL's rant) change my mind, but do want to check that it actually makes sense to start into real estate with this property. Here's some info:
duplex
purchase price: 100k - 110k
total rent: $1,300 per month (conservative - agent says it should be higher, will raise rent for one unit as it's currently owner occupied)
expenses: 50% of rent (includes property management, property taxes, insurance, hydro, water, snow removal, grass cutting)

Cash flow positive by about $300 per month. I haven't factored in repairs or vacancy in my expenses, but plan on building up a cushion until I have a better feel for those numbers.  I'm also hoping the rent will be a bit higher that $650 per unit, which will bring the expenses closer to 40-45%. I've worked the numbers, done my research, read about RE investing and am as ready as I'll ever be. I think I can handle the risks of having tenants.

So I guess I have 3 questions.
1. Do the numbers work?
2. Have I missed anything?
(Edited: my #3 was about the FIL rant, which I don't think was clear :)
3. Why does someone rant like that, when they have no facts, no data, just a negative opinion on being a landlord. What makes them think they have the right to shit on my plans just because it's not something they would do? Argh!
« Last Edit: June 06, 2013, 12:51:40 PM by MorningCoffee »

Another Reader

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Re: I was face-punched over idea of buying my first rental property
« Reply #1 on: June 06, 2013, 12:56:08 PM »
If the listed items add up to 50 percent, this one does not look promising.  Add vacancy and collection loss plus repairs and maintenance, and you may be as high as 70 percent.  At a purchase price of $100,000, that's a free and clear cap rate of around 4.7 percent.  I'm not doing all that work and taking on the risk for that return.

Part of the problem is you are paying utilities.  It's common here to separately meter them and let the tenants pay for them.  It encourages conservation and your income is more predictable.  The flip side is risking them being turned off for non-payment on the dead of winter.  And the rents need to be adjusted to reflect some or all of the expense being passed on to the tenants.

My parents always told me the same thing.  If I had kept my first house instead of listening to them, I would have a paid off property throwing off net income of $1,500 a month after all expenses. Real estate is an excellent investment, in the US especially because of the tax treatment.  But it has to be done correctly.

oldtoyota

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Re: I was face-punched over idea of buying my first rental property
« Reply #2 on: June 06, 2013, 01:03:22 PM »
One of my parents thought buying a house was a stupid thing to do (for them way back when). The other parent thought it was smart, and they ended up buying a home. Well, it has been the best-performing investment to date, I'm certain. So, yeah, it's human nature to go on about what one knows nothing about. Happens all the time!

MorningCoffee

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Re: I was face-punched over idea of buying my first rental property
« Reply #3 on: June 06, 2013, 01:17:38 PM »
If the listed items add up to 50 percent, this one does not look promising.  Add vacancy and collection loss plus repairs and maintenance, and you may be as high as 70 percent.  At a purchase price of $100,000, that's a free and clear cap rate of around 4.7 percent.  I'm not doing all that work and taking on the risk for that return.

Part of the problem is you are paying utilities.  It's common here to separately meter them and let the tenants pay for them.  It encourages conservation and your income is more predictable.  The flip side is risking them being turned off for non-payment on the dead of winter.  And the rents need to be adjusted to reflect some or all of the expense being passed on to the tenants.

My parents always told me the same thing.  If I had kept my first house instead of listening to them, I would have a paid off property throwing off net income of $1,500 a month after all expenses. Real estate is an excellent investment, in the US especially because of the tax treatment.  But it has to be done correctly.

Thanks for the feedback. I went hunting and the estimated expenses are at 46% of expected rent. I don't like that the rent includes hydro either, rent currently isn't high enough for all in. Heat and hydro amounts to almost half of the expenses!  I don't know if each unit has separate meters. If not, anyone know if it's difficult to change?

MrMoneyPinch

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Re: I was face-punched over idea of buying my first rental property
« Reply #4 on: June 06, 2013, 05:55:22 PM »
It's not that difficult, you are required to pay an electrician to do it:)

The job includes adding a new drop, panel and meter, and untangling the mess of indoor wiring.   If you are lucky, everything is labeled right, and the electrician will make short work of it.  If it looks like my current panel, well you have a vague idea of what is wired where.  The drop is usually wired by the electric company and is charged by the foot.

arebelspy

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Re: I was face-punched over idea of buying my first rental property
« Reply #5 on: June 06, 2013, 06:06:40 PM »
You were not face punched, you were scolded by someone who (presumably?) didn't not know what they were talking about.

A face punch is reserved for when you're doing something unMustachian.

You will have many detractors and naysayers.  Listen to them, reflect, but don't let them dissuade you from doing what you want to do or know is best to do.
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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Rollin

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Re: I was face-punched over idea of buying my first rental property
« Reply #6 on: June 06, 2013, 07:55:15 PM »
You were not face punched, you were scolded by someone who (presumably?) didn't not know what they were talking about.

A face punch is reserved for when you're doing something unMustachian.

You will have many detractors and naysayers.  Listen to them, reflect, but don't let them dissuade you from doing what you want to do or know is best to do.

Good advice.  Reflect, but ultimately he ain't livin' your life.  Funny, on a related note I used to have unhappy people tell me how to be happy after my wife passed (I guess they thought I wasn't).

I got the same negativity from a cousin who had bad luck in Detroit (with some rentals), but I went with my plans to rent instead of sell.  Now I have great tenants in the house, and with my second house added - both are paying for my new house!

oldtoyota

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Re: I was face-punched over idea of buying my first rental property
« Reply #7 on: June 07, 2013, 06:50:49 AM »
You were not face punched, you were scolded by someone who (presumably?) didn't not know what they were talking about.

A face punch is reserved for when you're doing something unMustachian.

OMG. There's a *language* for frugality being claimed by this site/board. I can't even bring myself to call frugality "Mustachian." Sounds too cultish for me!

MorningCoffee

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Re: I was face-punched over idea of buying my first rental property
« Reply #8 on: June 07, 2013, 07:44:01 AM »
You were not face punched, you were scolded by someone who (presumably?) didn't not know what they were talking about.

A face punch is reserved for when you're doing something unMustachian.

You will have many detractors and naysayers.  Listen to them, reflect, but don't let them dissuade you from doing what you want to do or know is best to do.

Good advice.  Reflect, but ultimately he ain't livin' your life.  Funny, on a related note I used to have unhappy people tell me how to be happy after my wife passed (I guess they thought I wasn't).

I got the same negativity from a cousin who had bad luck in Detroit (with some rentals), but I went with my plans to rent instead of sell.  Now I have great tenants in the house, and with my second house added - both are paying for my new house!

Thanks all. It sure felt like I was scolded. He's never been a landlord, nor has anyone in the family or close friends of his. Still not sure where all that came from, as it's certainly not from experience.

Rollin, I'm happy to hear your rentals are paying your house! I hope to have the same success!

arebelspy

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Re: I was face-punched over idea of buying my first rental property
« Reply #9 on: June 07, 2013, 09:37:57 AM »
OMG. There's a *language* for frugality being claimed by this site/board. I can't even bring myself to call frugality "Mustachian." Sounds too cultish for me!

Do whatever floats your boat.  I have no energy around the concept, it sounds like you do.

Using specialized vernacular among groups with particular interests is common to express ideas, and doesn't imply a cult.   Come to one of my real estate meetings and learn a whole new language around NOI, MAO, etc. etc. 

But infer whatever you'd like from it.  :P
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AlexK

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Re: I was face-punched over idea of buying my first rental property
« Reply #10 on: June 07, 2013, 09:56:35 AM »
Is the FIL wealthy with successful investments? If so, ask him some more questions. If not, do the opposite of what he says.

The house you're looking at seems reasonable but not great. Duplexes and other low end housing needs to have higher ROI than middle-end homes because the tenants tend to destroy stuff more often and it adds to the expenses. For example I have a 4-plex and in the last year 2 broken windows (new windows installed in 2010), 6 month old carpet destroyed by soda pop spills and cigarette smoke. My units are not separately metered so I pay for it all and charge each unit $100/mo for all utilities. Once I saw a window air conditioner sitting on a table outside the window running full blast, 1 foot away from the open window.

MorningCoffee

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Re: I was face-punched over idea of buying my first rental property
« Reply #11 on: June 07, 2013, 11:04:35 AM »
Is the FIL wealthy with successful investments? If so, ask him some more questions. If not, do the opposite of what he says.

Um, no, not a wealthy successful investor. Besides, he didn't even ask how much the duplex cost or how much rent was. It was entirely based on the fact he thinks renters are scum. (Well, he actually used much more interesting language). So I didn't take what he said very seriously, I'm just peeved about it. It did teach me not to open my big mouth.

The house you're looking at seems reasonable but not great. Duplexes and other low end housing needs to have higher ROI than middle-end homes because the tenants tend to destroy stuff more often and it adds to the expenses. For example I have a 4-plex and in the last year 2 broken windows (new windows installed in 2010), 6 month old carpet destroyed by soda pop spills and cigarette smoke. My units are not separately metered so I pay for it all and charge each unit $100/mo for all utilities. Once I saw a window air conditioner sitting on a table outside the window running full blast, 1 foot away from the open window.

Thanks, that great feedback. The key ideas I keep seeing is monthly rent at least 1% of property value (got it) and expenses below 50% (which it just makes). According to the cash flow write-up, with the rent more in line with the market prices, expenses would be at 48%, including a 5% set aside for repairs and another 5% for vacancy. (I hadn't included them the first time).

Is that too high? What range should I be looking at?

AlexK

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Re: I was face-punched over idea of buying my first rental property
« Reply #12 on: June 07, 2013, 01:55:32 PM »
I haven't been a landlord long enough to know if the 50% rule is true or not but a lot of the experienced guys say it is. Most investors want rent to be 2% of property value but I understand that is impossible to find in most areas. 

If you are using a property manager, repairs always cost much more than you would expect. The problem is they get a handy man in there and he decides what needs fixing and how long it will take. Not ideal.

This property is not a home run but it could be a decent investment. If it is in a desirable neighborhood that would help swing it to the positive side. The drawbacks to a bad neighborhood are higher vacancy and more tenant destruction, which is hard to estimate and factor in when running the numbers before you buy.

.22guy

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Re: I was face-punched over idea of buying my first rental property
« Reply #13 on: June 07, 2013, 02:23:28 PM »
Is your FIL a blowhard all the time?  I dealt with one for 10 years and it's a struggle.  He's a smart guy, but also a bit of a know it all?

My advice is to run the numbers and keep emotion (and FIL opinion) out of it. 

Ben

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Re: I was face-punched over idea of buying my first rental property
« Reply #14 on: June 07, 2013, 03:05:30 PM »
It seems I have a different perspective than the other posters. Your FIL is speaking from the perspective of experience (either himself or his perspective over a longer lifespan than yours). Didn't you ask him for his opinion? This is advice that you solicited from someone who means you well.

Being a landlord is not like owning stocks, and many people do not have the time or patience for an extra part time job, or a stomach for risk. Transaction costs are high if you decide it's not for you, can't offload it, etc. Many people lose money in real estate due to poor management, decision-making, greed, or bad luck. Do the math, but take his opinion into consideration since he is someone that you viewed as having an important perspective to take into account (before you know his opinion would contradict what you want to do, of course :) ). If it's your hometown, he may have a better understanding of your prospective renters.

MorningCoffee

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Re: I was face-punched over idea of buying my first rental property
« Reply #15 on: June 07, 2013, 03:55:34 PM »
I haven't been a landlord long enough to know if the 50% rule is true or not but a lot of the experienced guys say it is. Most investors want rent to be 2% of property value but I understand that is impossible to find in most areas. 

If you are using a property manager, repairs always cost much more than you would expect. The problem is they get a handy man in there and he decides what needs fixing and how long it will take. Not ideal.

This property is not a home run but it could be a decent investment. If it is in a desirable neighborhood that would help swing it to the positive side. The drawbacks to a bad neighborhood are higher vacancy and more tenant destruction, which is hard to estimate and factor in when running the numbers before you buy.

I could get closer to 2% on a few properties but they're in a terrible part of town. I wouldn't want to own there. This one is in a good but inexpensive (due to being a bit older) neighbourhood. It's also a quiet area of town, which hopefully means it would be to boring for those looking for a party place. I'm focusing on that general area of town.

Your comment about property managers and cost of repairs is a good one. I do plan on asking for references, but should do some hunting on my own, since I'm sure they won't give me the names of dissatisfied clients.

MorningCoffee

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Re: I was face-punched over idea of buying my first rental property
« Reply #16 on: June 07, 2013, 04:02:24 PM »
Is your FIL a blowhard all the time?  I dealt with one for 10 years and it's a struggle.  He's a smart guy, but also a bit of a know it all?

My advice is to run the numbers and keep emotion (and FIL opinion) out of it.

He usually isn't, which is why I was caught off guard I guess. I do plan to keep focused on the numbers, and decide if it's something we want to do, not what others think.
I also needed to vent... I am being careful not to vent to my husband :)

daverobev

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Re: I was face-punched over idea of buying my first rental property
« Reply #17 on: June 07, 2013, 04:09:50 PM »
1 hour from Ottawa - in which direction?

I would not want to own rentals in Ontario. Yes, you can, and yes, you can make it work but you have to VET your prospective tenants really well. Because IF you have problems, it seems like the game is rigged in the tenants' favour.

I live just about an hour from Ottawa, so I'm interested to know where you were looking!

tomsang

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Re: I was face-punched over idea of buying my first rental property
« Reply #18 on: June 07, 2013, 04:31:50 PM »
He could also be warning you off as he know or feels like he will be the one having to keep an eye on the property and deal with any emergencies as he is in town and you are an hour away. He will feel this way even though you are using a property management firm.  If there are any hiccups in the rental, he will probably be the one telling you he told you so.  Lots of fun.   

MorningCoffee

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Re: I was face-punched over idea of buying my first rental property
« Reply #19 on: June 07, 2013, 04:41:46 PM »
It seems I have a different perspective than the other posters. Your FIL is speaking from the perspective of experience (either himself or his perspective over a longer lifespan than yours). Didn't you ask him for his opinion? This is advice that you solicited from someone who means you well.

Yes I asked for it. And I got it. :)
My FIL is experienced when it comes to houses, roofs, renos, etc., and I asked him if he could take a look at a house (from the outside). We were planning on asking him to come along with us if we booked an appointment because he's as good as a home inspector and know he'd be honest about work that needs to be done. I'm hoping he meant well because being told I'm stupid if I do it doesn't exactly come across that way. I mostly feel badly for my husband, as he'll now have to deal with him and his comments.

MorningCoffee

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Re: I was face-punched over idea of buying my first rental property
« Reply #20 on: June 07, 2013, 04:44:52 PM »
1 hour from Ottawa - in which direction?

I would not want to own rentals in Ontario. Yes, you can, and yes, you can make it work but you have to VET your prospective tenants really well. Because IF you have problems, it seems like the game is rigged in the tenants' favour.

I live just about an hour from Ottawa, so I'm interested to know where you were looking!

Ha ha! Trying to steal my rental property? ;)
I've also heard that about tenants. I'm hoping dealing with a property management company will help that? They do screen carefully, I hope.
I'll send you a private message.

MorningCoffee

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Re: I was face-punched over idea of buying my first rental property
« Reply #21 on: June 07, 2013, 05:01:27 PM »
He could also be warning you off as he know or feels like he will be the one having to keep an eye on the property and deal with any emergencies as he is in town and you are an hour away. He will feel this way even though you are using a property management firm.  If there are any hiccups in the rental, he will probably be the one telling you he told you so.  Lots of fun.   

Yup, anticipating hearing "I told you so" already. Maybe he's thinking we're going to call him in the middle of the night, I don't know. We really don't impose on him, we do our own DIY work (or hire contractors when needed - we don't ask him even though we know he has the skills) and I'd like to think we're responsible people. Not sure why he'd think we wouldn't take care of it.

Praxis

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Re: I was face-punched over idea of buying my first rental property
« Reply #22 on: June 08, 2013, 12:24:16 PM »
Number time!

So, $110k purchase price.  Are you buying cash or with a loan?  With 80% down and 4% interest you should have a monthly payment of ~$550-600 depending on local taxes.  (Research local property taxes! Some regions are reasonable, some are insane.)

Then $1300 a month cash flow?


That's an internal rate of return (IRR) of 14%.  The house is worth 110k and returning $15.6k (pre-tax/insurance).

Leveraged with a 88k loan and $550/month payment, compared to a $1300/mo income minus 10% in property management fees (so $1170/mo income), you make $620/mo profit after expenses, or $7,440/year.  You put $22k down to buy the property, plus I'm going to assume $5k in closing costs + loan origination fees, so you are $27k out of pocket.

Leveraged, this property gives you a 27% return on best years (tenant occupied all 12 months, no repairs).

If we use the 50% rule and assume half of your profit (~$3.7k/year) will go to expenses, you will still average a 13.5% return.


Compare to this MMM article on leveraged real estate math.


In summary:

Max potential IRR: 14%
Max potential ROI: 27%
Estimated average ROI: 13.5%

This, folks, is why I buy real estate.
« Last Edit: June 08, 2013, 12:27:24 PM by Praxis »

Another Reader

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Re: I was face-punched over idea of buying my first rental property
« Reply #23 on: June 08, 2013, 05:28:04 PM »
I hope you don't buy TOO much real estate using those assumptions, at least not in the US.  The OP used a rent figure of $1,300.  I can't speak for rates and terms in Canada, but in the US, the OP is going to put a minimum 25 percent down and pay at least 1 percent premium over the owner-occupied rate.  Since 30 year fixed rates for owner-occupied properties are 4 percent, I will use 5 percent.  You assumed a purchase price of $110,000.  His principal and interest payment is around $443.

OP pays utilities, not a good thing because they are a big percentage of the expenses and there is no incentive for tenants to conserve.  Adding up all the expenses, including utilities, vacancy and collection loss, property taxes, insurance, and repairs and maintenance (including pro-rata capital improvements) gets the expenses up to a minimum of 50 percent.  That seems low with utilities, especially in a cold climate.  If the pro-forma from the seller indicates 50 percent, your actual expenses will be higher.  Seller expense statements reflect best case scenarios, and that's putting it nicely.  With utilities and reasonable taxes, say 55 percent as a best case scenario.  $1,300 x 0.45 = $585 is the net after all expenses except the mortgage. The net income after paying the mortgage and all expenses is $585-$443.  That's $142 a month, or $1,704 a year.  If The OP invested the down payment of $27,500 and the closing costs of $5,000 for a total $32,500, the hypothetical cash on cash return is $1704/$32,500, or around 5.25 percent.

If the OP pays cash, the net income is $585 x 12, or $7,020.  Dividing that by the all in amount of $115,000 gives you a free and clear cash on cash return of around 6.1 percent.

What Praxis is saying is after you allow $130 (10 percent) for property management and $130 (another 10 percent) for taxes and insurance in your mortgage payment (assuming you could get 80 percent financing with 20 percent down on an income property), you could earn these spectacular rates of return if you had no vacancy or repairs.  Not only has he not included the utilities, he's assuming 20 percent expenses net of utilities, which we already know is not achievable.  He then allows you an additional $3,720 a year in expenses, or $310 to get to a 13.5 percent return.   The trouble is that's 43.8 percent expenses, which we know is low, and the conclusion assumes financing that is likely not available to you.

I'm all in favor of buying and operating rental real estate.  However, the numbers have to be accurate, and they have to be analyzed carefully.  Small changes in the assumptions can have a dramatic impact on your return and can push you from cash flow positive to cash flow negative.  There is risk here because you do not have a good handle on the numbers.  In your shoes, I would do more homework before I started writing checks.

marty998

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Re: I was face-punched over idea of buying my first rental property
« Reply #24 on: June 08, 2013, 05:40:06 PM »
Why does everyone on this forum never take into account capital gains?

Even assuming a relatively small 3% adds over $3000 to the net return.

Is there something about your property market that cap gains just don't exist?

Another Reader

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Re: I was face-punched over idea of buying my first rental property
« Reply #25 on: June 08, 2013, 06:04:29 PM »
Appreciation is certainly part of the total return, if it happens.  If you live in the Bay Area or in the coastal areas of Southern California, it's likely to be the majority of your profit.  Other areas of the country may or may not experience appreciation.  However, here we are considering cash flow, as those are the "numbers" the OP was asking about.

arebelspy

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Re: I was face-punched over idea of buying my first rental property
« Reply #26 on: June 08, 2013, 06:17:50 PM »
Why does everyone on this forum never take into account capital gains?

Even assuming a relatively small 3% adds over $3000 to the net return.

Is there something about your property market that cap gains just don't exist?

Appreciation is unreliable.  Cash on cash return is much more reliable.

If you could get a stable blue chip stock returning 4% dividends versus a stable blue chip stock returning 10% dividends, and have no knowledge of the future with either one (and both are as likely as each other to do well in the future), which would you pick?

The properties will likely appreciate, yes, and it will be part of the overall return eventually calculated.  But when purchasing, it is often better to go with the property returning more off the bat, assuming it also will appreciate similarly to the one returning less (i.e. isn't in a warzone, etc.)

If you are making a straight appreciation play, fine, own it.  But most long term real estate investors view that as secondary, and given the choice between one with cash flow and one without, will choose the one with, and take the extra appreciation on top.

Also.. GREAT analysis on the numbers Another Reader.  That should be a post every would be real estate investor should read over and over until they understand where those numbers came from and why this may not be such a good investment (and where the OP needs more information to decide).
« Last Edit: June 08, 2013, 06:20:31 PM by arebelspy »
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Re: I was face-punched over idea of buying my first rental property
« Reply #27 on: June 09, 2013, 03:40:29 AM »
Regarding the management company- they really only vet as carefully as you direct them to. I use one because my rental is on the other side of the world, but I've been a bit disappointed at how much management of the management company I need to do. Another little caveat, when you're running the numbers, I'd recommend putting in a little buffer for repairs. Tenants vary, but some are very high maintenance and seem to need repairs monthly. Not sure about the laws where you are, but where my place is, tenant laws are very strong, and I pretty much have to pay for everything they ask for. sigh. but all in all I think it;s a decent way to invest and will pay off in the end.

Praxis

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Re: I was face-punched over idea of buying my first rental property
« Reply #28 on: June 09, 2013, 01:11:15 PM »
Hi Another Reader,

I hope you don't buy TOO much real estate using those assumptions, at least not in the US.

Quite a lot, actually.  However, I don't use a manager or pay the utilities (completely forgot OP said he would do this, it seems very unusual to me.)  I won't buy a property if I the monthly income isn't at minimum twice the PITI, or in other words, the net profit is more than the PITI.  I also generally add at least $25k to my net worth with each house purchase, and have to use ROE for return rates because my ROI is so high as to appear to be nonsense.

When I analyzed OPs property, it seemed to fit that hard rule I use- $1300 is more than 2x a $550-600 PITI.  However, you are right that I missed a couple things- the OP paying the utilities (very strange to me) + the property management fee will send the monthly expenses noticeably half of the income.

Quote
The OP used a rent figure of $1,300.  I can't speak for rates and terms in Canada, but in the US, the OP is going to put a minimum 25 percent down and pay at least 1 percent premium over the owner-occupied rate.  Since 30 year fixed rates for owner-occupied properties are 4 percent, I will use 5 percent.  You assumed a purchase price of $110,000.  His principal and interest payment is around $443.

Owner occupied properties are in the low 3's. I just did a non-owner-occupied loan at just under 4%.  They gave me a 0.5% premium.  I'd suggest using a mortgage broker to on non-owner-occupied as I actually went door to door to banks to compare their rates and they varied wildly, about half wouldn't even do it and most added 1-1.5%.

I assumed 4% interest, but I also assumed about $100/mo in taxes (this would be above 1% annually) and $50/mo in insurance.




Quote
Not only has he not included the utilities,

I DID forget this part, because I never do this on my properties. This is my bad and does make the numbers look significantly worse, and less than what I would usually go for.  OP, why is it that you want to pay the utilities?


Quote
What Praxis is saying is after you allow $130 (10 percent) for property management and $130 (another 10 percent) for taxes and insurance in your mortgage payment (assuming you could get 80 percent financing with 20 percent down on an income property), you could earn these spectacular rates of return if you had no vacancy or repairs.  Not only has he not included the utilities, he's assuming 20 percent expenses net of utilities, which we already know is not achievable.  He then allows you an additional $3,720 a year in expenses, or $310 to get to a 13.5 percent return.   The trouble is that's 43.8 percent expenses, which we know is low, and the conclusion assumes financing that is likely not available to you.


I'm not sure what the bolded part means?


Why does everyone on this forum never take into account capital gains?

Even assuming a relatively small 3% adds over $3000 to the net return.

Is there something about your property market that cap gains just don't exist?

Hi Marty,

Appreciation isn't set.  It's tied to inflation and the market.  It does intuitively seem like real estate will go up to match inflation (3%), but changes in the local market (a neighborhood getting nicer or worse, the attractiveness of the city, where the talent is going, whether people are tending to buy or rent, the liquidity of sales) overrides that by so much more.  You can't really count on it to appreciate.  People bought like nuts before the crash because they treated appreciation value as a given.

Buy a dividend stock for dividends, not appreciation.  If it appreciates, great.
« Last Edit: June 09, 2013, 01:14:54 PM by Praxis »

honobob

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Re: I was face-punched over idea of buying my first rental property
« Reply #29 on: June 09, 2013, 02:14:15 PM »
Ugh. Here to vent and gather some feedback.
 

So I guess I have 3 questions.
1. Do the numbers work?
2. Have I missed anything?
(Edited: my #3 was about the FIL rant, which I don't think was clear :)
3. Why does someone rant like that, when they have no facts, no data, just a negative opinion on being a landlord. What makes them think they have the right to shit on my plans just because it's not something they would do? Argh!

1.  What numbers?  There is NO such thing as "the math"!  Quit getting numbers over the internet.
2.  Rent growth and appreciation! Seriously, how can you come up with any decision without KNOWING these numbers.
3.  It's much easier to support a non active decision.  Plus I think he didn't want to be involved.

Here ya go.
http://www.mortgage-investments.com/resources/online-calculators/10-year-investment-in-real-estate/
« Last Edit: June 09, 2013, 02:33:34 PM by honobob »

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Re: I was face-punched over idea of buying my first rental property
« Reply #30 on: June 09, 2013, 02:19:43 PM »
If the listed items add up to 50 percent, this one does not look promising.  Add vacancy and collection loss plus repairs and maintenance, and you may be as high as 70 percent.  At a purchase price of $100,000, that's a free and clear cap rate of around 4.7 percent.  I'm not doing all that work and taking on the risk for that return.

 
Another reader can you define "a free and clear cap rate"?  Also, aren't you just guessing at v/c and expenses?  How does that give you a cap rate and even if you had actual numbers what would that number tell you by its self?

Why not just use a GRM if you're trying to compare properties?  WAY easier and much more accurate than a crap rate.

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Re: I was face-punched over idea of buying my first rental property
« Reply #31 on: June 09, 2013, 04:43:23 PM »
Cap rate = NOI/Value or NOI/Sales Price.  Free and clear cap rate = the yield rate for the unleveraged property, as well as the capitalization rate.

We are not valuing the property here, we are estimating the return.  Assumptions consistent with the OP's statements were made. 

Praxis:

I'm not seeing 30 year loans at the rates you quote.  Are your rates for 10 or 15 year paper?

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Re: I was face-punched over idea of buying my first rental property
« Reply #32 on: June 09, 2013, 05:04:01 PM »
Thanks everyone for the feedback. Lots of food for thought.

The OP used a rent figure of $1,300.  I can't speak for rates and terms in Canada, but in the US, the OP is going to put a minimum 25 percent down and pay at least 1 percent premium over the owner-occupied rate.  Since 30 year fixed rates for owner-occupied properties are 4 percent, I will use 5 percent.  You assumed a purchase price of $110,000.  His principal and interest payment is around $443.

I see I didn't include mortgage info, sorry. I can get a 25 year amortization, locked in at 2.9% for 4 years. I need to put 20% down since it's an income property. I would be willing to buy it for 100k, which is closer to what it's worth (based on research - seller's agent agreed it was a little high and price drop is coming. I'm glad he's not my agent, saying that to potential buyers)
Mortgage payment would come to $374 per month.

OP pays utilities, not a good thing because they are a big percentage of the expenses and there is no incentive for tenants to conserve.  Adding up all the expenses, including utilities, vacancy and collection loss, property taxes, insurance, and repairs and maintenance (including pro-rata capital improvements) gets the expenses up to a minimum of 50 percent.  That seems low with utilities, especially in a cold climate.  If the pro-forma from the seller indicates 50 percent, your actual expenses will be higher.  Seller expense statements reflect best case scenarios, and that's putting it nicely.  With utilities and reasonable taxes, say 55 percent as a best case scenario.  $1,300 x 0.45 = $585 is the net after all expenses except the mortgage. The net income after paying the mortgage and all expenses is $585-$443.  That's $142 a month, or $1,704 a year.  If The OP invested the down payment of $27,500 and the closing costs of $5,000 for a total $32,500, the hypothetical cash on cash return is $1704/$32,500, or around 5.25 percent.

Good info, thanks. I agree with the utilities comments, which is why I may keep hunting, but haven't decided yet. The agent supplied a copy of utility bills (heat and electricity just under 3K for 2012) but found his insurance really low ($600 per year). That may change once it's no longer owner occupied for one unit.

Closing costs estimated at $1,500 by agent and bank. So 21.5k cash out of pocket. (I'm sure something else may come up. I would have a few thousands aside, just in case).

$585 - $374= $211 per month left over after expenses and mortgage.
lets say 23k out of pocket (down, closing and a buffer)
$2532 (per year) / 23K = 11% cash on return (is that right? seems high)

That would be the current numbers. Rent is currently low for a utilities included duplex. Should be closer to $750 per month, which is what we would try for the empty unit. Unsure if we could raise the rent on the current tenant. More homework to do.


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Re: I was face-punched over idea of buying my first rental property
« Reply #33 on: June 09, 2013, 05:17:04 PM »
Thanks Praxis. I do appreciate the feedback.


I DID forget this part, because I never do this on my properties. This is my bad and does make the numbers look significantly worse, and less than what I would usually go for.  OP, why is it that you want to pay the utilities?


I'd much rather not pay utilities. It is quite common though in the city I'm looking to buy. What makes it more difficult is that this duplex used to be a single home, thus only one electric meter (which could be separated - estimated cost 2-3K) but worse, only one furnace. That cost has to be paid by landlord under our tenant laws (since tenant can't be charged per use, as registered on a separate meter or unit). Only work around I can think of is pulling out the furnace and installing electric heat in both units, then having separate meters installed.

So far, all income properties I've been interested include utilities, no separate meters. I'm still doing research to see if it's worth waiting for a property that isn't set up that way, or if it's cost effective to bring in an electrician.

honobob

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Re: I was face-punched over idea of buying my first rental property
« Reply #34 on: June 09, 2013, 05:47:46 PM »
Cap rate = NOI/Value or NOI/Sales Price.  Free and clear cap rate = the yield rate for the unleveraged property, as well as the capitalization rate.

We are not valuing the property here, we are estimating the return.  Assumptions consistent with the OP's statements were made. 

Praxis:

I'm not seeing 30 year loans at the rates you quote.  Are your rates for 10 or 15 year paper?

I've never heard of a cap rate for a leveraged property.  So are you just adding words to cap rate when you really just mean cap rate? 
No wonder it gets so confusing!

Return?  Operating return?  ROE?  If all expenses on all properties are 50% why isn't a GRM a better and easier way to   
guesstimate a return? http://www.retailinvestor.org/realestate.html#calculate

OK, good for year one, or is it?  Are all 10% caps great but all 5% caps bad?  There is way more to profitability than coming up with some crap rate.   


http://www.ehow.com/how_6771014_calculate-yield-rate.html
« Last Edit: June 09, 2013, 06:06:43 PM by honobob »

Another Reader

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Re: I was face-punched over idea of buying my first rental property
« Reply #35 on: June 09, 2013, 06:49:17 PM »
If you look at your first reference, the first step is exactly what I calculated.

For a more detailed discussion, I suggest "The Appraisal of Real Estate," published by the Appraisal Institute.

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Re: I was face-punched over idea of buying my first rental property
« Reply #36 on: June 09, 2013, 07:58:01 PM »
If you look at your first reference, the first step is exactly what I calculated.

For a more detailed discussion, I suggest "The Appraisal of Real Estate," published by the Appraisal Institute.
Calculate the Operating Return

a.Start with the rent saved (or earned, if this is an investment property).
b.Subtract operating costs that include an allocation for lumpy purchases that don't occur each year.
c.Divide the net yearly income by the total property cost (that includes the original legal and transaction costs).

The dollar value of the operating return will increase over time as rents increase - roughly in line with increases in the market value of property. You should not factor the increase into your calculated operating return %. Consider this like the stable 4% dividend paid by banks on their stock. As the bank grows, the value of its stock grows, and the dividend also grows, but remains at 4% of the stock price. The owners realizes 4% + capital gains over time.

This operating return may be over 8%, or it may be as low as 2.5%. It may be that in areas of the country that experience higher increases in house prices, the operating return is lower. And vice versa. Investors looking to buy rental properties look outside the major cities where the rents are higher compared to the selling prices. But in these areas the capital appreciation will be lower. If anyone has seen research that looks at this, please e-mail this site with the reference.



so you are saying you are computing a one year operating return?  Based on guesstimated expenses?  Do you have support that these expenses are normal/reasonable?  Seriously, you are attempting to calculate an operating return based on a CRAP rate!?  I hate to be the cap rate cop but what you are posting is nonsense.  As far as the Appraisal Institute can you refer me to their analysis of single family/duplex cap rates?  You are not answering my specific questions.  Why are you being so evasive.  It's not rocket surgery.

Another Reader

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Re: I was face-punched over idea of buying my first rental property
« Reply #37 on: June 09, 2013, 08:27:37 PM »
Why don't you do what I did, use the OP's assumptions?

What whoever operates your cited website did was to calculate the first year's "operating return," which is identical to the capitalization rate.  Get the book out.  The overall capitalization rate is the first year net operating income divided by the sales price or value.  A capitalization rate is a generic ratio.  It's the rate at which income is capitalized into value.  It can be used to analyze any income stream.  However, we are not valuing the property here.  The objective is to get an idea of what the OP's likely return would be, given his assumptions about the property.  If his assumptions change, so will his cash on cash return. 

In your world, you rely on appreciation for the bulk of your profit.  An hour outside of Ottawa, not so much.  Your Canadian website operator acknowledges this.  Cap rates in San Francisco are breathtakingly low and positive cash flow with leverage is difficult to achieve.  In places where appreciation is low, the return on investment must come from the cash flow, so cap rates are high.


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Re: I was face-punched over idea of buying my first rental property
« Reply #38 on: June 09, 2013, 10:12:30 PM »
He could also be warning you off as he know or feels like he will be the one having to keep an eye on the property and deal with any emergencies as he is in town and you are an hour away. He will feel this way even though you are using a property management firm.  If there are any hiccups in the rental, he will probably be the one telling you he told you so.  Lots of fun.   

That's what I thought too--the FIL may think he'll have to run interference on the property.

I don't understand buying investment property far away where you can't keep an eye on it. I don't understand buying investment property where you pay someone else to manage it. Just don't get that concept.

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Re: I was face-punched over idea of buying my first rental property
« Reply #39 on: June 10, 2013, 10:11:21 AM »
I am by no means as sophisticated of a RE investor as many on this board, but wanted to throw this out.  If others have read my other posts, they may guess what I will be bringing up:)

What is the value of the 30 year fixed rate loan? 

We have two rentals that have marginal positive cash flow and I feel very fortunate, because I was able to lock in a 30 year fixed rate loans at 3.875%(Non Owner Occupied "High Rate"). I feel like the value of the loans is about the same as than the value of the structures on the two properties.  If there is inflation in the future, rents will go up while the 30 year fixed will be a perfect hedge.  In 5 or so years with yearly increases in the rents, the cash flow will look much better, as my mortgage payments will stay the same.(Taxes and insurance may rise, but minimal compared to the loan).

Any thoughts on this?

I like leverage, when the goverment is giving away free money!   

honobob

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Re: I was face-punched over idea of buying my first rental property
« Reply #40 on: June 10, 2013, 12:49:44 PM »
Why don't you do what I did, use the OP's assumptions?

 
!.  They are incomplete.
2. They are more guesses than assumptions.
3. Of what use are they by themselves?

I don't question NOI/sales price= cap rate.   What I am questioning is the NOI you are calculating.  There's more to it than making up numbers and percentages.  It's like using a mallet and a melon scooper and saying you are prepared to perform brain surgery.  OK, it is an invasive procedure to the head but brain surgery?  Think not.

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Re: I was face-punched over idea of buying my first rental property
« Reply #41 on: June 10, 2013, 01:24:02 PM »
Why don't you do what I did, use the OP's assumptions?

 
!.  They are incomplete.
2. They are more guesses than assumptions.
3. Of what use are they by themselves?

I don't question NOI/sales price= cap rate.   What I am questioning is the NOI you are calculating.  There's more to it than making up numbers and percentages.  It's like using a mallet and a melon scooper and saying you are prepared to perform brain surgery.  OK, it is an invasive procedure to the head but brain surgery?  Think not.

I don't understand why you think my numbers are so incomplete. I didn't list every item, but I have exact figures in front of me and, when added up, they come to about 50% of my rent. I clearly indicated I gave percentages based on a rent of $650 per month x 2 units = $1300, or $15,600 per year.

I also indicated that with these numbers, I have about $300 left after mortgage payments. Mortgage payment could be $374 (25 years) or $311 (30 year), depending what I choose. I can lock for 4 years, which means we need to renegotiate the interest rate then. This is the norm here, so I didn't go into too much detail, since it will change.

No guessing, just estimates based on last year's numbers. The numbers will be different yearly, as taxes, maintenance, utility usage varies. I have no crystal ball, it's the best I can do.

honobob

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Re: I was face-punched over idea of buying my first rental property
« Reply #42 on: June 10, 2013, 03:10:06 PM »
Why don't you do what I did, use the OP's assumptions?

 

!.  They are incomplete.
2. They are more guesses than assumptions.
3. Of what use are they by themselves?

I don't question NOI/sales price= cap rate.   What I am questioning is the NOI you are calculating.  There's more to it than making up numbers and percentages.  It's like using a mallet and a melon scooper and saying you are prepared to perform brain surgery.  OK, it is an invasive procedure to the head but brain surgery?  Think not.

I don't understand why you think my numbers are so incomplete. I didn't list every item, but I have exact figures in front of me and, when added up, they come to about 50% of my rent. I clearly indicated I gave percentages based on a rent of $650 per month x 2 units = $1300, or $15,600 per year.

I also indicated that with these numbers, I have about $300 left after mortgage payments. Mortgage payment could be $374 (25 years) or $311 (30 year), depending what I choose. I can lock for 4 years, which means we need to renegotiate the interest rate then. This is the norm here, so I didn't go into too much detail, since it will change.

No guessing, just estimates based on last year's numbers. The numbers will be different yearly, as taxes, maintenance, utility usage varies. I have no crystal ball, it's the best I can do.
You would NOT be asking this is you knew how to figure NOI.  The percentages should be calculated for each category so they could be compared to a publication that furnishes that information on MARKET SALES for your type of property in your property's area and in the timeframe of your purchase.  Oh wait,  there is NO SUCH publication for sfh or small residential properties. Shucks. Kinda makes your crap rate useless.

If you can't tell why the "math" doesn't work in your home town but does an hour away you probably should NOT be investing in real estate.
« Last Edit: June 10, 2013, 03:24:39 PM by honobob »

honobob

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Re: I was face-punched over idea of buying my first rental property
« Reply #43 on: June 10, 2013, 04:20:59 PM »
morningcoffee
I am not trying to dissuade you from investing in real estate.  I love real estate and have done very well.  If you want to buy based on 50% of whatever good for you.  It may even work out for you.  All those RULES would have stopped me from making a few million in real estate.  I'm just pointing out alternatives and pointing out where someone is misusing an actual real estate process to come to some conclusion that is in fact not supported by the terminology they are spouting. 


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Re: I was face-punched over idea of buying my first rental property
« Reply #44 on: June 10, 2013, 05:11:43 PM »
I'm just pointing out alternatives

I must have missed this, all I've seen is quite a bit of arguing.

Please clarify for me: if you disagree with figuring an NOI and calculating the cash on cash return, what method, exactly, do you think is best?
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Re: I was face-punched over idea of buying my first rental property
« Reply #45 on: June 11, 2013, 02:29:56 AM »
@Marty...I think that Australia has had excellent and reliable capital gains with RE and we value that much more greatly Down Under: of course I think its chicken and egg..the more people who "believe" in RE and buy some, the better the market.

@OP ... one thing this website has taught me is to counter negativity with keeping an open mind, doing a lot of research/ fact finding/self education  and then using your brain to make the best decision.

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Re: I was face-punched over idea of buying my first rental property
« Reply #46 on: June 11, 2013, 05:56:45 AM »

@OP ... one thing this website has taught me is to counter negativity with keeping an open mind, doing a lot of research/ fact finding/self education  and then using your brain to make the best decision.

I totally agree. Thanks!

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Re: I was face-punched over idea of buying my first rental property
« Reply #47 on: June 11, 2013, 01:31:50 PM »
Do you factor into your calculations at all the possible increase in interest rates that could happen once you refinance in 5 years? The American RE investors here enjoy 30yr fixed rate mortgages I believe - Canadians do not have that.

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Re: I was face-punched over idea of buying my first rental property
« Reply #48 on: June 12, 2013, 10:16:51 AM »
@F140: that's not possible.  At best, one can do a little try with the historical mean, 8.7%.
We know 20% has happened, but what's the probability of that?  If you plan everything using the worst assumptions you will never do anything.

A quick info for our US friends: any fixed rate longer than 5 years in Canada is not binding the debtor after the 5th year, so banks mostly don't do it.  Some places give 10 year rates, but the big ones don't.

aclarridge

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Re: I was face-punched over idea of buying my first rental property
« Reply #49 on: June 12, 2013, 11:39:29 AM »
@F140: that's not possible.  At best, one can do a little try with the historical mean, 8.7%.
We know 20% has happened, but what's the probability of that?  If you plan everything using the worst assumptions you will never do anything.

A quick info for our US friends: any fixed rate longer than 5 years in Canada is not binding the debtor after the 5th year, so banks mostly don't do it.  Some places give 10 year rates, but the big ones don't.

I don't think it's possible to account for it perfectly either because it's an unknown, but assuming it will stay the same (i.e. at historic lows) might be the implicit assumption of the OP. One might want to structure an investment that still makes sense if rates are up to 6 or 8% in five years.