Thinking of buying a rental property! Opinions please

[Balance]

Hi all. I am thinking of buying a rental property here in the SF Bay Area. The property I am looking at is a condo selling as a short sale for $125k. It is a 1 bedroom/1 bath approximately 700 square feet. HOA is $385. This development used to command a selling price of $300k for a similar floorplan condo just a few years ago at the height of the market. (I know the past values mean nothing for the future but I just wanted to make a note of it) I have tracked it for the last 2 years and saw it drop quite significantly to the point where I think it makes sense to at least crunch the numbers.

I work as a real estate appraiser in the SF Bay Area. So I constantly analyze market trends in all the neighborhoods I appraise in. This development is centrally located on the Peninsula between downtown SF and Silicon Valley. It is within walking distance of YouTube's corporate headquarters.  I have done recent rental surveys in the subject's development and rents consistently go from a low average of $1,350 to a high of $1,500.

Here are the stats again
1 Bed/1 bath Condominium
700 square feet
$125,000 Purchase Price
Rental range - $1350-1500
HOA $385
Vacancy rate is sub 3%

My first question would if I plan to use it primarily as a rental property what % down payment would I need.  I was thinking of putting down 20% but is that sufficient for lenders?  My credit score is over 800 with no debt. But even with stellar credit and a good debt ratio I know lenders are still pretty strict on lending these days.

I will be managing the property myself to save on prop. management fees.  I don't see this development dropping much lower and rents are very strong here in the Bay Area. I have been waiting to buy in this development for over a year. I am concerned that rates will continue to rise. Does this seem like a good investment? 

Any opinions are greatly appreciated.  Thanks!

[arebelspy]

That's not a cash flow positive property.

I mean you can force cash flow with a large down payment, but based on 50% of rent going to expenses, management, vacancy, capital repairs, maintenance, etc., then the huge HOA payment, it doesn't leave enough to service debt at that purchase price.

(Yes, I understand you'll manage it yourself.  That's a management job you're paying yourself for, not a return on investment.)

Unless you're speculating and looking for appreciation, SF is just not a great place to invest in cash flow properties.

And to put it another way.. why would you want that place when you could invest half as much in a place like Texas, Vegas, whatever and rent for 1200 with no HOA and cash flow hundreds more per month?  Real estate is local, and that's an inferior place to invest for cash flow.  I'm a big fan of RE, but if I relocate to Manhattan or SF, I'm definitely not buying local properties.

[Balance]

Thanks for the reply.  Since this would be my first investment property I wanted it to be hands on without outside management (which I would have to do if I invested outside the Bay Area). But you are right, I would definitely see more cash flow elsewhere. I just feel like there will be future appreciation here and that rents will go up as well (in this particular city there is no rent control). But of course that is just speculation.  I really appreciate the response.  I will definitely have to do more research.

[goiyala]

I was also looking preliminarily (if thats a word) at a condo in Fremont for $180k. The rents there are ~$1500 for a 1b/1b. Even with $1500 rent, the numbers didn't come out good. The yearly cash flow was only about $1800 :(

So I think I'll stop looking for RE in the bay area like arebelspy suggested.

[arebelspy]

Invest in other areas of the country.  If you've the appetite for it, real estate in some areas is a great investment right now.  In others, not so much.  Texas is solid, they have such a diversity of employers nowadays.

[Rob]

Where can I learn the basics of this stuff? For instance, I have no idea what HOA is. (Yes I will Google that now)

[arebelspy]

Where can I learn the basics of this stuff? For instance, I have no idea what HOA is. (Yes I will Google that now)

Home owner's association.

Start reading some real estate investing books, check out forums like biggerpockets.com, and feel free to ask any questions, we'll gladly share if we know, or help find the answer.

[Rob]

Thanks. Any suggestions for where to start with books? I am graduating in May, I'm 22, but also debt free. I'm trying to learn so I can get involved while I'm young.

[arebelspy]

The one I've recommended several times for beginners is called "Building Wealth One House at a Time".  It's a great starting book, as it gives a good overview and general plan for purchasing real estate.  It's a light read and doesn't bog down too much in difficult concepts.  Perfect to start with.

Once you've read that, I've got at least a half dozen more recommendations, but I have yet to have anyone tell me they've finished that and want more.  ;)

[Rob]

Thanks, I'll check it out.

[HeidiO]

I'd buy it.  I am not an expert, but for some reason that doesn't keep me from typing...  California is its own market, and it is not normal.  In my town (Albuquerque) I wouldn't buy it - b/c appreciation happens slowly, and with your numbers it is gonna be about appreciation.  But CA has had 160 years of a boom/bust cycle, and I see no reason that's gonna stop today.  People who mess up in CA real estate buy at the top of the boom, not at the bottom.  You may have to hold it for a decade, I don't know when the next boom will come.  But short of The Big One hitting, it will happen.  I bought a house in Berkeley and sold 4 years later for double the price.  Mostly luck, I know.  But as I said, I'd buy it.
Heidi

[arebelspy]

I'd buy it.  I am not an expert, but for some reason that doesn't keep me from typing...  California is its own market, and it is not normal.  In my town (Albuquerque) I wouldn't buy it - b/c appreciation happens slowly, and with your numbers it is gonna be about appreciation.  But CA has had 160 years of a boom/bust cycle, and I see no reason that's gonna stop today.  People who mess up in CA real estate buy at the top of the boom, not at the bottom.  You may have to hold it for a decade, I don't know when the next boom will come.  But short of The Big One hitting, it will happen.  I bought a house in Berkeley and sold 4 years later for double the price.  Mostly luck, I know.  But as I said, I'd buy it.
Heidi

(Emphasis mine.)

AKA you'd speculate/gamble?

[HeidiO]

AKA you'd speculate/gamble?
[/quote]

Yes.  Not where I currently live.  Not in Vegas.  But where he is looking to buy - yes.  I think I put in plenty of caveats in that post, so that it wouldn't be misleading.   

[arebelspy]

Interesting.

Wouldn't it be better to find a solid investment with good returns than purchase and hope for good returns (appreciation / another boom & bust cycle)?

[wilk916]

The one I've recommended several times for beginners is called "Building Wealth One House at a Time".  It's a great starting book, as it gives a good overview and general plan for purchasing real estate.  It's a light read and doesn't bog down too much in difficult concepts.  Perfect to start with.

Once you've read that, I've got at least a half dozen more recommendations, but I have yet to have anyone tell me they've finished that and want more.  ;)

Thanks for the tip.  I just ordered it (no local libraries had it and found it for $4 used on BetterWorldBooks.com -- great site, BTW).

I'm going to read it and hopefully be the first to request the rest of the list.

[arebelspy]

The one I've recommended several times for beginners is called "Building Wealth One House at a Time".  It's a great starting book, as it gives a good overview and general plan for purchasing real estate.  It's a light read and doesn't bog down too much in difficult concepts.  Perfect to start with.

Once you've read that, I've got at least a half dozen more recommendations, but I have yet to have anyone tell me they've finished that and want more.  ;)

Thanks for the tip.  I just ordered it (no local libraries had it and found it for $4 used on BetterWorldBooks.com -- great site, BTW).

I'm going to read it and hopefully be the first to request the rest of the list.

Hah, I was hoping that little line tossed out at the end would entice someone.  :D

Real Estate is such a huge field, and there's so much to know, but you have to start somewhere.  And if you find it interesting, then it's quite enjoyable learning different strategies, tools, and options available to you.

[goiyala]

arebelspy - maybe you can start a post with the books you recommend. So we don't have to bug you and can just look up that post. Ofcourse biggerpockets will have a much better resource but I like this forum better - since I feel we are a small community :)

[Praxis]

That's not a cash flow positive property.

I mean you can force cash flow with a large down payment, but based on 50% of rent going to expenses, management, vacancy, capital repairs, maintenance, etc., then the huge HOA payment, it doesn't leave enough to service debt at that purchase price.

Can you talk to me about the 50% rule?  I guess I've never really "gotten it".

If half of your rent goes to expenses, the only way to have any kind of positive cash flow is to get some kind of absurdly good deal where rent is 3x the mortgage, right?

I mean, if rent is $1000, and you assume $500 goes to expenses, you'd have to have an incredibly tiny PITI to make any kind of decent cash flow on it.  For example, a $400 PITI (which would come with maybe a $60k house) would leave you with a cash flow average of only $100 a month after your expenses, which would be a horrible return on investment.  Using the 50% rule, the only way a 60k house purchase can bring a decent return is if it's, like, $1500 (1500 minus 750 for expenses minus 400 for PITI leaves you with a cash flow of $350 a month which should be a decent two digit annual return if you bought the house with no repairs to be made and no loan origination fees and no property manager).

[arebelspy]

P&I.  Not PITI.  T&I are included in the 50% rule.

[illy5603]

Can you talk to me about the 50% rule?  I guess I've never really "gotten it".

If half of your rent goes to expenses, the only way to have any kind of positive cash flow is to get some kind of absurdly good deal where rent is 3x the mortgage, right?

Right, welcome to "why people don't purchase buy and hold properties at retail prices in places like California" land. There is a guy doing it in the central valley (Michael Zuber at wealthbuildingpro.com) but he works his ass off getting the deals to the point that it is almost like a second job.
 
For my properties the monthly PITI+property management are at roughly 50% of the rental income.

[Praxis]

My monthly PITI + property management are at about 50% too.  That's why the concept of chalking up the other half to expenses makes me nervous.

I'm familiar with Michael Zuber and he was even nice enough to respond to some questions I had from him and provide some advice regarding a short sale I'm pursuing.  Hoping to do something similar in my region, except "outsourcing" a bunch of aspects of it (got someone else with experience to do the negotiations and getting birddogs to find deals beyond the scope I investigate).

[illy5603]

My monthly PITI + property management are at about 50% too.  That's why the concept of chalking up the other half to expenses makes me nervous.

I am comfortable with 50% covering PITI + Property Management and letting vacancy and repairs spill over a bit into the other 50% considering that the actual dollar amount of the 50% (~$500) That is a lot of repairs and a lot of mortgage payments. When you factor in the other 3 quadrants (Tax breaks / depreciation of rental asset, renters paying mortgage principal and the pie in the sky that is appreciation) it works out fine. Plus I have a second property with similar numbers. I look at it like a twin engine airplane. Plus Plus, both of my homes are recent (~3 months) rehabs.

I think this article sums up my opinion nicely = http://www.biggerpockets.com/blogs/1148/blog_posts/16950-the-perils-of-the-5-rule-myopia

[arebelspy]

That article is on point.  You don't just make money from cash flow.

It - correctly - points out that the 50% rule isn't the only way you make money. It's not the be all, end all for ROI.

It also - correctly - doesn't dispute the 50% rule.  It IS the best method for creating a pro forma cash flow / ROI.

My monthly PITI + property management are at about 50% too.  That's why the concept of chalking up the other half to expenses makes me nervous.

It may make you nervous, but if you don't plan for that, you'll take it in the shorts later when you aren't prepared for vacancy, repairs, capital expenditures, etc.

Taxes and insurance are already included in the 50% rule.  So you wouldn't subtract PITI and chalk up the other half, you'd just subtract P&I.  Basically start with your gross rent.  Take 50% away for all expenses. That's your cash flow if you own it outright.  If you have a mortgage, subtract P&I, and that's your cash flow with mortgage.

Most months you will cash flow a lot more than that.  But some months you'll have to replace a water heater.  Or your unit will sit empty for a bit.  Those months your cash flow will be quite a bit less, perhaps even negative.

For example, I have rentals that rent for 1.1k.  P&I ~ 270 (PITI ~ 400).  Most months I keep the spread, or 830.  But long term I'll actually keep about 280/mo (1100/2 = 550 to expenses. Minus 270 P&I = 280), because the months with more expenses will bring down that average (for example months where my cash flow is -2,500, which I have had .. tenant moves out, I get new paint/carpet, no income that month, pay the mortgage of 400, etc.)

[arebelspy]

The old rule of thumb you've probably heard if you've been in real estate awhile was "if you can cover the mortgage (i.e. P&I) with half the rent, you're good."  That was a simplistic formulation of the 50% rule.

That means you'll break even on the house, which is great, because due to the combination of appreciation (which goes along with inflation), equity buildup (principal pay down from your mortgage), and tax benefits (interest writeoff and depreciation), you'll be making money!