What kind of rate of return would you expect on a rental property?

[KBecks2]

Hi MMM Friends,

I am thinking again about getting started with a single rental property.  I want to ask what rate of return you feel is your *minimum* to be worth your time, effort and investment dollars.

Personally, I am guessing that I want at least a 10% rate of return. 

Should I expect a higher rate, like 12%, 15%, or 20%?

I am looking first for cash flow, but I am also looking in neighborhoods that Zillow (yeah, yeah, I know) is forecasting to have some mild appreciation (not decline).

Thank you for any insights.  I am looking to buy at a discount, but also to not have to do a massive rehab for the first property.  I am more inclined to purchase in the $50k - $70k range and rent for $1,000 - $1,400/month. 

These are in the city I live in and I would self-manage.

Thank you!

[waltworks]

Use the 50% rule to estimate your costs (ie if you are renting for $1200/mo, $600/mo will go to expenses) and you can work out an estimate of your return pretty easily. If you pay $72k cash for a place that rents for $1200, you'd expect something around a minimum 10% annual return on that money. Leverage can change the calculation but there are plenty of amortization calculators online that will let you quickly run the numbers so if you plan to finance the property start making spreadsheets!

Forget the appreciation part for the sake of calculating your return. The future price of the house is impossible to know or predict and Zillow doesn't know squat about what areas will appreciate. If you get appreciation (and want to sell) great, but you should be figuring out your return based on the rental rate and your expected costs unless what you are really trying to do is flip a house. Also remember that *just to break even* on appreciation you'll need at least 10% to cover fees/commissions at the front and back ends.

-W

[stealthrabbit]

Rate of return is Very location dependent.

My left coast properties are lucky to get 7%
Colorado similar (depending on area, but I am in a desirable location)
but... My TX and TN properties can get 10%+  (lower capital costs and decent rents).

Some TX locations are way high cost and property tax, so be careful.

(I prefer my income producing properties to be in an income tax free state)
I only do rural properties that I can place a guest house / apartment / shop / RV for me to live there for free (compliments of a cash flowing rental)

I try to buy so that I can get 1%/ month of purchase price in rents.
If you can buy stuff for $50k, that rents for $1000... you are in hog heaven!  buy MANY!

[Fishingmn]

You don't say if you are financing or paying cash.

I've bought all mine with cash which means it's harder to get a high return. Almost all of mine were bought with an initial cash return rate of around 9% but with rents going up regularly I have a few approaching 11% now. That said, with the price increases over the last 2+ years and reduction in distressed inventory it's getting much harder to find properties that work.

If I was financing with 25% down I'd probably be in the 12-15% range.

If you are self managing it may be safe to assume something slightly less than a 50% expense to rent ratio as that ratio typically assumes you are paying out for a property manager.

[arebelspy]

It depends on the goals for the property.  Sometimes the highest rate of return isn't the best investment.

Typically double digit cash on cash (with principal paydown and appreciation and tax benefits adding to that), though there are properties I'm looking to buy that will yield maybe 5-6% cash on cash - I have other reasons for buying them.

Figure out why you're buying, and what your goals are, then see what a reasonable return is for that property type/location/etc.  Then you can look for a "good deal" that's just above that range.

[jnc]

I own a few properties in the Memphis, Tennessee area even though I don't live there. It is a solid rental market with slight appreciation, nothing spectacular. But the cash flow is the best I have found so far (in terms of percentage).

As an example of a typical property I own:
- purchase price: $56,700
- rent: 700-725$/mo
- gross yield: 14-15%

I normally get a mortgage with 20% down though, so my return is much higher though closing costs on such smaller loans tend to be higher than average.
I own 4 of these properties and am in the process of getting a fifth. Let me know if you want more details.

[tj]

I own a few properties in the Memphis, Tennessee area even though I don't live there. It is a solid rental market with slight appreciation, nothing spectacular. But the cash flow is the best I have found so far (in terms of percentage).

As an example of a typical property I own:
- purchase price: $56,700
- rent: 700-725$/mo
- gross yield: 14-15%

I normally get a mortgage with 20% down though, so my return is much higher though closing costs on such smaller loans tend to be higher than average.
I own 4 of these properties and am in the process of getting a fifth. Let me know if you want more details.

Intriguing. How often do you get vacancies? I assume you use some sort of property manager?

[jnc]

I own a few properties in the Memphis, Tennessee area even though I don't live there. It is a solid rental market with slight appreciation, nothing spectacular. But the cash flow is the best I have found so far (in terms of percentage).

As an example of a typical property I own:
- purchase price: $56,700
- rent: 700-725$/mo
- gross yield: 14-15%

I normally get a mortgage with 20% down though, so my return is much higher though closing costs on such smaller loans tend to be higher than average.
I own 4 of these properties and am in the process of getting a fifth. Let me know if you want more details.

Intriguing. How often do you get vacancies? I assume you use some sort of property manager?

Yeah, I use a property management company as I've actually never set foot in Memphis :) They charge the usual 10% of the rent as a management fee.

I haven't had vacancies yet in the 1.5 years that i've owned these properties but most calculators on the internet factor in an 8% vacancy rate (i.e. 1 month per year). These guys' strategy is to price the rent slightly below market rate to attract longer term tenants which I think is helping.

[clarkfan1979]

You need positive cashflow to pay the bills. However, I think it's ok to speculate on rent increases and appreciation as long as you are not counting on it to pay the bills. With that said, I would recommend creating your own system for trying to predict changes in the future. If everyone followed the advice of Zillow it would create an artificial bubble. Try to figure out where people want to live and why? A fortune 500 company is building there new headquarters approximately 7-8 miles away from my house. How is this reflected in Zillow's estimate? It is not. However, it is real and it will impact local real estate.