2% rule not even good enough any more?

General Real Estate Investing
1

Thought I’d share some details from a conversation I had with my banker yesterday. For those of you who have read my other posts, you know I’ve had a pretty sweet deal for awhile now with financing. Basically by buying right, we’ve been able to get 100% financing for our deals and often extra money for repairs too. It looks like we’re finally at the point where our bank has given us enough financing and won’t be able to do any more houses. I can’t blame them as we’ve grown very fast the past year and a half. We currently have three deals in the works that I’ll describe below. What was strange is that my banker really got on to me saying how he thought we were paying too much for a couple of these houses. All will rent for more than 2% of the purchase price. What most people try to target for cash flow apparently wasn’t good enough on this deal. I was pretty surprised.

Anyhow, here are the properties:
#1. 3/1 950sq ft, brick, 3 yr old roof, all appliances remain, basically move in condition.
Will rent for $625/mo.
Purchase price $24,500

#2. 3/1 approx 1050 sq ft, HW floors throughout, good paint inside/out, all appliances remain.
Needs roof and soffit/fascia replaced, circuit breaker box installed, sewer pipe under house (just in crawl space area, not the main sewer line to the street). Have a bid for 6k for all that.
Also needs new vinyl installed in kitchen and a few drywall places fixed in ceiling where roof has leaked.
Total estimated repairs $7,500
Will rent for $575.
Purchase price $17,000

#3. 3/2, 1544 sq ft, remodeled kitchen/bathrooms. Good vinyl siding.
Needs a couple bedrooms repainted and about 1/2 the house needs carpet (or HW floors sanded if HW underneath). Also needs circuit breaker box installed, a refrigerator, and stove.
Total estimated repairs $3,000
Will rent for $600-625
Purchase price $22,000

Insurance runs $400 per house and taxes are about $1,000 per house.

We knew we were pretty much reaching the limit of our financing so we wanted to get a few more under contract before they pulled the plug. I feel like all these are solid deals any our theory was getting another asset or two at a reasonable price was better than just getting one more and then having to stop.
What are your thoughts? Would you do these deals?

2

Those are definitely good deals. It’s as if you bought a $67,000 house and rented it for $1800. Only it’s three units and they should be easy to get rid of in the future.

If the bank won’t lend more, sit back, take a deep breath and relax. Then you can work on improving the landscaping, your office, your personal home.

Other good deals will come to you. Like owner-carry financing. People are learning that you are in the market. Spread the word.

Furnishedowner

3

Justin,

I’m jealous. I wish deals like that were available in my area. My best deal so far has been a 1200 sq ft ranch in a nice middle class neighborhood purchased for $80K that needed $30K of repairs and is currently rented at $1600. And that is considered a great deal in this area. My quick estimate is that you’re getting around 3 times the return on your investment than I am.

However, once my repairs were completed I had about $70K sweat equity in each of my properties, and thats at my estimated “sell it in thirty days price” not an inflated “I wish it was worth” price.

Keep up the success.

jmd_forest

4

How does the 2% rule have anything to do with reaching the limit of your financing with this lender?

I don’t see it.

5

I was just saying we were looking for a few more deals and I thought we found some solid cash flowing deals where the rent is actually over 2% of purchase price + rehab cost. I was just surprised that the banker didn’t like these houses at the prices.

6

It sounds like a good deal to me. It could be because many of the smaller lenders hold onto their own loans in their portfolio, they’re usually more conservative than the banks who sell them off.

JP

7

If the bank thinks you are paying too much, maybe you can get the price down.

8

Maybe the banker knows something you don’t. Maybe the property taxes and insurance are so high (relative to the purchase price) that the property won’t generate a high enough cash flow to exceed the banker’s debt coverage ratio requirement.

9

We already have the prices locked down. I’m ok with everything. None of these houses have insurance costs or taxes out of line with the other ones we’ve done here. The numbers are very similar to other deals we’ve done. Some have been better than this, but these are no worse than some of our other deals.

jmd_forest - You’re dealing with a lot more money per house than us, but you also have a good amount of equity there. Some ours ended up being 50 cents on the dollar after repairs, but others are more like 75 cents. Ours are the stereotypical cash flowing properties. They’re not in horrible war-zone areas, but they’re not in suburban middle class neighborhoods either. But they come cheap and cash flow.

FO - Definitely looking forward to having all the properties in the shape we want them in and just doing any repairs that come up along the way. Our house has been neglected so we’ll get back on that and just relax some too. I’m in talks right now to start developing a trailer park (what can be more cliche than owning a trailer park in Mississippi?). We’ll see how that turns out. If that works out, that’ll be about the extent of our business ventures for awhile.

10

I would look at your actual expected expenses in detail. I found lots of cheap properties in northwestern New York that also generally had a 2% return. Problem was that once I factored in the incredibly high property taxes, in the good areas, that 2% went poof. I ended up needing to seek for at least 3% otherwise the properties would not cashflow and would actually be at a negative return.

11

Justin,
How did you have this conversation with the banker… Did you go directly to your local bank? If so, weren’t these properties already listed on the MLS as REOs?

Also, this is my first time hearing of the 2% rule. I worked some numbers and it definitely doesn’t work with properties in NJ. I’ll never find a house for $200k that cashflows $4k/month. Is this a general rule of thumb you use to buy properties only in your area?

12

NJBD - the 2% rule is to get 2% of the purchase price for rent…not to cashflow 2% a month.

It is a difficult thing to do in many areas of the country, like NJ.

13

sammy - There are no surprises here. No excessively high taxes, insurance, etc. These deals are really no different than many of our other ones here. That’s why I was surprised at his response. I know my market well. I don’t think there has been anyone else more active in this area than us over the past year and a half.

NJ - One was an REO. The other two were individually owned. All three came straight off the MLS like every other house we’ve bought. Keith already explained what the 2% was about. It’s much easier to achieve in smaller towns in the mid-west and south where properties are cheap, but rent is reasonable.

14

That is why I love being in Houston. You don’t have to be in a small town, but you still have a median income is $48k with an unemployment rate of 7%. That means they can afford $1000/month rent. Everyday you can find 1500 sqft houses with 3 bed 2 bath 2 car garage for $45k and PITI in the $500/month range. It means that you don’t have to be the smartest guy in the room to make a business out of this.

15

I got licensed with my state last year to be able to raise private money secured by property (contact you Division of Securities to find out what you need to do). For me, it required paying a nominal registration fee of about $100 and filling out some paperwork. Another local investor here, after I recommended it, will have his license in a couple of days and had to take a test as well to get his license to do it.

Why not skip the bank altogether, get licensed to raise private money and get private financing on all your future deals? There is a lot of money out there (especially in Houston) where people are not satisfied with the 1% or 2% they are currently getting.

Hope that helps.

Sincerely,

James

16

Bluemoon,
Sounds like we’re dealing with basically the same ratio of rent compared to purchase price. I’d be interested to see what your 50k houses there look like compared to my 25k houses here. How are your property taxes? I know they were really high when I lived in Corpus Christi.

James,
You’re right. We could start getting creative, but I think we’re just going to use this as an opportunity to start paying down the loans and improving our equity position.

17

The property tax rate here is $0.38/$100 of valuation. That is about $380 for a $100k house. But the real tax is the school tax. That depends on the school district and sometimes there is a junk tax (MUD etc.). My typical total tax burden is about $1500/year. My typical insurance is $500/year. My typical PI is $400/month. My average PITI is around $600/month. My typical house rents for $1200/month (I have one that rents for $1,100 and one that rents for $1,500). My houses are all pretty new my oldest house was built in 1975 but all the rest were built after 1985. When I buy them I make them all new and so I spend very little on maintenance. This summer I replaced a sliding closet door $40, and yesterday I had the A/C guy come out (home warranty $45). You can really run this business in Houston.

If you put back $100/month per house for unforeseen problems and your lifestyle takes $3,000/month you can retire with 10 houses pretty easily. You can manage 10 houses with little expertise.