I have some sophistication with investing but I am completely new to real estate beyond being a homeowner. I have been considering investments in multifamily (2-4 units) in western (non-coastal) states. Because I will likely invest out of the area in which I live and also to limit my personal liability, I am strongly leaning towards using a property manager.
Here are my assumptions:
If annual market rents on a 4-plex are $24,000, I am assuming operating expenses of 50% (which I assume includes vacancies) and property management costs of 10%. I am left with cash flow before financing costs of $9,600. If I assume a loan for 75% of the purchase price and a 6.5% interest rate on a 30 year loan, the purchase price has to be approximately $169,000 to breakeven on a cash flow basis (this implies a GRM of 7.0x or 84.5x the monthly rent).
Are these assumptions a good ballpark estimate of reality and is this a good approach to screening investments? Is this to aggressive/conservative? What am I missing?
Also, what advice can more experienced investors provide with respect to limiting personal liability (I am fortunate enough to have reasonable personal assets)?
As far as your assumptions they are a good ballpark figure for starting out. However, they are just a starting point. You need to use this in relation to your local market conditions (price, rents, local economy and vacancy rates for your type of property, etc) as well as your investment goals (long term hold for cash flow - short term hold for appreciation - opportunity for high appreciation due to improvement in property or management) as well as potential upgrades to property that can have a great effect on profitability (immediate changes to profitability by increasing rents to market rates - decreasing expenses - such as putting utilities on individual meters).
So you have to consider all of these factors when developing your screening model. However, the 50% expense ratio is a good one to start with.
As far as liability, there are many ways to limit your liability - various trusts and corporations - LLCs and the like. The only way to really figure out is best from both a liability and tax standpoint is get a good real estate attorney and tax accountant - ones that are knowledgeable of the tax - liability and real estate laws for your state - and find out the best way to do it for you. The reason is that you are right that if you have assets, then you have things to protect. However the laws of liability differ from state to state - and the ability to protect your assets through various corporate structures also vary from state to state. Many people like to use LLCs here (and check out the forum on Asset Protection, BTW) but LLCs have different costs and ability to shield against liability depending on the laws and judicial precedence of each individual state. So again, an accountant and attorney who know real estate, asset liability and tax law are important team members you need to ask that question to.
Why are you investing out your area? Getting started and learning what it takes is hard enough without factoring in travel time. Even if you have a property manager, you'll want to be visiting the property on a regular basis to make sure your investment is being taken care of. There must be something local for you buy.
Also, I think you're complicating things by making assumptions. You know the ASSUME cliche' I'm sure. The first thing you need to do is educate yourself in REI. Tjen you have to set short and long term goals. Then you develop a plan based on your goals. When you have your plan, what you need to do is develop a specific criteria of what you're going to buy. The criteria will define exactly what you're looking for. Now you have to set up a team that will help you achieve your goals with your criteria. They can't help you if you don't know what you want. You should have a proven successful model that will help you analyze the ACTUAL numbers involved in every aspect of your specific criteria. There are no assumptions. Only actual, verifiable numbers. It's these numbers that will tell you if the property is a good deal or not. There are two books that I recommend. ' The Millionare Real Estate Investor" by Gary Keller and " TheABC's of Real Estate Investing" by Ken McKelroy. The first one has models developed by over
100 millionare RE investors. These are very good books in regards to giving the fundamentals to get started. This website and forums are also good resources. I wish you luck. :beer
If annual market rents on a 4-plex are $24,000, I am assuming operating expenses of 50% (which I assume includes vacancies) and property management costs of 10%. I am left with cash flow before financing costs of $9,600. If I assume a loan for 75% of the purchase price and a 6.5% interest rate on a 30 year loan, the purchase price has to be approximately $169,000 to breakeven on a cash flow basis (this implies a GRM of 7.0x or 84.5x the monthly rent).
Al,
Don’t make this too complicated.
Here is the way I see your example deal:
Gross rents: $24,000 or $2,000 per month
Operating Expenses: $1,000 per month (50% of gross rents)
NOI: $1,000 per month
Mortgage: ($169K, 30 yr, 6.5%) $1,068 per month
Cash Flow: $68 LOSS per month (OUCH!)
This would not be a good deal! Putting down a big down payment would not alter the character of this deal (bad). Even if you have the cash for the deal, you still have the opportunity cost of that money that must be considered.
There are plenty of 30 yr. loans out there for investment properties. A 20 yr. loan will be $1260/mo. without the taxes and insurance. That would put him further in the hole. The only amount I’m confused about is the purchase price.
Al, when you said “assuming a loan of 75% of the purchase price”, is that 75% of the asking price? Or are you talking about offering $169k and THEN putting 25% down? That would put your loan about $130,000 which is $820/mo. That would give you about $180/mo. positive cashflow using propertymanager’s numbers. I don’t know of a lender that will give 100% financing on NOO properties. The lenders I’ve talked to want at lest 20% down. Keep in mind however that all these figures are based on assumptions. When you find a property, you may find that your expenses exceed the 50% of gross rents. Or the gross rents are the POTENTIAL GROSS RENTS. Get the rent roll, reciepts for maint., utilities, everything. All the numbers should be verified. The actual verified numbers are the only ones that matter. They will tell you the financial story of the property. Then, and only then, can you insert those numbers into the calculations to see if it’s a good deal or not. Good luck. :beer
Al, take a deep breath! Let’s start at the top. What is your investment objective?
You cannot evaluate any property other than does it get you where you want to go or not.
What you are envisioning is buying a property at retail and getting eaten alive by problems with your property manager at the top of the list! Property managers have a “Jones” for out of state owners. Like slow pitching to Barry Bonds!
Your first lesson as an investor, assuming you don’t want your career to begin and end with one purchase, is to find a motivated seller. A motivated seller is someone whose house has become his Enemy! It keeps him awake at night, makes him afraid to answer the phone, robs money from him every month, causes a knot in his stomach every time he has to go to it.
He will gladly give you his property! I am not talking about a run down junker on the “wrong side of the tracks” either. There are plenty of middle class property owners with properties in solid areas who miscalculated and bought their property at retail with a paper," $187/Mo positive cash flow" only to find that the second and subsequent months, it was more like Minus $250Mo after vacancies, repairs, maintenance and replacements. And then of course the tenants…
I know, I learned the hard way! At one time I had 40 rentals.
Now, I have none!
Using this method, you can rapidly build a portfolio of income properties across the US with no down payments, no bank hassles, no mortgage liability and no management problems!
And as far as real estate asset protection goes, the only safe alternative that does not violate the due on sale clause, (as a transfer to an LLC would) does not come with nasty tax consequenses and is not subject to seizure by creditors itself (corporations), is a properly constructed land trust.
Kiyosaki said that if you have money with no knowledge, you will not have the money for long.
Mike (propertymanager) gave you a concise view of the cash flow potential for this deal using your assumptions.
Here is how I would approach this one using your market rent assumptions and your cost of financing assumptions.
Gross monthly rental income is $2000 per month which leaves you a net operating income of $1000 per month after deducting operating expenses.
Your net operating income has to cover your debt service and leave enough left over for cashflow. You want the cash flow to be large enough to sustain the property. You never want to just breakeven. If your net operating income is equal to your debt service, then you are out of pocket as soon as you have an unscheduled repair or a major system replacement. If you require a $250 monthly cash flow from this property, then the most you can afford to pay in debt service is $750 per month.
$750 is the monthly payment for a $118,500 loan at 6.5% fixed for 30 years… If you only put down 20% to avoid PMI, then the most you can pay for this property (and still meet your cash flow criteria) is $148,125K.
In my quick and dirty rule of thumb estimating, property management cost is already part of the 50% expense overhead. For a property I am considering for purchase, property management is an operating cost in my detailed cash flow analysis.
If your detailed cost analysis shows that property managment will lower your net operating income to $800 per month ($9600 per year), then a $250 monthly cash flow requirement leaves only $550 for debt service. This amount will only support an $87K loan at 6.5% for 30 years. A 20% downpayment means that you can’t pay more than $108,750 for this property and still meet your cash flow criteria at these market rents.
Personally, I like cash flow to equal or exceed 15% of gross rent, so for this property I would use $300 as my monthly cash flow requirement As a result, my maximum purchase price will be lower. Quite a few contributors to these forums will tell you that your cash flow target should be $100 per month per unit for single family dwelling unit up to a 4-plex. If you adopt this criteria for this property, your cash flow target will be $400 per month.
This is a point of diminishing return question. Is it worth the time, effort, and risk for you to invest $22K in a rental property that only pays you $250 per month. Many would consider a 13.6% return on invested cash acceptable.
You have to decide on the investment criteria that makes good business sense for your situation.