I am trying to figure out what % discount I need to get in order to cash flow on a property. Some have been saying 30-50% discounts. This sounds great but I can’t imagine finding too many like that. Where I live here is a common scenario.
Home price 170k
I purchase for 145k (15% discount)
I get 1300/mo in rent and my expenses are as follows:
PITI=1200
All other expenses (gas, trash, electric, water)=paid by tenant)
so according to this example, a 15% discount would get me a $100/mo positive cash flow. I realize vacancies and other unexpecteds could occur but I do not see how I need to get a 30-50% discount to make this work. By the way, I would only hold the property 2-3 years and sell it on a rent2own basis.
I must be missing something to be off from others’ calculations by so much. Please fill me in so I do not buy properties too expensive.
You said ‘operating expenses in the real world are $650’ for this deal. What are these operating expenses that you speak of? All other expenses (gas, trash, electric, water) are being paid by the tenant. What could possibly add up to $650 per month outside of these expenses? Are you talking about vacancies? Please fill me in on these operating expenses. I defer to your expertise and am excited to learn on this one!
Operating expenses include taxes, insurance, vacancies, management, maintenance, advertising, entity maintenance, office supplies, legal fees, evictions, utilities paid by the owner (when vacant, rehabbing, etc), damage done by tenant (above deposit), court costs, lawsuits, capital expenses (although not technically an operating expense), etc, etc, etc.
Throughout the United States, operating expenses run 45% to 50% of gross rents. The vast majority of new landlords fail in a short period of time. The number one reason they fail is lack of cash flow. The number two reason is inability to deal properly with tenants.
if operating expenses average 45-50% nationally then the purchase price of the home has to be at 50-55% of the homes value in order to just break even on cash flow. Am I correct in saying this?
if operating expenses average 45-50% nationally then the purchase price of the home has to be at 50-55% of the homes value in order to just break even on cash flow. Am I correct in saying this?
Sonriffic,
No. Operating expenses average 45% to 50% of the gross rents. The home value to gross rent ratio varies greatly throughout the country. You must do a cash flow analysis for each property to determine the maximum purchase price.
I’ve never had operating expenses into the 45-50% range in 9 years of landlording (unless you’re including the mortgage?)…Each house is different…A $100 gross margin truly sucks, but if you have a house in great shape, where you don’t have to worry about replacing mechanicals (HVAC, water heater, appliances, etc.), carpet/tile is in great shape, etc.), then you probably won’t have to spend much to keep it up…Find out how much it will cost you for a yearly “tune up” on the HVAC, chimney cleaning, figure on a yearly average the cost for carpet replacement every few years, etc., then see what you really need to collect for rents…If you do your own minor repairs, you won’t spend much for plumbing, etc., but otherwise you might want to figure $50-60 per month for these minor calls to be made once in a while…Remember to factor in a 5% (or a safer 10%) figure for vacancy…Also depends if you plan to pay a property manager or handle it yourself…They end up taking 10% gross of the rents…Of the 15 houses I own, I only spend probably $50-$100 per month per house for everything, but that’s because I make sure they’re in top shape before renting them, and that’s all capital expenditures…
Mike… yeah, I need you to clarify that statement too because I’ve been calculating that my rents should be 2% of purchase price to cash flow. I had the same understanding as the Sonrific when you said operating expenses are 50% of rents.
So if I find a house that’s 50k that I can rent for $1000/mo, I’m working on the assumptions of: (this is is scenario math, not real world numbers)
PITI = 725
vacancy = $50 @ 5% of rent
legal cushion, advertising, maintenance =$ 100
then this hypothetical property would be cash flowing $125./mo.
this operating expense scenario is more than 50% of rent.
Of the 15 houses I own, I only spend probably $50-$100 per month per house for everything, but that's because I make sure they're in top shape before renting them, and that's all capital expenditures...
C’mon Buffinvestor, that’s just nonsense. I am absolutely certain that just the taxes and insurance are more than $50 per month. I think the problem here is that you don’t understand what the operating expenses are.
Realnew,
I’m having trouble understanding your post. Yes, you are right that the gross rents should be about 2% of the purchase price if you want it to cash flow. You are also correct that throughout the United States, operating expenses run 45% to 50% of gross rents.
So, if you find a house for 50K that rents for $1,000 per month, that meets the 2% rule.
Here’s how the math would work.
Gross Rents: $1,000 per month
Operating Expenses: $500 per month
NOI: $500 per month
Can you clarify this 2% rule for me? I’ve come across it before but am not sure if I’m understanding it correctly.
From what I understand… gross rents should be 2% of purchase price for the property to cash flow sufficiently? Is that correct?
.02 X Purchase Price = Gross MONTHLY(?) Rents?
Is this measure typically used with SFHs, multis …?
Example (so that I’m clear)
Purchase Price (i.e. 6 family): 325000
X .02
$6500 gross monthly rent?
$78000 gross annual rent?
Yes, you’ve got it all right. Just remember that the landlord doesn’t set the rents, the market does. So, you’ve got to use the formula backwards. In other words, if the rent is $6,500 per month, then the most you could pay would be $325,000. Also, please remember that the “2% rule” is just a screening tool. You must still do a cash flow analysis and consider the amount of equity you will pick up.