I currently own a rental in my hometown in Indiana while living out of state. Price appreciation in this area is negligible, but I’m considering buying another property there because I know the area well and have a good feel for location, management companies, etc. My current rental is financed on a 15-year note, and the monthly rent basically covers the mortgage payment.
I’m considering buying another property like this on a 15-year note, as the rental income with bi-weekly payments on the mortgage buys this asset for me free and clear in around 12 years. From there I’m netting $600-700/mo. plus I have the home completely paid off. Caveat: I have had good success with current renters and have had fairly minimal extra expenses, which I realize isn’t always the case.
Anyway, I could provide the details on the % of payment going to principal and what the rate of return would be, but I’m estimating that after factoring in the tax advantages, vacancies, repairs and management company expenses, I’m still making 10-15% on my initial 20% investment in year 1. Barring huge unexpected costs, my rate of return should get better each year from there as I get deeper into the amortization schedule.
Does anyone else approach residential rentals from this standpoint?
Your rentals should always pay for themselves so you don’t routinely come out of pocket for expenses. When you say the rent covers the mortgage payment, do you have property taxes and insurance in escrow where your mortgage payment is covering the PITI on the property?
There are several people out there who got stuck being landlords on a property they used to live in before they moved to a new location. Many of them have to come out of pocket just to make the mortgage payment every month.
I like the idea that you’re on a 15 yr note. Most of our stuff is on 10 yr notes. Other advantages to your situation are that you already have another property in that area and have management / maintenance people already in place. That’s important. You’re just replicating your system now by buying a new property. Those of us who finance for <30 yrs give up a little monthly cash flow to have the property paid off sooner. Make sure you can cover the PITI with the rent for sure, but also factor in some extra cash above and beyond that for vacancies, repairs, etc.
If your rentals truly take care of themselves financially, you’ll be able to keep growing. If they don’t, there will come a time that you won’t be able to afford to keep helping a bunch of them along with your other income.
Justin, that is a great question on PITI. Yes, the payment would cover PITI plus probably cash flow around a $100/mo.
So this is what I’m anticipating on the plus side of the equation annually:
Monthly payment = $1,200 ($100 cash flow/mo)
Tax advantages = $1,000 (net benefit)
Principal reduction = $3,600 in year 1, improving as we go
On the cost side:
Management company = $1,100 (10% of gross rent)
Repairs = $1,000 (estimate - I’m looking at “B” type properties with newer mechanicals, roofs, etc.)
Misc./ tenant acquisition or lost rent = $1,000 (estimate)
Initial investment = $18,000
Rate of return in year 1 (again improving with principal reduction) = ($5,800-3,100)/18,000 = 15%
So do others play it this way? Do you see holes in my logic? This is essentially what we’ve done with our other property, though we’ve had the extremely good fortune of having the same renters for 7 years. So the ROR has been much higher than 15%.
Anyone else with thoughts on this? Seems like it boils down to the quality of the mgm’t company and the tenants they find. And I realize that these deals look great when you have good tenants and are lousy when you don’t.
your approach is not bad, but you have been lucky to to have no vacancy and very light expenses for 7 years. I usually figure that 30-40% of monthly rent collected will go towards mgmt fees, repairs, with the balance to debt service. This is a good long term average on middle age properties when you figure in occasional big expenses like hot water heaters, heat pumps, and other big ticket items. Also a lot of turn over (i.e. once a year) can eat up a lot of expenses with repainting, minor repairs that are not chargeable to the tenant but necessary to keep the place in really good condition.
With that said, it can vary widely with area, type of property , etc.