Thanks Justin, I did miss that.
The problem you have is that many people see a formula and they run wild with it then complain if it does not work for them for one reason or another. People need to understand where the money is going, the rules of thumbs Mike gives us do generate less risk, but like Dave said, look at vacancies, rental market where the house is, condition of the house, how old are the appliances…etc.
I’'ve been hit with 3 defaults last month, thats 4 mortgage payments (plus my house) for 2 months and I need to change carpet at least on one of them. Thats about $3500 a month outbound with no inbound on these properties.
People need to plan these things.
It’s kind of interesting that the main complaint about the 50% rule over the past couple of years was that “there is no way expenses could be that high”. Of course, they are. Now, we’re hearing that it isn’t high enough. If the economy moves into a severe recession or depression, that may be absolutely true. The fundamentals of the rental business may change with much higher eviction rates and, even more worrisome, government intervention. In addition, as local governments lose their tax base, they’ll increasingly look to rich landlords that they can soak with various fees.
I haven’t seen higher eviction rates - YET - here in my little corner of Ohio. However, as I’ve posted many times over the past few months, I have been expecting to see that occur this winter. Many of my tenants are just barely making it and are paying during the 3 day notice period with a $50 late fee. If that’s occurring during summer, these tenants likely won’t make it through the winter heating season. Things could get VERY UGLY, VERY FAST! I would encourage anyone that is buying rentals to only buy properties at a HUGE discount (like a maximum of 50% of market value) and be sure that you have a positive cash flow.
Mike
Thanks, Mike. Great thread.
This is kind of my fear of getting too big too fast. I have a very stable secure job with good income so I could absorb a fair hit for a little while. But until I get some more reserves built up, I don’t want to over extend myself with too many purchases.
Back to the property evaluation technique. When we bought our first property, we had not heard anything about a 50% rule (or the reasoning behind it due to the NAA surveys). I just looked at what our mortgage was going to be, the average cost of utilities we pay, property tax, and insurance. I knew there would be other costs involved as we had to rehab the two vacant units to get them modernized and rentable. Then I evaluated what the current tenants were paying and what we thought we would get (just below market rent) for the other two. We had a fairly good monthly cushion and were fortunate the two vacancies were filled as soon as we had them available. So for me, the 50% rule has become a good way to estimate the unknowns, but I still also take a common sense approach to each property and write down our known expenses to see how it matches up to the current rent or market rent.
I do plan on getting and keeping our mortgage payments on all our rentals at least a few months ahead so it’s not a big kick in the nuts when things go south one month (this is in addition to building a reserve). It’s been tricky the past year or so with the one building trying to keep it ahead without loaning the business more money. We had another rehab come up that caused us to have to loan the business a little more money, but things are looking better now and we’re working on our next deal.
Hey I just wanted to say thanks to everyone for the replies and advice. This thread has kind of taken on a life of it’s own, so I’m just going to bow out gracefully, but just to clear anything up, I was thinking of offering $109k on this property. After reading this thread though, I think my first offer would be more like $99k depending on the price for homeowners insurance.
It’s not a 50% discount, but as of right now it would be paying for itself at that price and then about $75 extra / mo. We live and work in Michigan, but only plan on staying here another 5 years, so the place would get sold when we we move. I’m with you though Dave that it probably shouldn’t be looked at differently cash-flow wise just because we’re living there. Property tax rates for the duplex are actually a little lower than where I’m living right now, but I’m not sure how they stack up nationally. Mid-Michigan might be high over all.
Thanks again to everyone.
I agree with Justin’s statement. The way that I approach this is to use the 50% “rule” to qualify properties and then do my due diligence with numbers as close to reality as I can find. If tax and insurance is already eating most of the 50% NOI, then I will more than likely be negative.