housing market improving and/or running with the herd

My wife and I are fairly new to REI, and are pursuing purchasing a rental property. We thought about getting involved a couple of years ago, but decided otherwise. With the drop in housing prices and low interest rates, we decided to actively get involved again. After a few weeks of research and analysis we started looking at townhomes and SF homes at the low end of the price spectrum, but in average to nice areas. This area (Colorado Springs) appears to have a low rent to price ratio. The first townhome we were interested in was a foreclosure priced at $85k (+$100 HOA) and could rent for ~$850 per month. Likely high comps showed the fair market value might be $120k after all repairs. It was in terrible shape inside, but mainly needed just new flooring everywhere and paint. We decided to make an offer only to find out there were three other offers already submitted. We chose not join that crowd. Another townhome was $75k (+100 HOA) in worse shape, and could rent for about the same amount. It had six offers. The townhome next to it had just gone under contract at $95k. This is a respectable, but certainly not a great area of the city. We recently bid on a foreclosed SF house in an average area. This one looked like a good deal where $10k in repairs may increase the value by $40k and we would have positive cash flow assuming minimal maintenance overhead. There ended up being two other bidders, and we lost out even after bidding ~2 percent above the list price.

Is the average rental owner satisfied with negative cash flow? As opposed to what I’m hearing in the news, is the housing market improving? Are investors that have been sitting out and waiting deciding to jump back in now?

I have never put so much effort into something that has resulted in absolutely nothing to show for it except some experience. We continue to look, but we are finding very few good deals.

Unless you are well heeled and in an area with high appreciation (and there aren’t any right now) don’t even think about buying a home with negative cash flow. In fact, cash flow is about all I would consider in this market. That doesn’t mean others would disagree. Anyone can make a bad deal and it sounds like many do in Colorado Springs – a herd mentality indeed.

Townhomes and condo’s can have onerous HOA’s and limit your control, so they are probably not great investments. They also tend to be the first to drop in value and the last to appreciate. With as much competition as you seem to have, you might change niches. For example, I have found in several areas in the Midwest, distressed fourplexes can sell for as much as a decent SFR.

As importantly, what are you making offers on and who are you using? Are you using an experienced REO agent making offers to the bank or are the offers to homeowners? If you don’t like the advice or the quality of the deals, don’t be afraid to use multiple agents. I will typically make 8 to 10 offers to get one accepted. How strong are your offers?

Banks I know, and probably private individuals, like as clean a deal as you can structure. This typically means you did a pre-inspection and can offer to buy without an inspection contingency, you can pay cash, and you can close quickly (10 days). Anything you can do to get as close to this would improve your competitiveness. My offers aren’t always the highest but I make sure they are always the best. This counts.

Lastly, there are still a tremendous number of Alt-A and subprime loans scheduled to reset over the next few years and it typically takes about a year to foreclose. I know it can be frustrating, but the market is not going to pass you by anytime soon. Your patience will be rewarded even if it takes you another year or two. Let everyone else make their bad deals now and keep your powder dry for the killer opportunities. Change your criteria and realtors as often as necessary but don’t compromise, don’t chomp at the bit, and don’t become a motivated buyer.

Good luck.

Gillbertibe, I think you need understand the market value difference between rental properties and SFH’s. The $850 rent you mentioned is where you need to start when it comes to investment properties. As a general rule ( and a pretty accurate one) is using 50% of the gross rents for operating expenses like taxes, vacancy, maint., insurance, etc… The other 50% is to be used for debt ( mortgage PITI only). You would need to have your mortgage be no more than $425/mo. A 30 yr. $67k mortgage @ 6.5% is $423/mo. So if you bought a property for $100K under the same loan terms, you’d be losing $207/ mo. Keep in mind that these #'s dpon’t factor in your profit. A good rule of thumb is $100/mo./ unit. That would decrease your mortgage pmt. to $325/mo. If you’re bleeding money each month, all the comps in the world mean nothing. Comps are valid if you were to buy,rehab & sell. But you have to use the income approach evaluating rental property. This is one of the most important things you can learn about evaluating properties. Good luck.

I recently visited Colorado Springs, and, just out of curiosity, looked at real estate for sale in the area. I think that you have options. I would agree that you should not get a condo or townhome. Usually, the homeowners’ association dues ruin the cash flow on these. When you do decide to sell, people are less interested in buying these than they would be a single family home.
As a new investor and a person who is interested in being an independent rental owner, you should focus on positive cash flow and passive income. Even if you need to come in heavy with money, and take a while to fix the place and get it rented, you have a much better chance at success and survival if you put these factors above all else.
There are some independent rental owners who have a strategy of all cash. It’s hard to get started, but over time, it’s hard to lose.
Don’t go into this market looking for appreciation. Things are way too uncertain, and if your real estate portfolio eats money every month, what are you going to do in the event of disability or unemployment?
Take these examples:





Now, begin by deciding what you think is a good return on investment. Realistically, I think 6% is a good ROI based upon the above examples. Let’s say that you can get a house for 75K after repairs and it will rent for $1000/month. If you come in with all cash, then you can calculate annual revenues of 12K, (minus 6K per year in expenses) so income is roughly 6K minus taxes $680, and insurance $675 equals $4,645 divided by 75K (purchase price) is an annual 6.19%.
By assuming that 50% rental income equals expenses, then applying your minimum ROI, you can calculate your maximum purchase price.
Be sure to do a rental survey so that your rental income estimate numbers are accurate. In the above example, you should calculate mortgage payments and not borrow any more than a break even cash flow scenario.
There are other folks on this site who have formulas which are very good, but the above should be the mindset that you have in the simple name of survival.

  1. Lowball. It makes more sense to pass on a property than pay too much.
  2. Come in heavy with cash if you must, but do not accept negative cash flow.
  3. Do not buy in war zones. Perform your due diligence. Some properties are just too screwed up to try to own.

• The first rule is not to lose. The second rule is not to forget the first rule.

Warren Buffett

• After 25 years of buying and supervising a great variety of businesses, Charlie [Munger] and I have not learned how to solve difficult business problems. What we have learned is to avoid them. To the extent we have been successful, it is because we have concentrated on identifying one-foot hurdles that we could step over rather than because we acquired any ability to clear seven-footers.

Warren Buffett

In my opinion, putting more down or all cash doesn’t necessarily make it a good deal. You could put that money in a Money market account with no risk and is more liquid. You won’t get a 6% return, but you won’t have any suprises that cause you to lose money either. A few tenants from hell and some unexpected repairs will eat up that 6% fast. I feel its best to calculate the #'s based on 100% financing. That gives you some wiggle room if things start to go bad and you need to sell for some reason.

Thank you all for the insightful comments and instruction.

It may have sounded like was mixing cash flow and appreciation, but the reason I mentioned the value after repairs is because I may want to take the equity out of that rental for the next rental at some point.

We still haven’t purchased anything yet, but I think we are getting close. Reasonable deals don’t stay on the market long, but I think we are getting better at finding them sooner.

Is the average rental owner satisfied with negative cash flow?

Yes! The average rental property buyer is happy to buy a property at retail and then lose their butt in negative cash flow. That’s exactly why the vast majority of newbies in this business fail in a short period of time.

Paying $85K for a property that will rent for $850 per month is a huge LOSER!

Here’s how that deal would look in the real world:

Gross rents: $850
Operating Expenses: $425
NOI: $425

Mortgage ($85K, 30 yr, 7% NOO): $565

Monthly cash flow: 140 LOSS (OUCH!)

Why would anyone want to buy a rental property that LOSES MONEY? If you’ve got money to throw away, why not just send me $100 per month - you’ll still be ahead $40 per month!