I’d be interested to know how much location plays a part in your buy decisions. A lot of discussion has been devoted to cash flow numbers and what the property should bring before it is considered a candidate. But would the experts (like PropertyManager for example) settle for a property at 30%-35% expense ratio (rather than 40%-50%) if the property’s location is excellent? You can always fix a property but you can never move it.
Thanks.
Obviously, I would love to find properties that have expenses at 30% to 35% of gross rents instead of 45% to 50%. However, I’ve never seen a property with those kind of numbers. I assume that you’re talking about a relatively expensive property. Most of them simply will not cash flow. Do you have numbers for such a deal?
Mike
You did mention it once, but your expenses includes interest, insurance and RE taxes too?? For higher end properties, the repair expenses are not that hign, and I have tenants covering those under $200.00. But in Long Isand, insurance and RE taxes are starting to bite, with the monthly escrow, covering RE taxes and insurance, running at 25% of rent roll already.
I’m only making money on it holdng the place for over 20 years.
what your expense ratio is has very little to do with location, but a lot of other things. Yes, 30-35% is very achieveable for certain types of properties; again depending on a lot of variables, but not just being on the right side of the tracks. The often quoted 45-50% is just a top-down estimate (rule of thumb) which is a good starting point for making an estimate. Many new landlords, however, assuming nice properties commanding higher rents will suffer less damage. This is simply not true and actually quite the opposite. The amount of $$$ required to get a beater of an apt. back to rentable condition is a lot less than nice mid-size SFR and thus an occoasional bad tenant can increase those expenses.
I look at location in terms of rent-ability (and long-term ability to raise rents) and ease of exit if it is SFH or duplex.
Mike,
I bought a duplex 2 years ago:
Price: $135K
Current rent: $1450
Interest: %6.25
25% down
I basically do everything myself. It is in a very nice location. Currently it appraises at ~$160K. The points I’m trying to make are the following:
It is a lot more difficult to buy a property in a nice location using the rule of thumb price = rent roll/0.02. After all it is supply and demand. A property in a nice location is going to command a lot more buyers wanting it than one in a location that you have to really attract buyers by offering a killer deal.
Potential for appreciation and future rent increase. When I bought the property it was making $1200/mo. I know I won’t have any problem going to $1500/mo or even a bit more.
So how much would “potential for growth” would play a part in your decision?
Thanks a lot.
Potential for growth a.k.a speculation
Oldmandate,
I guess I don’t understand your question. Would I suffer through years of negative cash flow with a property in a nice neighborhood hoping for appreciation? Absolutely not. You basically paid retail for the duplex you mentioned. I would not have paid more than $60,000 for that same property. I wouldn’t need much appreciation, because I would have had $75,000 in equity at closing. More importantly, I would have had positive cash flow.
Jb_bak is absolutely right. I don’t speculate - I only buy a sure thing!
Mike
One other thing that I’m not seeing discussed (or maybe it is and its somewhere else) is ‘return on cash invested’. These days I can invest 20-25% down on a property. That could be $50-100K out of my pocket for a building. If I put that money into an interest bearing deposit in a bank I could get 5% on it. If I put it down on a real estate investment, BEFORE I calculate my cashflow on the property I should first remove the return I would have gotten if I put it in a no risk, long term investment. So therefore using this logic, the first 5% return on that money (e.g. if I put down $100K, the first 5% of this would be $416.66 per month of profit I make from the property is no more than I would get with the money in a bank account.
Therefore in our calcs, we consider a 5% expense on the property for the use of our money for the down, and then after that is deducted we then deduct all other expenses, leaving what is (hopefully) a positive cashflow.
Is this how other investors are doing it? Clearly there are factors that include appreciation and depreciation, but from a simplistic point of view I normally take the total rents, deduct mortgages, HOA, property taxes, allocation for vacancies, allocation for maintenance, AND my bank interest 5% expense, and then start to work the cashflow from there.
I know that this forum talks in terms of a 45-50% expense cost, but for us that may be somewhat simplistic because of the quantity of properties we hold and the types (most are multi-unit where expenses for one building are leveraged across many units).
Thoughts?
V
Therefore in our calcs, we consider a 5% expense on the property for the use of our money for the down, and then after that is deducted we then deduct all other expenses, leaving what is (hopefully) a positive cashflow.
I haven’t put any money down on the majority of my properties, so that’s not really applicable to my situation. However, I do agree that one certainly should consider the opportunity cost of any cash invested. On the few occassions when I do put down money, I calculate the cash flow as if the property were 100% financed.
If you check the research from any of the big apartment associations, you will discover that the 45% to 50% expense number is the average for hundreds of thousands of multi-unit rentals.
Mike
Yes, 100% financed properties would certain factor in the cost of the down as a cost of financing of the money, so that would make sense.
As for the 45-50% numbers, can you cite some actual examples of this? To be honest, after about 7 yrs of REI here in Phoenix, those numbers are way higher than we have ever experienced. But that’s not to say in situations different to ours that they might be correct. I just don’t see those sorts of expenses in our business, but then we do run this place like a very tight ship, and are incredibly stingy with spending money on anything absolutely unnecessary. But that’s me. Call me Uncle Scrooge… :cool
Redefining,
I’ve heard people claim that their expenses are low many times. So far, in every case they were either ommitting many of the expenses or only had a few properties and hadn’t seen (or didn’t claim) any of the big “unexpected” expenses yet (like damage done by tenants, evictions, lawsuits, capital expenses which are not technically an operating expense, etc).
Why not post the expenses for one of your properties? You may be the ONE who has somehow gotten dramatically lower expenses.
Mike
I picked up a nice property in a higher end area in LI, back in 1983, as a preforeclosure. The owner died, his son took it over, started a rehab, got into financial trouble, and sold the place trashed, but with $10,000 worth of materials. So I:
Total money invested: $25K in capital improvements.
I paid $70K for the place in 1983, basically the value of the land. As of this year, the FMV is $418K.
I broke even cashflowwise the first five years, though the ARV was $130K in 1984, had an offer for $127K, when the sale fell through. Kept $8K of earnest money.
Currently
I realize that I’m able to do this with below market rent. If I charge market, I make another $6K/year, and it’sll probably be eaten up in vacancies, repairs etc.
But it these folks move, it’ll be $2,300/month rent, still below market.
I learned that at a FMV of $418K, and $2,500/month rent, few people will be buying houses to rent in this neighborhood, and a frantic neighbor, a renter, frantically asked me to rent. He said “there are no rentals in this town”. He wanted his children to stay in the school district.
It’s true that my expenses are low in relation to the rent, and the returns are low in relation to FMV. But for what I paid for the place, the work I put into it, it’s not bad.
Generally, we do a once or twice a year inspection, whcih turned out to be more of a social visit, where we bring cake, and they make coffee. The tenant from 1990, my wife brings updated pictures of the kids.
Quite different than the rentals that you handle.
Frank,
Forgetting all the other expenses, just your taxes and insurance are 31% of the gross rents!
Mike
It’s quit true. But it’s not bad adding in the “capital gains”. I put in about 25K, and I’m sitting on over 350K equity.
That’s the tough part comparing the good areas to the not so good areas where the capital gains can be nil.
No one will buy in this area to rent now because they’ll be a HUGE negative cash flow.
the return on rentla property is composed of two pieces: cash flow and appreciation. The rental market spans a spectrum of property types that produces various mixtures of returns. In general, properties with very strong cash flow have lower appreciation than high end stuff that is neutral or cash negative, but historically have shown strong appreciation. Again, this is a general statement; however, is true most of the time. I can cite numerous real world examples of each type (as well as main have been discussed in this forum).
I tend to aim in the middle of the spectrum for properties that are cash neutral from day one, but some some pretty solid potential for appreciation based upon location and I try to grow rents while holding expenses constant. This is my long term business model that so far has worked well over the past 9 years.
Each range of the spectrum has it advanatges and detraction. Where most people fail is they fail to understand what exactly they are buying (from a business prespective).
Mike,
I think it goes back to what I started this topic with. It is supply and demand. If you have a nice property, in a nice location then the demand for people wanting to pay top dollar for it is there. If not, then you have to make it attractive. All I can say is this…there is absolutely no way anyone would sell you this property for $60K (that would be the cost of the land) and (at least where I am) no way will you be able to rent a $60K property for $1400/mo. None of these scenarios will fit my market.
None of these scenarios fit ANY market in most cases, only the truly desperate will let a property go cheap and most of the time this means there will also be at least some rehab to be done. That’s why you hear Mike say he is buying at 50-70% ARV, in most cases the properties are worth far more but he is getting them cheap due to certain factors. Factors include: light to extensive rehab needed, burned out landlords, nightmare tenants, divorce, inherited property that the beneficiaries want rid of to get a quick payday, owner retiring by choice or due to illness, etc. 99 times out of 100 the property would be sold for FMV, Mike is only buying that 1% and passing on everything else as it does not make good business sense to him.
For the record I wouldn’t touch $135k property with $1200/month gross rents with a 15’ pole and rubber gloves on. I see a lot of people going after properties with 1% of the purchase price in gross rents per month and I think that’s nuts…this property was 0.89% a month. No thanks, I pass on a million “deals” like this to get just ONE good deal with 2% per month.
It’s hard work to find those deals even as experienced investors. As a beginner, how would you being to search those?
Go to your local REI meeting and search out landlords that want out and are willing to do anything to stop the pain.
Not evey investor is the “no down”, “must make that cash flow” type investor. As others have said, it’s supply and demand, and often, too many dollars chasing too few properties, in CERTAIN areas…
Give you a good example. A relative of ours is a doctor, with a banker wife making 250K/year. Had a 3-family, bought at 200K, and paid off in less than 10 years, at which point it was worth 400K. The property is in SanFrancisco.
I recall he nets around 25K to 30Kyear after the property was paid off. His BIG problem. The incremental taxes on the Federal, state and local levels are killing him. He’s not going to quit his job as a doctor, nor his wife as a banker.
Solution??
Sold the place and did a 1031 into 2 SFH, TOTALLING $400K taKing on a $200K mortgage each. Object - take on enough debt to have no cash flow.
Why??
He’s killed with income taxes on the rent. He has these SFH’s for seven years now, and as of two years ago, reached the lofty price of $1MM each. If he sell’s, and pays the taxes, it’ll be at the low capital gains rate.
Taking the cash flow, if he made $20K/year, it’s $10K gone in taxes, netting $10K. Is he ahead taking NO CASH FLOW??
taking a look at the numbers, he’ll pocket $10K after taxes in cash flow from keeping the $400K free and clear house, and pocket $70K in the last seven years… Having two SFH with no cash flow, he made $600K each for a total of $1.2MM appreciation before taxes, and pay a realtively low capital gains rate if he sells.
What effect does investors like these have on folks looking to make some cash flow. They create a huge demand, pushing prices up, and they don’t care about cash flow.
Another problem is foreign investors coming in invests in the same way, but many shun getting mortgages.
So to do cash flow investing, you’ll have to do it in areas where these types of investors avoid, or don’t know about. An investor I met, who lived in Manhattan years back oriiginally invests in Manhattan, NYC, but moved on to White Plains NY some 15 years ago.
His theory?? As he’s also a broker, he said “folks from Japan and Hong Kong all heard of Manhattan, no one has yet heard of White Plains yet”.
Afer I make some investments up there, I’ll then tell them about it.