Is it just me or do I have to pay a dirt cheap price for a rental house in order for it to cash flow? I live right outside of Chicago in the South suburbs and want to buy a house with 100 percent financing. I don’t want to rule out a good rental house because I want to use 100 percent financing. Even if I pay points or put some money down, I still need an idea of the best price or maximum price I should pay.
Thanks,
ErickaD
ErikaD,
Yes, you have to buy properties at a big discount if you want them to cash flow. If you use the search feature of this forum (search “cash flow”), there are a bunch of threads on this issue. If you want the short answer. Divide the rent by .02 to get the maximum purchase price. There is a lot more to it, but that’s the short version.
I would strongly suggest that you get some more education about rentals before buying one. There are a million things to know if you want to be successful.
Good Luck,
Mike
Mike that is awesome! Divide by .02" I try to follow the same equation.
Good luck following that number up here in Massachusetts, you’d never buy a place with that kind of number. That means that if it’s renting for $800 a month, you shouldn’t pay more than $40k.
Another way to do it is to go by the cap rate. The cap rate is the net income divided by the purchase price. In some areas, you can find cap rates that range from 8-12. You should ask around to see what the cap rates typically are in your area. Net income is the amount you have left over once you deduct expenses. The mortgage isn’t included as an expense as everyone can have a different rate and different down payments. Expenses would be taxes, insurance, utilities, maintenence, management fees, etc.
It’s pretty hard to find properties that cash flow with 100% financing, usually the more money you have to put down for a down payment, the more likely the property will cash flow. That’s really the barrier to entry in this market, anyone can get in with 100% financing so the prices have gone up so that only those with deep enough wallets will be able to make a small profit.
Thats right thats why you go elsewhere to make the money in rentals. I have the same problem where I live. Cap rates run around 7% but thats terrible if I can get a property for 30k and rent it for 1k per mnth right?
Henry,
Finding properties that will cash flow in the real world is a hard task everywhere. It requires work and certainly is not like the guru nonsense we so often hear.
The trick in the whole cash flow issue is to identify the real world expenses. I agree with your statement that “Expenses would be taxes, insurance, utilities, maintenence, management fees, etc” with VERY HEAVY EMPHASIS ON THE ETC. Expenses also include advertising, entity maintenance, evictions, court costs, exterminations, capital expenses, vacancies, damage done by tenants, lawsuits, legal fees, fuel for your vehicle, office supplies, and many many more. Failing to account for these expenses will eventually doom a rental property business to failure.
Mike
propertymanager
I read once before in one of your threads about the 2% rule. I think that you are wording it different here. I’ve adopted your formula and try to apply it to all of my purchases. I’m trying to understand it a little clearer…earlier I thought that you could use the purchase price and multiply it by 2% which would give you the rent…example $40k X 2% = $800… that purchase formula would apply if the $800 would be acceptable in your investment area. If the rents were lower … say $600 in the area then of course you would have to lower your purhcase price to around $30-32k. Am I correct in using the formula in this manner ?
Speaking for myself yes that is how I would do it.
Diqueze,
Yes, it’s the same formula.
In the first case: Gross Monthly Rent needs to be 2% of the purchase price. In an equation it would look like this:
Rent = .02 X Purchase price
In your example Rent = $40,000 X .02 = $800
This equation is used to solve for the rent you need if you know the purchase price.
Now, if you remember your high school math (and for some of us it’s been quite a while), you can cross multiply to solve for the purchase price if you know the rent. After dividing both sides of the equation by .02 the equation looks like this:
Purchase Price = Rent/.02
If we use the numbers from your first example and assume you knew the rents were $800. Purchase price would be equal to $800/.02 = $40,000.
If you knew that the rent was $600, then the max purchase price should be $600/.02 = $30,000.
In reality, it is exactly the same equation. In one instance, you know the purchase price and you are solving for the minimum rent that you need to make the deal work. In the other instance, you know the rent and you are solving for maximum purchase price.
Hope this helps,
Mike
In my little corner of the world, I think it’s going to be VERY difficult to come across deals that would satisfly the formula that you guys are talking about. Homes just don’t rent for that much here.
For example: I’m currently looking at a repo. I estimate that I would have a total of $45,000 in it after rehab, with a market value of $60 - 70,000. Comparable homes in the area rent for $550.
$45,000 Purchase Price x .02 = $900 Mo. Rent! Way out of range.
$550 monthly rent divided by .02 = $27,500 Max Purchase Price!
How many deals am I going to come across where I can buy a $65,000 home for $25,000?!
Am I figuring this correctly?
Hi Land Baron Yes that is correct in your caluculations. If you cant find it then dont do it, unless you want to lose money. That is not the name of the game. With the numbers you gave you may be able to do a rehab and sell it to a homeowner for a quick buck. As a rental though it would not work as I see the numbers. If you want to do buy and holds which I believe is the best way to create true wealth. You can become rich by buying and selling or even at a high paying job, but to me true wealth is an accumulation of assets as well as tax benefits used together. Then you have to find a market that is good for rentals.
Land Baron,
Let’s look at the cash flow situation for the property you discussed.
Gross Rents $550
Less Operating Expenses $275
----------
Equals NOI $275
Less Mortgage (P&I) $338
---------
Equals Monthly LOSS $ 63
To me, an investment that loses money is not worth doing.
Your math was correct. You won’t find a lot of properties that meet this formula. That’s part of the WORK of REI. It’s not easy to find them here in Ohio either, these deals are probably less than 1% of properties on the market.
Mike
Going by other formulas, my numbers seemed OK.
The purchase price seemed OK:
ARV x 70% - Repairs = Maximum Purchase Price
$65,000 x 70% - $10,000 = $35,500
Cash flow was there too (small, but before income tax savings):
$6,600 Annual Rent less 45% Expenses = $3,630 left over for Mortgage and Cash Flow.
Cap Rate worked on the low end:
$3,600 Net Income divided by $45,000 Purchased Price = 8%.
What am I missing? This “.02” formula negates the others.
propertymanager,
How about the following numbers?
29 Monthly Cash Flow
I know, I know. It’s very small. But, I’m also considering tax savings and appreciation. At this point, I’m just wanting to get the ball rolling and REI will not be my only income. I’m thinking more about cashing in on the equity in 10 or 15 years.
I used 45% for the Operating Expenses. I thought I read once where you gave a range, and this was toward the low end. I won’t be using property management plus the home will be newly rehabbed, so I’m chancing that expenses will stay lower.
I was also planning on paying $5,000 down on the loan.
Seems that it would be VERY difficult to find a .02 deal with a median priced home in a nice neighborhood. I’d like to stay with homes that I would be willing to live in and that are in a neighborhood that will appreciate and provide an easier resell when the time comes.
Thanks.
Here’s what you’re missing. You’re trying to stick to a formula that works for someone else. All real estate is local. The conditions where the .02 formula and the 45-50% expenses work may not pertain to your area.
Another broker in the office just bought a property where I think the .02 number is actually .005. It’s a $250k condo with about $1500 in rent. He also has a $300 monthly condo fee that comes out of that $1500. His expenses aren’t anywhere near 50% though. He usually has long term tenants and in the market he’s in, they’re usually there for a few years. Also when they pay $1500 a month, they’re usually not dirtbags. I think his plan is to hold on for a few years and sell when the market goes up again.
Bottom line is that those formulas just don’t work for most things in Massachusetts and may not work for you depending on where you are. However to quote someone else “Of course the game is rigged, but if you don’t play, you can’t win.” Hope that answers your question.
Hi Land Baron take into consideration with my responses and I use pretty much the same formula as property manager. I am into my properties with no money. You may put down a bunch of money to get cash flow, there are always things that come up. My strategy is different. I like to get into the property at well below market and either fix if it needs and rent it if it needs then do a refi to pull out all cash I had in the property out of pocket plus a little bit extra and then still have a positive cash flow for an infinite return. This cannot be done on all properties. Only the ones that are bought “right” and the local circumstances alow it. For instance in one part of my state I can get low priced housing and rents that will give me a nice cash flow (where I invest). In another part of my state I wouldnt get a positive cash flow if I put down 100,000 out of my pocket. So a lot depends on the area you are in with the way you have to accomodate your investing. Either that or go where the properties are that accomodate your strategy. Good luck and let us know how you make out.
Thanks henryinma. I tend to agree with you.
Different areas, different goals, different approaches.
I think I’ll start a thread on formulas in the Beginners section.
Thanks.
Hi Henry how does he get a positive cash flow with no expenses at all, I dont see how he can get a positive cash flow unless he put down a lot of money. Right? It looks like hes negative by quite a bit. Just try to remember one thing when you figure what strategy you want to use. The numbers dont lie.
Henry,
Do you think that’s a good deal? A $250,000 rental renting for $1,500 per month?
I don’t understand how your friend could say with a straight face that his operating expenses aren’t anywhere near 50% of the gross rent. With ONLY the $300 condo fee, he’s already at 20%. Doesn’t he have any taxes? No Insurance? No advertising expense for new tenants? No office supplies? No management? No maintenance expenses? He’ll never have excessive damage done by tenants? He’ll never have an eviction? No one will ever slip and fall and sue him? No legal fees? Never have to make a trip to his rental therefore no fuel expense? I could go on and on!
Let’s pretend for a moment that his only expense was the $300 condo fee. The mortgage on $250,000 is about $1,875. He’s $675 in the hole each month before he even considers any more expenses. I don’t know about your friend, but I couldn’t afford too many of these good deals that are losing a bunch of money each month. The truth is that by the time you include the real world expenses, your friend will be losing about $1,100 per month!
I’ll leave these “deals” to your friend. I don’t need any like that!
Mike
Mike,
The market for Henry is probaby much different than the market you and I face. If Henry is anywhere near Boston, his appreciation rate is pretty high, so he’s picking up as much or more equity than he loses per month.
In Texas or Ohio, we don’t purchase anything with short-term appreciation in mind.
Having said that, I’m with you, $1200 a month (before PITI) on a $250K property is terrible - unless he bought the property for $100k and it’s worth $250k.