Trouble with business plans and how the wealth builds/business expands

[James Z.]

Hi all - I am working on establishing what I hope are realistic goals and trying to form a business plan around them. As I do so, and attempt to crunch numbers and look at listings for practice and to get a sense for the market, I'm running into some walls in my theoretical business plan.

I will have the resources in the next few years or so to get a conventional mortgage on maybe 4 single family homes that are worth about $200,000 each, standard 20% down. But after that my resources that I can devote to REI will be exhausted, and I'm hoping that my initial purchases will provide the financial foundation to continue expanding. In reading through these forums, it seems that a lot of new investors seem to get maybe somewhere around $150 in monthly cash flow from each of their single family home investments in this price range. I know that all circumstances are different, but that range seems to be something I have seen people post frequently.

If someone is only getting maybe $600 in cash flow monthly from their four investments combined, how are they realistically able to expand their business and build significant wealth? I understand that just by holding them and paying the mortgages that equity is being built. But even then, especially considering the fact that you are paying more interest than principal for the first several years, it seems like it would be a long time before the equity on those four properties would amount to something that you could refinance and pour into more or bigger purchases.

According to the math in this super simple (and probably flawed) example, the investor would be earning around $7200 in cash flow a year (before tax), and building equity in his properties. Even if all that cash flow is saved, it could be a few years before it was enough to purchase a fifth property, which would not necessarily tip the scales toward rapid growth.

I am hoping someone can cast some light on this topic in general. What am I missing? Some question points in my mind:

-Is $150/monthly/per unit in cashflow pretty low on the spectrum, and therefore skewing my sense of the business? My novice calculations would imply that one could get more from a $200,000 property, but I am fairly new to this and don't necessarily trust myself.

-I intend to be a buy and hold investor, but possibly sell some of the investments when the market is right. Is the seemingly low amount of cash flow just a reality that you deal with, and then the real wealth is built when the market is just right to sell off some of the investments and re-up with more/bigger properties?

-if my desire is to build this into a business and make it my full time job within the next 5-10 years, is this unobtainable without having a significantly larger amount of starting capital to pour into a larger amount of properties?

Sorry for the long post. Please feel free to answer any of these questions and elaborate on any related points; I really appreciate it, and know that there are other novices here that are having similar questions and concerns.

[Bradley Benski]

@James Z. 

I too am working on my business plan and hope to have it posted for review online before July 29.

My belief is that you cannot buy at full retail price and make returns in line with the risk in SFH rentals. You will also h ave to target a market where the rents will allow you to meet your targeted Cap Rate. In my case I’m defining the target market as 150K-200K (primary) at 70% ARV, with rental NOI in line with a 10 % cap rate. From there, it’s a matter of plugging in your financing and getting cash flow.

To compare two properties I own:

#1 is in Southern California and currently the ARV is approx. $270K. Several houses in the neighborhood rent for $1350. Tax and Insurance run about $4500 per year. A negative Cashflow if purchased at full retail, and if purchased at 70% ARV ($189K) it would cash flow about $139 per month. Not a good market to be a buy and hold as the rental income is just low vs. the price of the house.

#2 is in the DFW Metroplex and has an ARV of approx. $170K. (However, from 2005-2013 it was about $150K) and a similar house on the street rents for $1600 per month. Tax and insurance run about $5000 per year. Better, but if I buy it for $170K and do a conventional 20% down and 30 year, then the property only cash flows $108 per month. However, if you purchase it for 70% ARV ($119K) then with conventional 20% down and 30 Year the property cash flows $320 per month.

It takes a lot of houses to make a lot of money when they are financed. Additionally, if you purchase say 3 of the DFW based houses, and after a year sell 2 of the houses and roll the appreciation and all cash flow into paying off the remaining house, then with the mortgage paid off the house starts to cash flow up to $800+ per month. So it’s now a cycle of buying 3, hold for a year or more, sell two and pay off the remaining.

The bottom line is you have to set targets and develop your strategy on how you will meet your goals, which is the point of the business plan.  I think you're at the "Ah hah." moment that real estate is not a get rich quick scheme.  By the way, I have found 3 ways in which I can replace my work income in a 6-8 year timeframe as a Real Estate Investor.