Trying to figure out SF rentals

[Todd Willhoite]

I am looking at single family homes for buy and hold. In reading the forums it seems the higher cash on cash returns come from smaller houses in bad neighborhoods, at least on paper. It seems to me that those type of rentals will have people who will move often and trash the place. With higher turnover, more vacancy and the expense of repairing the place it doesn't seem likely the higher returns will materialize.

I have heard on the podcasts that cheap doesn't necessarily mean good. What are you looking for in a neighborhood when making a decision to buy a SF rental place?

What are typical cash on cash returns for SF rentals?

I read the rule of thumb of the 2% rule. So if a house sells for $100,000.00 it should rent for $2,000.00. In my area 2/1 houses start renting at $725 going up to maybe $1,000.00 for a real nice 3/2/2. So using the 2% rule the 3/2/2 only works if you can buy it for $50,000.00. I haven't even seen a 3/2/2 that needs a lot of work selling that cheaply. The 2/1 only works if can buy for $36,250.00. I'm not seeing any of those either.

Maybe I can buy a 3/2/2 built in 1980's that needs full paint, flooring, garage door, and some other work for $65,000.00 plus repairs. But it is in a neighborhood that is looking it's age, probably several rentals in the neighborhood and several owners not able/willing to keep up the maintenance on their homes. No major crime in the neighborhood yet. However I want to do buy and hold, and in ten or fifteen years this neighborhood will most likely be a dump with run down houses throughout the area.

I guess this is why they say look at a 100 houses make offers on 10 to buy 1. It looks like it will take a lot of looking to try and find a deal where the numbers work, especially in a decent neighborhood that has a chance of holding its value over the long run. Am I looking at this correctly, or have I missed something?

[Eric Fernwood]

Hello @Todd Willhoite ,

You are on the right thought path. Trying to conform to arbitrary rules (2%, 1%, 20% below market, etc.) makes no sense to me. Also, deciding up front on the type of property is a problem as well. You need to establish a clear goal and then measure every thing you do by whether it gets you closer (to that goal) or further (from that goal). If your goal is long term financial freedom, then I believe that every property you consider must meet three criteria:

• Sustained profitability - With real estate your minimum horizon is at least 7 to 10 years so a buying based only on the current market situation is likely to leave you in a very bad situation in a few years.
• Located in an area likely to appreciate over time.
• Landlord friendly laws and taxes.

Below is an illustration of the process I would follow:

The first decision is location which may not be where you live. If where you live does not meet all the above criteria look somewhere else. Below is how I would evaluate a potential area.

• Population stability or growth. Here is a map showing growth trends of major cities. If people are generally moving out of an area, the value of your property and the rent you receive is likely to fall. If the population is growing then you passed this hurdle.
• Crime and stable demographics. High crime and long term profitability do not go together. That said, every place has crime. What you need to know is what types of crimes and how frequently crimes occurred close to the property. Where can you find such data? One site is crimemapping.com. There is also good data on homefacts.com. Depending on your city/area you may have such data available from the police department or the sheriff's department.
• Stable or improving job market - A property is only as good as the jobs surrounding it. If major employers are leaving the area you should look somewhere else. Even if the number of jobs is stable, the earning power of the jobs must be stable or growing. For example, if the area is changing from high-paying manufacturing jobs to service sector jobs, potential tenant disposable income will decrease and property prices and rents will fall.
• Landlord friendly laws and taxes. Clients have told me that in California, if the tenant knows what they are doing, it can take up to 1 year to evict a tenant and cost thousands. In Las Vegas, the time to evict is typically less than 30 days and usually costs less than $500. No one ever considers evictions until one happens to you.

Unless the potential location meets all the above you need to look somewhere else. If the area passes all the above (there are more criteria but these are the main ones) then you are ready to consider what type, configuration, location and rent range do best in the area you are considering. Specifically, the minimum you need to know is:

• Type: Condo, high rise, single family, duplex, single story, two story, etc.
• Configuration: Two bedroom, three car garage, mud room, etc.
• Location: Usually a very specific area. For example, west of 23rd St and south of the river, etc.
• Rent Range: If the majority of the population to which you want to rent are willing and able to pay $1,000/Mo to $1,300/Mo. you should only be looking at properties that you can purchase, rehab and profitably rent in the same rent range.

Note that this is local information, which you cannot get from podcasts, seminars, books or similar information sources. What is the best source for this type of information? Local property managers.

The local property managers deal every day with tenants, maintenance issues, renting vacant units, local laws, evictions, etc. In short, every thing you need to know. Talk to 4 or 5 mid-sized local property managers in each city you are considering. Before you start making calls, develop a list of questions and ask the same questions of each property manager. (I have a set of property manager interview questions, drop me an email if you or any one else would like a copy.) Tell them that you are new to investing and are looking for a property manager to work with. After only a couple of interviews you will begin to have a very good understanding of the local market and what type of properties rent best and how long they typically take to rent. Remember that the property managers only make money when they collect rent so they want rentable properties too.

Once you talk to a few property managers you should now have a very good idea of what properties rent best and how much they rent for. The next step is to determine what such properties cost. The property manager may be able to help you here but if not you can use Zillow. Find recently sold properties that match the type, configuration and location you learned from your property manager interviews. Once you know typical costs, it is time to determine whether you can make a profit.

In my practice I am almost constantly making what I call an investigate/forget decision. I do this so often that I created an online tool which enables me to instantly estimate a break-even price (where rent equals recurring expenses). Below is a screen shot of the tool. If you (or anyone else) are interested in using this tool, drop me an email and I will send you the link. There is no charge or obligation for using the tool.

In the example above I entered the estimated rent and other factors and tapped Estimate. The result is that if the property were purchased for $185,000, the rent ($1,200/Mo.) would equal the recurring costs (debt service + taxes + insurance + property management fees + monthly fees). This means that if I thought I could get the property for $165,000 I would investigate further. If I thought I would have to pay $185,000 or more for the property I would forget this one and look for another. Remember that this tool is only for making a quick investigate/forget decision, not a purchase decision.

At this point you will know where and what to consider based on data, not a supposition. You will also know whether a particular area is likely going to be profitable or not. One other comment, as long as you buy investment real estate in a good area, all but the worst mistakes will be corrected over time through appreciation, inflation and rent increases. (We strongly recommend only investing in areas with growing population and low crime.) Do not settle for a bad area just because the properties are physically close or inexpensive.

Todd, I hope the above helps.