How to analyze current home as possible rental property?

[Ryan Bissell]

Hi, I am a new BP ... person.  I've just recently gotten the idea to invest in Real Estate.  I intend for my focus to be Buy & Hold, with the eventual aim of maximizing cash flow as a source of passive income.  I've educated myself a little bit on property analysis.

I expect my first rental property will be the house I'm currently living in.  So, I decided to "run the numbers" on it, to see how well it might perform for me.  But, the problem in my head is that I can think of multiple ways to characterize my investment in it, and I'm not sure which way is correct.  (Or, maybe they are both wrong, and some 3rd way is correct?)

Here are the deets: I bought it 19 years ago, for $200K.  If I believe Zillow, it has a market rent estimate of $1800, and is worth $300K.   My mortgage payoff is currently $85K.

FIRST CHARACTERIZATION: Completely ignore the nearly $330K of PITI that I've paid in the past 18 years as an unrelated sunk cost. Pretend that I'm buying this property waaaaay under market for $85K, with no money down, no closing costs, and $10K of make-ready (out-of-pocket). If I refinance that remaining $85K at 4.25% for 30 years, and factor in all my known expenses, and assume 6% vacancy & 7% management, then:

• cash flow $4150/year ($345/mo)
• CoCR 41.5%
• ROI 72.27%
• Cap rate 10.79%  (ridiculous, because assumes $85K market value)

SECOND CHARACTERIZATION: Recognize the cost of the property is $300K, but I have a $215K down-payment.  (Everything else the same as the above.)  Then:

• cash flow $4150/year  ($345/mo)
• CoCR 1.84%
• ROI 4.87%
• Cap rate 3.06%

As you can see, these both result in the same cash flow.  But the performance metrics look vastly different.  The problem in my head is that I care about the metrics, since the point is to decide how good this property is.  To me, the second characterization feels more honest considering the property since the day it was built.  But its CoCR (which I think is the metric I care most about) seems pathetic.

I guess I would summarize my questions as:

1. What is the right way to analyze a property that shifts from personal residence to cash flow investment, after decades of principal paydown?

2. Is my projected cashflow as depressing as it seems?  (Works out to be just 19% of gross rent.)

[Brenden Mitchum]

@Ryan Bissell

With $345/mo cash flow, why wouldn't you just refinance? That's a perfectly good amount of cash flow for a SF as long as you have factored in all expenses and vacancy.

If you are hesitant to jump into something large, you could do one of three things. Go small with that 4-plex, partner up with someone and go bigger, or pay for a mentor to walk you through the process. This will just be up to you and your risk profile. But don't be afraid of going big. Every day people are doing their first ever deal as an apartment complex. 

The bottom line here is that you have tons of options and it sounds like you already know the worst one is to refinance and purchase another primary residence so that's a great start and better than most!