Evaluating a Possible Rental Property

[John R.]

Greetings All,

I am evaluating a property to purchase as a rental. It is located in a suburb of Philadelphia, PA and is listed at $114,900. It has been on the market for 186 days and is a double lot that is supposed to be subdividable. The seller is describe as motivated. The first floor is one unit; is a 2/1 and is currently rented through 2/28/2014 at $675/month. The second and third floors make up the second unit, which is a 3/1 and is rented through 1/14/2014 at $870/month. It is described as VERY easy to rent with new carpeting and paint. There is a one car garage that is separately rented at $75/month.

The MLS report indicates the following:

RE Taxes last year = $4,049
Gross Annual Inc = $17,040
Total Annual Exp = $4,049 (Is this the taxes? Seems weird that it is te same exact number. If this is the taxes, then what about OTHER expenses?)

Net Operating Inc = $12,991
Gross Rent Mult = 6.74
Cap Rate = 11.31

I have no doubt that I am just getting started with my analysis; what else do I need to look at, research and learn?

I am working on comps for the area, but wonder why this property has been on the market for so long?

Thanks in advance!!
John

[Harry M.]

John, the thing about the 2% rule is that it is mostly designed to work with very inexpensive properties. For example, buy for 25K, spend 10K on fix-up, and rent for about 700/month. It takes into account that at this price point, you're most likely going to have more turnover, and repairs are more expensive as a percentage of gross rent. In many markets, the 2% rule just isn't possible, and I feel that with you looking into the 100+ price range, you could potentially pass up some good opportunities, even though they don't meet the 2% rule.

The 50% rule - search for it on BP for more details - states that over time and over a large number of properties, expenses (everything outside of P&I, and including vacancy) will converge to around 50% of your gross rent. This seems to hold up a lot better over a wider range of price points than the 2% rule. Note that if the landlord pays utilities, or there are HOA fees, then this goes on top of the 50%.

Using the 50% rule, your deal looks good:
Price: 114,900
Down: 28725 (25%)
Closing: 3000
Seller contribution (2%): -2298
Total cash invested: 29427

Gross Rent: 1545
Expenses: 772
NOI: 773 (8.1% CAP rate)

Debt Service (4.5% over 30 years): 436
Cash Flow: 336/month (13.6% Cash on Cash)

Total ROI (incl mortgage paydown): 452/mo (18.2%)

Obviously, you have to refine this by plugging in the real expenses as you figure them out, but at first glance it looks good.

Hope this helps,
-Harry