New Investor - Positive cash flow

[Brad Rondeau]

Hi, I'm 52 and looking towards retirement. I'm thinking about real estate investment in my area of south Orange County CA. I bought a condo about 3.5 years ago. I met my future wife and we bought a house in the same area. I have been renting the condo for 2.5 years to great tenants. After buying the condo for 365,000 I added about 21,000 in improvements - carpet, paint, new kitchen, new air conditioner/furnace etc. I recently refinanced at 4% 20 year loan. Loan balance is 273,691. I rent this for 2,225 per month. Association dues are 285. The escrow for taxes and insurance is 314 per month. The rent just covers all my payments and repairs.

I've been reading about the 2% rule. I think this is impossible in my area. Investors have been snapping up homes for 420,000 and I know those homes will only rent for 2,500 monthly - maybe they are just flipping them.

Anyway my repairs have been extremely small - about 250 per year. Mostly small plumbing issues that I can resolve myself. Currently my mortgage + escrow + HOA + repairs is about equal to my rent. I see my new 20 year low interest loan is retiring big chunks of principal each month.

I'm no where near the 2% rule as my rent is 0.57% of my purchase price + improvements of my condo (not even 1% rule). But I seem to be doing ok as the rent just barely covers all my expenses and the property is appreciating. Am I crazy for keeping this - should I get out now?

Also I am looking at purchasing a 200,000 rental home that will rent for 1,500. This is 60 minutes inland in Murrieta CA, in a very nice neighborhood. Again not even close to the 1% rule. Should I consider this. I can find single family homes inland that meet the 1% rule but usually in bad neighborhoods and in need of constant repairs. I want rentals with low maint and great tenants and good appreciation like with my condo.

Thanks for your input. Brad

[Jon Holdman]

Forget about the stupid 2% rule. It works when you're paying 6% on your loan and getting about $500 in rent per unit. At higher rents and lower interest rates, you can have a lower ratio and still be profitable.

That said is your rent just covers your P&I, taxes, insurance, HOA, and a few minor repairs you're really in the hole.

Some years ago when we went to Vegas for the first time, I played craps for the very first time. At Binions back when it was really Binions and not an outpost of Four Queens. I started with $200. Quite some time and no small amount of bourbon later, I walked away with a $500 chip. Woo hoo. Craps is a great game!

Of course, I was simply lucky. You've been lucky, too. Self managing and doing minor repairs helps a lot with cash flow, too. But some stuff you've not yet experienced is inevitable. You will have vacancies. Eventually carpets, appliances and air conditioners need replaced. The HOA decides a new roof is needed and has a special assessment. You'll get a professional tenant who drags out an eviction for six months. These things aren't unfortunate events. They are just part of the business. If you plan for them, you will do fine. You're planning that they won't happen. Its entirely possible to roll the dice a dozen times and never throw craps (2, 3, 12). But roll those dice 100 times, and you've likely to roll about 11 craps rolls. These additional expenses are just the reality, even if you personally have never experienced them.

The 50% rule seems to be born out strongly when anyone has presented any real data. Not one unit for a few years, but 1000's of units for many years. In any year, any unit can do somewhat better or much worse.

If you're self managing, you are earning the cost of a PM. I think that's a really good paycheck, in my experience. Especially as the rents get higher. Same for small repairs. But at some point you may want to do an around the world cruise or go to Italy for a month. And then you have to start paying someone to do these things. If you're buying rentals that are profitable even if you're paying a PM, these are options. If the rental itself is break even or cash flow negative, and the only profit comes from your labor, you're not really investing. You're buying a job. That's OK if that's what you're willing to do. And if you're willing to invest the time now and pay the properties off, they can still be cash flow positive in the future. But realize what you're doing and don't make a business model that depends on luck.