Buying and holding at market value??

[Tina D.]

Hello everyone, I am new to Bigger Pockets and the real estate investment world. I have been reading, studying, creeping on the forums, listening to podcasts, etc. for months am finally feeling prepared and ready to start on my first property. My strategy will be to buy and hold properties as I am looking for passive income.

HOWEVER....I cannot seem to find a property to start with. I am looking in a pretty specific area in Cincinnati, mainly because I know the area very very well, and I know it is a very strong rental market. It is also a hot area to buy so many properties are going into multiple offers or even above market value. So without cash (I will be financing), I am having trouble finding a good deal.

Is it not smart to buy a rental property at market value?? The rental market here is very strong, so I know I will have positive cash flow, but everything I have read says to go for 70% LTV only. How in the world do people do that? Really struggling with getting started...

Thank you so much!

[Thomas S.]

Purchasing generally has two aspects, positive cash flow and a exit strategy. It is not necessary to buy under market but is essential that you fully understand cash flow at what ever price you buy at. If you fully understand expenses, which most do not, and you have the proper rent to purchase price ratio then the numbers are all the matter.

However it is extremely common for novice investors to not understand the numbers and even experienced investors often ignore some numbers to inflate what they believe their cash flow to be. You must remember that cash flow has nothing to do with your expenses today they are all about long term expenses on a property, 5, 10, 20 years out. A investor that buys a fully renovated property may believe their expenses are minimal but the reality is their expenses long term are the same, relatively, as on every other property.  

Additionally many investors conveniently ignore the value of equity tied up in a property. Every investment property generates two separate income streams. One is of course the property itself but the other, that is conveniently ignored, is the equity. Paying down a mortgage does not increase cash flow it simply shifts the flow to a return on equity. Money must earn it's keep otherwise there is no value in having it. To properly calculate cash flow on a property one must at a bear minimum base the numbers as if the property is 100% financed. As a property appreciates this must also be taken into consideration which is why rents must be continually increased. This allows a minimum return on the equity equal to at least the prevailing mortgage rate. However money is far more valuable today and realistically equity should earn a minimum 5% or better return. 

Investors should not leave money dead and buried in a income property without insuring that the cash flow on the property is first paying a solid return on equity before considering the cash flow on the property. Many investors do not grasp this concept and believe they have a positive cash flow property when in fact once they apply a return to the equity they are left with negative cash flow on the property itself.

Bottom line is do the numbers and see if it works.  Most will not.