Can I get into real estate?

Question

Hey guys. I'm new to the forum, but I've been on here for a while reading articles, tips, et cetera, and it's been a great help so far. I have a few questions of my own though and I'd much appreciate your thoughts.
          
          Now, I'm interested in getting into real estate landlording; I'm interested in getting good cash flow. I feel like I'm qualified financially, but I still have a few concerns.
          
          Now, a bit more about myself: I am, by occupation, a surgeon in Texas. I have good credit and my current monthly income is typically $23,000 (before taxes). I'm only 33 right now and I'm pretty stable, so I feel that real estate would be a great thing to do right now.

I have a good bit in savings and I could always buckle down and save alot more as per my relatively high monthly income; I think these are my pros (maybe?).
          
          Now, here are a few of my concerns:
          
          I work a pretty hectic work week (it's not unusual for me to have 60-70 hours), so being a full-time landlord simply won't be an option. Would that mean I'd need a property management firm? And how much work is typically associated with landlording?
          
          A few questions:
          
          I was looking into properties and I think fourplexes would be ideal; would that be the case, since I'm paying a mortgage on one building while having four units?
          
          Should I go for cheap or more expensive (with better tenants, etc)?
          
          How many properties can one typically acquire in a year? One? Two? Five? More?
          
          Where do you guys find your properties to buy?
          
          And my biggest question: how much can you really earn?
          
          Those are a few of my questions and I'd love to hear all of y'alls suggestions and answers. My goal is to be earning at least $15,000-$20,000 monthly by the time I'm 40 from real estate. Is that a stupid pipe dream or a realistic goal?
          
          This is how I do my calculations, although I could be doing it completely wrong and if so feel free to correct me or offer constructive criticism,
          
          If I purchased a $300,000 property with a 30-year fixed mortgage, I would get 500-600 a month on the mortgage payment (at least, according to the calculators). If I purchased only fourplexes, I'd have 4 units and I would charge a rent of $700-$800, grossing me (assumning full occupancy) about $3200 a month. Then I subtract my mortage (-500), taxes (-100, let's say) insurance (-125) and maintenance fees (-300) for my net income of about $2000 per property. 
          
          Is that a good calculation?

I'd very much appreciate your tips for a newbie. 
          
          Thanks,
          Michael

Jon Holdman · Answer

Something's wrong with your mortgage calculator.  Investor interest rates are typically about 6% right now.  They're always higher than owner occupied properties.

I'll second what Sam says about reading in the Rental Property forum.  Taxes in Texas on a $300K property aren't $1200 a year (I used to live there).  You're missing a number of fees, like property management (10% of collected rent plus a half to a full month to fill a vacancy), vacancies, damage in excess of security deposits, utilities while its vacant or for common areas, CPA charges, legal fees, evictions, etc.  The rule of thumb commonly used is that expenses, capital items and vacancy will eat 50% of the gross scheduled rent.  If you're paying utilities (don't, even water if you can help it), it might be higher.  Texas' high property taxes and pest control issues might push it up too, though the milder climate pushes it down.  Anyway, its a good first approximation and better than trying to predict unpredictable events.

So, lets look at what you can expect from a $300K fourplex with $800 monthly rents.  Investor rates are about 6% right now.  You should plan for 30% down, though you might be able to do a little better at first.  I'm going to ignore closing costs (don't) and assume you don't need to do any fixup (you'll do better, though, if you buy properties that do need some work.)

Purchase: $300,000
Down: $90,000
Loan: $210,00
Rate: 6%
Term: 30 years
P&I payment: $1259

Gross scheduled rent: $3200
Expenses, capital, vacancy: $1600
net operating income: $1600
Cash flow (NOI less payment): $341
Cash flow per unit: $85
Cash flow per year: $4091
Cash on cash return ($4091/$90,000): 4.5%

Terrible, IMHO.  Real estate is risky and troublesome.  You want to have a much higher return than that.  At least up in double digits.  If you paid $200K for this property, your cash on cash return is 15%, which is getting to be interesting.

You would need 44 of those properties to hit your $15,000 per month goal.  At $200K, your cash flow is $760 a month.  So, you need 20 properties like this to hit your $15K goal.  That might seem like a lot, but that is the kind of number you'll have to hit to achieve those goals.

Another way to do this calculation is to assume 100% financing, and go for $100 a month in true cash flow (not the bogus "cash flow = rent - PITI" often spouted by people with an interest in you buying something.)  That is really saying you're paying yourself the same return on your cash as you're paying the bank on the loan, and then making the property stand on its own.  That calculation gets to the same $200K value.

If you can easily buy fourplexes like that off the MLS for $300K, you certainly don't want to pay that. You want to have significant equity right from the start.  A good rule of thumb is that you want at least 30% equity on the day you buy, or, at least after you finish any repairs.   With the uncertainties in the market, an even higher equity would be highly desirable.

Its hard to find deals like this.  You have to get out and beat the bushes.  Go to your local REIA and meet people.  Drive areas. Learn rents.  Tell everyone you know and everyone you meet you want to buy rental property.

Triple net deals like Don suggests might be an alternative.  They aren't going to be as profitable, but are a lot less work.  They're relatively big money.  For example, auto parts store for $1.3M, cap rate of 8%.  Cap rate is your rate of return if you pay cash.  Its much easier to determine on a NNN property because the tenant has to deal with insurance, taxes and maintenance (the "triple"),  If you put 30% down, you make 8% on the 30%.  If you borrow the remaining 70% for 7%, you're making the 1% spread on that.  So, your total return would be about 10.3%.  The risk is that your tenant goes under and your stuck with a big, empty, and all-too-often useless building.

Yet another option is hard money lending.  Lend money to rehabbers (fix and flippers.)  Your money is secured by property.  You can typically make 12-14% doing that.  The downside is that the deals are whatever size they are, so its hard to get all your money on the table.  And, you'll have downtime after one deal closes until the next one start.

Jon Holdman · Answer

Another thing I meant to add:  tax benefits.

You'll be told about all the wondrous tax benefits you get from real estate.  You'll be told you can offset your other income with the depreciation, so the crummy deals you'll be offered will generate negative tax.

Its all bull.  Yes, this might work for some people.  With your income, no, you cannot use any passive losses to offset your ordinary income.  That ability is limited to $25K a year in passive losses and only if your AGI is under $100K (single or married filing jointly).  That $25K phases out up to $150K and then its gone.

Further, and the person prompting the tax benefits always neglect this, you'll have to pay "deprecation recapture tax" when you sell.  In your situation, you would get some benefit, since you're in a high tax bracket and recapture is capped at 25% (for now.)

The benefit is really that a lot of the net rental income is tax free.  On a good deal, and you only want good deals, its unlikely the depreciation will fully cover the income, so you'll still have a little tax.  Crummy deals often generate new losses.

You really should have a discussion with your CPA before you start down this road.  If he or she seems clueless about real estate, find another one if you choose to pursue the path.  Real estate taxes are incredible complex.  If you're using Turbo Tax or some such, a good CPA would probably save you some money even if you don't buy real estate.  Doing real estate taxes with Turbo Tax is hopeless.  Yes, it and the other programs with do the math and make the forms.  They just can't tell you how to structure deals to minimize your taxes.  A CPA is just using super duper turbo tax.  The difference is that her or she knows what to put where.

Jon Klaus · Answer

7 years to $20K a month in net income?  Sure, it is possible.  Are you willing to bank/invest half your income to get there?  Once you are really rolling, your portfolio and can grow faster than you could imagine.  But you won't get there in a straight line.

Are you stuck on 4-plexes?  They are often over priced and can't be retailed to owner occupants.  They also aren't sold on cap rate, so portfolio commercial investors generally won't buy them either.  An advantage they've had in the past is that you could get good non-commercial financing on them.  Like a very low down and low fixed rate.  That's not so much the case any more.  Yes, 4 units together is easier to manage than 4 SFR's, but that's not a big advantage.

If I were you, I might get my feet wet with SFRs that have multiple exit options.  And then plan to move to commercial when your finances can support the move.  You could outsource property management and be willing to flip or sell some along the way to accelerate overall return.

NNN commercial leases can be a good way to go if you have no time for management, but as pointed out, returns are typically less.  And as Jon H, has said, if you lose your tenant you could have no performance for a long time.  There are ways to mitigate that risk, so NNN may be for you in a few years.

Another way to go might be to buy an apartment complex early on which does lend itself better to outsourced property management than SFRs or 4-plexes.  Perhaps buy a 20 unit first for $500K that grosses $150,000 and nets $60,000 a year before financing.  Perhaps one with upside where you can force some appreciation.  Then perhaps in 3-5 years you will be in a position to buy a 100 unit complex.

I probably don't need to tell you that "buying right" is a huge part of the equation.  Don't be too quick to buy a good deal, when a great deal could be had by waiting and learning the market a bit more.

Well enough rambling.  You are in a relatively unique position that could allow you to get to critical mass in REI within several years if make good (great) moves now.

Jon Holdman · Answer

No idea what's realistic for your area.  At $145K, you're paying about $36K per unit.  That would be a screaming deal in almost anyone's book.  I would guess you would have a very hard time finding such a deal.  That was really my point, which I didn't make very clear.  $1000 in true cash flow from a four plex is going to be a very difficult goal to achieve.

OTOH, paying $200K ($50K per unit) for a fourplex with $800 rents would still be a good deal.  With 30% down, you would hit $760 a month in true cash flow and have a 15% cash on cash return.  You're still going to have to search high and low for such a deal.  Crummy deals are easy to find.  Good ones are hard.

Property management is not actually all that much work.  The most work is when you have a turnover.  But with your work schedule and your goals, it may be too much for you to do yourself.

I'd consider starting with single families.  At least around here, they're actually better deals than small multis.  The bigger upside is that if you decide this is not for you, they're much easier to sell.

Your biggest obstacle is going to be financing.  With good credit, income, and some cash in the bank, its easy to get up to four mortgaged properties (including any you live in.)  With some work, you might find a bank that would let you go up to 10 conventional mortgages.  That's within fannie mae guidelines, but there aren't too many banks wiling to do that.

The alternative is commercial loans.  This will typically have a slightly higher rate, and will often have a shorter term.  15, maybe 20 years, at the most.  That's will cut into your cash flow a bit.  Developing a good relationship with a couple of smaller, local banks will go a long way toward fixing the financing issue.

Thanks.  I appreciate that.  Glad to help.

Bill Gulley · Answer

Hi, you might consider a different business plan initially. There are plenty of "investors" that are willing to work their way into a partnership deal, not only newbies but some with experience as well. A Realtor might be a good prospect. You back the deals and have them manage them. You can have a buyout agreement at anytime, so if things don't work out or you decide to pump in with both feet you can. You can command the lions share of the deal initially, especially if the other person is not on the hook. Think about an LLC and a managing member that can be replaced, that will give you passive income. Lots of possibilities for you...good luck, Bill

Sam M. · Answer

Michael,
 First of all I would like to welcome you to BP. You can find all kinds of information on here that can keep you from losing money on your first deal.

What kind of mortgage calculator were you using! A 300K mortgage at 6% will be 1,610.46/month and that does not include taxes and insurance.

I recommend looking up the "50% rule" and the "2% rule" here on BP to get a handle on calculating rental property purchase prices/income as well as learning about all the expenses you need to figure into holding an income property.

Tod R. · Answer

Michael,

Welcome to BP.  You really lit it up with your first post!

I would recommend getting familiar with as many aspects of real estate as possible (single family, multifamily, office, retail, etc.).  You should also start developing a network of trusted real estate contacts.  Once you have decided on the type of real estate, consider a JV with someone who's established and trusted in that area.  This would allow  you to leverage up on expertise as well as type and size of your investment.

Don Konipol · Answer

If you would like the benefits of owning real property but without the time consumption of most real estate ownership, I would suggest triple net leased properties.  these are usually leased long term to a single tenant who is responsible for maintenance, insurance and taxes.  Ideally, the tenant pays on time, takes care of all repairs and maintains property in good condition.  Depending on the credit worthiness of the tenant, these investment would typically earn 6 - 12% on an all cash investment, with the possibility than good financing can increase cash on cash return.  Downside is that lease rents are typically fixed (sometimes with small yearly increases) so should inflation pop its head you would have little short term protection until the lease expires.

Account Closed · Answer

Real estate is a smart option, especially for your current situation. I myself, am a single person with a higher income bracket than my colleagues who are 25. The properties should help with your gross income. A lot of improvements, and tax write offs help. I got into real estate, hoping to replace my day to day job. It's also another "security" as this day in age, who knows when someone will be laid off or fired. Good luck!

Jared Rine · Answer

I came on this forum to really learn and this thread has a lot of info in it...Thanks.

Can I get into real estate?

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