where to find areas with high rental and low buying price

Question

Hello,

What makes (or makes not) an area/neighborhood with high rental and low purchase price to make it a good deal.

What I find now is the rental price is around 0,5%. I think I am looking in the wrong area.

Jon Holdman · Answer

Typically the most profitable rentals are in less than the best neighborhoods. Not war zones, which are too hard to rent and have too many other problems, but working class neighborhoods. Not sure what tools you have in Morocco, but what you want to do is research rents in different area and research prices. Here in the Denver area, rents don't really vary that much in different areas. Certainly there are some really pricey areas, but generally a 3/2 house rents for $1000-1400. The price of such a house, though varies much more widely. Once you see those two basic facts, you then focus your research on lower priced areas. You drive around and have a look and weed out the ones where you're uncomfortable. What's left are areas where you can target your searching.

Finding good rentals is never easy. If you find an area that's at least close, you'll still have to do a lot of digging and searching to actually find deals.

Jon Holdman · Answer

Sorry, Champak, but paying 100x the rent will be a money loser.  If you believe the 50% rule, which is discussed at length in the Rental Property forum, and rents are 1% per month of what you paid, your NOI is 6% of the purchase price.  If you put down 25%, and your interest rate is 6%, then your interest charges are 4.5% of the purchase price per year.  That leaves you 1.5% of the purchase price in cash flow.  That's from your 25% down payment, so you're really getting 6% return on your cash (1.5% of purchase price return on 25% of purchase price invested).  That's pretty good, but the property is doing nothing for you.

Further, some of that 1.5% goes to principal payments, so you actually cash-in-hand is less than 6%.

Another rule of thumb is the rents should be 2% of the purchase price.  Since the market dictates rent, that really means you can't pay more than 50x the monthly rent.  Now, IMHO, that's not the best rule.  If works OK if the rent is about $500.  If the rent is $1000, you can pay more.  But not $100K.  Say you want a 12% cash on cash return.  You can afford to pay about $71,450 for a place that rents for $1000 a month:

Price: $71,450
Down: $17,863
Payment: $321.28 (6%, 30 years)
Rent: $1000
Expenses, vacancy, and capital: $500
NOI: $500
Cash flow: $178.72
Cash on cash return: 12%

If you pay $100K, your payment is right at $450 and your cash flow is $600 a year.  On a $25K investment, that's 2.4% cash on cash return.

A Lak · Answer

I was looking everywhere except in working class neighborhoods, I don't know how I missed it. I was only looking in areas that are for vacation/students/retirement/high income.

Now i have some work to do.

Thank you!

Jon Holdman · Answer

Yep, I know the old 1% rule of thumb.  I just can't get my head around making it work.  I think it does assume a relatively low interest rates.  It wouldn't even come close with the 15% rates from the early 80's or even the 10% rates from the late 80's.  It also assume a long term hold and slow but steady appreciation.  In my example, you're effectively parking $25K in the house with no return.  But if rents, values and expenses all increase 3% per year, after 30 years you have a free and clear house worth $240K and that's generating $1200 a month from the rent of $2400 a month.  Even after just 10 years of 3% appreciation (inflation, really), you're at $222 a month in cash flow and 10.6% return on your 25%.  I'm just not convinced that 3% appreciation is going to happen in the next 10 years.  Certainly the last few years have been radically worse for rents and property values and anyone who bought with the 1% rule in 2005 is probably in a world of hurt.

A Lak, some of this should work regardless of where you are on the planet.  Math is math.  But I have no idea what your market is like in Morocco or what factors might come into play.  For instance, I think the 50% rule of thumb is too optimistic for condos here in the US.  There may be factors in Morocco that make that number high or low.  I've spent quite a bit of time in India, and I know that labor costs there are generally much less than in the US.  That might tend to make property management and maintenance less than here. OTOH, I know interest rates tend to be a bit higher.  So, please consider conditions in your area.

Nevertheless, the rent/price ratio is really a key factor in what makes a good rental.  You just (ha! just!) have to find areas where this ratio makes a profit and where you're willing to go.

Champak Shah · Answer

Thanks Jon- I had just joined few days ago --I noticed this discussion --Not sure - But when I
satrted in 1981 --I was and still am conseravtive --and In Atlanta many investors still  use 1 %  rule.  We get appreciatiaon and equity build up-  Also I said 1% of ARV --not purchase price -- Most Investors --will pay only 70% to 80 % of  ARV in todays market and have 20% down  or  nhave swet equity for rehab so mortgage may be only 60% to 70% of ARV -- I agree some times may not have positive cash flow --but long term rent and hold --should have good return in Five years --When I started I also had  a full time job- and had special accelerated depreciation ( 15 years ) available --which was good offset on my ( and my wife's ) income --on Income Tax.

Also --if investor buys from FSBO -- can have leverage with less down and second mortagge by Seller -- I  had never put in more than 10% down and never had PMI --always had second mortgage by seller. 
As far as neighborhood- also I have diffenrent philosophy--specially in Atlanta market -- no offense- but I stay away from low income --black neighborhood--- also opposed to Section 8 tenants -  I prefer to buy in good neighbor hood--with only few rentals in a  subdivision --that way --my tenant maintians
proeprty well as per neighborhood- and appreciation is much higher-- and they treat house like they own or would like to own.

I never had problem in 18 years-- 
Sorry to disagree --but yeah todays market may be different --I am not buying any rentals anymore.

Jason L · Answer

Couldn't agree with Jon more.  This is great advice.  The math will simply work out better in working class neighborhoods ... no matter what country that is.

Champak Shah · Answer

Dont  know about Morrocco-- In USA --Atlanta or any other cities- I recommend area near --Hospital, College  Campus, Large Industrial Complex as well as near public transportation --many young families and single moms like to rent house - not fancy or upscale - just basic - low maintenance - -- Also first check nearby apartment complexes --find  out what they charge for rent - 2 br / 2 bath  and offer hosue  3br/ 2 bath for same price or $50 more --eventually they will buy --as Lease Option --also young parents with young children like the house for play area etc -- 
In Atlanta rule of thumb is rent should be atleast 1 % of house ARV -- meaning $1000 
rent for $100,000 house- -

Todd Brittingham · Answer

Yes, you definitely want to include working class neighborhoods in your search.  One easy way to do this is to start plotting out 3/2 properties that have sold in your area.  You will start to see where the various areas are that should solicit good rental markets.

As a general rule of thumb, high income areas are 90% owner occupiers
Working class neighborhoods are split 50/50 between owners and renters, and low income areas are about 80% renters.  Your returns will rise as you move from high income to working class to low income neighborhoods, but your risk moves up as well.  If you would like to venture into the low income areas, there are usually great opportunities for higher returns but you need to do so carefully.  Fully research the market, go out and drive around in the neighborhoods and get a good sense of where you are buying.  If you're still not comfortable, then stick to the working class neighborhoods.

A Lak · Answer

I am in Morocco.
Ex: purchase price of a 2 bedrooms apartment  $160.000 renting price $600.

What I need to know are the factors that makes an area to keep low prices and high rentals.

Jason L · Answer

That does seem pretty high... where are you looking?

where to find areas with high rental and low buying price

Most Popular Reply