Will an experienced investor please explain what I am missing?

Question

Hi,
I have been reading the forums here, and been learning as much as possible for awhile now.  I am interested in long-term cashflowing rental property investments.  I am moving to Lansing, MI for graduate school, and have recently been looking at places there.  I am somewhat familiar with the area already, and have been getting better acquainted.  My main question is: It appears that there are hundreds of homes for sale in the Lansing area that would cashflow a lot of money (relatively speaking of course).  Many of them, at market rent, would be well over 3 or 4 times PITI.  I am talking about rent ready homes, not handyman specials.  Resources I use: homes.com, rentometer.com, Ingham County website, craigslist.com, etc.  I am factoring location, proximity to downtown and Michigan State University, population decay etc.  Can someone please fill me in.  I am obviously missing something.  Please take into account the fact that I have yet to own real estate, am not yet an investor, rather a young person wanting to learn as much as possible before jumping in after school.

Jon Holdman · Answer

IMHO you need three things to have a good deal:

1) The cash flow has to be there, at least based on an estimate.  Assume the 50% rule is true (50% of gross scheduled market rents will to vacancy, expenses and capital).  Assume 100% financing.  Do you cash flow?  Now, apply the realistic financing terms and compute your cash on cash return?  Is that OK?

2) There must be demand for the rental.  No demand and your vacancies are going to be very high. To deduce this, you have to evaluate the market.  Do rentals come on the market and quickly disappear and someone moves in?  Or do houses sit vacant for weeks or months?

3) The must be equity.  Ideally, you would buy at a low enough price that you could turn around and sell the property quickly and not have to take a loss.  If the first two criteria are well met, though, you could be a little flexible on this one.  But if you're paying the same price that every other house is selling for in the area, you have to realize you're going to take a 10% loss for all the transaction costs for buying and selling.  That's 10% of the purchase/selling price, not your investment.  If you by with 20% down, you're talking about a 50% loss on your investment.

Ben L. · Answer

Cody  Lown, would you be able to provide us with an example of a potential deal you have come across?

Patrick Snyder · Answer

Lansing has a solid economy, low unemplyoment, gov't jobs, several colleges/MSU, and of course, GM.  GM has regained steam and has added a lot of jobs over the past years.

As for property taxes, you can find properties with a lower taxable value, you just have to look.  And non-owner occupied taxes are about 30% higher, but you can make up for it with a very low purchase price.  If you buy the right properties, the returns are really good!

Scott W. · Answer

@ MARK H - I don't think you're missing anything, except costs- the property taxes are high for owner-occupants, and basically double for investment properties

I'm in a different state but how are the the property taxes double for investment properties? I know, in our state, you lost the homestead exemption but it doesn't equate to double the taxes...not even close.  just curious.

Patrick Snyder · Answer

Hi Cody,

When you get some time, send me a message and I can respond to your questions.  I live in Lansing and can tell you specific areas to look for and when amenities are best.  we can talk about your target population as well, which will make a difference.  I look forward to helping out!

Cody Lown · Answer

Thanks for the great posts.  
Jon H,
I am familiar with the 50% rule and was using that as my guide. So, 1) Check. 2) While maybe not as high of demand as some places, it appears that houses on the east side of Lansing (closer to MSU) are not vacant very long.  So, semi-check. 3) Some work still needs to be done here.  This area will not appreciate, just as another poster said.  So that won't bail me out.  Furthermore, I have not been able to find comps for the area.  And from what I have read here, using county data is not accurate. Thank you for making it very clear what makes a good deal.
Ned,
I didn't think about the functioning, yet old point.  They very well could have a furnace or roof that will need to be replaced within a year or two.  
These posts have confirmed what I already thought: I need to ask more questions and do some more research.  I am going to continue to pursue an understanding of this market and possibly invest here.
Thanks for the help,
Cody

Ryan M. · Answer

I'm not to far from Lansing but what are they running rent month/purchase price =X%. There probably small potatoes due to vacancy and low rent to purchase. These are single family I assume and I'm not a fan, expenses % runs higher due to only one tenant to spread the cost on and when empty its 100% vacancy. Not saying there can't be some money made but its not worth the time/risk/reward, for me anyway.

Ned Carey · Answer

Cody,

It could just be a fluke of today's odd market. What you are experiencing is NOT typical. However in Baltimore this is the case, easy to get cash flowing deals.  However here it is almost impossible to get financing so I find partners to work with.

However you could be missing something. Expenses for a rental typically run about 50% of the income. This is for everything including vacancy, repairs, management etc. However Principal and interest are NOT included in this number because everyone gets different financing. So figure what the income is, cut it in half, and what is left should cover your profit and mortgage.

Remember that is just a crude rule of thumb. Your mileage may vary. It could be that expenses in your area are very high and the 50% rule may not be accurate.

It could also be that there is deferred maintenance. In other works the house is cheap but the roof, furnace and water heater are old and will need to be replaced soon.  This could mean what looks like a good deal is just mediocre.

Good luck,  -  Ned

PS - Wow I need to type faster. Two people responded while I was typing my response. BP is a great resource.

Mark H. · Answer

I don't think you're missing anything, except costs- the property taxes are high for owner-occupants, and basically double for investment properties.  Unless you're right on top of MSU, you can't command top rents - much of Lansing proper is in tough shape economically, since GM (and its suppliers ) have shed a lot of jobs there, and the state government is bankrupt.   Michigan is not particularly landlord-friendly, so evictions will take longer and cost more than in other states.  So you're getting a higher return for higher risk.

I'm not stating that it's a bad place to invest, just understand the risks & costs, & don't count on appreciation to bail you out.

Emilio Ramirez · Answer

Cody - Why don't you post a sample deal and I'm sure someone on hear will be able to help you further.