Thoughts on Paying Market Value but Cash Flowing Well

[Perry Rosenbloom]

Hi Everyone,

I'm under contract on a 4BR/2BA home. It's very clear that I'm under contract at market value price. 147,500. However, it will rent for $1,500/month and taxes are dirt cheap.

It is also entirely renovated and has many appealing features for higher end clientele in the area (exposed wood beams, gourmet kitchen, hardwood floors throughout). It is by far the nicest home in the subdivision and we are receiving an incredible amount of interest via Craigslist for the home at $1,500/month. I have no concerns about it achieving that rent.

My question is this: Clearly, we are paying market value. However, it flows cash... and should flow very nicely. It is the epitome of a turn-key rental, which is very important for my wife and I at this stage in our lives as I run an Internet Marketing business and we have a 9 week old son.

The home is located in an area that historically does not appreciate well.

What are your thoughts on this as a first investment? I know you make money when you buy, but the market is making this more and more challenging to do in my area. If you find a deal that cash flows, even if it's priced at market value, are you shooting yourself in the foot? I'm estimating a COC of about 21-23%.

My thoughts were, at these interest rates (we are locked in at 4.5% for 30 years), it is OK to buy at market value because you are essentially getting loaned money at below market value.

About me and my strategy:

I'm 28 years old. My strategy is to be acquiring 1 home every 1-1.5 years with 20% down until I hit 4 properties. Taking their cash flow, paying off one home at a time and once one home is paid off, acquiring a new one and continuing that process until I'm in a position to either pay cash for a home, or pay it off within 3-4 years. My plan is to execute that over the course of 20+ years to eventually own 10+ homes.

[Jon Holdman]

I have to make a few guesses to complete my analysis. I'm assuming you're going to put 20% down when you buy this house. You say "It is the epitome of a turn-key rental", so I'm going to also assume you will use a property manager.

My analysis gives this a cash flow of $152 a month and a cash on cash return of 6.2%. Here my complete analysis:

Purchase price: $147,500
Rehab cost: $0
Rent: $1,500
Exp, vacancy, capital %: 50%
Loan rate: 4.50%
Loan term: 30
Down payment %: 20%

Down payment: $29,500
Loan amount: $118,000
P&I payment: $597.89
Expenses, vacancy, capital: $750
Net Operating Income: $750
monthly cash flow: $152.11
annual cash flow: $1,825.34
total investment: $29,500
Cash on cash return: 6.19%

I think you're making a couple of invalid assumptions. One is that because its new and nicely renovated you won't have much maintenance or capital expenses. Most of the small maintenance is caused by tenants. New or not so new, stuff gets broken and damaged. Even a brand new furnace will need replacement 20 years from now, so you have to budget 1/20th of the cost every year.

High end finishes will need more maintenance going forward. Lots of discussion about bullet proofing rentals and what flooring holds up best (hint: the IRS assumes flooring lasts five years, I've been told judges here in CO assume carpet lasts three, so if the place has carpet, plan on replacing it every few years.)

I think you're thinking that because its a nicer rental that you will have less issues with tenants. I'm not sure there's any strong correlation.