What kind of returns are acceptable on RE investments

Question

Hi Folks,

I've been reading the beginners guide as well as reading BP forums and visiting some members webpages.   I currently live in NY but looking at investment properties in SE Florida as I winter down there and I'm looking to relocate in 1-2 yrs. I'm looking at RE investing for the longer term and plan to buy and hold for 8 - 10 yrs maybe more.

I'm wondering what kind of returns successful investors want to see on their properties before pulling the trigger and making offers. To date I've made 2 offers (one short sale & 1 foreclosure) and still waiting to hear back on both.

One the short sale after expenses of Mortgage, HOA, Ins, misc upkeep and collecting monthly rent I'm looking at 20%  annual return on my down payment. The foreclosure after looking at same expenses and rent I'm looking at 18.75%.  Am I setting my profit margins (annual ROI) too high?

Based on what I'm reading in the beginners guide the rule of thumb is to collect monthly rent equal to 2% of purchase price and currently with both properties I'm at about 1.2 or 1.3% of purchase price.  Wondering if I should get closer to sellers asking price, make a little less in the first 2 or so years and look to make my profits on the tail end when I sell the properties in the future.

Thoughts??

Many Thanks,

Roger

Joel Owens · Answer

Hi Roger,

Asset managers usually reject your first offer as they know it is not usually your last.

They want to see how much more they can squeeze out of you. Most buyers keep upping their offer by half and the asset manager only goes down a little thereby getting the buyer over to the sellers side more after their initial low ball offer.

I like to do the opposite. I only go up a few hundred to a few thousand. I want to see how much that asset manager will move on the second to third counter over to my side. If they are unrealistic and not coming off much I will leave it alone for awhile and see if they become motivated.

Now if this is already a killer deal then of course paying asking or over might still be okay to do. If it's a property that's not getting much action or is not known about (off market) you have more play in negotiations.

Matt Devincenzo · Answer

Welcome to BP Roger. I'm actually a FL native and choose to invest there instead on CA where I now live.

I actually think your 18-20% is too low! Here is why first of all let me say the 2% "rule" is not one I follow reason being it doesn't take into account leveraged or not and the more expensive a property the less "accurate" it becomes.

The 50% rule (search upper right corner for VOLUMES on what it is) is something that is based on years of actual average expense data, and while it may not be accurate to the % for a given area it will be generally accurate.

So now to why I think your return is a little low. You account for PITI and HOA and "upkeep" I'm assuming(maybe incorrectly) that is not a large number you've used for that. So if you include vacancy(8-10%), property management(12-14%), turnover(5%?) and a maintenance reserve(5-10%) that is easily 20-30% of your rent every month which sounds like a lot I know but if you start looking at it it can easily be that.

This doesn't account for good appreciation in certain markets, but I don't personally include that since as seen in the last few years appreciation can be negative.

I like to use cash on cash return and I like to be getting about what your numbers were 18-20% anything less and I could lend privately and make that without dealing with tenants or owning property.

If you post some numbers we can give you some real analysis that maybe will help you hone in on what to look for in your personal holdings.

Trent Begay · Answer

Wayne Brooks

Well truthfully I am not familiar with the area and demographics. i'm just showing the potential for better investments. The cost is lower and 20% down would go a lot further with something like that.

Personally, I would not pursue a 10 cap on a property like that when negotiations are adamantly heading in the wrong direction.

Anyway though good luck! If I can be of any service don't hesitate to ask!

John Thedford · Answer

If you have to invest a lot of time then your return should be higher. You could do something like hard money loans and earn up to 18% with quite possibly very little work. Buying property just to buy doesn't make sense. Weigh risk/reward to help make the best decision. Generally,  the higher the risk you should get a higher return.

Wayne Brooks · Answer

Roger H. 1.25% monthly income in a stable, desirable neighborhood is about the market here.  
Trent Begay that townhouse you referenced has about the same monthly % income, and is in Homestead, which is not near here and not as desirable an area.

Trent Begay · Answer

Looking at the figures I wouldn't go any higher, the cap rate is already pushed down to 10% and the monstrous HOA fee is eating profit.

Looking in your area there seems to be tons of better deals. Just browsing the generic craigslist website I found a similar investment with better numbers. http://westpalmbeach.craigslist.org/mdc/reo/3841005867.html

And according to the latest area statistics you should be getting closer to 13% capitalization rate: http://therealdeal.com/miami/blog/2012/04/11/west-palm-beach-fort-lauderdale-offer-greatest-returns-for-single-family-home-investors/

You can also look at re-amortizing your investment in 10 years for higher profit margins then pay it down enough to make an awesome profit and reinvest.

Roger H. · Answer

Hi All,

Thanks for your comments and suggestions.

@Joel Owens, As I'm just getting into RE investing I plan on managing a my initial 3 -5 properties (when I get them) to understand firsthand some of the landlord tenant issues. Then I will certainly look for a prop mgmt company to handle these and other properties cause like you I really don't want to work for my investments.

@Matt Devincenzo, I appreciate your offer to look at some of the numbers so here's the foreclosure numbers. It's a condo so HOA covers hurricane ins, water / sewer, landscaping, etc.

Heard from bank this morning and they rejected my offer. Will rework numbers and possibly make another offer of $100k.

Ask $114,900

Offer $95k
Dwn 20%

Monthly exp:
MTG: $368
HOA: $256
TAX: $152
INS: $77
Misc: $100

Monthly rent: $1250

Based on above annualized ROI is 18.7%

Now if I assume a realistic 5% vacancy monthly rent averages $1187 for a revised ROI of 14.8%.

No closing costs included included as I figure I'll deduct these from proceeds when I sell properties in 8-10 yrs.

Are there other expenses I should be calculating into my models?

Thanks,

William Brace · Answer

Roger H. Although opinions will vary greatly in this area, I am happy with 18-20% returns. I have one as low as 17% and one as high as 28%. It's really going to depend on your market where you invest. One investor may not touch anything less than 25% where the next investor only gets 10% in their area.

So long story short, I think your right on with your targets.

Jennifer Lee · Answer

I think 18-20% is great too! mine are around 10%
but then again, I am a low risk taker ;p

I am also consistently doing different things, so if I have to do it again, I would do it differently.

I use our own capital, little leverage  and no hard money. That is why my return % is lower (50-100% down)

With each project my return increase.  
Sometimes it's about Capital gain, 
sometimes it's about cash flow.
Sometimes it's about Prime Location for appreciation.

either way, My BIGGEST concern is BUYING right!!!

Trent Begay · Answer

I think 18-20% is great!

Here in Arizona you would be lucky to do so well. Properly managed expenses can be kept to a minimum, turnover can be put off for potentially years and a good reserve just needs to be established in your investment plan.

I am of course speaking from a perspective of someone with a educational background in project management, real estate, accounting, and organizational leadership. Someone who enjoys strategic and careful planing, and knowing how to utilize the numbers. However, maybe you see things from a similar prospective!

Even a 200% ROI wouldn't be enough for someone who doesn't manage money or assets well. Just play with the numbers and see if it all makes sense with the all the bills and debt service.

Here in Arizona investors want to see at LEAST a cap rate of 10% on lower class rentals [On more luxurious or in demand locations they are usually willing to go down to 6% or even 5%] That means that they want to see 10% of the building's cost is paid by the year's net proceeds. Of course the numbers are negotiable and determined by the market you are in too.

I've heard the 1% rule and the 2% rule, but I like competition, I encourage innovation,  why not check out similar rentals in the area? Do they match your numbers? What are they renting for? What if I offer incentives to draw tenants my way?

It's just smart investing over all I think. I would be more than happy to have you bounce ideas off my head if you wanted as well!

Just my two cents!

What kind of returns are acceptable on RE investments

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