Location, Location, Location -- cash flow?

Question

So, I'm trying to pull together a strategy for buying and holding...   I'm a fan of the philosophy to buy in areas that are popular, with population growth, good schools, low crime, and jobs or quick access to jobs.   I'm focusing in on a couple suburbs of Milwaukee..  (Muskego, Wauwatosa, and maybe others in the SW Milwaukee Co or Waukesha County.)

OK, so it's rather obvious that properties in attractive, popular areas are going to be more expensive and in higher demand.  I also want a quiet street and prefer a ranch layout, 3br.  Some homes are very old and would need a lot of updating.

I am trying to figure out how to get into these areas....   it is very unlikely to get in at under $100,000 and to get all my criteria for under $150,000.

I am willing to do a down payment up to $50,000, so I can look at properties up to $200,000 for 25% down.

Or, I can look at Fannie Mae and Freddie Mac programs where it seems I can do a down payment is only 3% down

So my strategies to find a "deal" seem to be:
1.  REO
2.  Find leads from a wholesaler when I get my criteria tighter
3.  Driving for dollars (find and search out vacant properties)
4.  Low bids

Another concern or fear that I have about buying a SFH and turning it into a rental is --- WILL IT RENT?   WILL I SET THE CORRECT PRICE FOR A RENTAL?  And, is it the wrong strategy to have a big loan and only get a couple hundred bucks a month in profit???

Sorry this is a lot of questions / uncertainty in one post.  I appreciate any feedback.

The goal is to build a monthly cash flow through several single family homes, duplexes or small multi family.

I am getting the feeling NOT to compromise on the area...    I think I just need some reassurance on this, because the cash flow and ROI seems so small.

Lastly, I see a few duplexes in my target neighborhoods that sit on the market a long time.  I'm thinking this may be an opportunity to try to make a deal.  It seems to be hard to "exit" on a duplex, but if it's a good one, maybe I'd never want to exit.

Thanks everybody!

Karen M. · Answer

Thanks so much Jon, what is interesting is that in suburb that I am most interested in pursuing, it's a growing area with fantastic schools and a great community feel, there are not very many rentals.   The other market I am looking at has tons of apartments.

I am trying to develop reasonable expectations and $100-$300/door is what I've read on here.

The main reason why I am looking at low crime, access to jobs and awesome schools is that the demand should, in theory, be very, very strong long term, and while I'm not necessarily going for appreciation, the area is not likely to fall apart.

Thanks so much for the reply.  It's obvious I have more homework to do on rents and neighborhoods.

Jon Holdman · Answer

If you have the case for a 20-25% down payment and good credit to get the loan, you're in a pretty strong position.

IMHO, you may well have to compromise on the area.  I don't know what kind of area you can buy for your (rather wide) price range.  But "nice" areas don't always make profitable rentals.  You need to look around and figure out where the rents and prices make sense.  Now, I'm not saying you should invest in a war zone.  The better rentals, though, and often in  not-so-nice areas.  You may also find areas folks consider to be not-so-nice are, in fact, filled with regular families, raising kids and living their lives.

Figuring out the prices for properties is pretty straightforward.  Figuring out rents takes more work.  But its crucial to your investment.  This is really the number you have the least control of.  Even being a little bit high vs. the neighborhood will mean its hard to rent and you get a crummy tenant.  So, look on these fair market rents sites as a quick and easy way to get an idea.  Then, look on craigslist, any local sources, and drive the neighborhood.  Pretend to be a tenant and start calling.  This is the only way to find out details like beds and baths, what's included in the rent and what does the tenant pay, and any other amenities.  Watch over time and see if properties come and go quickly or linger for some time.  Drive by them and have a look.  Better yet, try to get a look inside.  These are your competitors, the more you know about them the better.

Now, generating a loan of cash flow on a leveraged property is challenging.  You seem to be expecting more than "a couple hundred bucks a month in profit".  This often is about the best you can do.

Here's a sample of my calculations for what I would consider to be a pretty good, $100K rental.  The key inputs are the price you'll pay, the rehab (REO's ALWAYS need rehab), and the rents.  I'm assuming you're paying $100K, need to put in $10K for rehab (a pretty minor rehab for a REO), and can get $1300 in rent.

Price:	$100,000 
Rent:	        $1,300 
Rehab:	$10,000
Down %:	20%
Rate:	       4.50%
Term:	30
Down Pmt:	$20,000 
Total cash:	$30,000
Loan:	$80,000 
Payment:	$405.35 
Expense %:	50%
Expense Amt:	$650 
NOI:	$650.00 
Cash flow, monthly:	$244.65 
Cash flow, annual:	$2,935.82 
Cash on cash: 	9.8%
CAP rate	7.80%

That assumes you're paying for a property manager.  If you manage yourself, and do you own minor maintenance and make ready, you can earn that slice of your expenses.  So, it looks more like:

Price:	$100,000 
Rent:	$1,300 
Rehab:	$10,000 
Down %:	20%
Rate:	4.50%
Term:	30
Down Pmt:	$20,000 
Total cash:	$30,000 
Loan:	$80,000 
Payment:	$405.35 
Expense %:	36%
Expense Amt:	$468 
NOI:	$832.00 
Cash flow, monthly:	$426.65 
Cash flow, annual:	$5,119.82 
Cash on cash: 	17.1%
CAP rate	9.98%