Beginner with $200k

[Dan D.]

So, I do not own RE but want to use my savings of around $200k which is currently sitting in the bank and losing value, to buy some properties to get some decent cash flow.

My friend has been buying SFH's in North Carolina for the past 2 years. He does the taxes (he's a CPA) of the agent/management company that sends him the deals.

Monthly statements and review of his taxes show around 12-13% cap rates.  These props are bought 35-40k cash, then rented out for around $750-$800/mo.

My friend and I live in CA; so, using this person(s) in NC is my 1st "out of state" investing choice due to track record and trust. Living in So Cal makes it very difficult to find decent ROI.

Any suggestions for a newbie starting out?  Are the above cap rates sufficient?  Input appreciate.

[Mike H.]

I think you're missing the point on leverage though. You don't want to buy 35k to 40k houses and then finance them. Buy 130k to 150k homes and finance those. 

In terms of actual returns, someone above mentioned the returns would be lower. I don't believe that to be true. I think they'll be higher (maybe much higher) if you buy 130k homes and finance them then if you buy 40k homes and pay all cash.

Here's an example:

40k home. Rents for 800. You pay all cash so you're all in at 40k.
If cap rate is 13% then your netting 430/mo after taxes, insurance, pm, etc ? 

But whats your appreciation on 40k homes? Anything at all? 
Whats your principal paydown on a house owned free and clear? Nothing.
Do you have any mortg interest deductions? no.

So what does that house look like in 10 years? Its worth 45k maybe? 
Rents go up 200/mo but taxes and insurance 100/mo? So you're making an additional 1200 a year or 16% cap rate on the 40k?

But your depreciation expenses on 40k houses are next to nothing. 1k a year? So you're paying taxes on most of that rental income. 

Now. Lets buy a 130k house and put down the same 40k.
Your loan is 90k. Rent on that house may be more like 1400/mo
Taxes insurance and PM 350/mo? Mortgage - 550/mo?

Now you're making 500/mo gross profit which may be around 350/mo net profit.
Yes. That is less net cash flow than the 40k home would give you.  

But now lets look at the rest of the returns.
Your principal paydown is 100/mo.
Your appreciation on a nicer house in a good area is more like 3% on average (historically). So add another 3,900 a year or 325/mo in appreciation.
And you'll have a mortg interest deduction AND a much larger depreciation expense so that of that 350/mo net profit, you'll be able to keep just about everything out of those profits. 

And what does that house look like in 10 years? Your mortgage will be down to about 70k. The house will be worth about 180k. And as the rents go up on that one, your net should increase to 500 to 600 mo. Your appreciation will make you 3% of 180k, etc, etc.

So that is why, to me, it makes far more sense to use your money to buy nicer homes and finance them than it does to buy the junkers and pay all cash.

Appreciation, principal paydown, etc are key pieces of your overall return that you're losing out on.  Also, the risk is significantly greater in those lesser areas that you will be far more likely to get hit with a monster repair at some point when a tenant trashes the place or somebody steals all the copper while the house is vacant during a turnover.

When I first started, I was scared to buy the homes in that 100k price range (purchase and rehab for 90k to 110k but worth 130k to 180k).  I was buying houses in the 50k to 60k range that were worth 100l. Not necessarily that they were in bad areas (but a couple are- even though the houses are great).

But the reality is that those early houses cause me far more headaches than the ones in the nicer areas with the nicer layouts. Turnover doesn't bother me one bit in the homes I've bought over the last 5 years. I know they're in good areas with good layouts.  But some of the early ones can be a huge pain to deal with sometimes and I fear any of them having turnover. Renter pool is shaky and the risk to damage or collections or evictions is significantly greater. 

If I was investing out of state, I would never want to own a home - let alone a group of homes - in that lower end. The risk is too great. Maybe your cpa friend has a great PM company so they run it like a machine. But what if they go out of business? Or move? 

Stick with the nicer product in the nicer areas and your risk and loss of sleep (from bad tenants) will be significantly reduced. :-)