How on EARTH to get good ROI with expensive properties?

[Account Closed]

Would be EXTREMELY appreciative of advice.

I am currently looking to buy a SFH as my personal residence (to be made a future rental property once I move out). This is a 3BR/2BA house selling for for 550k. Even if I were to pay ALL CASH and immediately rent out this property I would only get about 3% ROI (less than 4%). This is TERRIBLE!!! Even when I inflate the rent price the ROI is HORRIFIC. It is NOWHERE near the 8% I could have gotten for my condo which I paid only 152K for which is now worth over 420+K.

1. I simply do NOT understand how the "1% rule in real estate" can even works on these more expensive properties!? I can easily meet the 1% rule with my condo but NOT the more expensive properties because the rent doesn't INCREASE enough to match the more expensive properties.

Because I can easily understand a 100K house which rents for 1k/month (there's your "1% rule met!"). But I simply do NOT understand how I see all these more expensive houses in the 500+K range being rented out to tenants... how on earth is the landlord is even able to make a single cent almost! Because that 500K property would have to rent out for $5,000/rent. RIDICULOUS. Not happening and I am in very expensive areas in very nice communities where housing is NOT cheap.

2. I was thinking of buying a 500K house (with a big down payment) and then in 2 years I would rent out this property when it's free and clear... but NOT if I am only going to get 3% ROI.

3. Another HUGE problem... I am going to end up in a situation where I have over 500+K equity TIED DOWN in this house and will not even be able to leverage it!!! Because I would be getting only 3% or 4% ROI with this property rented out... so how on EARTH could I ever leverage this property because I am not going to find any lender to lend me a loan for under 3%!

I could REALLY use some advice here.... I do not know what to do! It is urgent I buy a house to live in ASAP because, for the first time in my entire life, I am a tenant. Nothing against being a tenant but it is NOT for me and I am done paying rent watching it go up more and more and noisy neighbors driving me insane. However it it crucial that the house I buy now will be a GOOD rental property in the future... but I do not see how this is possible with a property at this price-point! :(

[Randall Alan]

You sort of answer your own question, you just aren’t realizing it.  In short , not every property makes a good rental.  As you pointed out, the $100,000 property is probably a sweet spot.  What you fail to connect is:  that is what you need to be buying if available… because the $500,000 property wont function as well.  I graphed this out years ago.  My question was simply: How do I maximize the use of my investment  money… what property do I buy?  I took a $75k House, a $125k house, and a $200,000 house.  What the math showed was the cheapest house that could be rented for the most money is the best purchase.  The $200,000 house returned the most income, but it was eaten up with higher mortgage and insurance and repair reserves.  It was much better to spend $80,000 down on 4 - $100,000 houses than 2 - $200,000 houses; or in your case one $500,000 house.  The $75k houses performed even better.  The $75k house from 4 years ago is probably the $125k house today.

Your challenge seems to be only looking at $500,000 houses, I presume because that is the caliber of house you want to live in.  And that is fine.  The fault in your approach is forcing your house to be a future rental as your only option.  

A better possible play is that you buy cheap rentals and don’t try to make your $500,000 house a rental  later.  Instead, you hold it if real estate is appreciating and sell it when you want and pocket the profits. At least that would have worked until recently.. but now the negative pressure in the form of very high interest rates is going to slow appreciation.  How much is yet to be determined… will house prices decline?  Probably… economics says yes.  But then you have to factor in inventory… if supply is still constrained prices may just plateau if buyers can still afford the higher prices / interest rates. A lot will depend on how well the Feds balance their tightrope act of slowing down the economy. 

The other thing you have to factor in is that you are now buying at a very bad time.   Prices are high, the cost of money is way up, the home owners insurance market is crazy with increases.  Insurance prices have doubled in two years… oddly enough driven by the high value of the real estate.  If the house is worth double, you now have to insure it for double as well.  Each of those factors act to diminish your profitability on your rental investment. 

One option is to wait for a better purchase environment.  Never fun to hear, but the urgency to buy something soon is probably sabotaging the best use of your money - which may be to sit idle while you wait for the market to reset 

So determine if buying your $500,000 home as a rental is a valid plan - and if not - consider other options.  it makes no sense to get a 3% return with an inflation rate of 8-10%… you are losing buying power. 

hope it helps a little
Randy