Focusing on the wrong thing?

[John Dunn]

I'm crunching numbers on my first investment purchase and suspect I'm focusing too much on the profit margin during the first two years (low single digits).   I think the margins will be between 10% (no refinance and lower interest rate) and 15% (refinance at a lower interest rate) in 5-6 years.   My gut instinct is the first year margin isn't the most important thing to focus on as long the property is profitable in the first two years.  Margins will improve over time since the largest expense (mortgage payments) is fixed.

[Randall Alan]

Quote from @John Dunn:

I'm crunching numbers on my first investment purchase and suspect I'm focusing too much on the profit margin during the first two years (low single digits).   I think the margins will be between 10% (no refinance and lower interest rate) and 15% (refinance at a lower interest rate) in 5-6 years.   My gut instinct is the first year margin isn't the most important thing to focus on as long the property is profitable in the first two years.  Margins will improve over time since the largest expense (mortgage payments) is fixed.

@John Dunn

Well, I would beg to differ... profit margin is always critical.  I don't look at closing costs, or repair cost to get ready to rent when analyzing that (but I am cognizant of those).  But I do look at the month 1 fully rented monthly margin.   Maybe we are talking different 'languages' here though... if you are saying that it will take 1-2 years to recover your up front costs to finance and get the house to rent ready, that is different.  While those costs are important considerations, at the end of the day my primary analysis is "How much money is the property going to net after principle, interest, taxes, insurance, and a maintenance reserve ?" (We usually go with a figure of about $100-150/month on the maintenance reserve.)  And remember that your taxes will reset the year after you buy it, so you need to guesstimate the new property tax rate - if nothing else call your local property appraiser and ask them, "If I buy this house for X dollars what will my ballpark property taxes be next year based on this year's millage rate?"  Many people don't realize this and get a big surprise 12 months after they buy a property.

The next question is: When is it worth buying a property?  For us we want at least a monthly net profit (after the above listed expenses) of about $300.  Below that it's just not worth it for us.  Everyone will have a different number.  But what I would argue is that it makes no sense to be upside down on a property in general.  One could argue an "appreciation play"... where you buy it because it will be worth more in a year or two... but with the markets in decline right now because of the Fed rate hikes, that is unlikely today - but made a lot of sense a few years ago.

So run your numbers, and see what they tell you.  

As to your margin percentages... I really don't think those are great numbers.  We are closer to 40-50% net profit based on total rent expense.  Granted, we bought most of our properties between 2018-2021 when rates were much lower.  So I get that todays' market is much skinnier on margins...  but would point this out:  Right now you can invest in a US Treasury Ibond and get 6.89% on your money leaving it in for a year... (less 3 month's interest for cashing it out early).  That's a zero risk investment.   When you quote 10% profit with all the risks that real estate brings (think the potential of needing a "new A/C system" that costs $6,000 and wipes out 20 month's profit at $300/month) 10% profit is really thin.  Your money is probably better in the stock market at those rates.

All the best!

Randy