First Purchase - Rental Property - Need Advise - Philadelphia

[Mike Rash]

I am purchasing my first rental in Philly and need your opinion(s).

Here are the facts:
Location: ZIP- 19125 - Kensington / Fishtown
Single Family - 2 Bedroom / 1 Bath - 900 square feet.
Completely Rehabbed in 2007 (all appliances are very basic, nothing fancy)... The house was sold in 2007 for $125k and then went into foreclosure 1.5 years later... The bank took possession and then eventually dropped the price to 75k, which I negotiated down to $58k.

So the final price is $58k (plus $3k in closing and etc) for 900sf which will rent @ $700 a month. The TENANTS will be responsible for ALL utilities. I will be responsible for taxes (only $300 a year) and insurance..

I am paying CASH for it, so there is no mortgage involved...

My main concern are the following:
1. Do the numbers make sense to you guys (they do to me - seems to yield about 10% ROI after all expenses)?
2. There are 2 abandoned houses on the other street... This seems to be common in the lower income neighborhoods in Philly... I just hope it does not spread to my street...
3. There is a house near-by being sold as SHORT SALE for 70k - but it is INCOMPLETE rehab and will require substantial investment (another 20k)... However it is much larger - about 1500sf.
4. Should I buy a fully completed house for $58k or try to buy a shell (abandoned house) for $10k and try to renovate it? ( I think it would cost about $40k to completely renovate).

Any advise is really appreciated!

[J Scott]

If you look around the site, you'll see that many here use what's called The 50% Rule to determine what expenses will be for a rental property. In general, The 50% Rule says that on average, across many rentals, and in the long run, expenses will be around 50% of gross income (the rent in this case). One thing to note is that this 50% also includes vacancy and longer-term capital costs, but not debt service (mortgage).

So, based on that rule, with a $700/month gross rent, you'll probably looking at about $350/month in expenses over the long-term.

That leaves about $350/month, which is what you'd use to pay your mortgage (if you had one) and your profit.

That $350/month is about $4200/year.

So, if you pay cash ($58K + 3K closing costs), your cash-on-cash return (your ROI) will be about:

ROI = $4200 / $61,000 = 6.9%

Not a great ROI for a rental property, but certainly better than a savings account these days.

Many here (including me) would say that if you could -- in theory -- fully leverage the property (get a loan for 100% of the purchase/rehab costs) and then still make at least $100/month in profit, it's a good deal.

In this case, assuming loan terms of 30 years fixed at 6%, your theoretical mortgage payment would be $348/month. That would leave you $2/month in profit, which isn't much.

So, the takeaways here are as follows:

- Many here would consider this a very thin deal. While you could make a profit if you have a loan for the full amount, it's a tiny profit;

- In reality, location has a lot to do with it. In some locations, just showing a theoretical profit under a fully leveraged scenario is a great deal (since you'll rarely be fully leveraged these days). If you live in one of those placed, that's something to consider;

- If you're looking to increase your ROI, consider financing the purchase. If you're risk averse, it doesn't have to be a large loan. Even a 50% LTV loan (for $29K), increases your cash-on-cash return by a percent or two;

- If you're doing your own property management, that will save you a chunk of money, and would likely bring your ROI to above 10% (still not great, but better);

- Lastly, $300/month in taxes seems very low. If this is accurate, it's possible that long-term your expenses will be a good bit less than 50% (the rule doesn't say that *every* rental will be 50%), and the numbers may look better for this deal.

Hope that helps...