Should I invest in this rental property?

Question

I am looking at an out of state property to buy as a rental. This would be my first out of state property and I want to know if others think this is a deal worth doing or not. 3 bed 2 bath home in Ohio.

The purchase price would be $167,000. The property is currently rented out for 5 years max (about 4 years remaining) for $1,375 a month. Assuming a 4.63% interest rate over 30 years.

Here is my budget as best as I can get: Taxes $1,734, repairs $750, Property Management $1375, Insurance $1,271 (this seems kinda high).

I am calculating about $261 a month cash flow and a Cash on Cash ROI of 8.36%.

Thoughts? Is this a good find or can I do better?

Tim Herman · Answer

@Mike Bussing so after the tenants move out what vacancy factor are you using. What if you have to evict before the lease is up. I use 8% of rents. Do you have an indestructible house that nothing wears out. You have no capex. My capex budget includes roof 25 year life span, floors 10 year life span, appliances and hot water heater 12 year life span, hvac 20 year life span, bath and kitchen remodel 20 year life span, etc. I use 10%.  Subtract 18% or $248  from your present cash flow you will have a whopping $13 per month return on your cash invested.

Anna Sagatelova · Answer

A 5 year lease is indeed unusual here, what are the circumstances and which municipality is it in?

Tim Herman · Answer

@Mike Bussing what if your tenants lose their jobs tomorrow. What if the governor extends eviction moratorium. The soft costs all go into a reserve fund, vacancy, repairs and capex. Capex can only go up not down. The minute something is replaced you have to set a reserve. Let's look at your new floors. Assume 1500 sf of flooring. My area to replace flooring is $6 sf. $9000/10 year life span/12 months in a year=$75 per month if the floors are brand new.  Floors are 3 years old when you buy the property so now you have only 7 years to recoup the cost. $9000/7/12=$108 per month or 44% more to put into capex.

You can do what you want to.Other people would not do this deal. Most investors want at least $200 free cash flow after all expenses and minimum 10% cash on cash.

Greg Scott · Answer

A five year lease is a big red flag.

In many states any lease 24 months or more creates some level of some ownership rights.  Understand the implications for Ohio.

Greg Scott · Answer

@Anthony Morrow To clarify further.  If you have rented to John Smith for 20 years, but in those 20 years he has had 20 1-year leases, he is simply a resident and can be evicted for non-payment.  If you rent to Mary Thompson on a 3-year lease, you may have created an issue, even during the first year.

Greg Scott · Answer

@Anthony Morrow No!  I think you misunderstood me.

There is a huge difference between having five 1-year leases and one 5-year lease.  The 1-year leases legally convey the resident is renting. A 5-year lease may provide some ownership rights to the resident.

Anthony Morrow · Answer

@Greg Scott my first time hearing this ever, I have a tenant who has been in my rental for 6 years now. So am I clear I need to change renters for a fear of some squatters rights??

Stone Saathoff · Answer

As others have mentioned that does sound fairly thin and some of the numbers you mentioned for expense seemed optimistic. Not necessarily a bad buy but there are better opportunities out there.

Nathan Gesner · Answer

You're not calculating cash flow properly.

Cash flow equals rental income minus all expenses.

Expenses include actual costs and forecasted costs. The forecasted costs are things like maintenance, capital expenditures (roof, driveway, etc.), vacancy, etc.

DISCLAIMER: I'm doing math in public before consuming my coffee so these numbers may be wrong!

Income is $1,375

Monthly expenses:

$250 taxes and insurance

$ 80 Maintenance (5% is low)

$ 80 Capital expenditures (5% is low)

$130 property management

$ 80 vacancy

That's $620 in expenses.

Purchase price is $167,000. Assuming you put down 20% ($33,400) you would have a mortgage of $133,600. At a rate of 4%, your mortgage payment would be $638.

$638 plus $620 in expenses = $1258 a month. Your rental income is only $1375 so that's a cash flow of $117, not $261.

My numbers are conservative. Unless this home is in really good condition, you should be setting aside more than 5% for maintenance and capex. I also think you're conservative on your property management and vacancy costs, but I don't know your situation so maybe those are accurate.

I'm in a more expensive market where average property price is around $260,000 and that kind of home only rents for $1,400 - $1,500 a month. It's difficult to find a cash flow property, but you can if you're patient. I am currently buying a house for $60,000 below appraised value that will cash flow $400+ a month.

Personally, I don't want a house unless it cash flows $200 or more. $117 just doesn't have enough meat on the bones for me. On the other hand, I don't know your entire financial situation, loss tolerance, market, and other factors. The good news is that real estate is a very forgiving investment vehicle and enough time can erase most mistakes.

Greg Scott · Answer

@Mike Bussing The "why" is much less important than the local laws regarding ownership.

It is possible that in this jurisdiction that a 5-year lease would assume ownership rights.  So, while an eviction of someone with a 1-year lease might be done in 30 days for a few hundred buck, you may be required to foreclose, which could take months and several thousand dollars.

Should I invest in this rental property?

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