WHAT DOES A GOOD DEAL IN INDIANAPOLIS LOOK LIKE

Question

When I  first started to look into Indianapolis I started to filter my potential deals by only looking at properties that were under $100k and meet the 1% rule, but I'm still not finding anything without offering WAY WAY LOWER than asking price. So I'm guessing I have to filter my searches further.

To cash flow $200 per month and get a cash on cash return of at least 10% at what price points  and rents for 2 bed or 3 beds in Indianapolis should I be looking at?

For example, should I even be looking at houses over $80k?

PS I want to do minimal rehab (paint, floor, kitchen cabinets only) since I am an out of state investor.Thanks.

Ross Denman · Answer

@Jason Ma I think that the expectation of 10% ROI and $200/mo are two totally different goals that are hard to hit at the same time. Currently, getting a 10% ROI in homes in decent neighborhoods in Indianapolis is typically going to have to be leveraged with bank financing. In order to get $200/mo cash flow, you have to have financing that's no more than $2,400 less than your annual NOI. Using the 50% rule, which I find to be very average for a large swath of properties over a number of years... let's look at a $1,000/mo rental.

$1,000/mo * 50% rule * 12 mo = $6,000 NOI.

Highest allowable mortgage payment is

$6,000 - $2,400 = $3,600 or a $300/mo mortgage payment.

At 6% interest on a 30 year amortization, you can only finance $50k.

This also means that you can invest as much as $24,000 down (for 10% annual COC ROI from $2,400 cash flow.) So what you're looking for is a $1,000/mo rental for an "all-in" price of $74k or lower and putting about 30% ($24k) down to cash flow properly.

You may be able to BRRRR in to this position from a cash acquisition and rehab from a wholesaler or distressed MLS property, and refinance $50k out, but if you are just looking to invest a max of $25k from the begining with conventional finance... you would be looking at financing a $75k deal with 30% down for a $1,000/mo rental.

My basic rule of thumb when working with my investors is to look for 80:1 rent ratios or lower, but rents higher than $900/mo. It won't quite get you to 10% the first year, and these ratios only produce about $1,200-1,800/year in cash flow, but they are good homes, easy to rent to decent tenants, better homes with lower maintenance costs, and usually retain tenants longer.

The lower you go in the market your numbers get altered by things like:

• Shorter tenancies
• Longer vacancies
• More expensive maintenance (especially on older homes)
• More late payments
• More likely evictions
• Drama... Drama... Drama... (I've seen stalkers, drug arrests, break-ins, bed bugs or other pests, pitbull breeding, domestic abuse, vandalism, theft, etc.)

Basically, the more cash invested, the larger the cash flow, but the lower the ROI. The more leveraged applied, the higher the ROI, but the lower the cash flow. Finding a sweet spot of 10% and $200/mo from the beginning isn't something that you are likely to find very easily. I have seen several deals that started at 8% COC ROI and with annual rent increases (because the homes are in the desirable area) the ROI is going up 1-2% each year as well as the 2.5-3.5% annual equity increase. As the equity continues to increase on decent homes, you will find ways to leverage that equity once you start building your portfolio and will be able to "absorb" homes in to your portfolio with the annual equity build each year, but the doesn't usually happen until you get to around 10 homes that appreciate $2k-$3k/year.

Hope that gives you some insight :)

Ross Denman · Answer

@Jason Ma You also have to consider that the underlying asset is growing in value and the rental income should increase every year or two (depending on current price and local market.) The most successful clients that I work with not only look at cash flow, cap rate, and COC ROI... they also consider IRR (internal rate of return) over a number of years. IRR is figured with discount rate (original equity position from buying under market,) cash flow (leveraged or not,) and equity growth over a number of years. Let's look at an example.

Year 1. Purchased a home at $90k for $22,000 after inspection, down payment, closing costs, minor repairs, and cleaning. The home is valued at $115k. This makes the discount rate $25k from the very beginning.

You rent the property at $1,100/mo for a year and after all expenses, you finish the year with $1,200 cash flow. This is not a very good COC ROI (about 5.45%.) That value of the home is now around $118,500 (about 3% appreciation.)

Year 2. The tenant stays (no vacancy or tenant placement fees) and the rent is raised to $1,125/mo.

You finish the year after all expenses with $2,100 in cash flow. COC ROI is better this year with the rental increase and stable performance. Year 2 COC ROI comes out to about 9.54% for the year. The value of the home has risen to $122,500 (about 3.4% appreciation.) Overall average is $3,225 cash flow over 2 years or an average COC ROI of 7.33%

Year 3. The tenant decides to move. You lose 2 months of rent (about $1,400 in mortgage payments,) spent $1,500 getting it rent ready again, and triggered a tenant placement fee equal to 1 months rent.

The home is rented this term at $1,150/mo. Year 3 only cash flows about -$1,650 (yes, negative) or a COC ROI of -.075%. The home's value has risen to $125,000 (about 2% appreciation.)

Year 4. The tenant stays and the market will not bear another rent increase this year. Total cash flow for the year ends up being $2,400 (10.9% COC ROI.) The value of the home rises to $129,000 (about 3.2% increase.)

Year 5. The tenant stays again and the rent increases again to $1,175. Total cash flow for the year ends up being $2,600 (11.8% COC ROI.) Value of the home increase to $132,500 (2.7% increase.)

Year 6. The tenant finally decides to move and you decide to sell the home. You still have an unpaid balance of $68,000 owed to the bank and you have about $4,000 in cleaning, repairs, and upgrades to sell it at the top of the retail market. The home is listed at $142,000 but ends up selling for $137,000. During this time you pay 4 mortgage payments totaling another $2,500.

Here's the total outlay in 5 years of owning this home.

Initial Discount Rate

$25,000

Cash flow

$1,200

$2,100

-$1,650

$2,400

$2,600

= $6,650 total over 5 years. Average of $1,330/year or 6.04% COC ROI

Appreciation

$22,000 (100% leveraged appreciation)

Principal Paydown

$2,000

Total = $25,000 + $6,650 + $22,000 + $2,000 = $55,650 profit (before selling costs and taxes.)

IRR = $56,500/$22,000 = 256.8% = annualized over 5 years = 51.3% averaged IRR annually

You can see that the original discount rate and the appreciation are the biggest numbers here. The longer that you hold the property, the more powerful the principal paydown can become a factor, but you will likely be refinancing too often for it to add up.

____________

With that being laid out... this is not a "cash flow" strategy. It's a mid-term hold strategy that capitalizes on the appreciation (the largest gain on a good leveraged investment.)

Instead of selling, most of my investors are continuing to hold. You do not have to sell the home to access the equity. Depending on your lender... you could likely access 75%-80% of this equity growth (through a refinance) to purchase 2 more similar performing homes and keep the current asset to leverage it's equity growth again in the future.

At three performing homes, you should be able to purchase another home like this every couple of years. Once you get to seven performing homes, you can likely purchase one every year. At about 12 homes, you should be able to purchase 2 homes every year.

This strategy reinvests the profits and compounds several factors and leverages them for maximum growth potential. You can build a million dollar portfolio in about 14 or 15 years (about homes) with only a $27,000 initial investment (including $5,000 available for reserves.) To expedite this, most investors continue to add personal funds to grow their portfolios much faster. Here's the outlay of this kind of portfolio growth.

Year 1-3 = 1 home

Year 4-5 = 2 homes

Year 6-8 = 3 homes

Year 9-10 = 4 homes

Year 11-12= 5 homes

Year 13-14 = 6 homes

Year 15 = 8 homes

______

To hit $200/mo cash flow, you will likely need to hold a $650/mo rental in all cash or have a rental of $2,200/mo that is leveraged with a mortgage payment (not including ins/tax) of $1000/mo or less (around $200k.)

I just put a $2,000/mo rental on the market in Bates/Hendricks that will come pretty close to these numbers, but I believe that the owner is refinancing a little over $200k, so he may not quite hit the $200/mo range and he's leaving about $40k in the home. His COC ROI is only going to be about 5% the first year, but that home should climb in value around $10k each year (25% ROI on leveraged equity increase ($10k/$40k.))

Hope that stimulates some thoughts.

Mike D'Arrigo · Answer

@Ross Denman You hit the nail on the head. Most buy and hold investors focus entirely on cash flow which of course is important, but it's only part of the equation. On average, cash flow accounts for only about 30% of the total returns from real estate. I talked about this in a recent Bigger Pocket blog.

https://www.biggerpockets.com/member-blogs/3992/83...

Mike D'Arrigo · Answer

@Jason Ma The 1% rule is arbitrary and is not meaningful. What difference does it make if you don't meet the 1% rule but meet your cash flow and CoC ROI target? At the end of the day, all that matters is your financial objectives, not whether you met the 1% rule. As @Ross Denman points out, it may be hard to hit both your CoC ROI goals and your cash flow goals. Higher priced properties with higher rents will generally produce more cash flow, however at a lower CoC return. This is primarily due to higher debt service on the mortgage. Lower priced properties in general will have higher CoC return because of a smaller mortgage but will have lower cash flow due to lower rents. You'll need to decide which is most important to you, CoC ROI or cash flow. They are two different things.

Mike D'Arrigo · Answer

I'm presuming you're asking what is the difference between cap rate and cash on cash.

Cap rate assume you are paying cash and is the annual net operating income divided by the full purchase price.

Cash on cash assume you are financing and is the cash flow (net operating income minus mortgage payment) divided by your upfront cash invested (down payment and closing costs).

Ross Denman · Answer

@Tushar Prasad We are going in to Spring right now, so the market demand makes it difficult to find these types of properties in March/April, but I see them every month on the MLS during the Fall and Winter months. We also see deals like these come across the wholesale lists, but usually they need more work. You can also find REO deals, HUD deals, auction deals, etc.

As far as purchasing homes at a 22% discount... that's 78% of ARV. Many investors actually target 75% of ARV or less because many lenders will only refinance 75%-80% LTV... so most deals that we see are somewhere in this range.

Lastly, often times you will be putting an offer in below ask. I don't recommend throwing out offers more than 10% lower than the asking price though as it really gives you and your realtor a poor reputation for wasting peoples time.

Mike D'Arrigo · Answer

@Jason Ma the cash on cash measurement is used for a financed purchase. If you're paying all cash, you'll want to look at the cap rate. What is a good return is going to differ for everyone. Also, as I suggested, ask yourself whether the return rate is most important or the cash flow, They are two different things. As an example, which would be more appealing to you, a property producing say $250/mth cash flow with a 7% cap rate or one producing $200/mth with an 8% cap rate? You have to decide that for yourself.

Pearly Tan · Answer

@Ross Denman

This the infamous snowball effect :)

Tushar P. · Answer

@Ross Denman - do you think all the subsequent calculations matter if anyone buys a property at 22% discount ($25k lower than $115k)? Is it easy to find a property at $25k discount in Indy?

Jason Malabute · Answer

I need to read this a few more times. First time went over my head.

WHAT DOES A GOOD DEAL IN INDIANAPOLIS LOOK LIKE

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