Being Smart vs Analysis Paralysis

[Kyle Scholnick]

I am having a very tough time finding good rental properties to buy. Not just in my expensive area, but everywhere. It seems like after you do a proper analysis, the potential costs/expenses are so high, almost nothing works unless the rent is 2% of the purchase price (which are hard to find as well).

I personally use the following to evaluate a rental property:

Taxes, insurance

Sewer/garbage/electricity/snow plow/HOA (usually paid by tenant, so not as important)

Maintenance 15%

Vacancy 10%

Capital Expenditures 15%

Property Management 10%

Mortgage/interest

I don't like to factor in appreciation at all to be safe

I am conservative with the % of rental increase per year so I try not to use numbers >2-3%

I like to be conservative with the maintenance and capital expenditures, but I don't think these numbers are that unreasonable, yet seems so difficult to find a deal buying  a house around retail price.

Is it only possible to be profitable if I am buying a foreclosure or a distressed property? Can you not be profitable using these numbers just buying retail value?

Am I using too conservative numbers?

I would really appreciate constructive advice from our community, rather than unhelpful comments like "Just look harder." I would really love some of the advice from all you experts and pros who do this stuff in your sleep.

Thanks!

[Russell Brazil]

@Account Closed I think something you are not getting in your analysis is the manner in which things like repairs/capital expenditure percentages change as home values go up.  Let us take one quick example.  An HVAC system on a $50,000 property is going to be $4,000-$5,000. So the cost to replace that is almost 8-10% of the value of the property.  An HVAC system on a $450,000, say in Silver Spring is going to be about $6,000...or 1.3% of the property.  So as you move into higher price brackets, your cost to repair and improve will decrease as a percentage of the property value. (Generally). That is why on these low cost rentals you need to hit the 2% rule in order to make money, but in other areas you can hit 1%, which is half and still make good money.

The other thing to keep in mind that these percentages that people throw out work over a large number of properties.  If you had a portfolio of 20 properties, you may be able to come up with a percentage of your gross rents that go to repairs. However over a sample size of 1, you can make no such guess. I have 7 properties...and I have some that have almost zero in repairs and capital expenditures...and I have 1 that has a huge amount.  So if I tried to apply some formula that says I need X% for Cap Ex and x% for repairs to my whole portfolio, that may hold up over the large sample size...but it will not hold up on any one individual.

Due to this fact I try to measure free cash flow. (What is available after the mortgage payment). If my free cash flow is high enough, that should give me leeway for repairs and the such.

You also need to bend to what the market gives you.  Where you you are located in Burtonsville, MD you wont find properties that fit the 1% rule. But I have a rental there, and it hits about 0.75%.  If you look over towards Germantown you can find properties that are pretty close to 1%. If you go to Frederick where Michael Paris is you can get stuff anywhere from 0.9% to 1.1%.  If you are more adventurous you can go north to Baltimore, and to southern PG county and hit the 2% rule or higher.

Also you say you ignore appreciation...while I think that may be a good idea on the early properties, as you need that cash flow basis...appreciation is how you really build wealth.  My initial goal was to create a cash flow portfolio...but then after I had sufficient cash flow I changed my strategy to now focus primarily on appreciation. You wont get rich on a rental throwing off a few hundred bucks a month (though you need that to pay your bills) but you will get rich off of having a number of properties that are going up in value while paying down the existing mortgage.