Overly conservative in my numbers for North West Houston area?

Question

Hi Biggerpocket,

I am trying to make sense of my rental numbers for SFRs in the Northwest Houston area and I can't seem to make them work so I am wondering if I am just looking at it differently from everybody else and am too conservative in my estimates or just completely looking in the wrong area ... Basically looking for feedback!

In order to get a rent of $1200/$1300 a month, I would expect a house in the $100-150k, approx. 1800 ft2:

- Insurance/HOA/Tax of about 30% rent (tax being the biggest hit at rates of 2.5-3%)

- Vacancy, Maintenance/Cap Ex and Property Mgt another 30% of rent

Even if I were to pay $100k for the house (20% down, 30 year loan at 5%) including rehab, I would barely cash flow.

If the house was actually worth $150 but still paid $100k for it, I would now be $100 negative cash flow due to taxes.

Tax/Vacancy/Cap Ex & maint/Property mgt are the major hitters. In order to reduce tax, I would have to find a house that is actually worth less than $100k but then I don't think I would get $1200 rent for it. If I look for a house that may get $1600+ in rent, then the house value has gone up quite a bit and taxes/insurance have followed so it's still not cash flowing.

So, is it just that I am overly conservative with Vacancy, Maintenance/Cap Ex and Property Mgt or just that there are houses that are not worth much but have high rents and I'm just missing them?

Cameron Tope · Answer

@Xavier G.

You're using real numbers from a property that you purchased to occupy? Is your target market in the same part of town? If not, it may be hard to apply that criteria from your current rental to your target market.

Regardless, focus first on what the goals are for your investment properties, ex. 400/mo cash flow. I say that because your goals may be unrealistic for the area?

My Katy rental has a $450/mo mortgage, taxes & HOA are ~$200/mo, insurance is ~$100/mo & property management is 8% (~100/mo). The property cash flows +$450/mo before vacancy & capex.

My COCR on this property is 32% (OOP ~$8,900 and cash flows ~$450/mo).

Cameron Tope · Answer

@Xavier G. truth is we don't know if you're being overly conservative.

Last property I purchased in Katy rented at $1,350/mo and I purchased all in at 95k. It cash flows  well and meets my criteria.

I wouldn't spend much time looking at hypothetical situations. Analyze a few real deals and see what you would have to pay for them to make sense for YOU. Maybe you are looking for a home run and missing base hits.

Best of luck!

Cameron Tope · Answer

@Xavier G. the taxes go up every year but I argue any increase, minimizing the damage.

Xavier G. · Answer

@Cameron Tope, I completely agree. Nobody should use someone else's numbers without due diligence. I was just looking for comparison to see if I was way off or maybe just looking in the wrong area.

Regarding the taxes, that brings up an interesting point. I can see where the first year tax could be lowered based on purchase price (it worked on my current house) but I can also imagine that the year after that, the tax man could bring the value back up based on comps in the area and there would be no homestead exemption to protect against a big increase. Wasn't this the case on your house?

Cameron Tope · Answer

@Xavier G. remember, my maintenance and capex are going to be extremely low for several years as I have just rehabbed the entire property and the taxes are low due to buying the property at 70% ARV (argue your taxes with your purchase contract, pictures and rehab costs).

Couple other tidbits; this is not my most profitable rental but it fits into my strategy and long term goals (this was actually a package of rentals I purchased from a landlord).

Be careful using my criteria as they may not fit your goals.

Best of luck!

John Leavelle · Answer

@Xavier G.

I can appreciate your thinking regarding CapEx and repairs/maintenance.  However, you might want to discuss that with your CPA.  The IRS looks at them differently.  Repairs are deducted in the current tax year.  CapEx is depreciated (deducted) over multiple years.  Your call.

Xavier G. · Answer

@John Leavelle,

I am putting Capex & Maintenance together as to me, replacing a roof, a water heater or having to fix a faucet are all repairs/expenses (big or small) I am expecting to have over the long term (25+ years), so I total all of it up and bring it down to a monthly basis. If the house I'm looking at is in really bad shape, I'll count those repairs in the cash I need upfront to put in to fix the house. But over 25-30 years, I'll still have to replace again the roof, water heater (maybe on less time), repaint (maybe on less time) etc ... Of course, If I planned on keep the house for only 10 years, the numbers would look very different.

@Cameron Tope,

Thanks for the numbers. They do help me understand what I'm looking at. The cash flow numbers I consider are after Vacancy, Maint & Cap Ex (which would bring your cash flow to less than $200 to compare apple to apple). The other big difference is the tax. Your property seem to have a very low tax rate compared to the ones I am looking at and the assessed value is quite a bit lower when compared to the rent you are getting. That's what's eating the remaining $200 cash flow for me. So it seems I'm not necessarily being overly conservative, it's just that the monthly rent vs taxes in the areas I am looking at is not favorable, which was my gut feeling.

And to answer your question, I am mainly re-using the insurance and maintenance cost from my current rental house as estimates for other houses (similar houses). However, when looking at a different house, I use the actual numbers for that house (taxes, HOA, rent in that area).

Thank you both for your feedback!

John Leavelle · Answer

@Xavier G.

CapEx and Maintenance are separate expense items.  The amount you need depends on the age and condition of the property.  10% for CapEx is sufficient for the initial analysis.  However, once the property is under contract you should have the property inspected to identify any problems with major systems (roof, HVAC, plumbing and electrical, etc).  An estimate of the usable life should also be determined to identify what needs to be replaced/upgraded in the future. Get a ruff estimate of the cost of each.  Use the total of the future expenses and divide by the appropriate number of months (5years = 60 months) to develop a more accurate CapEx amount.

Maintenance should be about 5%.  Again it will depend on the age and condition of the property.  Along with the quality of your tenants.

Once you own the property you will of course make adjustments.

Xavier G. · Answer

@John Leavelle, @Cameron Tope, thanks for your answers,

I am actually using actual numbers:

- insurance from my current rental house (not an investment at the time, just rented it when I moved to my current house)

- rent is in par with the market (based on my research) for the size and location of the house

- HOA and taxes are actual numbers

- Cap ex/Maintenance (10%) is a guess as I don't have 20 years of experience but looking at my current expenses on the rental, it seems about right

- Vacancy (10%) is a guess. Currently I am way lower than that but I consider myself lucky with my current renter (>5 years).

- Property Mgt (10%) is being conservative since I self manage my current rental but I understand that if I grow my portfolio, I may decide to switch at some point so I want to account for it.

@Cameron Tope, would you mind sharing your actual numbers on the Katy house (what you include in your expenses, loan payment, COCR ...)? That would help me figure out where we differ in our estimates. Maybe your house is smaller and valued at about $95k which would make your taxes lower than the houses I am looking at. There maybe many assumptions that are different than mine.

@John Leavelle, my expenses (not including mortgage) are definitely quite a bit higher than 50% (About 70%). I can't fight much with taxes and insurance so maybe I'm overkilling Vacancy/CapEx/Property Mgt or the houses I'm looking at are in a high tax area or a combination of the two ...

Here are my numbers for ref (ARV $150k, $95l loan, 20% down-5%-30years):

Insurance

$1,200

/year

$100

/month

HOA

$350

/year

$29

/month

Property & School Tax

$4,500

/year

$375

/month

Vacancy

10%

of rent

$130.00

/month

Capital   Expenditure/Maintenance

10%

of rent

$130.00

/month

Property Mgt

10%

of rent

$130.00

/month

Loan Payment

$6,120

$510

/month

Total Expenses

$10,728

$894

/month

Total Monthly Expenses

$1,404

Rent

$1,300

/month

Overly conservative in my numbers for North West Houston area?

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