My first Rental Property Purchase - Good Deal?

Question

The following is an updated version of what I posted on my BP blog recently. I'd like to hear what people have to say:

I recently purchased my first rental property in a neighborhood that is renting between $1000 and $1200 for single family houses depending on features/updates. We settled on a price of $60K. That gives an annual rent to price ratio of 20% - 24% or alternatively a price to rent ratio of 4.15-5, which is about as good as I've found in the area for a house with a clean Point of Sale. I thought I was getting a great deal. However, things are getting complicated. This city has insane property taxes, so this house is being taxed $3850 annually. I am contesting the taxes now, which are based on a $92k home value, but there is no guarantee that they will change, so I'm budgeting assuming the full $3850. Insurance is $800/year. Property management (if I choose to use it) is 10% of rent + 1 Month Rent for placement + $200 Renewal Fee, which I estimate at 14% of gross rent. Loan Payment of $260/month, $150/month for repair/maint/CapEx, and a vacancy rate of 10% basically gets me back to break even. All of this has me a little discouraged. I live in Cleveland with one of the best Price to Rent ratios in the country. I found a pretty clean house with a better price to rent ratio than the general cleveland market, and I still can't turn a profit? How is this possible? How could anyone find a profitable house to rent in other parts of the country where the price to rent ratio is 10 (or 30 or 40?!?) if I can't turn a profit on a house with a price to rent ratio of 5? Are any of my assumptions way off? Am I missing something?

I believe that I can still turn a decent profit by not using property management and implementing some improvements to guarantee a rent at the higher end of market rates, but I'm pretty surprised at how marginal this looks.

Brian Egan · Answer

Max Briggs Max, I'm an investor in Lakewood, OH and remember thinking the same thing on my first deal. However I realized (pre-purchase) that the property taxes were assessed at a very high value and while it took 14 months to get them reassessed it was a painless process. For Cuyahoga County, you apply in January, provide the purchase price (not your appraisal as it is/should be higher) and they will schedule a hearing. It was 2 people and myself in a conference room for 10 minutes. They said the Supreme Court has determined that an arms length transaction is the ultimate decider of home value and reduced my taxes from $190k to my purchase price of $110k. Then they mailed me a check for all the extra tax I paid. So do your own property management, get the tax value reassessed and you should be good to go. If you have any questions feel free to PM me.

Barry H. · Answer

MAX - Glad to see you are re-reviewing your position and seeing a glass half full scenario. After reviewing your math, I agree it looks like it can probably cashflow decently without a Property Manager. I will give you the BEST piece of advice I ever received from another Owner/Investor when it comes to self-managing. After doing super solid tenant screening (use the 33% rule - which means they need to make at least $3300 / Mo after taxes if you are charging $1100 in rent), make sure you include a Tenant Repair Deductible clause in your rental agreement. In short, this means anytime your tenant wants a lightbulb replaced or a toilet unclogged, they pay you $25 or $50 or whatever you feel will DETER them from calling you to handle something they should be handling themselves. Not all tenants have the "entitlement" mentality where they feel they can boss their landlord around whenever they want because they are paying outlandish rent money to you (in their mind), but the ones who are like that will drive you bananas. I realize you live in the area where you invested and it is probably not as much of a hassle to shoot over there from time to time (and it gives you a chance to check up on your asset), but having a Repair Deductible Clause will save you time and money as you move forward. Also, find a trusted Handyman/woman !! Good luck with your first investment and you are wise to have found BP - it took me 14 years !! :-)

Ross Denman · Answer

NA NA is correct. You have to figure in all of your expenses from the beginning, which includes taxes, insurance, and HOA fees. I have had a couple of our clients who were in the Cleveland area sell their rentals and move their money in to Indianapolis. While the rent ratios may not be quite as high, property taxes are around 2% of assessed value which is supposed to be based on FMV's. That would be half of your tax bill adding over $1,800 to your annual net.

Thomas S. · Answer

If you can not invest in multi units in your area that cash flow you need to look elsewhere. SFHs in most markets are extremely difficult to cash flow and do not make good candidates for rental. There is no point in investing in a market driven by home buyers.

Jeff Schechter · Answer

Yep. Agree with everyone. We have a lot of investors from neighboring states investing in Indy. Taxes are high, and so are your mgmt fees. All else being equal, getting those two numbers in line would make for a very acceptable deal.

Barry H. · Answer

MAX - You learned something from this deal. When I first saw you got a $60K property and were going to get $1000/Mo in rent, I was ready to jump into your market until I saw the rest of the picture. :-( I don't have a solution for your current problem except it might be good to shoot for a FLIP on the property you just acquired and get out of it. If you have a day job and you are able to write off interest and depreciation on the property, it may be a net positive for you (2%-4% annually). Add some appreciation in the next couple years and you may end up with a 6% to 10% ROI investment. Obviously the property taxes are killing you and shame on you for not figuring that into your calcs before you bought (but beating yourself up is useless at this point). Sounds like you are already committed to possibly using a property manager. If that is the case, then looking across state lines might be a good call - I believe Indiana has the types of returns you are quoting. Just some random thoughts. All in all, I don't think it is as bad as you may think. :-)

Max Briggs · Answer

Thanks Brian, that makes me feel a lot better. My taxes coming down to sale price of the home would really help this deal cash flow. I'm glad to hear that they aren't combative, just slow.

Jim Adrian · Answer

@Max BriggsFor vacancy you may be able to adjust your % after looking at 1 month mortgage + 1 month utilities (holding cost). I would go take a look under "Tools", then "FilePlace: Free Form & Files" to find some starter files for analysis that other people have created and shared. I believe you get 5 free downloads a week. Make sure you screen very well, "Tools" then "Tenant Screening".Here are 2 you may want to checkout to get started. https://www.biggerpockets.com/files/user/RSanders1221/file/rental-property-analysis---very-detailedhttps://www.biggerpockets.com/files/user/JimA732/file/rental-expenses-report

Max Briggs · Answer

Thanks to everyone for the input. In response to those that told me that I should have known all of these costs up front, I agree with you, and I thought I did, but as the deal unfolded I had to tweak some of my estimates and the tweaks changed things more than I would have expected (This is my first purchase after all). The list included an insurance estimate of 1% of home value being raised to 1.3% (relatively minor), going from an assumed 10% property management fee to 14% after taking into account placement and rental renewal fees, and raising my original vacancy budget from 5% to 10% (I'm honestly still not sure what the right number is, I've just decided to go more conservative. Property managers have told me that they typically run under 5%). These tweaks effected the math pretty substantially. Also, finding out that there is an 8 month back log for requests to reevaluate property taxes also deflated me a bit because I thought reducing that bill would give me additional cushion and it still might, but it won't help me in the short term. At the end of the day, even with the high property taxes I'm looking at a $650 mortgage payment including P&I, property tax, and insurance. I think I can reasonably assume an $1100 rent, so I've got $450/month left over to cover cap ex and repairs, vacancy and turn a profit, which seems like it should be enough especially now that I've decided not to use property management. I guess I'm feeling better about the whole thing now that I've decided against property management, which as many of you pointed out is very high in my area.