Would you?

Question

4BR, 2B, single story, 2,300+ sqr ft home built in 2004 in very desirable area only a few minutes from my residence.

Property is not a typical rental, ask is in low 200's, I'm considering an offer with hopes of maybe getting it for around $190K.

Market shows rent in the $1700 to $1800 range, this home should pull $1800 due to finish out. DOM for lease comps average 20 days. There are no units available in this subdivision at this time.

Flooring is all hardwoods with tile in wet areas, no carpet at all. Rounded corners and arched entryways. Corian countertops. Property shows like new, paint all neutral, turn key ready.

At $190K with $1,795 rent, the 50% rule looks like this:
PI @ 4.875 = 1005.50
NOI = 1795/2 = 897.50
Cash Flow = -108 a month.

I would do my own management, so that saves me PM fees or about 10%, so using a 60/40 split I get:
PI @ 4.875 = 1005.50
NOI = 1795 * .60 = 1077.00
Cash Flow = 71.50 a month

With 25% down and using 40% for expenses I get a cash flow of 322.88 or a 8.16% return on cash invested.

8.16% is probably well below the minimum most investors are looking for, but this is not a typical rental.

I've looked and looked at lower end properties and just can't bring myself to buy from that pool. The other two investment properties I own I would live in, that's been a requirement I go by.

I prefer higher end homes in nicer neighborhoods.
I know there's more money to be made at the lower end, but I just can't bring myself to go there.

I have the funds for this, and would still have plenty in reserve. I'd be able to replenish the funds used for this purchase fairly quick (less than a year).

I've never done a fix and flip and I've never bought a home that needs extensive renovation. I'm handy around the house, but a full time job and family time limits how much time I'd have fixing houses.

I'm comfortable paying more for a turn key, desirable home in a desirable area. I manage my rentals myself, so I save on PM costs.

I have to wonder why anyone would rent for $1795 when they could buy the property and pay less to own it. Still undecided if I'll put in an offer or not.

I know most would pass on this - is there anyone that would consider it - anyone?

Has anyone else had long-term success with a similar strategy?

Mike McKinzie · Answer

Kevin I think you mean that you don't need the cash flow today to LIVE ON. But, as investors, we are ALWAYS looking for cash flow. The more cash flow today, the more you can INVEST today. You don't want tenants to just buy you the house they are living in, you want them to buy you other houses as well. In my example above, tenants in one house helped me buy 3 more houses. Then those tenants can help you buy 9 more houses. My Dallas/Ft Worth PM company charges me 7% of the months rent to manage the properties. But the best part is that they bring really good deals to me, they manage over 5,000 SFRs across 4 states. I mention this as PMs can be a good source for excellent deals. Current investors get into trouble and just want out, therefore, I get a house that already has a tenant and management in place, and usually 20-40% under market. There are lots of deals out there, you just need to work hard and find them. NEVER pay retail for a rental!

Mike McKinzie · Answer

Kevin This is pushing the envelope even for me. My highest price I paid this year was $155,000 for a similar house to this and it was already rented for $1,600/month. It is in Crowley, Texas. While the 50% rule doesn't usually pertain to higher end, newer properties, you can still expect 40% expenses. Other's will disagree with me on the 50% rule but a $500 water heater is a $500 water heater whether the house rents for $500 a month or $5000 a month. I bought a brand new house in Fort Worth 4 years ago and it is averaging under 30% expenses per year over that four year period. I could end up with a large repair, say $5,000, and it would still average under 40% per year. I would be curious as to what other reasons you may be desiring to purchase this house. Would you live in it eventually? Do you feel there is a strong chance of decent appreciation over the next 5-10 year term? If you are looking for $1,795 a month rent, I would try to find something no higher than $180,000 and possibly $170,000 in price. You might even offer $170,000 for this house and see where it goes. Running some quick numbers and using 40% and a price of $190,000, I see a 6.8% return. At $170,000, it rises to 7.6%. (Using all cash) I like 7.5% or higher because it is 3 times the current 10 Year T-Bill rate. What other expenses are there? HOA fees? Insurance costs? Utilities? Another philosophy that I have is that I never want to see the house, deal with a tenant or have to show the property. Most of the guys on BP that talk about 10%, 15%, 20% or more returns also manage, do repairs, screen tenants and collect the rents personally. I did that for 10 years and after being physically threatened more than once, I said enough was enough. So I accept the lower returns and wake up to see the money automatically deposited into my bank account, every month. Therefore, the risk in Real Estate is worth 3Times the 10 Year T Bill Rate, which is currently 2.5%, to me. Others here on BP make good returns on HML's, but ask Rich or Jon about foreclosing on JUNK properties! 25% sounds great until you lose $50,000.00 on one deal. Slow and steady, on middle to high middle end properties gives a good return while allowing you to sleep at night as well. It usually offers a fairly good chance for healthy appreciation as well. Let me give one more example of why I like the slightly above middle ground properties. I own a house in California, that currently rents for $2,000.00 a month. At the height of the market, it would sell for $697,000 (verified closed comp). I put it on the market earlier this year for $420,000 (more to TEST the market than really sell it) and got an offer for $330,000, all cash. I turned it down, as I know there are closed comps for over $400,000 and took it off the market, I learned what I needed to learn. So why don't I sell it? Because I have pulled money out of it, 3 times, and bought 3 other properties. And I will do it again. This is a CASH COW for me. Refinancing is much cheaper than selling, by a LOT. Shoot, just the COST of selling this house is a good down payment for another property. So Kevin, unless this house has some other outstanding feature, such as closed comps over $225,000, I think paying $190,000 for $1,795 is not really that great. You might be better off looking in the $140,000 to $160,000 range and getting $1,500 - $1,600 a month in rent. IMHO.

Kevin C. · Answer

I know you do a lot with MH's and do well with them, they're just not my cup of tea. Doesn't matter what market you're in as long as you do well in it, and Jon, I know you've done quite well in the market you've carved out.

Kevin C. · Answer

Thanks Mike - that's the sort of information I need. There would be no plan to someday move to this house, but we could since I like to buy only homes that I would live in. I'm looking to add another property to take advantage of the low finance rates available now. Locking in sub 5% money for 30 years is a bargain in my book. An alternative option I'm considering is finding another property where we live (very desirable area with acreage) and take advantage of the low rates. I have a son and daughter in law that would love to live in the area we live in, but they absolutely could not begin to afford it - unless..... I was willing to subsidize them for some period of time. I'm OK with that - helping family while at the same time building wealth. The down side is I'd have a lot of cash invested with little or no return. Let me restate that, there would be no cash return, but the real returns would be immeasurable. I am fortunate to be in a position to go either direction - go after the cash flow, or go after a property that would mean the world to my son and his family. Long term, I'm investing to build wealth and cash flow. I don't need the cash flow today, but will one day. Once I find and purchase this next property, in all likelihood it would probably be at least a year before I would be comfortable looking for another property - especially if I go with the 'family' option.

Jon Klaus · Answer

Mike and Kevin, lest you think I rent low end only, my last one rented for $1300. Also great points on pulling equity out of high end homes to do more deals.

Kevin C. · Answer

Jon, I know your market and knew this would not interest you at all. You have your market carved out and do extremely well with it, but it's not for everyone. Was not planning on attending the meet-up mostly because I don't have a need for alternative funding, at least not now or in the foreseeable future.

Jon Klaus · Answer

Kevin, you might know that I would not do this deal as a buy and hold, but I won't try to talk you out of it. However, I would get with MikeM from Colorado, because he likes nicer, higher end rentals, too. http://www.biggerpockets.com/users/Inmountains I'd want him to weigh in on the numbers, rationale, and ultimate exit options. Are you coming to our meet up next Wednesday? http://www.biggerpockets.com/events/752-dallas-ft-worth-meet-up