Investor · Atlanta, GA · Member since 2012 · 408 posts · 37 votes
This home is a duplex, built in 2006, each side has 4 bedrooms and 3 baths with hardwood floors. Each side is currently rented for $650/mo.
Initial price: $64,900.
We offered $67,500 and lost to a $68,000 bid. The closing fell through and they were asking for highest and best. We offered $68,500 with 1% of the agent fee going to the closing costs (I found the property myself).
And...we WON.
With $15,600 gross rents minus about $800 in taxes and $800 in insurance. Assumed takeover price of about $70,000 with all fees and closing costs.
$14,000/$70,000 comes out to a 20% return. I know these are still fairly gross numbers, but I'm comparing apples to apples.
We have come close to these numbers before, albeit, in better areas. $55,000 home rented for $900/mo for example.
The neighborhood is a bit small, but it is located within an hour of a major city and 40 minutes from a major university. In my opinion, as long as rents are stable, I don't care if I don't see any appreciation. On the other hand, I think investors (like me) will push these property values up to at least a CAP 15 price, if not CAP 10.
I think this property will perform above the 50% rule.
Given that it was built in 2006, it will almost certainly operate at a lower expense ratio for the first several years, as you won't have to deal with capital costs, your vacancy will probably be lower and maintenance costs will be trivial.
But, remember that the 50% rule is talking about long-term costs -- if you hold long enough, you're going to have to replace the roof, replace the HVAC system, replace the siding, etc. And maintenance costs will increase. And you'll eventually deal with rent loss, evictions, etc, even if only occasionally.
For example, in reality, that $6000 roof you'll need to buy in 20 years is actually costing you $25/month ($25/month * 20 years = $6000); likewise with the HVAC, siding, water heater, etc. You can either factor in the $100/month capital costs forever, or just expect that in 20 years, you may have a year where you lose $10K because you have to replace this type of stuff. Either way you do the accounting, your long-term expense ratio will be the same.
These are facts of life with rental properties long-term, and while it may seem like they'll never happen, I promise they will.
All that said, you may not be facing 50%...but don't make that assumption based just on today's numbers. For example, if you're doing your own PM, that will likely save you 10-12%, which is a real savings...though you will be trading your time for that savings, and your time is presumably worth some amount of money, right?
As Uwe stated above, the 50% rule brings this deal to the 11% Cap rate. Remember to calculate CAP using NOI which is your gross rents minus all expenses.
Are you stocking away money every month for future repairs?
If the area is good then this is a good deal for a fairly new property.
We have a separate account for repairs.
I think this property will perform above the 50% rule. Given that it is already rented out, helps for immediately cash flow.
It's a small town, I'm not expecting a lot of appreciation. I just hope that the tenants are quiet and treat the property with respect. (and pay rent on time).
I think this property will perform above the 50% rule.
Given that it was built in 2006, it will almost certainly operate at a lower expense ratio for the first several years, as you won't have to deal with capital costs, your vacancy will probably be lower and maintenance costs will be trivial.
But, remember that the 50% rule is talking about long-term costs -- if you hold long enough, you're going to have to replace the roof, replace the HVAC system, replace the siding, etc. And maintenance costs will increase. And you'll eventually deal with rent loss, evictions, etc, even if only occasionally.
For example, in reality, that $6000 roof you'll need to buy in 20 years is actually costing you $25/month ($25/month * 20 years = $6000); likewise with the HVAC, siding, water heater, etc. You can either factor in the $100/month capital costs forever, or just expect that in 20 years, you may have a year where you lose $10K because you have to replace this type of stuff. Either way you do the accounting, your long-term expense ratio will be the same.
These are facts of life with rental properties long-term, and while it may seem like they'll never happen, I promise they will.
All that said, you may not be facing 50%...but don't make that assumption based just on today's numbers. For example, if you're doing your own PM, that will likely save you 10-12%, which is a real savings...though you will be trading your time for that savings, and your time is presumably worth some amount of money, right?
Good points all of you, thanks for the clarification J Scott.
I haven't used the same numbers for most of our purchases, but using that broad stroke it would help compare the true value of different purchases we have made and plan to make.
That being said, CAP rates are typically not calculated using the 50% rule. It would be nice if there was a standard.
For now my brother will be managing the property and will be earning his fair share.
BTW, we have also made an offer on a duplex nearby, nearly the same story but the asking price is $50,000. One half is rented for $550, other half is empty. I hope we'll have our offer accepted on that one as well.
Jon Klaus, right, but net operating income is not a standard equation.
I typically look at gross rent Vs purchase price. And then make adjustments based on variables specific to the property. Age, cost to fix up, rented or unrented, etc.
For accounting and financial security, it does make sense to look at 50% as a baseline, and outperforming that as a goal.