Let's Analyze a Deal Together!

Hey everybody,

I thought we could take a look at a potential deal an agent sent me today to see if I should go ahead and purchase it. 

Here it is!

Nothing fancy but I like it! Just your typical 3 bed 1 bath home in a nice family neighborhood. Exactly what I'm looking for if the price is right.

Asking Price: Just Reduced to $132,500

Seems reasonable... It's slightly below the area median home price of 150k. Personally I think just below median is the sweet spot. It's also listed slightly below comparable 3 bed 1 bath homes in the area... but wait...

We're real estate investors! We need to know, what's the cashflow?!

Before we break down the numbers, let's see what the rent to value ratio is (my favorite quick screening tool for potential deals)

A lot of experienced folks will tell you that your house needs to meet the 2% rule. That means that if you buy a 100k dollar house you need to be able to rent it out for 2000 dollars.  

I'm not saying that isn't doable... if you're into putting up signs that say "I buy ugly houses!" and clean up homes that smell like cat pee, you can do it. I'm not knocking that at all, the people that do that are the ones who make the big bucks. 

This home is on the other side of the country and is move in ready though, so I know I'm going to have a tough time hitting 2% 

All 4 of my units so far have been purchased near 2% or even a little higher. That said, this home is in a great school district and in a nice neighborhood in a state with a growing population and economy.  It is also a no income tax state with very low property taxes... so I may be okay going down as low as 1% if the numbers look good. Let's take a look. 

Step 1: Determine Rent:

I went to rentometer.com and plugged in the address and bedroom count of this home. It came back with a median rent of 1185 for similar style homes in the area. I double checked with my agent who thought 1100 was more accurate (I love agents who don't try to exaggerate local rents). 

So we'll use 1100 for our calculations

Step 2: Come up with a purchase price for purposes of these calculations

In order to determine mortgage and other costs, we need to estimate what we're going to pay for the house. It's listed for 132k.... but at 1100 per month rent we're looking at a .8% RV ratio. Not going to cut it. I won't go below 1%, so let's assume we can get this house for 110k.

Step 3: Determine Mortgage Costs:

Find a mortgage calculator and determine how much it is going to cost per month to borrow 88k dollars (Purchase price minus downpayment) 

I used the calculator on biggerpockets.com and determined that I would be paying 479.15 in principal and interest (mortgage payment)

Step 4: Determine Property Tax:

I am not getting political here, but boy you have to love conservative states as a real estate investor. Property taxes are.... drumroll please.... 613 dollars per year. Wow! 

Step 5: Determine additional costs:

A lot of people who haven't done this before may just stop at step 4. Don't do it! There are a lot more costs to owning rental property than just your mortgage and property taxes, such as:

Maintenance and Repairs: Stuff breaks, enough said! I expect 8% of my gross rents to go to repairs each year. Hopefully less. 

Cap Ex: This stands for capital expenditures. Of all the expense categories this is the one most often left out or lumped in with repairs. The point here is that all of the big ticket items in a home have a predictable shelf life. So... if you like math, you could go through each big ticket item like the roof, furnace, AC etc. and determine its cost and useful life. You could then determine how much you need to put away each month in order to cover these expenses. 

I don't like math... so I'm just going to use 5% of gross rents for Cap Ex. I think a lot of people are going to think that's too low, but all of the big ticket items on this home have been recently replaced, and I don't anticipate holding properties for more than 5-7 years... so I use 5%. Use whatever you think works for you though.

Vacancy: How often your unit is empty and therefore not making money. I use 8% of Gross rent, which equals out to 1 month per year. I hope this house isn't empty that often, but you'll never get burned being conservative. 

Utilities: This varies by area. Fortunately where this home is located, the tenant pays all utilities. 

Insurance: I haven't gotten a quote on this one yet. I'm going to guess 125 per month, we'll see!

Management: Someone has to manage the thing! I'm a good 2000 miles away. I use 10% of gross rent in my calculations for management. I'm thinking about increasing this to 12% but for now let's use 10.

So.... should I buy it??? Let's see:

Hmmm.... not bad. The cash on cash return is definitely low. Not the deal of the century but not bad.

Now, if this was in a C area, I would pass on this one for sure. However, it's in a nice neighborhood and even has some appreciation potential. So while this home increases in value, and the principal is paid off by my tenant... I still get to make $100 per month! Before you say "oh cmon now, stuff breaks!... what about vacancy?... what about management?" Don't forget! I already budgeted for that. 

So... for those reasons, I'm going to make an offer. Since it's just an okay deal I think I'll offer 100,000 instead of 110,000.

In fact, I already offered 100k this morning! 

Haha sorry guys I didn't mean to trick you! I just didn't want to give away the ending. Cross your fingers for me... Unit number 5 here we come!