All Forum Posts by: Eric Fernwood

Hello @Donald M. ,

Your concerns on high-rises are valid. I've looked at them several times for potential investors and the numbers never work due to high HOA fees. I looked at a typical unit in one of the towers you mentioned and what I found for this property is similar to the others that I have looked at in the past.

Based on the above with 20% down and typical loan your return will be approximately -6%. Or, you will have a negative cash flow of about $250/Mo.: Rent - Debt Service - Property Tax - HOA - Management Fee - Insurance. So, financially it is not a good investment. I called the HOA and they have changed their policy now in that you can use any property management company you wish. So, things have improved.

In general, I have not found any of the high-rises to even break even. I have a further problem with the high rises here since I have lived in high rises in other cities and countries. To the best of my knowledge none of the high rises here includes the basic ecosystems like a grocery store, pharmacy, restaurants, etc. When I lived in NYC I could pretty much get what I needed within the building complex or within walking distance. Not here. You will need a car to go buy just about anything you need which reduces the desirability of living in a high rise in my opinion. 

Several of my clients who originally considered high rises instead purchased town houses in some of the nicer communities. These offer a similar level of security but some you can walk to shopping and have a positive cash flow. 

Some of my other clients who started with high rises decided to go with smaller single family homes in guard gated communities. In some cases the reason they wanted the high rise was not to have to deal with maintenance. The way homes are built here (to handle the high temperatures, etc.) there is not much in the way of maintenance unlike what I see on the east coast. Below is a typical Las Vegas property. With properties like these we are seeing 4% to 8% return.

Donald, I hope I answered some of your questions. If you have more, feel free to post another question. 

Best Wishes.

Hello @Matthew Fiebig ,

Use Google to search for property managers. For example, according to your profile you live in Edgewood, Washington. I Googled "Edgewood Washington property management" and got several pages of hits. Click here to see the search results. I next tried "Las Vegas Nevada property management" and got similar results. So, that is how I would get a list of property managers. (Phone book? I have not seen a phone book in years.) After you look through a few property manager websites you will start to have an idea about their services and possibly even their fees and such. Choose 4 or 5 that look interesting to call. Tell the property manager that you are new to investing and you are looking for a property manager to work with.

Before you start making calls, develop a list of 10 to 15 questions. This is important: ask each property manager the same questions and compare the answers. You will quickly know who is providing facts and who is providing fiction. This is your method of validating what they tell you. I have a list of property manager interview questions. Drop me an email (or anyone else who would like a copy) and I will send you the list. The list includes a lot of questions, far more than you will be able to ask in a 20 to 30 minutes initial interview.

So the process is:

1. Develop a list of 10 to 15 questions designed to understand the property manager's focus (specific area, commercial, industrial, etc.), number of properties under management and the type, configuration, location and rent range that do best. I would choose mid sized property managers. They will have enough properties under management to know the market but small enough to be interested in a new client (you).
2. Google the name of the city/state plus the words "property management" of the area you are considering to get an initial list of property managers.
3. Look through their websites and see what types of properties (commercial, only high-rise, etc.) they primarily manage. You want property managers that focus on the type of property you are considering.
4. Look at their geographical coverage, they may not cover the specific area where you are considering.
5. Read their "corporate profile" and listen for the "ring of truth". I looked through a few of the property manager websites and some were puffing and I would discount them.
6. When you have a short list of 5 to 10, prioritize them and, starting with the lowest (not top) call and set up a phone appointment. Tell them you are new in real estate and are looking for a property manager to work with. Make notes of their answers. After you go through 2 or 3 you will have a pretty good idea of what is happening in that area and the type, configuration, location and rent range which do best. Remember that you are not just looking for "facts", you are trying to determine if this is an individual you can trust with your money.

Matthew, I hope this helps. Feel free to ask if you have more questions.

Hello @Lafontant Cherilus ,

I hear a lot about "rules" on some of the forums. However, in my option, there are no "rules". For example, the "50% rule" states that at some point at least 50% of your rental income will be spent on expenses. You have no control over the cost of debt service and property taxes but you have some degree of control over maintenance costs. Maintenance costs are driven by:

• Age and condition of the property (deferred maintenance)
• Quality of the property manager
• Quality of the tenant
• Climate
• Construction

For example, I live in Las Vegas and below is how a typical single family home is constructed.

In my experience, between $500/year and $1,000/year is on the high side of what most of my clients experience. However, I know of situations where tenants were improperly screened and they did thousands of dollars of damage to a property. You need to determine the condition of the specific property you are considering before you buy or you purchase a maintainance nightmare. Have the property inspected by a good property manager and then get estimates from a good contractor on rehabbing the property before you buy. For example:

• Roof condition - Has the roof had multiple repairs and is at the end of it's useful life?
• Plumbing - Leaks? Is the sewer pipe connecting the property to the sewer main damaged by tree roots or corroded over time to the point where you need to have it replaced?
• Windows - Wooden windows only last so long (especially if they are not maintained) and need to be replaced.
• Exterior siding - Does it need to to be scrapped and painted or replaced?
• Interior - What is the condition of the floor treatments, electrical, appliances, etc.

In summary, depending on the property, the tenant, construction, deferred maintenance, etc. you could spend 10 x the collected rent on expenses. Your living at the property and doing the work yourself will help reduce the labor component of some of the repairs but there are many tasks you may not be able to do like replacing the roof or rewiring/replumbing the property.

Hope this helps.

Best Wishes,

Hello @Kujtim Beganaj ,

The first property is always the scariest. @Gerald Harris brought up some important points on rehab costs and such. One of the great things about real estate is that as long as you buy in a good area, all but the worst mistakes will be corrected over time through inflation and rent increases. So, the question is whether the property is in a good area and whether the property is profitable. I recommend vetting all properties by the following three criteria:

• Located in an area likely to appreciate over time
• Sustained profitability
• Real estate investor friendly taxes and legislation

So, before you decide to proceed I recommend you look closely at the area.

Location

The old adage that the three most important things in real estate are location, location, location is still true. However, areas that are good today can decline and sometimes areas that were once bad get better. Is it possible to accurately predict what an area will be like in 15 or 20 years? No, but you can make a reasonable guess what an area will be like in 5 years and extrapolate from there. Three indicators I think you should watch are population, crime and job stability.

Population Migration

If people are moving out of the area, the housing prices and rental rates are likely to fall. If people are moving into an area, then there is likely to be appreciation and rising rents. Here is a website that shows population shift by area. Also, many areas have populations that are getting older. As people age they tend to want smaller properties and lower rents. If you are considering a home targeted towards families and the area is aging, you will likely find demand decreasing. So, also check the population demographics.

Crime

Stable or increasing property values and rents rarely occur in areas with high crime. People with sufficient income move from areas with high crime to areas with lower crime. The people who cannot afford to move remain in the area with increasing crime but they tend to have lower incomes thus resulting in falling rents and property values. What you need to consider is the types and frequency of crimes in the area and how it is changing. Where can you find such data? One site is crimemapping.com. There is also good data on homefacts.com. Depending on your city/area you may have such data available from the local police department or the sheriff's department. Remember that it is not just crime in the specific neighborhood that matters, you also have to consider areas near the property where people will shop and such. For example, I was evaluating a property in an area that I did not personally know so I was using Google Street View to check the drive path to the property. I noticed a strip mall near the property where I anticipated tenants would shop. When I checked that location on one of the crime sites I discovered that robberies and assaults occur frequently at the strip mall and that the situation appears to have been the same for the past few years. I rejected the property based on these findings. So, check the shopping areas that tenants would use. You should also check the sex offender database. See familywatchdog.us but there are likely many others. Some states/counties/cities have their own sex offender/crime websites.

Job Quantity and Quality

In many parts of the US, manufacturing and similar jobs are going away and what remains are service sector jobs. Service sector jobs tend to pay less than manufacturing and similar jobs so the families of these workers have less disposable income. Less disposable income means that they cannot afford to pay the rents that they did in the past. Look at the major employers, what industries they are in and their future prospects. Another key indicator is inflation adjusted per capita income over the past few years. If you see a declining job market or dropping per capita income adjusted for inflation, you need to carefully consider the long term value of the property. On inflation adjusted numbers, "official" inflation during 2014 is at 1.7%. However, “official” inflation numbers do not include energy or food. Personally, I use energy and eat so the inflation I experience at the gas station and the grocery store is much higher than the “official” number. Depending on whose numbers you use, actual inflation is between 6% and 10% per year. Keep in mind that unless the per capita adjusted income is rising at or greater than the rate of actual inflation, your potential tenants disposable income is eroding. What this means is that if you buy a property that rents at the upper end of the rent range, you will likely have increasing time-to-rent and declining rents over time.

Real Estate Investor Friendly Taxes and Legislation

Legislation concerning tenants vary by state, county or city and can have a huge impact on your return. An example is evictions. Clients have told me that in California, if the tenant knows what they are doing, it can take up to 1 year to evict and cost thousands. In Las Vegas, the time to evict is typically less than 30 days and usually costs less than $500. The best source of this sort of information would be local property managers.

State taxes and property taxes are another big factor to consider. For example, suppose you are considering two identical properties that rent for the same amount (yes, this is an over simplified and contrived example!). And, one is located in Austin and one is located in Indianapolis. Which one is better? Below is a table showing approximate state personal income tax (I will assume a person filing separately with a $50,000 income) and property tax rates for both cities. (Note, please forgive me if I am off on the values. My goal is to communicate a concept, not accurate math.) Note: Property taxes source and state income tax source.

In order to have some numbers to work with I will use the following.

• Purchase price $150,000
• Rent: $1,000/Mo.
• Financing: 20% down, 4.5% interest, 30 year term.
• Down Amount: $30,000
• Debt Service (PI): $600/Mo

Below is a (oversimplified) formula for estimating cashflow assuming 100% occupancy, no maintenance, etc. in order to keep the numbers simple:

Cash Flow = Rent x 12 - DebtService x 12 - PropertyTaxRate x PurchasePrice

And, to take into account state taxes:

Annual Cash Flow = (Rent x 12 - DebtService x 12 - PropertyTaxRate x PurchasePrice) x (1 - StateTaxRate)

For Austin: ($1,000 x 12 - $600 x 12 - 1.9% x $150,000)x (1 - 0%) = $1,950/Yr

For Indianapolis: ($1,000 x 12 - $600 x 12 - 1.07% x $150,000)x (1 - 3.4%) = $3,086/Yr

In summary, if the property is in a good area, you follow Gerald's advice and the property is profitable, you should be OK.

Best Wishes,

Hello @JJ Buckner ,

Whether you buy a property from a bank (foreclosure), an individual, turnkey or any other source is not the important factor. Before you buy anything, I recommend that you clearly define your end goal in real estate investing. If that goal is financial independence then you will want to vet each property by whether it gets you closer to or further from that goal. Keep in mind that in order to achieve financial freedom, you need properties that will generate profits for many years, not just today. I believe you should evaluate each property based on whether it meets the following criteria:

• Located in an area likely to appreciate over time
• Real estate investor friendly taxes and legislation
• Sustained profitability

Buying a property that does not meet all three of the criteria is likely to be a long term financial problem.

Location

The old adage that the three most important things in real estate are location, location, location is still true. However, areas that are good today can decline and sometimes areas that were once bad get better. Is it possible to accurately predict what an area will be like in 15 or 20 years? No, but you can make a reasonable guess what an area will be like in 5 years and extrapolate from there. Three indicators I think you should watch are population, crime and job stability.

Population Migration

If people are moving out of the area, the housing prices and rental rates are likely to fall. If people are moving into an area, then there is likely to be appreciation and rising rents. Here is a website that shows population shift by area. Also, many areas have populations that are getting older. As people age they tend to want smaller properties and lower rents. If you are considering a home targeted towards families and the area is aging, you will likely find demand decreasing. So, also check the population demographics.

Crime

Stable or increasing property values and rents rarely occur in areas with high crime. People with sufficient income move from areas with high crime to areas with lower crime. The people who cannot afford to move remain in the area with increasing crime but they tend to have lower incomes thus resulting in falling rents and property values. What you need to consider is the types and frequency of crimes in the area and how it is changing. Where can you find such data? One site is crimemapping.com. There is also good data on homefacts.com. Depending on your city/area you may have such data available from the local police department or the sheriff's department. Remember that it is not just crime in the specific neighborhood that matters, you also have to consider areas near the property where people will shop and such. For example, I was evaluating a property in an area that I did not personally know so I was using Google Street View to check the drive path to the property. I noticed a strip mall near the property where I anticipated tenants would shop. When I checked that location on one of the crime sites I discovered that robberies and assaults occur frequently at the strip mall and that the situation appears to have been the same for the past few years. I rejected the property based on these findings. So, check the shopping areas that tenants would use. You should also check the sex offender database. See familywatchdog.us but there are likely many others. Some states/counties/cities have their own sex offender/crime websites.

Job Quantity and Quality

In many parts of the US, manufacturing and similar jobs are going away and what remains are service sector jobs. Service sector jobs tend to pay less than manufacturing and similar jobs so the families of these workers have less disposable income. Less disposable income means that they cannot afford to pay the rents that they did in the past. Look at the major employers, what industries they are in and their future prospects. Another key indicator is inflation adjusted per capita income over the past few years. If you see a declining job market or dropping per capita income adjusted for inflation, you need to carefully consider the long term value of the property. On inflation adjusted numbers, "official" inflation during 2014 is at 1.7%. However, “official” inflation numbers do not include energy or food. Personally, I use energy and eat so the inflation I experience at the gas station and the grocery store is much higher than the “official” number. Depending on whose numbers you use, actual inflation is between 6% and 10% per year. Keep in mind that unless the per capita adjusted income is rising at or greater than the rate of actual inflation, your potential tenants disposable income is eroding. What this means is that if you buy a property that rents at the upper end of the rent range, you will likely have increasing time-to-rent and declining rents over time.

Real Estate Investor Friendly Taxes and Legislation

Legislation concerning tenants vary by state, county or city and can have a huge impact on your return. An example is evictions. Clients have told me that in California, if the tenant knows what they are doing, it can take up to 1 year to evict and cost thousands. In Las Vegas, the time to evict is typically less than 30 days and usually costs less than $500. The best source of this sort of information would be local property managers.

State taxes and property taxes are another big factor to consider. For example, suppose you are considering two identical properties that rent for the same amount (yes, this is an over simplified and contrived example!). And, one is located in Austin and one is located in Indianapolis. Which one is better? Below is a table showing approximate state personal income tax (I will assume a person filing separately with a $50,000 income) and property tax rates for both cities. (Note, please forgive me if I am off on the values. My goal is to communicate a concept, not accurate math.) Note: Property taxes source and state income tax source.

In order to have some numbers to work with I will use the following.

• Purchase price $150,000
• Rent: $1,000/Mo.
• Financing: 20% down, 4.5% interest, 30 year term.
• Down Amount: $30,000
• Debt Service (PI): $600/Mo

Below is a (oversimplified) formula for estimating cashflow assuming 100% occupancy, no maintenance, etc. in order to keep the numbers simple:

Cash Flow = Rent x 12 - DebtService x 12 - PropertyTaxRate x PurchasePrice

And, to take into account state taxes:

Annual Cash Flow = (Rent x 12 - DebtService x 12 - PropertyTaxRate x PurchasePrice) x (1 - StateTaxRate)

For Austin: ($1,000 x 12 - $600 x 12 - 1.9% x $150,000)x (1 - 0%) = $1,950/Yr

For Indianapolis: ($1,000 x 12 - $600 x 12 - 1.07% x $150,000)x (1 - 3.4%) = $3,086/Yr

In summary, I would be less concerned about the cost of the property and more concerned about the long term value and whether it will get you closer to or further from your goal.

Best Wishes.

Hello @Guillaume Derouet ,

I see a lot of emphasis on ROI in those forums and want to add my thoughts on why ROI alone can be misleading. Most investors hold properties for many years: 10, 15, 20+ but ROI is a snapshot of the property as it is at this moment in time, not what it's likely to be in 5 or 10 years. If your goal is to achieve financial freedom through real estate, I think you need to consider more than just the current ROI. I think you should measure each property by at least the following criteria:

• Located in an area likely to appreciate over time
• Sustained profitability 
• Real estate investor friendly taxes and legislation

Location

The old adage that the three most important things in real estate are location, location, location is still true but areas change. Areas that are good today can decline and sometimes areas that were once bad get better. Is it possible to accurately predict what an area will be like in 15 or 20 years? No, but you can make a reasonable guess what an area will be like in 5 years and extrapolate from there. Three indicators I think you should watch are population, crime and job stability.

Population Migration

If people are moving out of the area, the housing prices and rental rates are likely to fall. If people are moving into an area, then there is likely to be appreciation and rising rents. Here is a website that shows population shift by area. Also, many areas have populations that are getting older. As people age they tend to want smaller properties and lower rents. If you are considering a home targeted towards families and the area is aging, you will likely find demand decreasing. So, also check the population demographics.

Crime

Stable or increasing property values and rents rarely occur in areas with high crime. People with sufficient income move from areas with high crime to areas with lower crime. The people who cannot afford to move remain in the area with increasing crime but they tend to have lower incomes thus resulting in falling rents and property values. What you need to consider is the types and frequency of crimes in the area and how it is changing. Where can you find such data? One site is crimemapping.com. There is also good data on homefacts.com. Depending on your city/area you may have such data available from the local police department or the sheriff's department. Remember that it is not just crime in the specific neighborhood that matters, you also have to consider areas near the property where people will shop and such. For example, I was evaluating a property in an area that I did not personally know so I was using Google Street View to check the drive path to the property. I noticed a strip mall near the property where I anticipated tenants would shop. When I checked that location on one of the crime sites I discovered that robberies and assaults occur frequently at the strip mall and that the situation appears to have been the same for the past few years. I rejected the property based on these findings. So, check the shopping areas that tenants would use. You should also check the sex offender database. See familywatchdog.us but there are likely many others. Some states/counties/cities have their own sex offender/crime websites. 

Job Quantity and Quality

In many parts of the US, manufacturing and similar jobs are going away and what remains are service sector jobs. Service sector jobs tend to pay less than manufacturing and similar jobs so the families of these workers have less disposable income. Less disposable income means that they cannot afford to pay the rents that they did in the past. Look at the major employers, what industries they are in and their future prospects. Another key indicator is inflation adjusted per capita income over the past few years. If you see a declining job market or dropping per capita income adjusted for inflation, you need to carefully consider the long term value of the property. On inflation adjusted numbers, "official" inflation during 2014 is at 1.7%. However, “official” inflation numbers do not include energy or food. Personally, I use energy and eat so the inflation I experience at the gas station and the grocery store is much higher than the “official” number. Depending on whose numbers you use, actual inflation is between 6% and 10% per year. Keep in mind that unless the per capita adjusted income is rising at or greater than the rate of actual inflation, your potential tenants disposable income is eroding. What this means is that if you buy a property that rents at the upper end of the rent range, you will likely have increasing time-to-rent and declining rents over time. 

Real Estate Investor Friendly Taxes and Legislation

Legislation concerning tenants vary by state, county or city and can have a huge impact on your return. An example is evictions. Clients have told me that in California, if the tenant knows what they are doing, it can take up to 1 year to evict and cost thousands. In Las Vegas, the time to evict is typically less than 30 days and usually costs less than $500. The best source of this sort of information would be local property managers. 

State taxes and property taxes are another big factor to consider. For example, suppose you are considering two identical properties that rent for the same amount (yes, this is an over simplified and contrived example!). And, one is located in Austin and one is located in Indianapolis. Which one is better? Below is a table showing approximate state personal income tax (I will assume a person filing separately with a $50,000 income) and property tax rates for both cities. (Note, please forgive me if I am off on the values. My goal is to communicate a concept, not accurate math.) Note: Property taxes source and state income tax source.

In order to have some numbers to work with I will use the following.  

• Purchase price $150,000
• Rent: $1,000/Mo.
• Financing: 20% down, 4.5% interest, 30 year term.
• Down Amount: $30,000
• Debt Service (PI): $600/Mo

Below is a (oversimplified) formula for estimating cashflow assuming 100% occupancy, no maintenance, etc. in order to keep the numbers simple:

Cash Flow = Rent x 12 - DebtService x 12 - PropertyTaxRate x PurchasePrice

And, to take into account state taxes:

Annual Cash Flow = (Rent x 12 - DebtService x 12 - PropertyTaxRate x PurchasePrice) x (1 - StateTaxRate)

For Austin: ($1,000 x 12 - $600 x 12 - 1.9% x $150,000)x (1 - 0%) = $1,950/Yr

For Indianapolis: ($1,000 x 12 - $600 x 12 - 1.07% x $150,000)x (1 - 3.4%) = $3,086/Yr

The lesson is that while ROI is a good tool to compare properties with the same property tax rates, income tax rates and real estate legislation, it is not a good tool for comparing properties in areas with different property or income taxes or different real estate legislation.

In summary, while the current ROI is important, you need to take a long term view of the areas in which you are considering buying properties as well as considering other factors. So, if you have three locations with similar ROI numbers, long term considerations may make your selection much easier.

Your feedback is appreciated.

Hello @Todd Willhoite ,

You are on the right thought path. Trying to conform to arbitrary rules (2%, 1%, 20% below market, etc.) makes no sense to me. Also, deciding up front on the type of property is a problem as well. You need to establish a clear goal and then measure every thing you do by whether it gets you closer (to that goal) or further (from that goal). If your goal is long term financial freedom, then I believe that every property you consider must meet three criteria:

• Sustained profitability - With real estate your minimum horizon is at least 7 to 10 years so a buying based only on the current market situation is likely to leave you in a very bad situation in a few years.
• Located in an area likely to appreciate over time.
• Landlord friendly laws and taxes.

Below is an illustration of the process I would follow:

The first decision is location which may not be where you live. If where you live does not meet all the above criteria look somewhere else. Below is how I would evaluate a potential area.

• Population stability or growth. Here is a map showing growth trends of major cities. If people are generally moving out of an area, the value of your property and the rent you receive is likely to fall. If the population is growing then you passed this hurdle.
• Crime and stable demographics. High crime and long term profitability do not go together. That said, every place has crime. What you need to know is what types of crimes and how frequently crimes occurred close to the property. Where can you find such data? One site is crimemapping.com. There is also good data on homefacts.com. Depending on your city/area you may have such data available from the police department or the sheriff's department.
• Stable or improving job market - A property is only as good as the jobs surrounding it. If major employers are leaving the area you should look somewhere else. Even if the number of jobs is stable, the earning power of the jobs must be stable or growing. For example, if the area is changing from high-paying manufacturing jobs to service sector jobs, potential tenant disposable income will decrease and property prices and rents will fall.
• Landlord friendly laws and taxes. Clients have told me that in California, if the tenant knows what they are doing, it can take up to 1 year to evict a tenant and cost thousands. In Las Vegas, the time to evict is typically less than 30 days and usually costs less than $500. No one ever considers evictions until one happens to you.

Unless the potential location meets all the above you need to look somewhere else. If the area passes all the above (there are more criteria but these are the main ones) then you are ready to consider what type, configuration, location and rent range do best in the area you are considering. Specifically, the minimum you need to know is:

• Type: Condo, high rise, single family, duplex, single story, two story, etc.
• Configuration: Two bedroom, three car garage, mud room, etc.
• Location: Usually a very specific area. For example, west of 23rd St and south of the river, etc.
• Rent Range: If the majority of the population to which you want to rent are willing and able to pay $1,000/Mo to $1,300/Mo. you should only be looking at properties that you can purchase, rehab and profitably rent in the same rent range.

Note that this is local information, which you cannot get from podcasts, seminars, books or similar information sources. What is the best source for this type of information? Local property managers.

The local property managers deal every day with tenants, maintenance issues, renting vacant units, local laws, evictions, etc. In short, every thing you need to know. Talk to 4 or 5 mid-sized local property managers in each city you are considering. Before you start making calls, develop a list of questions and ask the same questions of each property manager. (I have a set of property manager interview questions, drop me an email if you or any one else would like a copy.) Tell them that you are new to investing and are looking for a property manager to work with. After only a couple of interviews you will begin to have a very good understanding of the local market and what type of properties rent best and how long they typically take to rent. Remember that the property managers only make money when they collect rent so they want rentable properties too.

Once you talk to a few property managers you should now have a very good idea of what properties rent best and how much they rent for. The next step is to determine what such properties cost. The property manager may be able to help you here but if not you can use Zillow. Find recently sold properties that match the type, configuration and location you learned from your property manager interviews. Once you know typical costs, it is time to determine whether you can make a profit.

In my practice I am almost constantly making what I call an investigate/forget decision. I do this so often that I created an online tool which enables me to instantly estimate a break-even price (where rent equals recurring expenses). Below is a screen shot of the tool. If you (or anyone else) are interested in using this tool, drop me an email and I will send you the link. There is no charge or obligation for using the tool.

In the example above I entered the estimated rent and other factors and tapped Estimate. The result is that if the property were purchased for $185,000, the rent ($1,200/Mo.) would equal the recurring costs (debt service + taxes + insurance + property management fees + monthly fees). This means that if I thought I could get the property for $165,000 I would investigate further. If I thought I would have to pay $185,000 or more for the property I would forget this one and look for another. Remember that this tool is only for making a quick investigate/forget decision, not a purchase decision.

At this point you will know where and what to consider based on data, not a supposition. You will also know whether a particular area is likely going to be profitable or not. One other comment, as long as you buy investment real estate in a good area, all but the worst mistakes will be corrected over time through appreciation, inflation and rent increases. (We strongly recommend only investing in areas with growing population and low crime.) Do not settle for a bad area just because the properties are physically close or inexpensive.

Todd, I hope the above helps.

Hello @Karen M. ,

The following is what I go through with my investor clients concerning risk management.

First, there is no way to avoid risk, you can only manage it. Everything you do has risks. While you are reading this email you could be struck by a meteor. (Note: a person was actually struck by a meteor in Sylacauga, Alabama on November 30th, 1954. She was injured but recovered. However, in 1911 a dog was killed in Egypt by a meteor. So, people and dogs are struck by meteors, but not very often.) So, you need to keep "the worst that could happen" in perspective. A lot of bad things could happen but most are unlikely so you have to consider the cost benefit. For example, I live in Las Vegas, Nevada. While there are earthquakes, I am not aware of any damage ever caused by an earth quake. Could a major earth quake happen here today? Yes. Likely? No. So I do not see the cost-benefit of earthquake insurance in Las Vegas. My point is to be reasonable and always consider the cost-benefit ratio.

I divide investor risk into a few different categories:

Hello @Matthew Fiebig ,

Before I talk about the deal process have you verified that apartments are the right choice in your area? Before you seriously consider anything I recommend you take a step back and take a wider view. Is the geographic area you are considering a good investment area? If it is a good area, are apartments the best type of property? Do not get caught up in some "technique"; every market is different and you need to look at the bigger picture before you zero in on anything. See this thread for the process that I would follow to identify the best area(s) and type(s) of properties to invest - http://www.biggerpockets.com/forums/12/topics/153168...

Ask a few local property managers whether apartment buildings rent well, you will usually get an honest answer. The reason the property manager will answer honestly is that the last thing they want is another unrentable property. So, if you ask them what to buy they will be happy to tell you what type, configuration, location and rent range do best. They will also be able to tell you what the apartment you are considering should rent for if it is in market ready condition. Matthew, all we do is investment real estate and we never consider buying a property unless the property manager agrees.

Let's assume that all the property managers tell you that the apartment is a good investment. They will also be able to tell you that in market ready condition the units will rent (making the following up) for $600/Mo. for two bedrooms and $400/Mo. for one bedrooms. Also, that it should take about 45 days to rent a market ready apartment.

With this information you now have a very good understanding of the financial potential of the property. Based on this you can then calculate what the property is worth to you and this is the amount you should offer. When I first started out in real estate investing in Houston (many years ago) I followed this process. I made a lot of offers. Some people got angry, some people laughed but some accepted my offers. I made very good money from my Houston properties.

If your offer is accepted the due-diligence starts immediately after the contract is executed. During the due-diligence period you need to get the property manager, inspector and anyone else you need into the property. You also need to get the leases and have your property manager review them. @Brian P.  made an excellent point about getting the tax schedule for the property as well as the documents I mentioned in my last post. Once the inspections and document review is complete you need to look at the numbers again. Unless the numbers look good and the property manager agrees, cancel the contract.

Matthew, I hope the above helps to clarify the process.

Hello @Peter Smith ,

One of the most frequent reasons people do not want to invest in real estate vs. other types of investments (stocks, bonds, etc.) is that they do not understand the difference between real estate revenue streams and accumulate and draw-down, which is how other investment types work. I pasted in an article below which I recently wrote that compares real estate to other types of investments. Your feedback would be appreciated.

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Why Real Estate?

Real estate investment (not flipping) is the common mans easiest path to financial freedom. By financial freedom I mean a revenue stream which you (and perhaps your children) will not out live, is inflation friendly and tax advantaged.

Accumulate and Draw-Down vs. Revenue Stream

I am frequently asked by new investors, "Why real estate is better than dividend stocks, CDs, annuities, etc. for achieving financial freedom?" I will explain the difference using an (overly simplified) example where financial freedom is defined as a long term revenue stream of $5,000/Mo.

Accumulate and Draw-Down

Achieving financial freedom through traditional investments consists of accumulating a large quantity of funds and then drawing-down these funds over a fixed period of time. The amount you need to accumulate is totally dependent on how long you need the funds. If you plan on living another 30 years (I will assume zero inflation and zero working capital growth which I will explain later) the math is simple:

30 Years x $5,000/Month x 12 Months/Year = $1,800,000

So, if you accumulate $1,800,000 you can draw down $5,000/Mo. for 30 years with the understanding that at the end you will have zero funds. "What about capital appreciation?" Appreciation and inflation need to be considered together.

Official inflation during 2014 is about 1.7% (source). However, remember that the “official” inflation numbers do not include energy or food. Personally, I use energy and eat so the inflation I experience at the gas station and the grocery store is much higher than the “official” number. Depending on whose numbers you use, actual inflation is currently between 5% and 10% per year(source 1, source 2, source 3 , source 4). For simplicity, let's assume that from now on inflation will be 5%. What this means is that you will need 5% more money each year just to have the same buying power as the previous year. Based on 5%, the amount you need to accumulate before draw-down increases from $1,800,000 to $2,000,000. Is 5% a reasonable guess as to future actual inflation? Not necessarily. During the 1980s the “official” inflation was over 14% (source). At 14% inflation the amount you need to accumulate before draw-down would be $6,500,000!

"But what about asset growth and assets that can handle inflation?" There is a tradeoff between the level of risk and gain. Conservative investments like CDs are currently paying about 1% thus with even the official inflation you are losing about 0.7%/yr in buying power. "What about a portfolio of stocks that can handle inflation?" While it is certainly possible to maintain such a portfolio even the big mutual funds have a hard time achieving it. But, suppose your investments could track inflation there are still two problems: 1) Every month that you draw-down funds you are reducing your working capital and thus potential gains. 2) In order to maintain the right portfolio mix you are going to have to frequently buy and sell stocks. Every time you sell stocks all profits are subject to capital gains tax which further decreases your working capital.

In summary, I do not believe that the average person can achieve a life-long revenue stream using the traditional accumulate and draw-down approach because:

• It is unlikely that the common man can accumulate the necessary millions.
• Accumulation and draw-down is a finite proposition; the income is only for a fixed number of years and what happens if you outlive your investments?
• Even moderate inflation can easily wipe out any fixed amount of accumulated funds over time.

Revenue Streams

According to The College Investor over 90% of the worlds millionaires created their wealth by investing in real estate. Why did they choose real estate? Revenue streams! I will start my explanation by estimating the amount of money necessary to create a life-long revenue stream of $5,000/Mo. Suppose you could purchase a property for $100,000 and rent it for $900/Mo. (This is very realistic in a lot of markets throughout the US and in some markets the returns can be higher. ) The monthly PITI (PITI stands for monthly principle, Interest, taxes and insurance) would be about $550/Mo (20% down, 30 year, 4.5%, 1% tax, 400/Yr insurance). (Warning, over simplification coming!) If I assume the property is always rented, the numbers work out to be: $900/Mo rent - $550/Mo PITI which results in a revenue stream of $350 per month. If I obtained 15 such properties I will have a revenue stream of $5,250/Mo.which never ends. And, the total capital I needed to establish such a revenue stream is 15x$20,000 = $300,000 compared to $1,800,000 in the accumulate and draw-down approach!

Here are some additional advantages of investment real estate:

• Cumulative: In the above example, each revenue stream will cost you $20,000. The positive cash flow from each revenue stream helps you buy additional revenue streams. Note that there are many financing alternatives to standard 20% down investor loans which include loans from smaller banks, seller financing and even government programs for first time home buyers, etc.
• Inflation: If you are using the accumulate and draw-down method, inflation is your enemy. With real estate, inflation is your friend. This is true because rents tend to track inflation but debt service is constant. Further, when inflation occurs interest rates increase thereby limiting people’s ability to purchase homes increasing demand for rental properties.
• Tax savings: With the accumulate and draw-down approach the IRS will love you (not good) because everything is visible and easy to tax. With real estate there are lots of expense deductions (Like coming to Las Vegas to check on your properties!). Another advantage of real estate is depreciation. (source). The IRS mandates that you depreciate the typical investment property over 27.5 years. (This is a phantom deduction because in the long run most real estate prices increase.) For our example property, deprecation will be about $2,900/year/property which offsets rental income. Many people have a positive cash flow from their real estate but still have tax losses.
• Leverage: While debt is bad leverage is good. Using common investor loans you can (in the example above) gain the income of a $100,000 property with only $20,000. There is no such leverage with other financial instruments.
• 1031 Exchange: Remember that every time you sell a stock you pay capital gains on profits. With investment real estate IRS rule 1031 ([source](http://www.irs.gov/uac/Like-Kind-Exchanges-Under-IRC-Code-Section-1031)) enables you to sell (“exchange”) one type of property for another and, if handled correctly, is not a taxable event. So, if the best investment today is single family homes in Anchorage and the situation changes such that condo medical offices in Houston are now a better deal, you can sell the single family homes and buy the medical condos with no tax due if you adhere to the 1031 rules.
• Forgiving: As long as you buy investment real estate in a good area, all but the worst mistakes will be corrected over time through appreciation, inflation and rent increases. (We strongly recommend only investing in areas with growing population and low crime.)
• Requires little time: Once you buy good investment real estate it requires little personal time if you use a good property manager. If you choose to manage your own properties, be sure to watch for a forthcoming article titled, “How to Fail in Real Estate”.

Summary

The accumulate and draw-down method has serious problems including outliving your investments, taxes and inflation just to name a few. You never outlive real estate revenue streams and they are tax advantaged and inflation friendly. To me, there is no comparison when it comes to financial freedom, real estate is the clear winner.

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Peter, I hope this helps. Please do not hesitate to contact me if you have questions.

Best Wishes,