All Forum Posts by: J Scott

Well, if those are the real numbers, I'd say you're getting a hell of a deal...

Looks like you'd be buying with a near 17% cap rate, 30% COC return, and 31% total return...in fact, if you could turn around and sell it as a 9-cap, you could immediately turn a $250K profit (even after selling fees!)...

Now, that said, the only way that would be the case is if:

1) the seller didn't know how to determine the value of his property, and was ripping himself off;

2) you had the ability to reduce expenses to a point where very few owners can; or

3) the seller is extremely motivated for some reason and is willing to practically give away his property.

I'm guessing it's none of these, and that you are actually being too conservative in your pro-forma estimates. First, if expenses are coming in at much less than 40% of gross income, that should be a red flag. And it looks like yours are coming in at less than 25%.

Some questions:

- Is the 10% vacancy the total income loss? For example, if you have 10% vacancy, and 10% of your tenants don't pay (and have to be evicted), that's actually 20% loss. Too many buyers don't figure total loss when considering vacancy;

- $1000 per year in total maintenance seems *very* low. Does this include deferred maintenance and reserves for capital improvements (new roof in 10 years, HVAC replacements, etc)?

- Do you plan to spend any money on unit turn-over? What happens when someone moves out? Don't you need to get the carpets cleaned, the walls repainted, the bathroom scrubbed?

- Is the water sub-metered for this property? If not, you'll be paying for that.

- What about trash/sewage? Are your tenants paying that? Probably not, so you need to factor that in.

- Who is going to do the general upkeep of the property? Will you be picking up trash, mowing the lawn, landscaping, etc? It's not factored in, so either you're doing it or it needs to be free.

- Are you going to advertise the property to find tenants? Or will they magically find you and come beating down your door? If you plan to advertise, there will be a cost associated.

- $25/month in accounting fees seems low, but let's assume it's correct. I imagine this doesn't include tax consulting and tax preparation fees. Are you a tax professional or do you plan to hire one to help you keep some of this money?

- Will you be consulting an attorney to handle any contractual or legal issues (evictions, leases, purchase agreement, etc)? If so, factor that in.

- The insurance estimate seems low to me...have you verified this yourself, or are you trusting the current owner's pro-forma?

- Will you be doing the property management yourself, or hiring that out? If you're doing it yourself, do you have the time/energy/skills to do it successfully? What if you decide at some point in the future that you want to hire out the PM role...you should factor in those costs now, just in case.

I could be wrong, but it looks to me like you're ignoring a lot of costs associated with this property, and will be in for a big surprise when you start actually writing checks. My first question to you would be whether you put together this pro-forma yourself (based on actual numbers and experience) or if you just listened to the current owners description of the expenses.

All that said, it may still be a great deal, just make sure you do your due diligence before pushing ahead...

What makes you think that an LLC can't provide benefits?

First, I absolutely agree that the 50% rule is a valuable tool for doing an initial assessment of a deal...

But, that said, the statement above is just plain incorrect.

Mike -

You'd probably agree that across the hundreds of thousands of SFH investments across the U.S., the average purchase price for those properties is around market value for their location (in fact, you'd probably agree with this almost by definition).

If I then said to you, "Mike, since you own a lot of rentals, your average purchase price for each of those is probably around market value for the location in which you bought."

Would you agree with that statement?

Of course not! Because you're not an average investor and you don't make average investments. You ensure through your techniques that the properties you purchase are well below market value. Regardless of what the "typical" or "average" investor does, you do better

So, what's to say that an investor who is specifically focused on minimizing expenses can't do the same thing? Or even that an investor can't do the same thing without even realizing it. For example, let's say that I focused my investing on areas that met the following criteria:

- Taxes disproportionately low
- Insurance rates below national average
- Only new or fairly new homes
- Had close contacts in the contractor business, who provided me great rates
- Ensured all multi-unit properties were submetered
- Had a brother-in-law who was an RE attorney

If those accurately reflected my criteria and my situation, I think I could safely say that my OE would be less than the national average, regardless of how many houses I owned.

The average is a wonderful thing to model against, but luckily not all of us (or the things we do) will trend towards it... :)

Again, that said, if you don't have any reason to believe you're not average, the 50% rule is a great one...

Absolutely. Real estate is one of the best hedges out there against inflation...

Wow, I had a complete cognitive breakdown on that one... :)

Thanks for the correction, Wheatie...you are 100% correct, and I don't know what I was thinking when I wrote what I did...

After 10 years, you have nearly $860K in equity, so you're almost a millionaire...

But, like Wheatie pointed out, you've spent over $400K to get to that point.

So, while the author could argue semantics to conclude that you've almost attained millionaire status in 10 years, most people would say you're only halfway there...

mouschi -

In general, to figure out your cash flow (profit) on a rental, you follow the following steps:

1) Calculate your income
2) Calculate your expenses (not including mortgage/debt service)
3) Calculate your Net Operating Income (which is Income minus Expenses)
4) Calculate your Cash Flow (which is Net Operating Income minus debt service)

So, if your house rents for $1000/month (your income), and you pay $500/month for things like taxes, insurance, maintenance, property management, etc (your expenses), then your Net Operating Income is $500/month ($1000 - $500 = $500).

If you then pay $400 in mortgage/debt service, your Cash Flow is $100/month ($500 - $400 = $100). This $100/month is your profit.

The 50% rule states that your expenses (#2 above) can *generally* be estimated at half of your total income (#1 above).

Of course, this is just a generalization...it could be more or less, but it's a good rule of thumb for doing back-of-the-napkin analysis of a property.

Hmmm...you might be a good landlord, but let me recommend that you don't go into animal training...I don't think you'd be as successful... :)

It generally boils down to a couple things:

1) What kind of return can you get elsewhere (opportunity cost)? You can get about 4% in a CD, maybe 8% in the stock market long-term if you're good, etc. Perhaps you have a business plan that will earn you 20% return on your money. A good return really depends on your other options.

2) How hard do you need to work for that return? If you need to be a property manager, deal with difficult tenants, drive long distances to your properties, etc, you'll probably want a higher return than if you just have to sit back and let a professional PM manage your property.

3) How much does the investment money cost you (cost of capital)? If you can borrow at 4%, then an 8% return isn't bad. If you can only borrow at 10%, then an 8% return is going to hurt.

4) What is your risk? If your risk is low, a smaller return isn't unreasonable. But, if you're taking a huge risk on the investment, you'll obviously want a higher potential upside.

Some investors are happy with an easy 10% return. Others would rather work hard (for example, undertaking a difficult apartment building "value play") and shoot for a 40% annual return (which wouldn't be unreasonable).

Building on what Wheatie said, using your more specific financing assumptions ($5K down, 6.3%, 30 years), along with the 50% rule, you get the following:

Gross rent: $470
Expense percent: 50%
Expenses: $235
NOI:$235
Payment: $209
Cash flow: $31+/month

So, that's $369/year cash flow, which at least is positive in terms of pure cash flow, but let's calculate the returns:

Cash-on-Cash: $369/$5000 = 7.38%
Total Return (w/equity accrual) = 15.04%

So, not a great return, but maybe not as bad as was originally portrayed; keep in mind that this doesn't include closing costs, which would reduce your return by a percent or two).

Personally (and I think a lot of people here would agree), a return like that isn't worth the effort of having to manage the property (you could get a slightly smaller return from a savings account), and the big risk is if you have any deferred maintenance or unexpected expenses, at which point you could easily go cash flow negative.

While I've seen a lot worse deals asked about on this forum, this one isn't particularly great...especially in this market where great deals are available on every corner.