All Forum Posts by: J Scott

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.

Sorry...see message below...hit Submit too soon...

A few more random thoughts from all these posts:

- Instead of just getting an "or assigns" clause in the contract, why not put in a contingency along the lines of, "If due diligence indicates that the investment return on the property is inadequate, buyer can back out of the deal?" This way you can back out if the numbers don't work *and* you can't get another buyer

- With a 30% downpayment (as you indicated), the place does look like it will cash flow about $160/month. The problem here is the following:

A 30% downpayment is $39,000 (plus there's closing costs, but we'll ignore those for now). You'll be cash flowing $160/month or $1920/yr. Your cash-on-cash return (your annual return on your cash outlay) will be 1920/39000 = 4.92%.

A high interest savings account will generate 4%...and that's a much safer and easier investment! My point is, even with cash flow, it's not a great investment

- It's very difficult to estimate things like maintenance, turnover expenses, eviction fee, etc. The 50% rule is good, and the nice thing is, if you do a great job of managing the property, and come in under 50%, you'll be pleasantly surprised at the end of the year. This is much better than making aggressive assumptions, and then making less than you thought

- In terms of vacancy, this is going to be highly location/property dependent. For example, if there are 10 other houses for rent on that street, you're going to have to be the cheapest (and also one of the best) to keep vacancy down. If your property is a 3/1 and the one for rent next door is a 3/2 at a comparable price, people are going to want that extra bathroom. To find out vacancy rates in your area, talk to property managers, other investors, etc. Also, get to know the area and see how long those For Rent signs tend to stay out given the rental prices being asked