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Factoring in downpayment on 50% Rule, first deal!

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Craig S.

Real Estate Investor from Northeast, Ohio

Jan 17 '13, 01:51 PM


Hello,

I am getting all the numbers gathered for my first deal, rough total purchase price to be about $110,000 on a duplex. I will need to make some repairs to the foundation and replace the carpet in the entire house, I would estimate maybe $5k or $6k in repair cost. I will probably be applying for a FHA 203k remodel mortgage in which the repair costs can be factored into the mortgage. So, total mortgage will probably be around $120,000. It currently rents for $600 per side, although I will be moving into one. I think there is also an opportunity to raise rents after I complete the repairs.

I am considering the 50% rule to play it on the safe side factoring in operating expenses. The roof was recently repaired, all new windows last year, and a new furnace and hot water heater in one side last month.

When calculating in the 50% rule, what do you calculate as the standard downpayment (20%), or do you factor in the ACTUAL downpayment in each case? Obviously with only 3.5% down on FHA, my monthly mortgage payments will be higher, making it harder to achieve cashflow. Also a big component for me is that my PMI insurance will be around $150 per month due to only the 3.5% down/equity (with FHA, PMI insurance is required for 60 months unless I refinance).

Here are my current (rough) numbers:
(Please check and make sure costs look accurate)

Sale price = $110,000
Est. rehab costs (added into mortgage) = $6,000
Total property cost = $116,000
Closing costs added to mortgage (est. 5%) = $5,800
Total Cost = $121,800
Downpayment of 3.5% = $4,263
Mortgage on $117,537
Estimated PMI insurance = $150 /month
Estimated PITI (excluding PMI) @ 4.75% interest = $740 /month
Total monthly payment = $890 ($740 PITI + $150 PMI)

Currently rents for $600 per side.

In this case, I will only have roughly $600 per month of NOI (using 50% rule). Leaving me with a negative monthly cashflow of $290 per month until the PMI is paid off in 60 months bringing my cashflow to [negative] -$140 /month.

But again, this is only with 3.5% down and paying $150 in PMI monthly. Also, after I repair the property I am hoping to be able to raise rents $25 - $50 per month per side.

What do you guys think? I am overwhelmed with learning everything and trying to estimate all the numbers/cashflow/etc. and want someone's opinion?

Thanks in advance,
Craig



Uwe S.

Real Estate Investor from Dublin, Ohio

Jan 17 '13, 02:18 PM


Hello Craig,
a $120k duplex in Ohio is really a rare one and with only $1,200 maybe $1,400 monthly income not the burner.

In order to achieve a good positive cash flow with $1,4k in rents you must pay 30% down with my calculation. I would look unlikely to that deal.

-Uwe



Craig S.

Real Estate Investor from Northeast, Ohio

Jan 17 '13, 02:29 PM


Thanks Uwe for your input. The property is listed at $115,000, so I was assuming negotiating to at least $110,000, but hopefully more. Also Uwe, there are several $120,000 duplexes in my area all 2 BR and about 960 SqFt per side.

Any other opinions from anyone else?

1) Do you investors focusing on long term buy & hold usually strive to put down exactly 20% to make your cashflow numbers work, or do you put down the necessary downpayment (20% or more) to achieve the initial cashflow you desire?

2) I see that many investors say that most rentals will get between $100 and $200 /month cashflow. Do you typically put down what it takes to achieve this cashflow?

3) Back to my original question I was interested in... When calculating the investment potential of a property and using the 50% rule, are you assuming a certain downpayment percentage, like 20%? It is hard to cashflow on any property with only 3.5% down and PMI insurance I would assume...



Jeff S. Donor

Real Estate Investor from Portland, Oregon

Jan 17 '13, 03:06 PM
1 vote


@Craig S. the down payment has nothing to do with the 50% rule. It doesn't matter if it is financed 100% or free and clear. The 50% is expenses before debt relief.



Craig S.

Real Estate Investor from Northeast, Ohio

Jan 17 '13, 03:13 PM


Ok thanks for clearing that up, seems like a dumb question now that I look back at it.

What is the best way for individuals to calculate an estimated mortgage payment, call the banker?

I have found calculators online, but they all seem to be different and have so many variables (especially with FHA that it get's confusing).

Does this calculator seem accurate: http://www.203kmortgagelender.com/fha-203k-calculator.php



Derek J.

Real Estate Investor from Brooklyn, New York

Jan 17 '13, 04:01 PM


@Craig S., out of curiosity, why do you want to do a deal that doesn't give you positive cashflow? even if you live in it, you're subsidizing your tenants rent. Why not offer a price that will give you cash flow, and walk away if it doesn't work?

If you just want to calculate payment, look up how to create an amortization table in excel. you'll need to know the interest rate.



Steve Babiak

Real Estate Investor from Audubon, Pennsylvania

Jan 17 '13, 04:15 PM


bankrate.com and mortgageprofessor.com are two sites where you can calculate a mortgage payment.



Steve Babiak, Redeeming Properties, LLC
Telephone: 6109082183
...


Craig S.

Real Estate Investor from Northeast, Ohio

Jan 17 '13, 04:19 PM


@Derek J. I am currently living rent free but will be getting married in 5 months and will either be purchasing a property or signing a 1 year lease on an Apartment which will cost about $1,000 per month including utilities. I would rather put the cash towards my own investment rather than paying $$ in straight rent. I was also thinking about possibly refinancing the property after a year or two and putting in the 20% equity, which will eliminate PMI insurance and lower the payment, hopefully getting positive cashflow. The property is also in a great location close to work and in a decent growth area for Ohio. What do you think? I could also rent for 6 months at a higher rate and search for a better deal in the meantime.



Craig S.

Real Estate Investor from Northeast, Ohio

Jan 17 '13, 05:17 PM


Ok so I have enlightened my confused brain and think I am understanding this more clearly now.

So according to the 50% rule, 50% of gross rents is set aside for all operating expenses. Then debt service (being PMI, homeowners ins, and taxes) are deducted from the remaining 50% of what's leftover, correct?

I was getting the calculators confused because some were automatically factoring in taxes and/or insurance estimates. Now I realize that I need to find exact taxes and insurance (and PMI) on my own. The mortgage calculators are the exact same when oy considering principal and interest.

Here's my numbers:
Gross rents = $1,200 /month
X 50% = $600 NOI
Total mortgage = $125,000 (including Reno funds - FHA 203k)
Mortgage payment (principal and interest @4.75%) = $652

Then do the rest of the following expenses come out of the 50% rule allowance?
Monthly property taxes = $187.5 ($2,250 annual on current assessment)
Homeowners ins. = $58 /month (estimate)
PMI insurance = $150 /month (estimate for FHA)

Look at these numbers and let me know. Thanks!



J Scott Moderator Donor

Real Estate Investor from Ellicott City, Maryland

Jan 17 '13, 05:27 PM


Originally posted by Craig Sturgill:

So according to the 50% rule, 50% of gross rents is set aside for all operating expenses. Then debt service (being PMI, homeowners ins, and taxes) are deducted from the remaining 50% of what's leftover, correct?

Nope, not quite...taxes and insurance are part of expenses. And rent loss and capital costs are part of the 50% as well...

Try watching this very unprofessional video I put together that will explain it better:

http://www.biggerpockets.com/forums/311/topics/72246-the-50-rule-video-tutorial


Mortgage payment (principal and interest @4.75%) = $652

That's the other important part of the equation for doing the rough analysis...

If your gross rents are $1200/month, the 50% rule says that, long-term, your NOI will be somewhere in the vicinity of $600 (50% of gross rents). Your cash flow will be your NOI minus your debt service payment (P&I), which puts your cash flow at:

$600 - $652 = ($52)

You're losing about $52/month long-term, give or take a few bucks...

Now, you can put down a bigger downpayment, which will bring your P&I down, and will increase your cash flow, but then your IRR/COC/ROI will likely decrease.



Medium_lishproplogoJ Scott, Lish Properties, LLC
E-Mail: [email protected]
Website: http://www.123flip.com
CHECK OUT MY BIGGERPOCKETS BOOKS: http://www.biggerpockets.com/flippingbook


Craig S.

Real Estate Investor from Northeast, Ohio

Jan 17 '13, 10:52 PM


So is PMI Insurance included/factored in properly in the 50% rule then? And I know the 50% rule is just that, a rule. It just seems that if I were to include the PMI insurance into the 50% versus not having PMI insurance in the deal at all, there is an obvious cashflow difference.

So according to my example above, here are my numbers:

Total mortgage = $125,000 (including Reno funds - FHA 203k)
Mortgage payment (principal and interest @4.75%) = $652

Gross rents = $1,200 /month

X 50% = $600
Less:
- $150 PMI ins
- $58 homeowner ins
- $187.50 taxes /month
= $204.50 (left over for all other expenses)???

X 50% = $600
Less:
-$652 for debt service
= ($52) monthly cash-flow

Does this now seem correct? I know the 50% rule is just a rule and maybe I am focusing too much on it as a working equation. The $204.50 left over for ALL other operating expenses seems like it might be low, but then again maybe not?

Also, when the PMI insurance is "paid off" at 20% equity, I am still getting more cash every month in my pocket, but it would technically not increase my rents or cashflow under the 50% rule then, is this correct? Seems odd as I would be putting $150 more into my pocket every month.

I am understanding this more little by little so thanks for all your help!

P.S. J Scott, easy and simple video! Thanks

Craig



J Scott Moderator Donor

Real Estate Investor from Ellicott City, Maryland

Jan 18 '13, 05:29 AM


Originally posted by Craig Sturgill:

So according to my example above, here are my numbers:

Total mortgage = $125,000 (including Reno funds - FHA 203k)
Mortgage payment (principal and interest @4.75%) = $652

Gross rents = $1,200 /month

X 50% = $600
Less:
- $150 PMI ins
- $58 homeowner ins
- $187.50 taxes /month
= $204.50 (left over for all other expenses)???

X 50% = $600
Less:
-$652 for debt service
= ($52) monthly cash-flow

Does this now seem correct?

I would include the PMI in the debt service, not the 50% expense column.

So, in your example above, the $150 wouldn't come out of the 50% in the part first, but instead would be added to the $652 debt service and come out of the second part, for a negative cash flow of $202/month.

And you'd have $350 to cover all the rest of your expenses (maintenance, property management, capex, etc).



Medium_lishproplogoJ Scott, Lish Properties, LLC
E-Mail: [email protected]
Website: http://www.123flip.com
CHECK OUT MY BIGGERPOCKETS BOOKS: http://www.biggerpockets.com/flippingbook


Craig S.

Real Estate Investor from Northeast, Ohio

Jan 18 '13, 07:25 AM


@J Scott - Ok thanks for the help! Is there a sticky or something on this forum that shows literally all expenses and how they are factored into the 50% rule? If not, that might be helpful for me and other new investors to follow. I know there are several posts talking about the 50% rule, but I have not seen one with a completely exhaustive list of every expense that could be considered, and to which collumn it would fall in.

And to some of the more seasoned investors, how closely do you follow this rule? Do you just use it as a quick deal evaluation tool to see if a property is worth further analysis, or do you heavily stick to this rule as part of your overall investment decision?



Jeff S. Donor

Real Estate Investor from Portland, Oregon

Jan 18 '13, 08:08 AM


@Craig S. here is a property that was built in the 20s that had no upfront repairs. Most everything has been done to this property so it has gone from poor condition into very acceptable shape. You should not experience this extensive of repair very soon but eventually you will. These are the totals of 20 years ownership rental.

http://www.biggerpockets.com/files/user/Jeff1/file/sf-rental-income-and-expense-20-years


Edited Jan 18 2013, 08:17 by Jeff S.


Craig S.

Real Estate Investor from Northeast, Ohio

Jan 18 '13, 08:33 AM


@Jeff S., thanks for your reply and cost example. I see that over 20 years, your average monthly cashflow would equate to about $389 /month. This of course would not factor in paying debt service. Did you buy this free & clear or at least have positive cashflow?



J Scott Moderator Donor

Real Estate Investor from Ellicott City, Maryland

Jan 18 '13, 08:42 AM


Originally posted by Craig Sturgill:
@J Scott - Ok thanks for the help! Is there a sticky or something on this forum that shows literally all expenses and how they are factored into the 50% rule?

Any costs associated with the property (not the loan) fall into the 50%. This includes taxes, insurance, maintenance, property management, utilites, lawn care, turn-over costs, vacancy, rent loss, concessions, capital costs, etc.


And to some of the more seasoned investors, how closely do you follow this rule? Do you just use it as a quick deal evaluation tool to see if a property is worth further analysis, or do you heavily stick to this rule as part of your overall investment decision?

For me, this is a quick and dirty estimating tool -- it tells me whether a property is worth looking at in more detail. 50% is a long-term average and won't be applicable to every property in every location and in every circumstance. In some cases, it could be closer to 40% or 60% -- you'll need to take into account things like high (or low) property taxes, HOA/condo fee dues, neighborhood, type of tenants, etc.



Medium_lishproplogoJ Scott, Lish Properties, LLC
E-Mail: [email protected]
Website: http://www.123flip.com
CHECK OUT MY BIGGERPOCKETS BOOKS: http://www.biggerpockets.com/flippingbook


Jeff S. Donor

Real Estate Investor from Portland, Oregon

Jan 18 '13, 08:45 AM


Paid 25k with 2k down owner contract 9% interest. Did virtually no repairs for 13 yrs while section 8 tenant was there. One tenant during that time so cash flow all that time. When she moved I rehabbed it and changed the type of tenant and raised the rent. Had property paid off by the time rehab was done so borrowed some money to fix-up. Unfortunately the rehab was a real hassle and took 10 months and cost a lot. This was the only vacancy. Credit line used and paid off quickly.



Jeff S. Donor

Real Estate Investor from Portland, Oregon

Jan 18 '13, 09:09 AM


Looked up everything, guess my memory was off a little. The down pymt was $1250 with pymt of $250 at 9.25% and 1/4 interest increase and 3% pymt increase per year, 10 yr balloon. The rent was $410 after an adjustment from $390.



Craig S.

Real Estate Investor from Northeast, Ohio

Jan 18 '13, 10:08 AM


Ok thanks guys for the information and sharing your knowledge! I now have a much better picture of how everything works. I also understand that the 50% Rule is just a rule and should not be used as THE only calculation for an investment. Further analysis should be done once I weed out all of the bad apples using the 50% Rule.

With my current deal, although in the short term there will be a negative cashflow of about $150 - $200 /month (mostly because of PMI), it is still a favorable deal for me so far. Because this will be owner-occupied by me, my other alternative is to spend $825 /month in rent (plus utilities) to live at another apartment owned by someone else. So although I will have initial negative cashflow, it will be made up by not spending the $825 rent of another apartment. After I meet the 20% equity (after 60 months on FHA) my PMI will drop off. I also think I can raise rents from $600 to $650 per side (duplex) with my minor rehab and upgrades. So at that point I will be slightly better than breaking even. I will also be managing this myself.



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