Help me understand this deal and 50%, 2% rule 70 posts by 26 users

Posted: 04/17/2008 at 03:53PM

I hope I'm doing this correctly. Thank you in advance.

3-unit apartment complex
Asking Price = $119,500 (I easily understand that this is way too high)
Total Monthly Rents = $1,235

Using the 2% rule, I would need the house to be $61,750 (61750*.02=1235 or $1235/.02 = 61750)

50% Rule says that $617.50 of Total Monthly Rent will be used for expenses.

So a $61,750 mortgage (at 100% financing, 8% interest, 20 year payback) per month is $516.50. I think I'll be able to get 100% financing if I can prove my assets, etc.

Therefore $516.50 (mortgage payment) + $617.50 (anticipated expenses) = $1,134.

$1,235 (monthly income) - 1,134 (Total Expenses per month) = $101 net income per month

I thought I'm supposed to be making over $100 per door!

Am I calcualting something wrong? Please let me know.

Thanks again!

Matthew08

Posted: 04/17/2008 at 04:13PM

From what I've read here, the $617.50 refers to taxes, insurance, management, maintenance, entity maintenance, advertising, utilities (at least during vacancies), legal fees, damage done by tenants (over the security deposit), vacancies, setouts, lawsuits, and capital expenses (not technically an operating expense).

Matthew08

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Posted: 04/18/2008 at 11:10AM

You might also want to figure this deal from another angle -- the cap rate for the property.

Take the gross yearly rents and subtract from that the percentage you think it will cost you to operate the property: maintenance, taxes, insurance, etc. This percentage usually/maybe/sometimes averages around 50% depending on many variables. The one variable you have most control over is YOU. Will YOU be managing for free? Will YOU be doing repairs and maintenance for free? This is how many investors start out. Finding a wonderful tenant who will stay for years and years will also lower your overall operating expenses by minimizing vacancies. So you might actually be able to significantly lower that 50% average.

There's a nifty little property analysis tool on this very here website you can noodle around with, too.

So now you must decide what return you want on your invested dollars. And that's a decision with many variables that only you can decide on.

Personally, I like the advice of some of the wiser people here who only invest if they can get instant equity of 30% or more. That gives you a really good safety cushion, and, of course, will color your decision of what is a good return on your money.

But keep this is mind: deals are like taxis; if you miss one another will come along by and by.

Good luck and let us know if you get this deal.

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Posted: 04/18/2008 at 04:10PM

Should folks feel that if they can not meet this " rule" they should not invest period NO! not a rule, its a suggestion and an example of what is possible in some areas of some states, not many!

Ask any of the thousands of multi millionaire investors on the East and West Coast if their properties fit these suggestions!

James,

I agree with you 100% that there are many ways to make money in this business. But if there are thousands of multi-millionaires getting rich on the East and West Coasts, why are you buying your rentals out of state? It seems to me that although not calling it the 50% or 2% rules, you are essentially doing just that by buying at a steep discount that will allow you to generate a positive cash flow.

I'm assuming that the thousands of multi-millionaires you're talking about on the coasts made their money on appreciation instead of cash flow. If that's true, why don't you just buy a bunch of rentals in California and become a multi-millionaire yourself?

What I'm trying to accomplish with the 50% rule, 2% rule, and the $100 per unit per month cash flow suggestion is to get new landlords to think about the realities of the business. If they want to speculate on appreciation, that's fine. However, they should at least understand the expenses that will be involved and the amount of money they will lose each month if they pay retail for a property in California in hopes of appreciation.

The vast majority of new landlords fail in a short period of time. That's true even here in Ohio, despite having a much better opportunity for cash flow than you do in California. They fail for 2 reasons: 1) they don't understand operating expenses and pay too much for their property, and 2) they can't deal properly with the tenants.

Mike

Posted: 04/19/2008 at 01:32AM

Mike, Do you feel that the above statements are not accurate?

James, Yes, I think your statements are accurate. There are many ways to make money in this business. You certainly can buy property with a negative cash flow IF the market appreciates faster than you the money you lose and you can afford to hold the property until you sell. In addition, tax benefits/depreciation can help if you have other income.

Do all investors who don't follow these rules fail? Certainly not. I agree. However, the vast majority of newbies do fail, not only in real estate investing but in any business. In the rental property business, they fail because they don't have adequate cash flow (because they paid too much and didn't understand operating expenses) and they don't know how to properly deal with tenants.

P.S. I would LOVE to hear more about how YOU " deal properly with the tenants" . That's a scary thought-LOL. O.K. The tenants you often talk about are a MUCH different breed than the typical tenant here and in many places. There are many tenants in my area that pay from 2800-7000 a month for rent.

That's very simple - I follow the lease and I insist that they follow the lease. If they don't follow the lease - I evict them. If they don't pay the rent in full and on time - I evict them. I would treat a $7,000 per month tenant exactly like I treat a $300 per month tenant.

In addition, as I've said many times before, 90% of our tenants here in Ohio are fine. They pay the rent on time and take care of the property. Another 9% of the tenants have some issues (such as calling me about personal problems, making noise, dirty, etc). Only 1% of the tenants need to be evicted and about half of those are the inherited tenants that came with the buildings we purchased. So, in total, of the tenants that were screened properly (that I screened), 99.5% of them are acceptable at any one time. Do you really think that is any different in California? I'm sure that there are a few nutjobs paying $7,000 per month in rent. I don't believe for a minute that no-one that has a $7,000 rental is a drug addict. People are people even in California.

Mike

Posted: 04/19/2008 at 09:58AM

How many times have you posted THIS? Where the heck was I considering I have more forum time at present than any other current member? LOL

I don't know - maybe riding your bike!

If this is the case, then why do you focus on the .5% so heavily and make it out to be the opposite? I find odd that you have posted and blogged so heavily about all the dead beats and drug addicts and problems and I don't recall many posts commenting on the 95% of the great tenants who make your rental business a breeze?

What is there to say about a good tenant? It would be a pretty boring blog to say that all the tenants did fine today. In addition, the troublemakers are always the ones that get the attention from the landlord and quite frankly those are the ones I am thinking about. If you're going to be getting into the rental property business, you'll realize this soon enough.

Lets get back to the topic now, and forget about what we don't understand about one anothers realities, and appreciate where we do understand each others realities, o.k.?

I don't think we were ever off-topic. In addition, I'm not really sure what your business is. I thought you were investing out of state so that you could buy properties that would cash flow. Is that not the case? If not, I'd like to hear what your business is!

Posted: 04/19/2008 at 01:12PM

I'm almost thinking about this too much BUT in the case of multifamilies what is really 30% equity? I know what it is technically, but it seems like the FMV is a moving target.

Is FMV based on comparisons? how do you determine the 30% equity?

thanks for all the input on the subject by the way.

Matthew08

Posted: 04/19/2008 at 07:34PM

Spacewaya,

In reading through the posts, I did not catch an answer to the question, " Can you raise the rents?"

They do seem low. How many bedrooms per unit? What are you calculating for the rent of each unit? Are we talking about a 1st floor, 2nd floor, 3rd floor situation or something different?