Cash flow with rising interest rates
Appraiser · Houston, TX · Member since 2016 · 2 posts · 11 votes
How are you guys able to make deals cash flow with new rates (assuming traditional bank financing)?
For example, a retaltively cheap house in the Houston market is listed at $250K. Assuming 6.73% rate, 20% down, 30 year note, and taxes and insurance, we're looking at a monthly note of $1,900 per month. If HOA fees are included, then its nearing $2,000 per month minimum.
The three most recent rent comps in the neighborhood are in the $1,500 to $1,800 per month range. So how are you guys making long-term hold deals work? I know this is just one example, but this is a relatively cheap house so it should cash flow under normal market conditions.
I have come across this issue with nearly every listing I analyze. Am I missing something? Are there methods around this issue?
@Marcos Falcao here are your levers to pull on:
Equity - To keep traditional debt you outlined; you probably need to increase your equity position. You can do this by using a larger downpayment, or buying at a steeper discount. A lower LTV can make a property cash flow.
Debt - If you want to move away from traditional debt, you can use creative solutions like seller finance to get a more favorable rate. Here you can set terms that aren’t constrained to a bank’s lending requirement. Just have to get the seller on-board, which most won’t be, but you only need one.
Income – Look at ways to maximize rent. You mentioned rent comps at $1,500 to $1,800. Could you rent by the room? Could you add a bedroom to get a bump in rent?
Location – Are you looking in an area that is already established? You could look to buy in a gentrifying area where you can see that the path or progress is moving.
Right now, is a time to sharpen our axes as investors. In this market it is harder to just stumble onto a deal, we need to be figuring out different ways to make deals.
I agree with you for a lot of investors - including for myself. I'm BRRRRing to break even right now. but i get the forced equity and so I don't care very much about monthly cash flow.
but, a lot of new investors on BP aren't in a financial position to take a hit on cash flow for even a couple months, let alone a few years.
that's the disconnect here.
Honestly that's a really positive way to look at thing, makes complete sense.
How are you guys able to make deals cash flow with new rates (assuming traditional bank financing)?
For example, a retaltively cheap house in the Houston market is listed at $250K. Assuming 6.73% rate, 20% down, 30 year note, and taxes and insurance, we're looking at a monthly note of $1,900 per month. If HOA fees are included, then its nearing $2,000 per month minimum.
The three most recent rent comps in the neighborhood are in the $1,500 to $1,800 per month range. So how are you guys making long-term hold deals work? I know this is just one example, but this is a relatively cheap house so it should cash flow under normal market conditions.
I have come across this issue with nearly every listing I analyze. Am I missing something? Are there methods around this issue?
Honestly that's a really positive way to look at thing, makes complete sense.
Best values are typically not listed. They are off market. Most off market either are in rough condition or have a risk item.
Seller provided financing (subject to or owner financing) can provide better terms that traditional financing.
Value adds can increase value and rents. These can be rehab, add BR, or more sophisticated value adds.
Alternative rent models other that LTR can cash flow. Rent by room, STR, LTR.
Lower LTV will cash flow with traditional LTR. Only question is how low does LTV have to be to cash flow. Recognize this option kills return and that you are buying that cash flow and paying for it up front.
Some/many investors are willing to purchase properties that are cash flow negative at purchase and rely on rent growth and appreciation to produce their return.
This is the most scary of all. Some people do not do underwriting or lack the knowledge to do proper underwriting. Being on BP, you would think this would be rare. I am convinced it is not that rare. I talk to investors at various meet ups. They state they purchased a great property. Ask what the COC is, no idea. Ask what expense projection they use and they respond the PITI is so and so. Even on BP I see it. Saw a post yesterday of a nice home with a rent/value ratio that was near 60% (I did not calculate it). They seemed to include only PITI and PM in the expense projection on a large home where maintenance/cap ex likely was going to exceed $500/month. Using their expenses it cash flowed. Yes it will cash flow until a big expense item. Fortunately for them they purchased it as a retirement home and not an investment (it is a poor investment RE). They will have a tenant pay much of their expenses until they are ready to retire. I resisted the temptation to show why it was a poor investment because it will work for their primary purpose.
I suspect I am missing a couple ways people are buying residential RE in this high cost, high rate market but covered most of them.
Be careful. Definitely do conservative underwriting prior to purchase. Look for ways to make it work. How many wholesaler lists are you on? How many meet ups do you attend? Do you have the time to do value adds? Have you looked into STR, MTR, rent by room? Have you placed search on MLS for seller financing? Have you contacted FABO? Do you drive for dollars? Have you considered SEO? There are a lot of ways to increase the chances of obtaining cash flow properties. If you are simply waiting for a turnkey cash flow property to fall into your lap, you may be waiting a long time.
Good luck
If you don't accept cash flow negative, putting more money down, or go through creative means to making a property viable this won't work in this 2023-fwd market. Buying OTM in good areas is arguably going to be the best route to go, or putting larger downpayment to offset cash flow negative.
If you're buying off-market properties or that have certain risks to it and making it viable, you're buying crap properties. Or you're on a wholesaler list that's completely blind. Every wholesaler list I'm on is basically pricing it terribly OTM with full risk reno. But even if you're taking one, it's rarely going to be worthwhile. I have about 18 cities I am looking at with all the wholesalers on it, they're all ****. They are all pricing as if you'll get great ARV. And if it's in decently good neighborhood, they're pricing you flat to land value. Their logic is this area has skyrocketed so much, the land is worth it alone. There's literally a listing in Houston, TX, where the wholesaler has it marked at $370k. There's houses all around it for $365k-$425k. Some fully update, that house itself in Houston would rent for about $1800 so OTM. But what does that tell you about the underlying property?
If you're doing "conservative" underwriting, you are looking in markets that do not have quality properties that can field an extended DOM. You want to be in position to buy properties right before the masses en sue. For example, I went under contract in a property that after PM fees will be about $-180 OTM, I bought it within 2 days on the market. After we got past earnest, the seller's agent informed us there were 7-10 offers that came after above list(I bought -$25k under list on a sub 350k property). In every area I have tabs on(that I am trying to get in front of the masses), people are aggressive. I am sure if I looked for crap areas I can squeeze out that cash flow.
If you're able to conservatively underwrite and create a legitimate two way on the bid/ask for the house, you're in a **** area.
There's a problem if you are in a **** area. Think about this way, in the most aggressive hiking situation and in the most risk-off most first time homebuyers(millennials) environment, there's still bidding wars out there. What does that tell you to that underlying property when risk is set to be turned back on? Yeah, at minimum, that land value just skyrocketed. And at the second worst case, your rent premium just skyrocketed.
Of course there are some market outliers, Austin, Nashville, SD are nose diving but even at certain levels(well above conservative underwriting) those get scooped up. You can't get too cute there, either.
Sure you might make you're $200/mo on that wholesale grade D property, but that one looming expense wipes it out. Either put more money down or accept negative cash flow, but if buyer direction is showing us anything it's quality over quantity. Don't buy those $80k houses in Indiana or Detroit, buy the better property in the growing area that's still "affordable".
Go take out Huntsville, AL for $250k rather than Toledo, OH for $175k. Accept a loss for this year and maybe the next 2-3. You want quality properties. Or if you're able to afford more, go buy that $350k property in Durham or Houston, and accept negative cash flow. It's worth more than that $210k property in some obscure part of the country.
If you're going to allocate capital, a safe bet is fed funds is not going to be south of 1.5 or 2 for a long time, your yield on equities isn't going to be this 8-9% people got from '12-22, it'll be 4-6%. And if I'm wrong, I am actually benefit inherently too. There's limited land, there's more limited land in desirable areas. The yield on appreciation will be far greater than seen before(besides Q4 20-Q2 22). If it's costing you an extra $300/mo to keep the property, that's $3600/year. Let's say rent never goes up and you're **** out of luck for 5 years, that's $18,000 for 5 years. Trust me, if rates were comfortable you wouldn't get that house for that price, you'd be ponying up more and more in a downpayment. You are basically losing Mtm as opposed to more upfront, but you're guaranteeing you are owning that parcel of land in that specific area.
I have seen people put more money down to get it to cash flow with the idea they will refinance when interest rates drop.
They'll lose that same extra money they put down on closing costs.
I agree with you for a lot of investors - including for myself. I'm BRRRRing to break even right now. but i get the forced equity and so I don't care very much about monthly cash flow.
but, a lot of new investors on BP aren't in a financial position to take a hit on cash flow for even a couple months, let alone a few years.
that's the disconnect here.
Investors like you and @Jack Martin are what's making the market "strong" and going to create pain for the investors that are hoping the RTP tightens in all markets and are waiting to buy. It'll definitely tighten in some. In above average markets, when rates go down the underlying house will go up significantly in value and and rent will exceed the PITI had you bought when rates were high. You won't need to refi, and you realize now you won't sell. You literally just weathered a $1200/annual hit to own primo.
How are you guys able to make deals cash flow with new rates (assuming traditional bank financing)?
For example, a retaltively cheap house in the Houston market is listed at $250K. Assuming 6.73% rate, 20% down, 30 year note, and taxes and insurance, we're looking at a monthly note of $1,900 per month. If HOA fees are included, then its nearing $2,000 per month minimum.
The three most recent rent comps in the neighborhood are in the $1,500 to $1,800 per month range. So how are you guys making long-term hold deals work? I know this is just one example, but this is a relatively cheap house so it should cash flow under normal market conditions.
I have come across this issue with nearly every listing I analyze. Am I missing something? Are there methods around this issue?
In general there's a bit of a stand off right now between buyers and sellers. At least in my market. Not a lot of deals are getting done, and the agents, lenders, etc. are feeling the pain.
Some folks seem to be getting deals done by using ARM products. Some deals are getting done via seller financing. It seems there are some buyers who are gambling that rates will be lower in a year, so that when it comes time to refi, they'll be ok; I don't know but am guessing those are people using OPM and charging fees along the way.
The thing that stands out to me about your post, however, is that you seem to want to purchase a turnkey property and CF. Even if that was possible, and I'm sure it is in some markets, I wouldn't recommend it. You have no equity buffer. A deal is only a good deal imo if you have a way to add value, unless you are worth $20 million and purely in wealth maintenance mode.
How are you guys able to make deals cash flow with new rates (assuming traditional bank financing)?
For example, a retaltively cheap house in the Houston market is listed at $250K. Assuming 6.73% rate, 20% down, 30 year note, and taxes and insurance, we're looking at a monthly note of $1,900 per month. If HOA fees are included, then its nearing $2,000 per month minimum.
The three most recent rent comps in the neighborhood are in the $1,500 to $1,800 per month range. So how are you guys making long-term hold deals work? I know this is just one example, but this is a relatively cheap house so it should cash flow under normal market conditions.
I have come across this issue with nearly every listing I analyze. Am I missing something? Are there methods around this issue?
In general there's a bit of a stand off right now between buyers and sellers. At least in my market. Not a lot of deals are getting done, and the agents, lenders, etc. are feeling the pain.
Some folks seem to be getting deals done by using ARM products. Some deals are getting done via seller financing. It seems there are some buyers who are gambling that rates will be lower in a year, so that when it comes time to refi, they'll be ok; I don't know but am guessing those are people using OPM and charging fees along the way.
The thing that stands out to me about your post, however, is that you seem to want to purchase a turnkey property and CF. Even if that was possible, and I'm sure it is in some markets, I wouldn't recommend it. You have no equity buffer. A deal is only a good deal imo if you have a way to add value, unless you are worth $20 million and purely in wealth maintenance mode.
If you have to force equity into a deal to make the house acceptable, I question the location.
Quality locations still have bidding wars. A deal is good, not only good, but good, if there's always demand for the product. Just alone a good location will always reap that. It's what makes class A neighborhoods impossible to buy and cash flow after the fact. Try to get very good properties before they are recognized. Not intrinsic deals when there's investors hungry. It's telling you something. It may rent, but nobody wants to buy it. Buy in areas people are fighting for but the barrier of entry is low(relative to you).
How are you guys able to make deals cash flow with new rates (assuming traditional bank financing)?
For example, a retaltively cheap house in the Houston market is listed at $250K. Assuming 6.73% rate, 20% down, 30 year note, and taxes and insurance, we're looking at a monthly note of $1,900 per month. If HOA fees are included, then its nearing $2,000 per month minimum.
The three most recent rent comps in the neighborhood are in the $1,500 to $1,800 per month range. So how are you guys making long-term hold deals work? I know this is just one example, but this is a relatively cheap house so it should cash flow under normal market conditions.
I have come across this issue with nearly every listing I analyze. Am I missing something? Are there methods around this issue?
In general there's a bit of a stand off right now between buyers and sellers. At least in my market. Not a lot of deals are getting done, and the agents, lenders, etc. are feeling the pain.
Some folks seem to be getting deals done by using ARM products. Some deals are getting done via seller financing. It seems there are some buyers who are gambling that rates will be lower in a year, so that when it comes time to refi, they'll be ok; I don't know but am guessing those are people using OPM and charging fees along the way.
The thing that stands out to me about your post, however, is that you seem to want to purchase a turnkey property and CF. Even if that was possible, and I'm sure it is in some markets, I wouldn't recommend it. You have no equity buffer. A deal is only a good deal imo if you have a way to add value, unless you are worth $20 million and purely in wealth maintenance mode.
If you have to force equity into a deal to make the house acceptable, I question the location.
Quality locations still have bidding wars. A deal is good, not only good, but good, if there's always demand for the product. Just alone a good location will always reap that. It's what makes class A neighborhoods impossible to buy and cash flow after the fact. Try to get very good properties before they are recognized. Not intrinsic deals when there's investors hungry. It's telling you something. It may rent, but nobody wants to buy it. Buy in areas people are fighting for but the barrier of entry is low(relative to you).
I'm not sure why you would suggest that it only makes sense to add value or force appreciation in questioning locations. Adding value or forcing equity is how you create real wealth in real estate. Cashflowing turnkey properties might provide you with income eventually, when you've finally acquired 20 or 30 doors, but it won't create substantial amounts of wealth in a short period of time. The areas that provide good immediate CF without you having to do work or add value are probably the areas that you want to avoid.
How are you guys able to make deals cash flow with new rates (assuming traditional bank financing)?
For example, a retaltively cheap house in the Houston market is listed at $250K. Assuming 6.73% rate, 20% down, 30 year note, and taxes and insurance, we're looking at a monthly note of $1,900 per month. If HOA fees are included, then its nearing $2,000 per month minimum.
The three most recent rent comps in the neighborhood are in the $1,500 to $1,800 per month range. So how are you guys making long-term hold deals work? I know this is just one example, but this is a relatively cheap house so it should cash flow under normal market conditions.
I have come across this issue with nearly every listing I analyze. Am I missing something? Are there methods around this issue?
In general there's a bit of a stand off right now between buyers and sellers. At least in my market. Not a lot of deals are getting done, and the agents, lenders, etc. are feeling the pain.
Some folks seem to be getting deals done by using ARM products. Some deals are getting done via seller financing. It seems there are some buyers who are gambling that rates will be lower in a year, so that when it comes time to refi, they'll be ok; I don't know but am guessing those are people using OPM and charging fees along the way.
The thing that stands out to me about your post, however, is that you seem to want to purchase a turnkey property and CF. Even if that was possible, and I'm sure it is in some markets, I wouldn't recommend it. You have no equity buffer. A deal is only a good deal imo if you have a way to add value, unless you are worth $20 million and purely in wealth maintenance mode.
If you have to force equity into a deal to make the house acceptable, I question the location.
Quality locations still have bidding wars. A deal is good, not only good, but good, if there's always demand for the product. Just alone a good location will always reap that. It's what makes class A neighborhoods impossible to buy and cash flow after the fact. Try to get very good properties before they are recognized. Not intrinsic deals when there's investors hungry. It's telling you something. It may rent, but nobody wants to buy it. Buy in areas people are fighting for but the barrier of entry is low(relative to you).
I'm not sure why you would suggest that it only makes sense to add value or force appreciation in questioning locations. Adding value or forcing equity is how you create real wealth in real estate. Cashflowing turnkey properties might provide you with income eventually, when you've finally acquired 20 or 30 doors, but it won't create substantial amounts of wealth in a short period of time. The areas that provide good immediate CF without you having to do work or add value are probably the areas that you want to avoid.
We are seeing the same thing in my market. It's hard to get the numbers to work. My approach has always been to buy and hold. That is where the wealth comes from. If you can weather the storm in the short term of little to no cash flow and you pick the right property, over time you should still make money.
@Marcos Falcao we had 10+ years where rent was rising, combined with low interest rates, then inflation zoomed, covid, etc which helped prolong the top of the cycle pushing rents up even higher. That rent growth is leveling off and the fed is trying to drive down asset prices/disinflate.
Does this mean real estate is no longer a good investment? No, but expectations have to change. Paydown at 6.5% produces pretty good results if the debt service and expenses are paid for by the tenant, for instance.
Or, putting more (inflated) cash down may not be the worst decision either. And there are always value add and tired landlords with no rent increases for 10 years out there to make the equation balance.
Its always a formula balancing appreciation, cash flow, equity and taxes.
You have to get creative to get cash flow! Whether that's adding value, renting by the room, renting furnished, etc. It's near impossible to buy a rent ready long term rental and get cash flow, in just about any market.
There isn't a 'catch'. If the numbers don't work, the numbers don't work. Don't try to force it.
IMO you needed '1% rule' to cash flow before. But now? If you're not buying at least 1% rule, you're going to be negative on cash flow (I don't count putting down 50% then being able to cash flow as really cash flowing).
Think about that $250k home you're looking at. If it leased for $2,500/month you'd be fine.
I was buying 1% properties when rates were in the 3's and I'm getting 1%+ now to make up for higher interest. The last single family homes I bought were a bunch in the galleria area. I paid $245k/each and they lease for about $2,300/month. Not quite 1% but close. Last week I put a large multifamily under contract for $53k/door that brings in about $725/month in rents. A year ago that would have been $80k-$90k/door.