Rental Property Investor · Sarnia/Port Huron · Member since 2014 · 8 posts · 2 votes
I'm in Canada. Cheapest places in the city I live in go for about 170k, and you couldn't get them for much lower than that (no distressed housing of any sort). Now, what you get for that 170k isn't much (an old townhouse, in a not-so-great part of town). With 20% down, and a 25-year mortgage (max Canadian banks will allow), monthly mortgage at 3.7% = $700. Add on insurance, property taxes, and repairs (bound to be high), and the cost to the landlord should be in the range of $900-1000/month. Meaning, to fulfill the 50% rule, a landlord would have to rent such a place for $1800-2000/month. No way that would ever happen. A renter would expect much better for that kind of money and wouldn't pay much more than 1200/month for such a place.
I think this makes a lot of sense. Why would anyone rent when the cost to own is SO much lower than the cost to rent? And why aren't investors flooding into the market, causing market prices to rise and rental rates to fall?
Think about it. First of all, most businesses would be quite content if they could sell a product that costs them $500 for $1000. That's a pretty good markup, maybe quite typical in retail. But that $500 is for the product alone. That business then has to pay employees, rent, utilities, insurance, etc...
If it costs you $500 a month for mortgage, insurance, property taxes, and repairs, and you can rent out such a place for $1000 a month, then you're doing a lot better than that business. Especially because a good portion of your mortgage cost is principal. That's an exceptional return. And it's significantly less work to manage a rental than to manage a retail business.
When something sounds too good to be true, it usually is. But, obviously, given the success of a lot of you (such that there is a 50% rule); this is a case in which it sounds too good and is true. Haven't you ever wondered why? I'm just curious because I know there's no way you could satisfy the 50% rule in my market. 80% at best. And, you know what, I think that is fair and still a pretty good investment.
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
12y
Real estate isn't a commodity because it can't be moved. Demand and supply vary dramatically in different areas, creating substantial pricing differences.
Rental Property Investor · Baltimore County Maryland and Tampa Florida · Member since 2013 · 2k+ posts · 2k+ votes
12y
The reason some don't own even though it may be cheaper is because they have terrible or no credit or they simply do not want to own.
If numbers don't work, then you either have to look via other sources (ie. not houses for sale on the MLS) or look in another area.
Not everyone is flooding the market to be an investor because not everyone is willing to get into real estate. Some people do not like to invest or take any risks what-so-ever. If it were easy to be wealthy, everyone would be. It's very possible, but you have to be able to do what it takes.
Residential Real Estate Agent · Cookeville, TN · Member since 2013 · 1k+ posts · 948 votes
12y
I think that you misunderstood the 50% rule. The 50% rule (if I understand it correctly) says that your operating expenses will typically be 50% (plus/minus) of your market rent. Note that operating expenses do not include your mortgage payment. For example (and these will vary, but the overall average will be about 50%), 10% vacancy, 10% property management, 10% taxes and insurance, 10% maintenance, 5% advertising, 5% misc.
So, if you want to have positive cash-flow, your mortgage payment needs to be no more than 50% of your market rent (or your market rent needs to be twice your mortgage payment). In your example with a mortgage payment of $700, your market rent would need to be $1400 for you to break even. On the other hand, if your market rent for the property is only $1200, you can still achieve the 50% rule by making a larger down-payment on the property so that your mortgage payment is only $600.
That's my understanding of the 50% rule. Someone please "learn me" if I'm wrong.
Welcome to BP! Please, take a few moment to pop into the New Member Introductions forum and let us know a little it about you.
What you have depicted in your inaugural post is the general dilemma of the Canadian real estate market. Nationally, housing prices are 5+ times household income. In Toronto and Vancouver, they are approaching 11 times. Edmonton and Calgary would likely both fall in the next tier of costly real estate.
Here in the Maritimes we have not seen quite the meteoric flight of property prices you have in ON and AB, but then again, we have not seen any real increase in average family income in a generation.
I agree worthy investments are getting more and more difficult to find, and if you try to apply many of the rules of thumb espoused here on BP (1%, 2%) to most markets in Canada you risk becoming immediately discouraged. The so-called 50% rule (some use 60% if the landlord handles utilities) does have statistical validity over the long term and is a good guideline to use as s first screening filter. It is not a replacement for a through analysis of a property as every situation is unique. The 50% rule {guideline} states that your operating costs should be not more than 50% of your rental revenue. If you rent a property for 2000/month, then operating expenses (insurance, taxes, maintenance, management, landlord carried utilities & services, vacancy allowance) should be no more than $1000.00/month. This leaves you with $1000/month to service debt and, hopefully, provide you a return.
The answer to the your question on why folks would rent when the {operational} cost of ownership appears to be so much lower is not singular. People rent for many reasons, but some common ones are:
1) they do not have sufficient resources to make the downpayment on a property purchase;
2) they do not have the credit history to qualify for financing;
3) they are in the area temporarily, or periodically, and do not wish to establish roots (students, oil field workers, politicians & staff attending the legislature, etc);
4) home ownership is just not right for some folks.
BTW: You should be able to secure residential mortgages (1-4 unit properties) from any of the Big 5 banks for <=3.0% for a 5-year term, variable rate mortgage on a 25-30 year amortization.
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
12y
Welcome to BiggerPockets, Matt. In some place the rental yields are lower/higher than in other places. You happen to live in an area with lower yields.
You could invest elsewhere. That has its own challenges, but is doable. Some here do It well. I do it, but in a city where I have a trusted team on the ground.
You could accept lower yields in your city. Perhaps you'll get better appreciation, and it will make it easier to manage.
You could fix and flip in your own city. There are other options, too.
The 50 percent "rule" states that expenses over time will be about 50% of your income. The 2 percent "rule" says that the monthly rent you receive should be 2% or your purchase price. This doesn't apply in many places. 3-5 years ago, it was more common because of recession, banking crisis, high foreclosure rate, RE bubble burst, etc.
Residential Real Estate Broker · Washington, Washington D.C. · Member since 2013 · 150 posts · 77 votes
12y
Hi Matt,
I've often asked the same question that you posed in your article. In live and work in Washington DC and our market has very high rental rates. I agree with you, the 50% rule does not work in every market. In DC, if you can cashflow $200 per month on a property, thats pretty good in my book.
The reasons that not everyone is jumping in and buying instead of renting are numerous:
1. Not everyone wants to deal with the potential headaches of being a homeowner (or the bigger headaches of being a landlord). Old houses require regular maintenance which takes time and money.
2. Many people in my market feel like they're only going to be here for a couple of years and don't want to "commit" by buying a place.
3. Not everyone can qualify for a mortgage, especially with the tightened lending standards that we've seen in the past few years.
4. Buying a home can be quite intimidating. There is a huge learning curve when it comes to buying a home and many people just feel more comfortable paying rent.
Rental Property Investor · Sarnia/Port Huron · Member since 2014 · 8 posts · 2 votes
12y
Sorry, I should clarify a bit. I know why renters rent. I am a currently a renter.
My situation: I've maxed out all my the money I can save in tax-free/deferred accounts and still have about $2000/month available for savings, so I'm looking into real estate. The bank pre-approved me for 600k.
If I bought two places each for 300k, one with 5% (15k) down and one with 20% (60k) down, I could rent both out for a total of $3600/month, and a mortgage payment of $2500/month. Add in insurance, property tax, and repairs (next to none, as these would be new places), vacancy is actually a non-issue (renters are a dime a dozen), and the cost to me would be about $3000/month, meaning I could have a positive cash flow of $600/month. And I'd actually be very content with that. I'd be happy with no cash flow. For putting 75k down, tenants will have my 600k in houses, which I expect will keep pace with inflation, paid off in 25 years. Heck, I'd even be fine with a bit of a negative cash flow, knowing in the future that my rents will increase with inflation but my mortgage payments won't (at least not as much as inflation).
Why then are investors on this forum demanding such high returns? Obviously, the bigger the better, but we're talking about a competitive marketplace. Investors like me should be driving rent prices down and housing prices up because they're satisfied with lower returns and even no cash flow. I mean, that must be what is happening in my market, seeing as I find rents seem to closely mirror what landlords must be paying in mortgage payments and other expenses. I, for example, rent not because my finances are poor but because my rent is 1200/month on a place that would cost me 250k. I wouldn't save much by owning a similar place, and I haven't wanted to use my savings as down payment, as I've been getting a very good return on my stock portfolio. Now, if I knew my place were worth 100k, I would definitely drop 5k of my savings into buying a similar place, as the mortgage payment then would be about a third of my current rent. But that's not the case, so I'm in no hurry to own (for my own sake; as in, not for investment purposes).
While I'm very satisfied with my stock portfolio returns, I always have to ask myself how I am able to achieve such returns. The stock market is a competitive marketplace. I shouldn't be able to buy low and sell much higher, but I can because I can find undervalued stocks. Undervalued stocks should not exist because other investors should recognize their bargain prices, buy them up, drive up the prices, and no longer are they undervalued. And this should occur instantly, such that stocks are never undervalued for more than a fraction of a second. But I find ways (beyond the scope of this topic). Nevertheless, I always ask myself, why do these opportunities exist. And I can always come up with an answer, and it's usually: "because I'm looking where no big, smart institutional investor bothers to look [small cap stocks - not worth their effort] and where your typical investor is too ignorant, stupid, or fearful to notice the bargain." And that's comforting because I know, as long as that doesn't change, I will very likely continue to profit.
Which is why I don't understand how landlords can charge such high rents relative to the cost of owning. Whenever there is a bargain to be had or profit to be made, investors and businesses should step in, buy up the bargains, offer lower prices in order to gain market share, and effectively make the prices more fair to consumers (in this case, renters). That's capitalism in a nutshell. I know it can be intimidating to buy an investment property, and it can be a real headache, but the returns should negate that. Any business opportunity could be a headache, but the potential returns make it worthwhile. Hence the reason entrepreneurship exists.
I know, I know. Who cares why landlords can make inordinate returns on investment? They do, and that's all that matters. But haven't you seriously considered this? Not just for your own peace of mind? That you'll have reason to believe you'll continue to make a profit in the future? I just can't help but wonder...
Rental Property Investor · Baltimore County Maryland and Tampa Florida · Member since 2013 · 2k+ posts · 2k+ votes
12y
Renters only pay for what they are willing to pay. Any landlord who doesn't want vacancies will rent it for what it'll get in that market. The prices are plenty fair to consumers.
Rent prices have nothing to do with the mortgage cost. They are unrelated.
Some may buy a rental with appreciation in mind, but the typical goal is to make money from day one...not 25 years later once you've paid the place off.
Even if the place is new, you must factor in repairs in case a renter destroys the place or something else happens that maybe insurance can't cover.
If you are fine with no cash flow, go for it, but again, not everyone wants that.
Rental Property Investor · Sarnia/Port Huron · Member since 2014 · 8 posts · 2 votes
12y
But why doesn't the market behave like the gas prices market? Gas prices are really quite low. Odd to say, but they're not much higher than what gas stations pay the wholesaler. This is because competition drives prices down. If Joe's Gas sells gas for 4.10/gallon, and Jim's Gas right across the street sells gas for 4/gallon, then Joe is either going to have to lower his gas prices or go out of business because no one is going to buy gas from him. There must be money to be made at 4/gallon, so Joe will still make money at that.
Result is, consumer wins. Competition drives prices down to levels where businesses barely profit. In the case of rentals, competition should drive down rental prices to a point where landlords barely profit. Though they still should earn somewhat of a profit for the risk taken and headache involved; otherwise no one would be a landlord. At the same time, the profit shouldn't be so great that everyone with good finances wants to buy a rental, thus driving up the prices of rental properties and driving down the rents.
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
12y
Real estate isn't a commodity because it can't be moved. Demand and supply vary dramatically in different areas, creating substantial pricing differences.
My situation: I've maxed out all my the money I can save in tax-free/deferred accounts and still have about $2000/month available for savings, so I'm looking into real estate. The bank pre-approved me for 600k.
I'd be happy with no cash flow.
Heck, I'd even be fine with a bit of a negative cash flow, knowing in the future that my rents will increase with inflation but my mortgage payments won't (at least not as much as inflation).
Why then are investors on this forum demanding such high returns?
Not everyone wants to invest their money in something that won't show returns for 25 years. In 25 years a lot can happen.
There are some who would be more than happy to invest in something that pays out at 2% if they are currently only earning 0.5%. It sounds like you would be happy to have 0% returns or negative returns.
I try to maximize my returns NOW, while still having the house that is gaining equity every year. I prefer to see double-digit returns.
If you want higher returns, you typically need to have a little higher risk. And you need to determine what you're comfortable with.
Rental Property Investor · Baltimore County Maryland and Tampa Florida · Member since 2013 · 2k+ posts · 2k+ votes
12y
"At the same time, the profit shouldn't be so great that everyone with good finances wants to buy a rental, thus driving up the prices of rental properties and driving down the rents."
Again, just because the potential profits are so good does not mean everyone with good finances wants to buy a rental.
I'm not sure if you seriously have something against real estate investing or are honestly asking this question.
Accountant · Thornton, CO · Member since 2011 · 170 posts · 33 votes
12y
"Some may buy a rental with appreciation in mind, but the typical goal is to make money from day one...not 25 years later once you've paid the place off.
Even if the place is new, you must factor in repairs in case a renter destroys the place or something else happens that maybe insurance can't cover.
If you are fine with no cash flow, go for it, but again, not everyone wants that. "
Very good points. I tried what @Matt M. said above once buy turning a property on a 10 year loan into a rental with no cash flow, relying on appreciation and amortization of principle to make up my returns. It got ugly fast. The first tenants had cats that destroyed the carpet, then they quit paying. I had to cover all my losses out of pocket by working a 2nd job - bc the investment threw off no excess cash flow to cover losses. Now, I will always plan to be cash flow positive in the first year, or I won't do the deal.
Chicago, IL · Member since 2014 · 26 posts · 0 votes
12y
Result is, consumer wins. Competition drives prices down to levels where businesses barely profit. In the case of rentals, competition should drive down rental prices to a point where landlords barely profit.
My initial thought to this line of reasoning is that if renters are a dime a dozen, as you describe, there is little incentive for landlords to lower rent. In a market with fewer renters, they can afford to be choosier, and thus drive the market re what they're willing to pay. In a market with plenty of renters, people are happy to have a roof and will pay the going rate with fewer demands.
Investor · Clairemont, CA · Member since 2011 · 3k+ posts · 2k+ votes
12y
They are somewhat with American homes for rent, Blackstone ect getting into the REO to rental game over the last few years. But they have higher costs to maintain the business, meaning small local investors can achieve much higher returns on their 1 and 2 rentals they manage themselves.
I think the piece of this puzzle that you're missing is the actual effort/headache that can come with those returns. First RE is not liquid, it will never be liquid. If you needed to get cash out of a property and had the equity to refinance, it would best case scenario still take 2-3 weeks likely to get your money back out. Also along with this, the costs of selling are high, so it is not a investment vehicle that lends itself to repositioning quickly or frequently. So when something like the '07 bubble bursts you're stuck where you are and with what you have for the time being. Or even if you have a job transfer, you can't take the property with you and that's a big investment that can actually be damaged unlike a stock that could lose value but truly only exists in electrons that someone can't drive up and smash with a brick.
Which comes to the next point. Stocks don't have an ongoing cost of ownership, RE definitely does. Case in point, I just had a tenant in another state inform me last week of some flooring issue. I thought it would be small, turns out it's not and is actually a moisture issue causing the wood floor to buckle. So after 3 months of vacancy (and making mortgage payments the entire time) and a fresh refinish on those floors, I have already spent nearly $500 on maintenance, still haven't found where the water is coming from or how much that will be to fix and am going to have to replace the entire floor once the water issue is fixed costing a minimum of $3000 on the low end.
So that phenomenal return I'm getting sure doesn't feel like it this week!
Homeowner · Brampton, On · Member since 2013 · 72 posts · 8 votes
12y
Awesome discussion. One thing that hasn't been covered:
Pricing for RE is set differently. Some types of RE (commercial or multis) are priced based on Cap rate. That means that the prevailing rate of return in an area is how the price is determined.