Price to rent ratio
Massapequa Park, NY · Member since 2008 · 15 posts · 1 vote
Total newbie here, considering buying a property to rent (two family home) and hold for 5-10 years before selling.
I'd like to have a break even or positive cash flow and was wondering if there was a rule of thumb of what ratio of home cost (sale price) / (annual rent) would be a good place to start?
Thanks
I've made a couple of threads in the Landlording forum on this topic sticky. Have a look at those for more than you ever wanted to know about expenses.
Really, expenses are the only tricky piece of evaluating a rental. Everything else is just simple math.
One rule of thumb is the rent should be 2% or more of the price. That translates into a rent multiplier just over 4.
A better rule of thumb is to assume expenses will be 50% of the monthly rent. Subtract the desired cash flow off the remaining 50%, and that's your max P&I payment. Use the rate and term you can get to do a present value calculation to get the max price. Ignore down payments, since you don't want your money working for free.
So, for example, with that calculation, if market rents are $1000, your NOI is $500. Subtract $100 for desired cash flow, and that leaves $400 for the max payment. At 7% and 30 years, that will give a PV of $60,123.
Hmm, I wonder if these #'s need to be adjusted in different markets. I'm on Long Island (NY) and the absolute cheapest houses are 300K, I'm looking at a property 350K, that can rent for about 3200 a month. Does that sound like a horrible investment?
Yes, horrible sounds like the right word!
Mike
Wow, it just seems like it would make it almost impossible to do a buy and rent type of thing here then.
If a place costs $350K and rents for $3200/month, you could certainly buy it and rent it. P&I on a 100% note would be $2328/month. NOI after 50% expenses will be $1600. That puts you in the hole by $728/month.
Even with a more optimistic assumption of expenses being 40% of rent, you're still in the hole $408/month.
If you pay cash, and using the optimistic 40% for expenses, you get $1920/month in cash flow. That's a 6.6% return on your cash. Slightly better than CDs, but not much.
Does this investment make sense..
Purchase price of 3 family home: $70,000
Taxes: $2000 per year
Gross Rental Income: $1500
Landlord pays water, insurance and taxes only. Tenants pay utilities.
What do you guys think ?
Well, the landlord pays more than that. You have to pay maintenance, property management (which you might do yourself), advertising, tenant screening, capital expenses (roof, sewer, etc.), evictions, vacancies, tenant damage, etc.
Still, that looks like a good deal.
Rent: $1500
All expenses: $750
NOI: $750
P&I: $466 ($70K, 30 years, 7%)
Cash flow: $284
Then you can't own rental properties there except as speculation. If you get some appreciation, enough to make up for your monthly losses, you'll make money. If appreciation is less, or, as is happening in many, many, many places, negative, you'll lose money each month and when you sell. The math could care less about your market. The math tells you whether its an investment (i.e., generates income each month) or speculation (requires appreciation to avoid losses.)
Jon,
What an easy and straightforward answer. I think this should be kept at the top of the starting out page (sticky?) and labeled "The Basics."
Clearly there are a large number of real estate investors out there paying way to much for their investment real estate. Most don't take into account their own money - that includes the agents selling the properties. The goal is to keep hunting and find those gems that you can add value (equity) too. Then bring the 50% rule into affect. Let the losers buy the losers and you will be laughing all the way to the bank.
I've made a couple of threads in the Landlording forum on this topic sticky. Have a look at those for more than you ever wanted to know about expenses.
Really, expenses are the only tricky piece of evaluating a rental. Everything else is just simple math.
The 50% rule has been spoken here as if it were gospel and relevant on every single investment. In my book, it is not so. Particularly with Frank's property he is looking at (or was looking at).
A property that has a monthly gross rental income of $3200 will not have expenses reaching anywhere close to 50% in most cases. For properties with $400-$700, I am sure they do. Percentages can change dramatically depending on the gross rent. Rather than using a percentage rule, why not calculate the taxes & insurance, then add in a vacancy reserve, a capital reserve, and a misc. expense reserve. Paying 10% for PM on this type of property would be ridiculous and probably self manageable, even from a distance, so that fee can be erased. Properties of this caliber will have a much lower tenant turnover ratio, little to most likely NONE tenant damage beyond the deposit, and evictions will be much less likely. People able to afford this amount in rent are middle to upperclass and less likely to cause problems. If the property is in great condition or close to new, the capital expenses will be minimal in a 5-10 year period as well.
Point being, do the math with actaul figures and estimate reserves and other expenses that do not occur on a monthly basis, rather than use a simple percentage.
Can this be a good investment? That question can only be answered by the investor who does the proper and necessary due diligence on the property and if it fits within their game plan.
I disagree. First, this is a duplex, so the rent is only $1,600 per unit per month. While this COULD have a middle class tenant in it, it could also have a bunch of lower class tenants sharing the rent. A $1,600 per month rental would be unheard of here in Ohio, but $1,600 for rent certainly isn't upper class on Long Island or NYC - not even close.
Will is correct that IF you had a well-screened middle class tenant, that the eviction rate and tenant damage could be lower. However, the property taxes are sky-high on Long Island (one of the highest in the nation) as are all the other taxes. In addition, socialist bastions usually have some of the most unfavorable eviction laws in the country. So, while you may not have as many evictions, the cost of the eviction and the time it will take will be much greater. The point being that it all averages out and the 50% rule is still the most accurate gauge going.
That is not to say that a person shouldn't do all possible due diligence. While expenses are almost never much below the 45% to 50% range over time, they could be higher on an individual basis. You might also find that the government issues are so onerous that it isn't worth holding rentals on Long Island even if you could find a property that would cash flow. Even here in Ohio, dealing with the government stupidity is very frustrating and can be more aggravating than dealing with tenants because it's harder to fight.
What? I thought you said that property managers MADE you money? Just kidding - I'm glad to see that you're converting to the self-manage school of thought! One little point though, even if you manage, you still can't "erase" the management expense - not unless you work for free (I don't). As I've said many times, property management is the most over-paid job on the planet! You certainly don't want to give that away!
Mike
I do not know the other area . But in PA North Wales, $280,000 with home association fee $135 can only rent $1750 per month. A lot houses rents out like this.
Suffice it to say that there are various opinions as to a good ratio for expenses, or whether or not it can even be reduced to a simple ratio.
Find out what you can about a deal, then make some consideration of what you can't find out. Some expenses are impossible to predict, like tenant damage or evictions. Some are difficult, like roofs, furnaces, and sewer lines. Some are easy, like taxes, insurance, and property management if you use it. Don't stop with the simple ones because its sure there are more than just those.
I've removed quite a number of posts from this thread. This topic of the "50% rule" gets pretty heated. Its been hashed out before in the sticky threads in the landlording forum. In addition, I'll refer readers to another, more recent thread Validate the 50% Rule.
A 350K house on Long Island may very well have $1600 per month in expenses when you factor in the high taxes, cost of insurance, maintenance, etc. Especially in Nassau County, 350K does not buy you a great house. It's likely to need repairs and considerable ongoing maintenance, all of which will add up.
For these reasons, as Jon mentioned earlier, often the only way to make money there is through appreciation. Even then you have to hope that the appreciation covers the negative monthly cashflow in the end.
^agreed, let this discussion continue -an interesting and informative one!
(I didn't even think the original posts deserved to be deleted as they were relevant and astute)
That is not correct. Every ad I see uses key words and phrases to draw attention and many of them use "great cash flow" In fact I have seen several ads from companies and individulas advertising their property with rents below a 1% purchase price ratio and state "great cash flow".
Secondly, you only assume my numbers indicate negative cash flow. I and my investors have experienced otherwise. You can argue that all you want, but it makes no difference to me. What I experience has nothing to do with your opinions.
I really don't care what you think is more appropriate. I run my business and make my ads the way I see fit. I don't tell you how to write your book, do I.
Besides, my investors do get the education from me. It does not have to be all spelled out in an ad. Get a clue.
My point was simply to state that I and my investors don't ever experience this type of occurance and thus have less expenses and headaches becasue of it. That is all.
Wrong again. I did no such thing. What I said is that the data you always refer to to prove the 50% rule, comes from apartment buildings as single family owners do not report their expense items or ratios to the public. I have stated that these two investment vehicles, in MY OPINION, have differnt expense ratios. I have also stated that lower income properties such as units with $600 monthly rents and below do have higher expense ratios. I have not aggressively argued that I don't use a 50% rule EVER, I said I use it as a "back of the napkin" analysis and have used that terminology many times.
So to be clear, I think the 50% rule can be a useful tool but should not be used as a reliable source to make decisions to purchase or not to purchase. Furthermore, I feel that it can be useful for a quick analysis, but investors should consider other factors when using ANY AVERAGE RATIO rather than figures as an investment with a 25% vacancy average over the past will have a much higher expense RATIO over that of the same valued property with a vacancy of only 5%. That is it.
You can believe that if you like. I really don't care. I have seen Tim post several times that he has used a 50% rule long before ever coming to BP and that his Father used it decades ago. (Tim, if I misrepresented anything about you here, I apologize, I am going strictly off of memory).
John Dessauer is a full time apartment investor who also teaches and mentors others and he is one who teaches the use of a 50% rule long before you started investing as well. Look him up if you like. Scott Scheel is another who has a commercial property academy and teaches the usage of a 50% rule. None of these people ever claimed to "author" the rule, but do teach how to appropriately use a 50% rule as well as many other rules.
It is quite arrogant to claim to be the author and creator of a rule that has been used for decades before you ever invested in RE.