I was wondering if there is any generic formula you plug in your investments to see whether they are worth the return? I am assuming you would compare everything to a risk-free type investment like a CD or Savings Account and additionally maybe something like a mutual index fund for your analysis.
For me, I believe I would normally pay somewhere between 700-900 on rent not including utilities. I mention this because cost of living varies from city to city.
Given that, on a property that was purchased for 157k, how much cash flow do I need to make it a good investment? I also plan to spend approximately 5k in repairs so I guess the total cost to me is 162k.
I didn't get into the specifics of the property detail because I'm not sure if it matters what type of property it is. The analysis should be purely based on hard numbers right?
Have you run the analysis through the property analysis tool? ( http://www.biggerpockets.com/recritic.html ) You need to account for all expenses when calculating cash flow. As for percentage on returns - I do not know of a formula on that. There may be one, but I don't have it. Maybe there are others who can fill you in a bit more here.
1. level of risk comfortability - what are you comfortable with?
2. speculation projections - if it's a breakeven property now with conservative numbers - does that offset the fact that speculations indicate large equity growth in the near future
3. your operation funds - what you have in the bank to manage the property and possible negative cash flow
4. experience - you or any partners you may have that have done this before.
this is just a quick snapshot. formula's to the noobs like us are like little bits of comfort. they "let us know" in black and white if it's "good" or "bad".
it's just not that simple. BUT
a quick formula you could use to match rent income to value would be:
monthly rent divided by value of home = rent to value ratio - anything over 1 could be considered adequate.[move decimal over 2]
now, for 162k, the property you are featuring in this thread - what is its value?
assuming 162k value -
it looks like a .9 rent to value ratio - less than 1. but .9 is not necessarily bad...
or you could use this formula:
gross rents devided by 2 - per annum mortgage payment = possible cashflow - this is a quick snapshot view of cashflow...
now if you're thinking..okay now what...refer to beginning of this post - it all depends on what you or your company can handle.
other things to consider are:
interest rate & terms
money down
loan amount
taxes
Fixed Expenses
Variable Expenses
market value
market speculation
rentals in area - vacancy rates
quality of renters
property management - you, your business, or someone elses
repairs - you doing the rahab or relying on contractors (good luck)
now you probably know all this so it's redundant BUT, in my opinion, all of the above is really what counts, bottom line. i don't care if you buy a 20k unit and rent it for 400 a month and have a 10k loan. the KEY, i would say is BUYING BELOW MARKET VALUE...but that's a whole other post...bottom line, if you ain't buying below market, you're not investing, you're...doing what any other schlub can do and probably operating either too close to break even or just in the red period.
1. level of risk comfortability - what are you comfortable with?
2. speculation projections - if it's a breakeven property now with conservative numbers - does that offset the fact that speculations indicate large equity growth in the near future
3. your operation funds - what you have in the bank to manage the property and possible negative cash flow
4. experience - you or any partners you may have that have done this before.
this is just a quick snapshot. formula's to the noobs like us are like little bits of comfort. they "let us know" in black and white if it's "good" or "bad".
it's just not that simple. BUT
a quick formula you could use to match rent income to value would be:
monthly rent divided by value of home = rent to value ratio - anything over 1 could be considered adequate. move decimal over 2
now, for 162k, the property you are featuring in this thread - what is its value?
assuming 162k value -
it looks like a .9 rent to value ratio - less than 1. but .9 is not necessarily bad...
I am not sure how you are making your calculations. rent, let's say = 1400. value = 162000. if you did rent/value = something very close to 0.
the only way you can get rent/value > 1 is if the rent is = value or rent > value. and assuming value is 162k, your rent will never be 162k.
For houses that you plan to flip you just need to find an appreciating market
For houses that you intend to rehab you should look for low days on market
------------------------------
juza, is it really as simple as that though? rent x 100 = max value? I can imagine that would be really tough to find in most major metros. some condos dtown chicago go for 950 a month for a studio and I'm pretty sure I can't find a seller that will sell it to me for 95k.
But at the same time, just because I'm not in an area where SFH cost 50k, and you can easily apply that rental rule of 100 to, doesn't mean I shouldn't be allowed to play the RE game.
There has to be a model in which people from big cities run their analysis through that has to differ with people from smaller cities. Just because purchase price and rent will vary accordingly.
this is what i'm talking about when i say that there is no formula that gives you the ultimate thumbs up. these things are just quick snapshots that can help you make quick judgements, which can let you know whether or not to proceed with more in-depth analysis. that's all they can do.
and the formula i gave you is:
monthly rent/value
so 1500/162,000 (is this the value or just the price?)
= .009 - move the decimal over 2 = .9 for this formula
so you're just under 1, which means that's an okay rental price that matches the value of the property. that's it.
Don't skim over the most important thing I wrote. In my opinion - if you're not "buying right" - below market by at least 25% - then you're not investing. rei is ALL ABOUT "buying right" - finding "motivated sellers", deals and such. that's why you'll hear people talk about "wholesaling", foreclosures and such, because they're a given -usually - that they're below market value.
and "motivated sellers" are those that are in pending divorce, family problems, money problems, investors who ran the property poorly, other "investors" on burn-out etc. if this property for 162,000 is being sold by an agent or seller that really isn't "motivated" to sell - then you're wasting your time. now all sellers are "motivated" to sell - that's a given - they want to sell their property, unless they're just putting it on the market to see what offers they get (kinda like market researching). But a MOTIVATED SELLER is hungry and they want OUT yesterday!
as an INVESTOR, this is what you look for, period. whether you're flipping, rehabing and selling or renting. it's hard, in any area of the country to buy at market and see any type of positive cash flow. looking at rentals only - lets say your strategy is to purchase to hold and rent - thus sucking up appreciation, depreciation and cash flow, tax benefits etc.
rents usually are comparable to values in the area OR they're less (not good - see Long Island, New York). If you don't "buy right" - you're cash flow will be so near break even on paper, that there is a FANTASTIC chance that you'll be in the red.
forget the formulas - focus on YOUR MARKET. focus on the real numbers. who's selling, why are they selling, how hungry are they, condition of the neighborhood (safety/properties/etc), and condition of the unit itself (can I do the repairs, what's it gonna cost me) and finally, the quality of renters in the area and vacancy rates.
EXPERIENCE - this involves having advanced knowledge of rei - being able to look at something and KNOW it's a gem, realizing that even at or below break even for a year or two, a certain investment is a great opportunity regardless and this of course, depends on the next factor.
CASH (OPERATING FUNDS, DOWN PAYMENT, BUYING ALL CASH, ETC.)
Individuals, partnerships, Corporations etc, that have the means to close in 48 to 72 hours, or have enough funds to take on a negative cash flowing investment for an indefinite period of time - again, knowing it's a killer investment opportunity. Plus, if you've got CASH - you can make any rental cash flow - the more you put down or pay all cash - sure you'll be in the black - [cash killers for the noob are mortgages, contracted work, commissions and high taxes]
the more EXPERIENCE and CASH, you or your company has - the more you can speculate and not worry about having negative cash flow. But even these experienced investors avoid such situations usually and no investor really likes a break even or red situation - people want to make money - period.
if your'e starting out - don't waste your time with at market junk. move on.
Noobdogs wrote a lot (I didn't read all of it) and he's definitely right about one thing: these "rules of thumb" are just to get a ballpark. If the property passes the basic tests then you do more thorough analysis. It's just that not all properties are worth the time it takes to do in depth analysis.
is breakeven that bad? i feel like break even would be fine for me.
i'm about to close on a condo for 157k. it's a 2BR 2 BA. multiple comps in the past have come out 180k, but those units were in really good condition. i got it appraised and it came out at 165k. i have a friend who says he can help me do most of the rehab for 5k so i just assumed it will cost closer to 10k.
so i'm assuming after making repairs of 10k on top of me 157k, my net profits would be 180k-167k = 13k.
I thought that was a good deal but you guys are suggesting I need 25% return but that would mean I need 40-45k profit.
So I make my 13k sweat equity, and I saw a studio apt in the building go for 750/mo so I figured that if my mortgage payments are 750/mo and my assessments are 500/mo, I would need 1250/mo to break even.
If I get a roommate and charge 600-700/mo I would only have to come up with 550-650/mo which is already cheaper than the 800-900/mo I was previously paying. On top of which my "rent" is now going toward principal.
So in my mind, I feel that this was a pretty good deal for me but still no where near the 25% returns some of you had suggested.
i just want to point out that if you break even you're either working for free or only getting paid for the work you've done, which isn't good investing. or atleast, its not smart investing. you want to get a return on your investment, otherwise whats the point?
When I say breakeven, I mean from a month to month cashflow perspective. I still made my 13k in equity. And if your cash flow is easily breakeven now, doesn't it stand a good chance to think the cashflow will eventually be positive in the future?
you're living in this condo. so you are personally going to buy it and live in it and plan to sell it.
that is an entirely different strategy than straight up rehabing to sell, mainly because you can still live in it and make the payments yourself, take on a roomate or whatever.
do you have a job that pays you income?
reason i ask is because with that little a margin between ARV and purchase price, there isn't much you can do in terms of pulling money out.
plus, remember, as many rei guys will say, "CASH IS KING". Equity does not pay the bills. that's the everlasting problem of the basic homeowner (and re investors may own a personal home, but they ain't going about their business as a homeowner does, ie. buying at or too close to market value). homeowners look at equity and think the world of it. bottom line is though, you can't realize it unless you sell it or rent it out or take it out in the form of HELOC's or refi's and invest it in something with a much greater return than you're paying for in interest on the loan. and even though rei is a much more stable investment vehicle HANDS DOWN over the stock market, equity or value in a home can fluctuate with the market - what it's worth today, could be worth LESS in the future.
and yes, rental income is just that - income. it is taxable. but it's pre-tax dollars - you get paid up front and your accountant deducts every damn penny he/she can, to lower your taxable wages and additionally, depreciation impacts this positively as well. if you rent properties, the advantages are numerous. don't forget appreciation values (assuming you're buying in an appreciating area). employee dollars are after tax - the gov't gets paid before you do - major disadvantage.
In response to the issue of taxation: This is not a simple topic; this is why you want a good accountant on your team. The income that you report is going to depend on ownership structure (LLC? sole properietor? C Corp?). Many people WILL pay regular income taxes on the net income you earn, but others will receive passive income treatment. The same is true for tax losses.
you're living in this condo. so you are personally going to buy it and live in it and plan to sell it.
that is an entirely different strategy than straight up rehabing to sell, mainly because you can still live in it and make the payments yourself, take on a roomate or whatever.
do you have a job that pays you income?
reason i ask is because with that little a margin between ARV and purchase price, there isn't much you can do in terms of pulling money out.
plus, remember, as many rei guys will say, "CASH IS KING". Equity does not pay the bills. that's the everlasting problem of the basic homeowner (and re investors may own a personal home, but they ain't going about their business as a homeowner does, ie. buying at or too close to market value). homeowners look at equity and think the world of it. bottom line is though, you can't realize it unless you sell it or rent it out or take it out in the form of HELOC's or refi's and invest it in something with a much greater return than you're paying for in interest on the loan. and even though rei is a much more stable investment vehicle HANDS DOWN over the stock market, equity or value in a home can fluctuate with the market - what it's worth today, could be worth LESS in the future.
and yes, rental income is just that - income. it is taxable. but it's pre-tax dollars - you get paid up front and your accountant deducts every damn penny he/she can, to lower your taxable wages and additionally, depreciation impacts this positively as well. if you rent properties, the advantages are numerous. don't forget appreciation values (assuming you're buying in an appreciating area). employee dollars are after tax - the gov't gets paid before you do - major disadvantage.
well yes, in the current scenario i had described i would be living in one of the rooms. it's a 2BR 2BA. and yes i do have a job that pays me income. in the future though i was planning on moving out in 2-3 years. does that change any of the analysis?
i guess i am also holding home equity in high regard but that's only because i'm a saver and don't try to live a lavish lifestyle and am not too worried about needing to pull the money out (even though i know it's always smart to keep an emergency fund). my next investment would be financed by either:
1) a combination of savings + sale of current condo
2) a combination of savings + HELOC on current condo (but i also understand that there won't be much equity to draw on in 2-3 years)
i guess the problem is i really like the area i'm in and think the property will be worth a lot in the future (5-10yrs).
personally, if i'm single and/or married with no kids and i have an income that pays the bills, the following strategy sounds like a very good one.
1. buy a property in an appreciating area to live in - below current market value 20% minimum.
2. improve that property to increase ARV.
3. live in it over 2 years.
4. sell it, no cap gains taxes, and buy another property.
or
4. HELOC/refi for more money
5. Open LLC/S-CORP
6. Use $ from 4 to fund step 5.
7. LLC/Corp to buy another property below market value and rent one, live in the other (keep the one you live in out of the business).
8. Continue paying down both - one with renter, other by you.
9. Wait 2 years, repeat 4 - 9.
During all this, over 10 years, you accumulate 5 or so properties (or more if you can buy cheap, way below market), you get rewards of appreciation (hopefully/most likely) and depreciation (rentals), and of course, increase cash flow. Additionally, you take on greater responsibility, more headaches and challenges, but ya know what, that's what life is all about.
Everytime a relative of mine says that they'd never do that because this or that happens and evictions and the like are aweful blah blah blah, I just take a look at the way they live (check to check, etc), and think,
"bring it on!"
personally, if i'm single and/or married with no kids and i have an income that pays the bills, the following strategy sounds like a very good one.
1. buy a property in an appreciating area to live in - below current market value 20% minimum.
well shoot. i already messed up step 1. comps for a similar unit in excellent condition was 180k and i purchased a rehab-condition one for 157k. is there any reason why 20% is the min?
Also, when you say below current market value, do you mean it's market value as it stands or in pristine condition? because why would anyone ever sell their property 20% cheaper than it's inherent value unless they are really motivated and under duress?
But yeah, the plan you laid out sounds good. I just needed some guidance on what is a reasonable plan to follow. If you you've done it before then I'm more confident in knowing what my potential exit strategies are and what I can do to build up my portfolio.
u finally nailed it -
"why would anyone ever sell their property 20% cheaper than it's inherent value unless they are really motivated and under duress? "
BINGO.
now, this deal - now you're saying it's 180 value and you got it for 157 or it's 162 value?
i'm still unsure of what you want to do with this property. if you're rahabbing it for 5000, thus putting yourself into it for 162 total then you're repair is increasing its value another 23k over what you're paying for it - sooo
then you're selling it?
or
renting it
or
living in it
the strategy i pointed out in last post is not by any means, my own. MANY re investors do that. in fact, i'd say that about over 50% of rei's that invest in SFH or some duplexes, triplexes - do it this way. over 10 years, they accumulate rentals, maybe they sell 1/2 of them off, use the profits to pay off the other half, thus reducing liabilities, or maybe they invest in more.
bottom line is, that's the bread n butter of rei. now on this little post, steps 1-9 seem cut and dry, but there is alot of analysis, work, sweat, and risk involved.
i mean, you want my opinion of this deal you're talking about - i'd say, from the little i know, pass on it. move on. it won't cash flow or it'll be super tight and there's just not enough margin there for you to make any substantial profit.
ARV = 180,000 X .70 - 5000 = 121,000 - you're paying 36,000 over that. from my perspective, you're paying market value. and even if you live in it, these things have a way of going like this:
projected rehab cost = 5000
actual rehab cost = 15,000
Especially, when you're first starting out and/or living in it. if you live in it after buying it at market value - okay, you do some improvements and it increases in value - good - now don't keep dumping money into it - STOP. be disciplined, keep it nice, and keep to your plan - then do whatever, refi, sell, etc. but that's not easy. it's real easy for the wifey to say, "oh honey, i want a new kitchen floor" 6 months later, "oh this damn sink and bathroom, i hate it" and 1 year later, "what if we added another room, knock this wall down, and buy a new refridgerator...."
You need to get an APOD. It is a spreadsheet that you plug in the numbers such as cost, annual rental income, your tax bracket etc. It figures all kind of stuff incouding your tax advantage disadvantage, income potential etc. It tells you all kinds of details. Here is a link to one I think works pretty good. Once you click on it you need to look for this "Buying an income property? Project your income and profits for the next 10 years. Essential when making a loan application.". The link that follows that is the APOD. Save it to your computer and have fun.
For houses that you plan to flip you just need to find an appreciating market
For houses that you intend to rehab you should look for low days on market
It would be very hard to find one property in my area where this could be true.
any 2 bed 1 bath condo is minimum 200k in my area, and we are not getting 2k a month in rent, i trust you.
i know i have looked.
Magic rental formula's are a good tool to use to weed through all the dud's, but running an actual income/expense statement on any rental property is always the best way to go when you are making a final decision.
Each market is different, and areas inside of each market are different. For my market and for the areas that I am mostly interested in having rental property (lower blue collar neighborhoods) my "magic formula" is rent X 50 = max value. If I go above those numbers then there needs to be some type of upside potential on the deal (i.e. built in equity or a strong appreciating area). Now this type of return on rentals may not be feasible in your market. Your market may not be a good market for rentals. Just like growing palm trees in Alaska is not a good investment. Each market is unique, and deciphering what the best strategy for profitting in your market is key to success.
Now in reference to juzamjedi's rules on finding a good "flip" deal, I would have to say that it entails more than just finding an appreciating market. You can actually make a lot of money flipping properties in areas that aren't even appreciating. In reference to looking for low days on market for a rehab seems to be very sound advice. I think looking for the "hot" areas within your market is key for any rehab project.
in the number one school district in the state
in a premium township
in a specific area with absolutely beautiful homes around it
on a .35 acre nicely shaded flat lot
with a sunset right in the back yard
that is in need of minor repairs
that looks aweful to the untrained eye - and i mean bad
that smells like cats
with hardwood floors throughout
in need of a kitchen redo (cabinet refacing)
needs minor upgrades to bathroom
needs quick finishing walls in basement, throw down some rugs
needs driveway paving
HOUSE was a rental, husband passed and wife wants to sell it.
asking price: 299,000 - as is - it is probably priced about okay for the condition it is in.
Price we're negotiating for - 265,000 (maximum)
Projected repairs - 23,000 (we do the work - 1 month completion)
Projected Closing Costs (X2) - 28,000
Projected Holding Costs - 15,000 (6 months - 8% 30 yr term - just a regular PITI)
ARV - 395,000
Profit - 75,000
the above numbers are extremely conservative. our first offer was 249,660