The only chance of finding positive cash flow is...

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The only chance of finding positive cash flow is...

Joe Edwards-Hoff
Homeowner · Grandview, WA · Member since 2010 · 155 posts · 21 votes

I'm only a couple weeks into researching real estate. Well, I actually own a home and rent it, but that is besides the point. I'm just trying recover an unwise past investment. Hopefully my current refinancing goes through and I won't be paying the difference anymore. (Renting to good friends though, and I still have use of the premesis and my 1k sqft shop.)

Anyway, I got started listing to Rich Dad Poor Dad, and other things they do. I am almost done with 16 hours of Bob Allen lectures. I've heard good and bad about both, but what's important is that I got inspired by these audiobooks and now I am doing my down to earth research.

It seems like both Bob and Bob (Kiyosaki and Allen) quoted that if the yearly gross rent was 10% of the purchase price, it was a good deal. At one point someone even mentioned monthly being 1%. Now, on here I am seeing 2% for monthly, and then 50% (40-50) being the expenses. That is obviously a different picture than what they paint. Which I'm sure, sadly, a few people on here probably learned the hard way.

So, if we use those realistic numbers, you really need to have a good LTV ratio if you want positive cashflow. And that is what I currently think I want.

So what options does that leave you with? I guess the main purpose of this post was to figure out what I would need to be looking for if I wanted positive cash flow. Preforeclosures? Maybe REOs. Maybe get lucky with a FSBO. If there are any other avenues for acquiring properties with a LTV I could profit off of, please let me know.

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Jon Holdman
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
16y

Actually, you want a property that cash flows with a 100% LTV (loan to value) loan. That means the property itself cash flows. Then, you start putting in cash (a down payment) and there is more cash flow. That additional cash flow is from your money, not from the property.

Commercial properties often use the term "cap rate". That's the return you generate if you pay cash for the property. The idea there is that you will make money as long as your interest rate is lower than the cap rate. Once you finance the property, you will make the full cap rate on the down payment. You'll make the difference between the cap rate and the interest rate on the financed portion.

Keep in mind all those gurus are selling education. They're goal is to get you to spend more and more money on ever more expensive education products. So, they have to present RE investing as if its easy and fun and a way to make a fortune with no effort. If they told you it was hard work, you would just walk away rather than buying something else.

The 50% rule seems to be solid. Lots of people have argued with it, but every time someone has real data for a significant portfolio (the results from one house for one year are not meaningful), its been borne out. So, if you buy a property where the rent is 1% of the price, and you're paying 6% interest, you're going to be just break even. That is, your gross is 12% of the purchase price. 50% of that, or 6% of the purchase price goes to expenses. With 100% financing, 6% of the price goes to interest. That leaves you with zero. Now, if you put in 25% down payment, your interest is only 4.5% of the price, leaving you with 1.5% of the price as your return.

1.5% of the price as a return divided by 25% of the price as your down payment gives you a 6% cash on cash return. Not high enough, IMHO, to be interesting.

Further, you actually have a principle payment. While you will get that back later, its money out of your pocket for now. And, if your intention is to live off your rentals, it money you can't live off of.

Even further, this neglects costs of buying the place (2-3% of purchase) and any fixup.

I think your question is "where can I find good deals"? Thats a pretty frequent topic here, so do some digging and you'll get ideas. REOs have been working for me, though this has become more competitive. Direct marketing (letters) works for some people. Making sure EVERYONE in the area knows you're buying works for some people. I've not heard many people say they had luck with FSBOs, which are often the case of the seller wanting too much for their property and being unwilling to pay a commission to get it.

Bottom line? It is REALLY hard to find good rental properties. You have to put a LOT of work into it.

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  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    I can't believe that we have to rehash this simple concept every few months.

    Mike M - we already proved in another thread that your expenses are in line with the 50% Rule across your portfolio! Do I really need to go back and dig up those old posts? Furthermore, we've already rehashed that the 50% Rule is meaningless when it comes to a very small number of rentals and it means nothing when it comes to ONE rental.

    As to this idea that the water heater in a low income rental costs the same as the water heater in a $500,000 house. Please excuse me for saying so, but that it ABSOLUTELY an idiotic argument and shows a clear lack of understanding of expenses. That $500,000 rental in California also has a MUCH higher eviction expense; higher property taxes; all kinds of socialist government registration fees and costs that the Ohio rental doesn't have, etc, etc, etc.

    Taz, who was skeptical of the 50% Rule, did a study of over 30,000 rental units in different areas and of different rental rates. IN EVERY CATEGORY, the expenses (as defined by the 50% Rule) came out in the range of 45% to 50%.

    Furthermore, as Jon said, EVERY SINGLE TIME that someone has claimed that their expenses were lower than the 50% Rule and when they could post the numbers, they were proven wrong. EVERY SINGLE TIME!



    In case you haven't noticed, house prices have been going DOWN, not up. There are currently MILLIONS of houses of excess inventory with a significant percentage being held off the market. Real estate will be going LOWER and may not recover for a generation.

    California and many of the "progressive" states are broke. We have deficits and unfunded entitlements in this country that can NEVER be paid. The demographics of this country would have resulted in a depression starting in about 2012 all by itself. ANYONE THAT IS COUNTING ON FUTURE APPRECIATION is taking a HUGE GAMBLE!
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  • Joe Edwards-Hoff
    OP
    Homeowner · Grandview, WA · Member since 2010 · 155 posts · 21 votes
    16y

    Alrighty, although I am still going to be keeping about 45% in mind when estimating expenses, it is nice to see a few other people who are thinking on the same line as me. I think the water heater example was great. Regardless of house size, you can typically get away with the same sized/price water heater. I think carpet and roofing apply as well. Though you pay more for the extra square footage of a larger, higher rent, SFR, I still think dollar for dollar the percentage will be lower.

    Regardless of what percent it is, as a beginner, I'd rather plan for rain and have the sun end up shining...

    1Reply
  • Mike McKinzie
    Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
    16y

    MikeOH. Oh, never mind.

    0Reply
  • Bill Patterson
    Real Estate Investor · Portage, MI · Member since 2010 · 470 posts · 315 votes
    16y

    Hey Joe....are we having fun yet?!! As you can see from this spirited discussion, there are a lot of variables to what seems like a simple value estimating formula. I use rules, formulas, etc. only for a quick look. Then I do my own calculations taking into account the items already mentioned that can affect the reliability of these formulas. If it still looks good, I would move on it. Do this and you should be ok. As you get experience and find other variables that can affect your potential investment, you will do better.

    By the strong feelings shown by all of the BP members posting to this thread, I suspect that their own systems are working for them. There is always more than one way to skin a cat (or pick a winner)!
    Bill

    3Reply
  • Account Closed
    Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
    16y

    It is nice to have a rule of thumb that gets you in the ball park and if you like the park. Then your system is working for you.

    The 50% rule probably is a wise way for someone starting out to estimate expenses. I'm sure the average beginning investor doesn't realize quite all the costs involved in holding property. Some maintenance might be deferred, but eventually a bigger cost is paid for not doing the regular maintenance. There are costs of doing business, advertising, evictions, mileage, supplies, etc.

    The 2% rule is much more difficult to attain in some markets. I'm happy with the returns that I get from my rentals though. This year I can say that I could quite easily live off the cash flow from the properties, I own. I still choose to work as both an investor and an a CPA because I enjoy it.

    I think it helps everyone here to know that there is more than one way to analyze a deal. Understanding your investment goals and building systems that help you achieve those goals is key. When you are starting out you need more safety. Later, IMO you can fine tune your analysis so that it more closely matches your investment goals.

    0Reply
  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    The VAST MAJORITY of newbies in this business fail and one of the major reasons they fail is that they don't understand the REAL WORLD EXPENSES. In this thread, we've seen the mentality that cause newbies to fail and precisely how that mentality leads to their destruction.

    I find it particularly interesting that the 50% Rule covers ALL expenses, and yet we continually hear ridiculous arguments about water heaters and carpet. At most, only about 10% of the 50% expense total are maintenance expenses. So, even if a newbie claims that ALL of the normal maintenance costs somehow magically don't apply to them, then they still have expenses at 40% (really 35% to 40% since the 50% Rule states that expenses will be 45% to 50%).

    What we have seen in this thread is that newbies somehow think that the industry-wide normals don't apply to them. When in reality, if anything, their expenses will be HIGHER because they don't yet understand the business and therefore make mistakes.

    I know that we can't save all the newbies from failing, but it would be nice if at least a few could learn without having to crash and burn. Ugh!

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  • Account Closed
    Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
    16y

    Jon, I agree that there is a tendency when analyzing a deal of pushing numbers to make a deal look good. I also realize that some only look at year one income and expenses. Anyone buying a rental property needs to understand that it is a long term investment.

    I like to be very conservative when putting an analysis together. Having a list of normal expenses might help someone new so that they don' leave out expenses. A rule of thumb makes for a good guide as well.

    I think sometimes there is also confusion regarding the difference between costs and expenses. In accounting these are defined differently. I'm assume that those using the 50% rule include vacancy in with the expenses as well as a reserve number that reflects current expectations of future major repair costs spread over the years.

    I have found that many investors do not consider reserves. Major expenses are a fact of life with long term assets. Much better to plan ahead and have the money, than hope that you have extra cash when a major repair is required.

    3Reply
  • Joe Edwards-Hoff
    OP
    Homeowner · Grandview, WA · Member since 2010 · 155 posts · 21 votes
    16y

    Here's a good example of what may alter the 50% rule. (Again, not that I think it is a bad rule, it is acutally what I am going by for now, but also considering whether it'll be less for various considerations.)

    There are some apartments that are under construction. Construction stopped and they are selling. Now, if one were to finish these off, and used the right materials, they could be maintenance free for a long time. Though the initial investment may be higher, you can at least have peace about roofs, foundations, and water heaters for a good while. (Assuming you put in quality stuff...)

    0Reply
  • Mike McKinzie
    Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
    16y

    The Reverend has spoken. If everyone follows the 50% rule and then calculates the validity of an investment, the failure rate would drop. Personally, I try to keep it under 50% and am quite happy at 40%. The problem is, some of my investments, it takes 3 months rent just to pay the Property Tax while others take just 1 month rent to pay the Property Tax. If all of my investments took 3 months rent to pay the property taxes, then I would be looking north of 60% for expenses. On the other hand, if they all took just 1 month rent to pay property tax, then I would be around 40%. Luckily, I mix it up, just like a mutual fund, to keep my average just a tad below 50%.

    But I still think a $500 water heater is a cheaper PERCENTAGE of the rent on a $2,000 a month rental vs a $500 a month rental, even if the reverend calls that a RIDICULOUS argument. :roll:

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    16y

    Yes, you would have some assurance these items would at least be new. That's far from "maintenance free".

    Construction varies in qualify. New, but poorly constructed properties can be very troublesome. Research how many homeowners are in lawsuits with builders over quality issues in newly built homes.

    If construction has stopped before the property is dried in (has walls, roofs, doors and windows to the point they keep weather out), the framing has been exposed to the weather. That can create ongoing issues if there was damage that's not repaired.

    Some maintenance, like lawn care, painting, carpet is routine.

    Most maintenance is caused by tenants. Doesn't matter if its brand new or 100 years old, people can do the same damage.

    So, yes, you can reasonably expect to have somewhat reduced capital item costs (furnaces, roofs, and the like are, for tax purposes, capital items, not maintenance) for some period of time. That will reduce that 50% number by a bit. I wouldn't reduce it by more than 5% or maybe 10%.

    Keep in mind, these numbers are just estimates. The property will do what it will do. The estimate is to try to keep you from expecting one result and being badly surprised by the reality. When you're doing the analysis, you can push the numbers wherever you want, and can justify buying just about anything. After you've bought, though, it will be the property and the tenants doing the pushing. Best to be conservative in your evaluation rather than optimistic.

    3Reply
  • Vikram C.
    Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes
    16y
    Originally posted by gijoe985:
    they could be maintenance free for a long time.


    I think this is not a good way to think about an investment property. You should consider the possibility that you may wish to sell it later, and when you do that, the items will not be new and the buyer will have to assume something similar to the 50% rule in deciding how much to pay you for the property. If you assume a lower expense and overpay for the property, you could end up taking a capital loss when you try to sell it later.

    I think a better way to value a property would be to assume the typical long term expenses and then add back any possible savings in the initial few years when you expect items to be covered by warranty. Of course, if you have to do all this to justify your purchase, then you are probably paying the top end of the justifiable price range for it and it may turn out not to be such a great investment.

    3Reply
  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    So the 50% Rule was right after all!!!
    `

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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y

    WOW, points with passion!

    In my mind there is no such thing as maintenance free, maybe reduced maintenance, but if you don't have the expense, a landlord should have a "sinking fund" a kind of a savings account for those estimated expemnses and capital mexpeditures that will be coming. So you're still setting aside at least part of the estimated costs, or should be.

    A new property still has expenses, the plumber going over to get the rubber duckie out of the toilet! Most of my expenses in any property I owned, brand new to over a hundred years old at the foundation, did not arise from the building and improvements, they arsie from tenants being in the place.

    While capital expense are delayed for a new property, they will be coming, so expect them, plan for them and set funds aside for them regularly. Bill

    1Reply
  • Joe Edwards-Hoff
    OP
    Homeowner · Grandview, WA · Member since 2010 · 155 posts · 21 votes
    16y

    Well, I guess maintenance free isn't what I was really thinking. I guess I was just figuring that you would not have to do much "building maintenance." Obviously aesthetics will need to be gone over between renters. I'm sure as well as other things too.

    I will say that I am happy I got to be a part of this discussion. I have learned a lot and I think that by going back and forth, it is helped clarify the issue. For me, and I'm sure for others who will read this int he future.

    1Reply
  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    Financeexaminer is EXACTLY RIGHT! Most of the maintenance expenses that arise in rentals have absolutely nothing to do with the age of the building - they have to do with the idiot tenants. In fact, you'll have far fewer foundation problems on a building built in 1835 than one build in 1985 - because buildings built in the 1800's were built to last - not like this stuff being built today (I have both).

    0Reply
  • Mike McKinzie
    Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
    16y
    Originally posted by MikeOH:
    Most of the maintenance expenses that arise in rentals have absolutely nothing to do with the age of the building

    Let me 'harass' MikeOH just a little bit with a re-phrasing. "Most of the maintenance expenses that arise in rentals have absolutely nothing to do with the amount of rent being paid!"

    I don't like the 50% rule, I will stick with the 49.9% rule!!! :lol:

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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y

    LOL, Mikes' M and OH, can we agree that the 50%/2% rules are generally valid as an initial analysis and that only after specific data concernig a particular property is gathered should an investor make the investment decision?

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  • Jason Reed
    Member since 2010 · 4 posts · 1 vote
    16y

    First I would like to say this is a great site. I have been reading everything I can to learn as fast as I can. I am in MI where the housing market has been hit hard. I think now is a great time to invest before the market bounces back. I have a couple simple questions from basic math. I am fairly confident I can pick up a decent house for about 30K with a few K for upgrades. Based on my research, I should be able to rent between 7-$800/month. If I assume half of that for expenses (including property tax), and then add a loan payment, how do you guys cash flow when first getting started. On top of that, it seems like banks do not want to write loans under 50-$60K. Without paying cash, I do I get going? I refuse to say I wish I would have in 5-10 yrs from now so I really want to learn all I can and make good choices. Thank you and I look forward to the responses!!

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  • Mike McKinzie
    Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
    16y

    I can NEVER agree with MikeOH. That would be heresy!! :roll:

    0Reply
  • Bill Patterson
    Real Estate Investor · Portage, MI · Member since 2010 · 470 posts · 315 votes
    16y

    Wow! Mike OH, I'd like to see those rentals! I've never done Sec 8, but have been in the student market for years. I've never seen anything like that in the worst "student ghetto areas" that I have never considered!
    Bill

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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y
    Originally posted by Mike M:
    I can NEVER agree with MikeOH. That would be heresy!! :roll:


    So much for diplomacy! I give up......LOL
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  • Mike McKinzie
    Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
    16y

    I used to play this in High School.

    http://en.wikipedia.org/wiki/Diplomacy_%28game%29

    Great Game.

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  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    I don't agree with that. For example, in my low income, Section 8 rentals, I PAINT the floors. The maintenance cost of maintaining painted floors vs. carpet is much different. Likewise, in my low income rentals, I take out the closet doors, remove all ceiling fans, remove all screen doors, take out all dishwashers, remove garbage disposals, and do not provide air conditioning. Is that different than a $2,000 per month rental? You bet it is!

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  • Mike McKinzie
    Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
    16y

    Wow Mike, good thing you don't invest in Phoenix, you might get a backlash with no AC.

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  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    It's not that they don't have air conditioning, we just don't provide it. It was in the high 90's here this week and most of my low income renters have window a/c. In fact, most don't have to pay for it, they get them free from.....you guessed it.....THE TAXPAYER!

    2Reply
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