Financed Investment Property Returns

15 Replies

I am currently in the process of reviewing a few options for our first rental property purchase and I was wondering what a typical return looks like on financed investments? I have read that the basic rule of thumb is the 1% of the purchase price from a rental standpoint, and I would love to hear a little more about some of your tangible experience around your returns and cash flow on some of your properties. I am looking into out-of-state investing (shout to to David Greene) in markets suchs as Memphis, Jacksonville, and Indianapolis. Thanks and Happy holidays.

1% is a good rent to value ratio is you're going to finance. You should find properties that have 15-20% cash on cash return.

I invest in Memphis and know the market well. 

Thanks @Antoine Martel and @Jennifer Slaughter for your replies. This is helpful. I suppose my struggle at this point is trying to make the numbers work on a financed investment property even when you achieve the 1% on rent. After adding in mortgage, taxes, insurance, repairs, vancancy, long-term cap ex., property mgmt., etc. it seems like the return is quite low as a generalization -- especially on turnkey properties where there is little to any forced equity. 

@Antoine Martel 15 - 20% COC return....that does not consider vacancy %, prop mgmt %, yearly maintenance reserve %, capex %, correct?

@Mark Gabriel what assumptions are you using for the above 4 items? 

Originally posted by @Mark Gabriel :

Thanks @Antoine Martel and @Jennifer Slaughter for your replies. This is helpful. I suppose my struggle at this point is trying to make the numbers work on a financed investment property even when you achieve the 1% on rent. After adding in mortgage, taxes, insurance, repairs, vancancy, long-term cap ex., property mgmt., etc. it seems like the return is quite low as a generalization -- especially on turnkey properties where there is little to any forced equity. 

 What kind of cash on cash are you getting when you plug all those numbers in there?

@Antoine Martel my calculations show that I would be getting 13% CoC return without factoring in repairs, vacancy, and cap ex. If I budgeted 5% for each of those areas (probably a little low) then my CoC would decrease to 5%.

Originally posted by @Mark Gabriel :

@Antoine Martel my calculations show that I would be getting 13% CoC return without factoring in repairs, vacancy, and cap ex. If I budgeted 5% for each of those areas (probably a little low) then my CoC would decrease to 5%.

 So that is just a bad deal then. I sell turn key rentals and sell them with returns of 15% cash on cash minimum. 

I am not from the hot markets you are discussing.  Not that long ago I would not look at property unless it had a 2 % purchase price.  I like low B and C properties.  There are still plenty of 1.5 out there.  Depends if you have a long term hold or shorter period.  

I am not looking for a lot of appreciation, (I do get some).  I am looking for the cash flow.  The properties pay themselves off, stay maintained and upgraded at times.  

It appears many of these 1%, properties could be in trouble if the market corrects, if they are financed with ARMs, or an area gets hammered by circumstance. 

If the market has a correction, it seems everyone jumps on the same bandwagon.  When it is hot everyone is buying (like now), when it turns cold everyone heads for the exit (2008).  We can remember these.  You have to purchase to be able to weather the storm. 

I believe interest rates will regain some somewhere closer to historical norms. But it could spike, could you afford for your ARM to eventually increase to a much higher rate. Remember that if everyone is headed to sell, sometimes a favorable loan is not available.

Real Estate is great, and it can take you where you want to go, however while your riding this Bull you have to watch the HORNS.  

Excellent advice from @Ron Flatt .

Regarding the 1%/2% rules, in our area (these are MontCo and DelCo PA) I essentially don't even look at a deal that doesn't exceed 2%.  I'm calculating that as (monthly gross rents)/(all acquisition and rehab costs).  Here are the calculations for the 7 properties I've bought so far:

1.61% - This is the first one I bought, ended up spending more than I should have on rehab.  Live and learn.
2.07%
5.46% - This is the one I'm technically just closing on today, so there might be some surprises, but it'll still be insane.
2.55%
2.30%
2.09%
2.85%

Thanks,

Chaz

484-602-5567

I am impressed @Charles McCabe. 

I thought my numbers looked good, but I feel like a slacker now.  

The kicker for all to remember, you have to get a deal going into.  Otherwise you are fighting an up hill battle to get to even.  If Murphy's law shows up even once, it can hurt.  


Hey, @Ron Flatt , sorry for the delay; somehow I never saw a notification that you replied.  Compared to you I'm a Super Newb, so I say this with all due humility, but remember that those rules are very market-dependent.  For instance, I've run the numbers on a bunch of properties in central PA (I'm in urbanized southeastern PA) and 1% is a relative winner.

And I thought it might help to round out the conversation by mentioning that I put together a spreadsheet to do what the BP rental calculator does. The big difference is that in my sheet, each property is a single line, which makes it very easy to compare potential investments and run what-if scenarios (e.g. what if I had to amortize over 20 years at 6% vs 25 years at 5%) and I can quickly do it for entire portfolios of properties. And each line gives a color-coded go/no-go on key indicators (CoCR, DSCR, % Rule, etc.), so I can easily get a birds-eye view of all the properties I've analyzed (328 to date) and get rudimentary market intelligence (e.g. average $/sf in the 19401 ZIP code, with or without rehab). Sorry if that was too techy, but I've been an IT guy for 25 years and it kind of comes with the territory ; >

I saw in your profile that you've bought some notes.  I'd love to pick your brain about that.  All the math makes sense, but I don't feel like I have a good feel for the day-to-day, hands-on mechanics of it.

484-602-5567

@Ron Flatt , and another thing about market dependence is that expenses can vary *a lot*. For instance in Delaware County PA, the property taxes are really high (I'm paying ~$2500 for 3/1 rows and twins). And insurance can be crazy different. For instance, I'm paying ~1000/year for a 3/1 SFR in one location, but ~$3800/year for a 2/1, 2/1 duplex in the same county because it's in a flood plain. So your 1% properties may net more than my 2.5% properties.

484-602-5567

Hi @Mark Gabriel ,

I wouldn't get to concerned with the rules of thumb like the 1%.  That is more of a quick-n-dirty eye test to see if further evaluation is worth it.  To me investing is like working a story problem backwards.  I look at what a property can rent for, then decide how much i would expect to make monthly, and then use that to come up with the offer.

If something rents for $1,000 per month, and i want to make $150 in cash flow, my monthly payment would be $850(1k rent - $150 cash flow) -$210( 7% vacancy, maintenance, and cap ex) - $225 (estimated monthly taxes and insurance payment) = $415.00 mortgage payment.

100k purchase price with 20k down payment = 80k mortgage at 4.75% for 30 years = $417 payment monthly.

with that scenario: $150 cash flow x 12 months = 1800 divided by 20k investment = 9% coc.  So i am making what i aimed for in C.F., but the overall return is still a bit lower that i would like, so i would adjust the offer slightly downward.  

Hi Mark,

In my opinion there is rarely on rule that you can apply to all scenarios. I think they usually look good on paper but I evaluate every property on a case by case basis. Probably my best investment broke every rule there is. It didn't have any cash flow and there were a ton of vacant rentals in the neighborhood but it was right by where they were building a mass transit station. Here I am 3 years later and it's gone from $117,000 to around $225 in value. It's never been vacant more than 3 weeks, and I rent it for $1695, and my PITI and property manager come out to $1080. If I would have followed all the "rules" there was no way I would have bought it. My only regret is I didn't buy more home in the area! Always consider all the factors and then just ask yourself if it makes sense

Good luck!

Ben

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