low cost cash flow ppty - pls help me understand

low cost cash flow ppty - pls help me understand

Investor · Brooklyn, NY · Member since 2013 · 254 posts · 28 votes

Can someone please help me understand the the reason why these low cost properties are so popular?

It seems that many people are purchasing these low cost properties that generate a net positive cash flow of about $100 per door after all expenses and reserves for repairs/maintenance. Typically these properties can be as low as $20K to $30K each.

I understand the appeal of owning homes that are so inexpensive. But I don't understand why these are good investments.

Say if I purchase 20 of these low cost properties at $20K each, the finances will look like this:

*20 low cost properties
*total cash investment = $400K ( ie 20 x $20K per property)
*net profit per door = $100 (that's the average CF what I was told)
*Total cash flow per month = $100 x 20 properties = $2000 per month in cash flow.

My question is instead of spending $400K cash to purchase 20 low cost properties, wouldn't it make more sense using the $400K cash to buy just ONE decent property free and clear in a nice and stable area? There must be some areas across the country that can generate about $2000 a month in cash flows by owning just one property.

Why subject ourselves to the headache of managing 20 properties when the returns is about the same ?

Besides, my biggest biggest concern is the potential liability from owning 20 units. Based on my example above, my chance of being sued by tenants automatically goes up 20 folds.

Am I missing something ?

Any advice would be appreciated.

thanks
MJ

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Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes

13y

If the homes are free and clear as in your example, they should cash flow at more than $100/mo. In fact. If they rent for $500/mo each, they should cash flow somewhere near $250/mo each. That's $60k cash flow per year on the $400k investment.

You make good points about liability and management ease. A middle choice might be a 20 door apartment complex.

Think Monopoly. You start with the houses before you move to the hotels, otherwise you are too far into the game before you can start buying.

See this reply in the discussion

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Glenn Espinosa
Rehabber · Alexandria, VA · Member since 2011 · 446 posts · 171 votes
13y
Not a lot of people have $400k in cash. A lot of people can find ways to put $20k cash together, however. Thats why these properties are so popular.

Entry point and overall risk is lower when you're dabbling with the lower end homes.

0 Reply
Jon Klaus
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
13y
If the homes are free and clear as in your example, they should cash flow at more than $100/mo. In fact. If they rent for $500/mo each, they should cash flow somewhere near $250/mo each. That's $60k cash flow per year on the $400k investment.

You make good points about liability and management ease. A middle choice might be a 20 door apartment complex.

Think Monopoly. You start with the houses before you move to the hotels, otherwise you are too far into the game before you can start buying.
5 Reply
Ben Leybovich
Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
13y
Mary Joe,

I am not sure who is giving you this info. But, in Ohio I can buy homes for 20k and rent them out for $450 in every city, which would easily leave me with CF of about $300/mo. I don’t do it because these types of investments are high management, but it can be done very profitably. In fact, if CF is the primary objective with disregard to equity retention or appreciation, this style of investing may be the most lucrative.

As to why several houses are safer than one – Multiple Revenue Streams. When going into battle, would you rather have 1 soldier on your side or 20? I prefer 20. If something happens to one or even several, I’ve still got many more to take care of me. I feel, and most investors on BP will agree, that it is much safer to make $2,000/mo spread among 10 investments, that to make all of it in on place. If something goes wrong with that one house, you’ll be in trouble in a big way.

Incidentally, this reasoning is why I prefer to buy multi-family apartments. I can pick up nice buildings in desirable areas at $30,000 - $40,000 per door, with each unit generating $100/mo of CF or more. Hope this helps.
1 Reply
Xing Zhu
Durham, NC · Member since 2012 · 498 posts · 48 votes
13y
Mary,
people who buy low cost homes do much better than your calculation. It is true that the liability increases, but it is already factored into the insurance cost. Besides, diversification reduces the overall risk. On the profit side, low cost homes do have a definite advantage.

Of course, buying a lot seedy homes requires a lot work time on the investor(including the time spent on any legal claims by the tenant) and such time is often overlooked in the cost computation. If you add this to the cost, then it is unclear to me whether the aforesaid advantage still exists. Nevertheless, investors may still view this as an equivalence of self employment without self employment tax.
0 Reply
Gary Houck
Engineer · Lexington, KY · Member since 2012 · 31 posts · 7 votes
13y
As a person who buys properties like you're talking about I thought I might interject. I bought a duplex for 14k that I live in and recently bought a sfh for 9k. I buy at these prices because I can afford it, it allows me to get in the real estate game and learn and at a very low cost point. Also, in my case I believe the neighborhood is in the processes of gentrification(appreciation).
3 Reply
Ben Leybovich
Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
13y
Gary Houck Good for You!
0 Reply
Tim Delp
Real Estate Investor · Jacksonville, FL · Member since 2012 · 109 posts · 22 votes
13y
As mentioned by other posters I think your analysis is way off on the cash flow numbers. I recently purchased a home for $35,000 that is rented for $850/month. Taxes and insurance run me about $1,800/year so I have cash flow of $700/month.

What happens in real estate is that as prices go up rents do not increase proportionally. I own other properties that would cost $200,000 today that rents for $1,200. if that property was owned free and clear it would provide about $800 positive cash flow.

The cheaper properties can be more management intensive so some of the extra cash flow comes from having to stay on top of your residents and they may not have the same potential for appreciation.

Each investor has to decide what works for them and their goals. I've owned rentals now for over 10 years and this recent purchase is my least expensive and best return, I have great tenants that call the 31st of the month letting me know they have the rent money, they do usually have a few minor things that need to be fixed but well worth it and allows me to slowly make the improvements to the property.
0 Reply
Jon Holdman
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
13y
To have a property generate $2000 in cash flow if it was free and clear, you would need rents of $4000, $3000 if you self manage. I think it is very tough to find a $400K rental that will get $4000 or even $3000 in rent.

OTOH, owning a large number of $500 rentals, which would produce $250-333 a month in cash flow if free and clear, means you're dealing with a lot of tenants.

I think there's a sweet spot where you're dealing with higher rents than $500, but also dealing with houses priced cheaply enough to that the price/rent ratio works. Its pretty easy around here to buy a $100K house that will get $1000 in rent. So, you're $400K would get your four houses and $4000 in gross rents. I do not believe its possible to buy a $400K house here that will rent for $4000.

If you have financing in the mix, the math is a little more complex. But its still just math. What can you actually buy? What are the real rents? What financing can you get? Do the math, and there's almost certainly some middle ground.

OTOH, $35K that rent for $850 are great deals. I don't even come close to believing Tim Delp saying taxes and insurance are the only expenses, but these will still produce a lot of cash flow.
0 Reply
Tim Delp
Real Estate Investor · Jacksonville, FL · Member since 2012 · 109 posts · 22 votes
13y
Jon Holdman You are correct that when I was referencing cash flow I didn't include maintenance and/or vacancy. I was simply showing a point of reference between two different properties. I'm thinking the majority of real estate investors on bigger pockets realize that if you own a house you will have maintenance and if it is a rental your renters will move out, but I appreciate your insighfulness!!
0 Reply
Steve Babiak
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
13y
I've posted this once before, but I'll repeat just to get further discussion.

My income qualification is monthly gross income of 3 times the monthly rent. For that $3000 of rent that Jon Holdman mentioned for the one $400K house, your tenants' household monthly gross would have to be $9K per month; people with that income will be looking to buy for the most part. You want to find locations where median household income matches with the neighborhood rents are! There is another thread where you can actually find some of that info, shown below; it's important that investors understand how to connect some of these dots ....

http://www.biggerpockets.com/forums/311/topics/81250-median-home-price-by-zip-code
2 Reply
Rob K.
Investor · Southeast, MI · Member since 2012 · 2k+ posts · 1k+ votes
13y
I think there's definitely some fuzzy math going on here. In my area, 20-30K houses rent for $600-900 per month. The cash flow is a lot higher than $100.

I think that the people you're referring to who are making $100 per month are using financing and the $100 per month is after taxes, repairs, AND a mortgage payment.
1 Reply
Xing Zhu
Durham, NC · Member since 2012 · 498 posts · 48 votes
13y
Originally posted by Rob K:
I think there's definitely some fuzzy math going on here. In my area, 20-30K houses rent for $600-900 per month. The cash flow is a lot higher than $100.
I think that the people you're referring to who are making $100 per month are using financing and the $100 per month is after taxes, repairs, AND a mortgage payment.

--------------------------------------------------------------------------------

Yes, a friend of mine in Michigan bought houses a couple of years ago around $20K each with rent over $800 each. He said the net operation income had been over 20% a year.
0 Reply
Mary Joe
OP
Investor · Brooklyn, NY · Member since 2013 · 254 posts · 28 votes
13y
Thank you so much for all your comments, very helpful.

Question: does umbrella insurance together with owning the properties in LLC provide sufficient protection against potential lawsuits from tenants?

Say if there is a fire in one of the units, someone dies and the judge decides that it is due to the landlord's negligence. Would umbrella insurance cover that?

0 Reply
Jon Klaus
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
13y
Besides an umbrella policy, you also need a liability policy on each property. You can get a package deal on this.
0 Reply
Mary Joe
OP
Investor · Brooklyn, NY · Member since 2013 · 254 posts · 28 votes
13y
Originally posted by Jon Klaus:
Besides an umbrella policy, you also need a liability policy on each property. You can get a package deal on this.

Thanks Jon, so with the umbrella policy + a liability policy on each ppty plus owning all properties in a LLC , will that be sufficient if someone dies in a fire in one of my ppty and the judge decides that it is due to landlord's negligence ?

I like investing in real estate but I also always imagine the worst, with 10 or 20 units, I can't possibly rely on the property managers to ensure that all the units are in compliance with all government codes and regulations. There is so much that can go wrong that can be attributed to the landlord's negligence. This is my biggest concern.

I read it somewhere that an investment property is a liability generating asset, I always keep that in mind.

0 Reply
Jon Klaus
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
13y
I don't think you can completely insure away risk, but you can get close. I'll let the insurance experts weigh in on this. You might start a new thread.

I read an excerpt from Schwarzenegger's autobiography this morning. Did you know that he's been a real estate investor for many years? This is from when he was about to buy his first property:

A little risk is needed, perhaps not as much as Arnold's, but just enough to have a chance for serious success.
0 Reply
Jon Holdman
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
13y
There's a saying that applies to much of life: "We overestimate the consequences of failure and underestimate the conesquences of success". Yes, bad stuff can happen. You cannot possibly make all possible bad stuff go away no matter what you do for insurance or entities. By far the biggest risks in this business are the simple stuff - paying too much for too little rent. Add to that underestimating expenses. Buy decent properties that produce good rent vs. the cost to get into the deal, screen your tenants, do things correctly, and you will probably be OK.
2 Reply
Ben Leybovich
Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
13y
Mary Joe In case of serious injury or death, the case that will be against you is that of negligence. If you are found negligent, no amount of insurance will save you…
0 Reply
Ben Leybovich
Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
13y
Jon Holdman Is there a name to go with that qoute?

"We overestimate the consequences of failure and underestimate the conesquences of success"

This is excellent! Thank you.
0 Reply
Mary Joe
OP
Investor · Brooklyn, NY · Member since 2013 · 254 posts · 28 votes
13y
Originally posted by Ben Leybovich:
Mary Joe In case of serious injury or death, the case that will be against you is that of negligence. If you are found negligent, no amount of insurance will save you…

Thanks Ben. I am sorry, getting a bit confused here. FRAUD I can understand it will not be covered regardless, but here in this article it says umbrella insurance may provide coverage for negligence,

http://www.answerfinancial.com/insurance-center/umbrella-insurance-explained-and-why-you-might-need-it/

Say with 20 low cost properties, they are most likely in sub par locations, properties are likely to be a little run down, and the caliber of tenants are probably less desirable. A simple electrical wiring problem in any of the properties could turn the house into a fire hazard.

Low cost properties may not be appropriate for me after all if it is true that no insurance will cover landlord's negligence.

0 Reply
Ben Leybovich
Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
13y
Mary Joe,

The operative word is "MAY". Sure it may, but it will likely not help. As an investor you will always be held to a higher standard. Sure – an umbrella helps. Sure – and LLC helps. Sure – 100% leverage helps. But, nothing is a guaranteed protection.

Incidentally, you keep coming back to “20k properties.” You can get sued for a fire in a 2 million dollar apartment complex just as easily. I would not define your investment strategy based on either liability – there will always be some, or the available capital. Whether you have 20k or 200k you can do the same things.

My preferred mode of investing is 100% financing, or as close to it as possible. There are several reasons:

1. I don’t need down-payment.
2. This forces me to only do the extra-ordinary deals. If I can cash flow well in an 100% financing mode, it is truly a good deal. It’s easy to buy CF with more down-payment. But you shouldn’t have to.
3. If the asset is fully leveraged, helps to deter law suites some what. Sure, if the attorney is paid by the hour then they may sue you any way just to get paid, even though there’s no equity to be had. (Liens have to be cashed out first) But, if they work on commission they will tell their clients that there is no equity so even if they get the judgment, they won’t get paid easily through the sale of the asset. This makes them pause…

But, you will not run away from liability. Hope this helps
1 Reply
Harry M.
Real Estate Investor · Dallas, TX · Member since 2010 · 449 posts · 173 votes
13y
My wife and I sometimes compare buying our first rental to having our first kid. Yes, you do as much as you can to be ready before hand, but at a certain point you have to say "to heck with it, we're as ready as we'll ever be" and be prepared to learn on the fly.
1 Reply
Mary Joe
OP
Investor · Brooklyn, NY · Member since 2013 · 254 posts · 28 votes
13y
Originally posted by Ben Leybovich:
Mary Joe,
Incidentally, you keep coming back to “20k properties.” You can get sued for a fire in a 2 million dollar apartment complex just as easily. I would not define your investment strategy based on either liability – there will always be some, or the available capital. Whether you have 20k or 200k you can do the same things.

Thanks, yes we can get sued by tenants in a 2 million dollar home too, but the essence of my example is whether I want to subject myself to the potential of a major lawsuit by ONE tenant or 20 tenants, hence I used these low cost properties in my example.

I think this is a very important factor to consider if insurance will not protect against landlord's negligence. With 20 units, it is a lot more difficult for the landlord to ensure that there is no negligence reflected in any of the properties.
0 Reply
Ben Leybovich
Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
13y
Mary Joe,

You simply need to find the Golden Mean. 1 property is not a good thing either. You need to diversify the revenue – Multiple Revenue Streams. That’s why I like multi-family.

At the moment, for example, I have a 10-unit under contract at $375,000, which means that I am paying $37,500 per unit. This buys a 1980 building in a desirable (solid B) area, in which the units rent for about $600/month. Even though the building will be financed 95% LTV, there will still be $1,000/mo. of CF after 15% vacancy and maintenance. In short, I believe that there is a way to split the difference between low-cost and high-cost properties, and small to mid-size multi is one way to do it. Hope this helps…
0 Reply
Will Browm
Investor · Buford, GA · Member since 2012 · 120 posts · 31 votes
13y
Mary Joe,

I too am new, but dove in with two homes bought for cash and rehabbed for under $50K. They are 1950's brick ranch homes. The wiring was updated at some point and I think they are very safe. I have been negligent with nothing nor have I been fraudulent. I receive $1,550 each month and set all of it aside for expenses and buildup for additional rentals. Both have pretty bulletproof walls and roofs are in good shape. Using the 50% rule plus the fact that I self-manage (10%), I am cashflowing $930. I am holding more from the rent, but I assume smarter people than me know I will have extreme costs later.

I agree that you need to find where you are comfortable and jump into the game. I bought where I could after developing a business plan after many, many hours reading on BP. I learned that a lot of people were successful with homes I could buy and I am not scared of management or lower end areas. Find your niche.

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