High vs low value rentals

[Jonathan Lucas]

I hope this makes sense, here goes:
I was doing some math on properties locally available for rent in joplin, mo. I recorded information on each individual property, put the address in zillow to find the purchase price of similar properties, figured mortgage payments, taxes, and insurance, and got a rough estimate of cash flow.
What struck me is how much lower the ROI (based on rent charged) was for the higher rent properties. Also, properties with half the value were producing similar amounts of cashflow.
The only reason I can figure is A. My numbers were wrong, or B. the higher priced properties are more valuable for their resale price than their cashflow value.
Any thoughts on this?
Thanks!

[Mike H.]

I think its always ok to post new questions on old topics.

Otherwise, these boards would just start becoming a card catalog system where people would post a reference to the old url. Thats no fun. Plus, the same people that see the new post may not have weighed in on the earlier posts.

That said. I would say your numbers are, for the most part accurate in terms of the lower priced homes generating more returns when looking at the price to rent ratios.

But keep in mind a couple of things:
1) The low end homes don't appreciate much at all.
2) They also tend to be more difficult to get loans on (smaller amounts and local banks' unwillingness to own a bunch of paper in bad parts of town).
3) Your rent to price ratio is leaving out another key factor in terms of profits - your ongoing maintenance. The make ready and vacancy costs for the lower end product tends to be much greater. And the low end stuff tends to run the risk of getting a tenant that simply trashes the house. That can always happen on any type home. But in terms of odds, the lower end stuff tends to see a greater risk of it occurring.

And all it takes is one bad tenant to trash the place and you could lose your profits on that house for the next 2 or 3 years.

To me, I think there's definitely a balance I tend to prefer. I'd much rather stay in the 75k to 95k range for my deals where they homes appraise out at roughly 120 to 150k. Nicer neighborhoods with better renter pools and much less likely to have the homes trashed.

That being said, I also think its good to grab some of the lower priced homes as well sometimes if the numbers really make sense. Although I do stick to the lower priced homes in the nicer areas. Typically, those are smaller homes or maybe on a busy street. Things that might limit resale value but might not matter at all to a renter looking to get into a decent school district on the cheap.

I'm in the midwest so planning on appreciation only is not a good model. I want the full suite of returns on my investment properties (i.e. rental profits + principal paydown + appreciation + tax benefits) and I think a balance of bread and butter properties with some low priced stuff to boost net income is a good fit for me.

A good example is what I just did the past 3 months.
I closed on a house 3/2 at about 1350 sq ft for 35k. It was in surprisingly good condition. BUT it had no garage although its in a nice area and a decent school district.

I'm only getting 925/mo (if it had a garage, i'd probably be asking 1100) but the taxes are super low and I'm making about $475/mo before maintenance/vacancies. Not as much in appreciation though or principal paydown (30k loan is all I have on this one - I paid the other 15k out of pocket).

And then yesterday, I just closed on a house one town over but in a much nicer school district. Its a 3/1.5 with a 2.5 car garage and a great yard. I got it for 72k and will be putting in about 16 to 18k. My HML on this one was for 85k so I'll be coming out of pocket for the rest.

I figure my profit before maintenance/vacancies will be about $400 a month.

But here's the difference:

All in at 50k on home 1: appraised out at 75k.
Profit before maint/vacancies: 500
Appreciation (assuming 3%): 185/mo
Principal paydown: $65/mo (30k loan, 20yr amort, 6% int)
Total: 750/mo in profit

All in at 93k on home 2: appraise out at 135 to 140k
Profit before maint/vacancies: 400/mo
Appreciation: 330/mo
Principal paydown: 125/mo (85k loan, 25 yr amort, 6% int)
Total: 855/mo

So is the lower priced property really generating more in returns? It has a higher cash flow. But the other areas you make money in real estate aren't going to deliver as much so your real return is often better on the stuff up the ladder.

Then again, you need that cash flow to help you build your portfolio. So thats why I believe a mix of each is a good way to go.

In a perfect world, maybe 75 bread and butter, 25% high profit/low price homes would be ideal - at least for someone like me.