This Birmingham, Alabama property was put into service in September of 2014 and was the successful beta test to prove the concept of remote out-of-state investing. I acquired the property from a marketer that makes connections with the rehabbers in certain markets and finds buyers such as myself who are typically located in low price to value ratio locations (this does not necessarily mean high-priced locations) such as California, New York, Hawaii, Seattle, Portland, and basically the coastal areas that all the cool kids what to actually live. Marketers have their place if the buyer is totally clueless but once you purchase a few of these properties the marketer really does not offer much value. The only thing I see that they would offer would be someone to be the bad guy role in a negotiation but many of the marketers are buddy-buddy with the rehabber because of their business relationship and won't stick their neck out for you. As the buyer, you need to take ownership of the due-diligence process and negotiations because that marketer is not a licenced agent and does not have a fiducial responsibility to you.
Check out my previous post more a bit more context. My goal was straight cashflow so Memphis and Birmingham were at the top of my list as opposed to Atlanta/Texas which seemed to trade off some cashflow buffer for appreciation potential. I was comfortable going with a seemingly grungier city because I was going for cashflow (rent/value). A wise mentor of mine told me once "the security of your investment in a market correction is how much cashflow/buffer there is from between your rent minus expenses... when bad times come, how much can you lower the rent to ride out the bad times." I think most people get wrapped around in analysis paralysis over the plethora of data such as crime stats, employment trends, population trends, etc. Those indicators tell part of the story but for me the reason I moved forward was just talking to a couple of people who were (not referral based salesmen) investors with disinterested agendas that said "dude, just buy it (from the right people), it just works". If you have ever heard the saying "stand on the shoulders of giants" that's what I did - if it worked for these other investors then I'm just going to start where they left off - after all every month I delayed action I lost a potential $200-300 of cashflow. In the end, maybe it's just because of my personality, I chose Birmingham because I heard so many podcast ads for Memphis and saw all the investors going there.
I apologize, it has been so long that it's hard to remember, but there were really no huge exceptions in the due-diligence process. I did a 3rd party inspector that I got off a referral from other investors. Remember do not take a referral from anyone on the sellers side as that is a huge red flag for their integrity due to the conflict of interest. A big difference in my growth as an investor is running these processes together with the lender's parallel process and being able to effectively negotiate additional renovations or contract terms. Looking back I probably over paid a few thousand at least more than I would have today with my experience because you just can't read about this stuff. Also it's worth noting that you always should connect with a few property management companies and interview them early in this period. In addition, use them to validate your rental numbers and property location.
I paid cash for the property initially because it was the sellers terms. I would never it do it again this way since I basically waived my right to a property appraisal. The next step was to refinance the property with a convention Fannie Mae mortgage to pull out most of my initial investment. We had a lot of trouble getting the property to appraise for the value due to the technical processes of the appraisers. Finally, after the third try I finally got an appraisal number that I was able to live with, but the damage had been done and I had to have all my cash tied up in the deal for 2-3 months. Lesson learned was to always have a financing/appraisal contingency to ensure that the property that you buy appraises and that what you pay is what it is worth. This is another example of a standing on the shoulder of giants, when you are financing from day 1 the bank owns 75-80% of the home via the mortgage and they are doing their due diligence too via the title work and appraisal. Therefore use the banks process as your friend. I got a lot of help from my lender in this transaction as they were the ones behind the scenes working the appraisal issue. This the difference between going with any big bank lender and a lender that works exclusively with investors. Again the golden rule is to always go by referral by another investor.
After the smoke cleared I was out of pocket $27K and had a $50k mortgage. The interest rate was a little under 5% but that does not matter. Sophisticated investors do not look at interest rate and the amount of debt instead they focus on cashflow and effect on net worth.
After all the closing issues got taken care of everything else went pretty smooth and the property got filled by a nice family. Here are the numbers per month:
- 10% Property management
- $395 Mortgage/Interest/Insurance/Taxes (PITI)
I typically get $300-400 per month after expenses.
Knock on wood - it really does not get any better than this property because in the first 18 months of ownership I have experienced no vacancy and only $300 of repairs. :) So yea things are pretty boring on this one.
What % of your monthly rent are you assigning to long term repairs, 10-20-30 years out. Right now your cash flow suggests 0% where as normally long term expenses on a SFH would run in the 30% - 50%. This would be your vacancies, utilities when vacant, advertising, legal, accounting, repairs, minor reno between tenants, capitol expenditures and your insurance, taxes which you have included. Are you assuming you will sell before any expenses happen.
Have you calculated the 5% return, off the top of the rent, for the 27K you have tied up in the property.
All things considered in the real world of long term rentals I think your positive cash flow is about $100/month plus about $112/month return on your equity. Not bad for day one return.
This is a 18 Month Report Card. Many of the cap ex were taken care of in acquisition with my contractor. I figure I should be smooth sailing for 1-5 years in terms of cap ex. Other than that I assume I take home 70% of rents after expenses.
Your expense calculations are only accurate if you sell the property tomorrow. Investors do not calculate cash flow based on a snap shot in time it is calculated based on the life of the property.
Vacancies, tenant vandalism, cap and other expenses are factored in from day one not as they occur. They are based on a estimated percentage depending on the type of property in question. A SFH, for example, would customarily have a 40% to 50% expense ratio long term regardless of the condition of the property today.
Debt repayment calculations are based on 100% financing numbers to insure the investor receives a return on the equity they have in the property in addition to a return on the property itself..
I would assess your property as follows
rent - debt service - equity return (5%) - expenses (50% as SFH) = cash flow
850 - $291 (50000, 5%, 25 yr. ) - $112 (5% return on equity) - $425 (50% of $850) = $22 (positive cash flow.
You could reduce your long term estimated expenses to 30% giving you a positive cash flow of $192 but you would not want to hold beyond about 20 years following a full reno..
great post. well thought out and realistic numbers!
Here's what confuses and keeps me in analysis paralysis mode.
@Lane Kawaoka listed? I don't doubt that all those expenses are legitimate and that it's a great idea to account for them from the start, but it seems like it would be hard to find deals that worked if they were always accounted for and it seems most people do t account for them. Just wondering...
I don't personally agree the aforementioned underwriting especially the quazi 5% holding costs but I'm not really here to argue that. What I do know is this being my first property like I said I over paid by 3-7k cause I did not know what the heck I was doing. @Sundeep Amin It really has nothing to do with 1% 2% that is just a starting point. I can get properties all day long today that rent for 800 that cost 40-50k but the tenant quality is lower and the 'time' it takes to acquire it.
That brings up the *Time-Money-Experience* triangle. Look I know that there are a lot more experienced folks who have the ability to find 2-3% deals and do magical things. Myself I have a full-time job that I make a good salary and I enjoy going to for the most part. Heck I get free coffee there. What you see in these forums is what I call the #BPBP Syndrome (the BiggerPockets Bi-Polar Syndrome). What I mean is that the vocal folks on the forums are very active saying and they can do much better. Real Estate is their job and they are damn good at it. I am a passive investor who has limited time to source screaming deals and just needs to place my money and quit screwing around on the sidelines. I believe passive investors like myself are actually the (quiet) majority of folks on BiggerPockets.
I think what we can all agree is that real estate is the best investment vehicle out there and what I love about it is that even when I buy these "lukewarm" deals I still reach my goals faster than the stock market.
@Lane K. you really need to factor in the costs of repairs, cap ex, and vacancy. You do not have much now, but you will. You will have clogged plumbing, appliance repairs or replace, water heater replacement, roof replacement someday, carpet, paint, etc. You get the idea. You don't have many now, but they will come. I would at a minimum use 5% for vacancy, 5% for cap ex, and 10%for repairs. These figures will cut your cash flow in half. I think it is great you took action, we are just trying to make you see a bigger portion of the picture than you can see right now.
I use 30% for expenses. Maybe in a few years I will bump up to 40%.
@Lane Kawaoka having owned 350 of these including 34 in Birmingham.. for long term cash flow numbers.
you should use 50%... so 875 rent cash flows 437.00 minus your payment your positive about 42 a month.. this is what it will be over a 5 to 7 year hold. your still very much in the honey moon phase.
and if you do 10% better then your at 125 or so a month.. won't be more than that based on my expienrce.. what you do have though is someone else paying your mortgage. and the whole reason most folks should buy rentals..
Thanks for posting.. and good luck with it.
Thanks for the reply @Lane Kawaoka seems to suggest its better to start somewhere than not do anything...?
Forget the mortgage for a moment - that's a separate issue from the property itself.
What I see is a property that after expenses (your mortgage payment is not an expense for this purpose, that's separate) is going to realistically yield around $450/mo in income, or $5400/yr. It cost $77k. That's a 7% cap rate. Pretty ordinary. The 5% debt will push your CoC return up slightly from that, and as other people have noted will probably leave you with somewhere around $50-100/mo in cash flow, plus some principal reduction.
Sophisticated investors do not look at interest rate and the amount of debt instead they focus on cashflow and effect on net worth.
That is the opposite of true. To a sophisticated investor, the interest rate and other terms of financing are critical aspects of a deal, near the top of a list of other important metrics like cap rate.
Overall this is an utterly ho-hum deal that will probably work out okay, but is far from great.
To me, the true 18 month report card would include a comparison of if you would have used that same ~$75k as a down payment to buy a place in Seattle because that was basically your opportunity cost in my opinion for buying out of state ... put them side by side ... cash flow plus appreciation ... which one would've been the better investment? I don't know Seattle, so I don't actually know the answer, but would be curious to see that analysis.
@David Faulkner the allure of out of state lower price point is the cost of entry.. its were an investor can get into the game with 15 to 25k and HOPEFULLY a reserve account of at least 10k ( which is prudent). Seattle market is quite robust and very much like SOCAL in price points and rates of returns on rentals.
@Sundeep Amin I think if investors go into these at 50% and do better hey that's great.. but if they go in thinking 25 to 30% and it does not materialize over time. then they are disappointed or even worse they don't keep enough cash on hand for the unexpected.
Turn over is the key in these markets.. if @Lane Kawaoka gets very lucky and has a tenant stay 5 years and treat the home like a homeowner then his numbers will be close.. But wishing is not reality in these markets and with the tenant demographic in these areas... generally renters stay 18 months on average 2 years max and they move on... leaving you with a turn over expense.. And or if its Section 8 you need to do an annual update which usually is 500 min to a couple grand a year...
turn overs are the key component here. Of course if your plumbing to the STREET is brand new and you have new pex... you have new wiring new roof New mechanicals.. the rest of cosmetic if the house has good bones.. that helps for sure. its hard to make a case study with just one home.
you could also have one were the tenant left at 5 months and did 5k of damage.
or you could be buying in Dallas area and have your foundation go wonky and spend 3 to 5k fixing it .. which happens on almost all homes in that area. etc etc some of this is regionalize for sure.
Great info @Jay Hinrichs , I'll definitely plan for 50% expenses to limit downside risk as much as possible when I price any deals I want to go for. I'm glad several experienced folks, @Thomas S. and others, chimed in here because I would have otherwise thought the deal Lane proposed was pretty good, where it looks to actually be ok, which I think is still fine.
Makes me wonder how hard it is to actually find "great" deals that cash-flow while accounting for 50% expenses. Thank again to all who commented for the great info!
@Sundeep Amin its a double edge sword.. prices have rebounded faster than rent in most cash flow areas.. so return compression Is what your seeing.
but its great for those that had the capacity or risk tolerance that bought in 2009 through 2012 ish.
as when we were buying then we expect prices to rise and they did.. and for me I sold out of my 350 homes and took my profit. So all good on my end.
You can still find plenty of homes that rent for $800-900 and cost $45-50k all-in, which is around a 10-11% cap rate. Maybe a little better if you find a good one. They're in C areas mostly though and usually require some repairs (included in above numbers), so entail a bit greater headache. They also tend to be more difficult to finance, which also lowers your overall expected return if you would otherwise be getting a loan. One additional advantage of these is that you can often end up all-in below market price, so have an alternate out of just selling for a modest profit.
It gets much harder to find the same level of cash flow as you move up into B and A areas, where cap rates are more like 5-7%. Similar is true of solid multi-families.
I live in Birmingham and am very familiar with these type of houses. . This is a great deal. The exorbitant expense scenario some have come up with is not realistic for the area
I am in San Diego and specialize in Escondido.
The cap expense I use is $300/month for SFR of standard rental size (think 800' - 1100': 2 or 3 BR, 2 BA or less) and $250/month attached. I derived this number with a cap expense sheet that I bound on BP and replacing the numbers with my expected costs (higher than elsewhere) and my experienced life span (My experienced life range varied significantly from other projections: for example sliding aluminum windows I experienced a shorter life than the work sheet, similar for HVACs. I do not base cap expense on rent because the correlation is weak. If I have a 1120' 3/2 rent at $2500 and a 4/2 1450' at $1900 (BTW these are 2 of my units and the $1900 is a close to market rent) which is likely to have greater cap expense? I believe the larger 4/2 is likely to have higher cap expense.
I typically start with 75 to 80% LTV (the lenders typically want 75% LTV so finding greater than 75% LTV is more work). I attempt to keep my equity as low as I can but sometimes it gets a little high (I have a few units were for various reasons my equity is above 50% of value which is not leveraging the money well).
Here is what I use for my cash flow numbers: Rent - Mortgage - Escrow (tax and insurance) - Cap expense (see above) - 10% rent (maintenance and vacancy: I actually have so far experienced less than 10% for vacancies and maintenance but I have a cheap dedicated maintenance person and take good care of our tenants) - incidentals (I have 3 units that I provide gardener and 2 units that I pay water/trash). Ideally this results in a positive number. If it does not I also look at the return if I include the principle from the payment. Note when the interest rates are low the principle from the payment can be substantial (I have one property were the principle form payment is >$500/month and a couple of others at >$400/month. This principle gain is net worth gain but obtaining it is similar to obtaining appreciation (i.e. requires a refinance or ELOC) so is not as desirable as cash flow not a result of principle gain.
As for purchases in San Diego: It is real difficult to find a cash flowing SFR using my numbers. Multiplexes in select areas of San Diego will often cash flow but not like other parts of the country. Where traditionally money is made in San Diego by buy n hold is in appreciation and rent appreciation. I have purchased properties that did not cash flow using my formula when purchased but I believe my last property to not cash flow will cash flow next month (rent appreciation) but where I have made most of my REI money is on the property appreciation.
Escondido has been a very good market for me. I recently refinanced a few of my properties and took out all of my initial investment. So I have no money currently in on those properties and yet they have equity and are cash flowing (one is soon to be cash flowing).
Hopefully this answers many of your questions including if investors are including all expenses (they should be) and how investors are making money on buy n hold in San Diego.
Thanks for that breakdown and info @Dan Heuschele . I agree markets like SD are better for appreciation and have heard before that rent appreciation can also get them to cash-flow as well. I'll take a deeper look at your cost breakdown to get a feel for what's possible here in town.
@Lane Kawaoka #BPBP might be the most insightful and useful hashtag to describe many of the conversations here. LOVE it!
I say "Good for you." The chances of executing on a "slam dunk" deal that you hear people on BP tout is highly unlikely when it's your first deal and you're not all-in on real estate. Assuming one aspires to do more than just one deal, IMO, the real goal of that first deal should be to set you up for deals #2-5. You're getting a 5% return on your capital. You're taking home some pocket cash each month. And, you've got someone paying your mortgage. That's awesome. You're setup for your next at bat.
Now, for deals #2-5, just focus on bumping that 5% up to 7% or 10%. Or, focus on going from $50 in free cash flow to $150 in free cash flow each month.
One day, you'll have the experience and track record and luxury to look back and scoff at your returns from the "good old days" because you'll find a high-return path that suits your specific skills and appetite for risk.
Or, you'll pay off the properties and retire with some monthly income. Nothing wrong with that.
Originally posted by @Michael D. :
Overall this is an utterly ho-hum deal that will probably work out okay, but is far from great.
I think that's Turn Key in a nutshell - from the perspective of an active investor. For some folks, this is exactly what they want: slightly more involvement than buying a mutual fund, the psychological effect of owning a 'tangible' investment, and acceptable returns (for them anyway.)
I also think this type of investing takes a pass on most of the opportunities REI affords those of us who are more active.
@Lane K. I get that you're busy - I am too (50 hour a week job that's an hour away, wife works full-time nights, and we have three kids in school and activities) - so I can appreciate how you value your time. I also appreciate you taking the time to post your experience with this type of investing (because real numbers can be hard to find on these types of deals) but if I were you, I'd take @Jay Hinrichs opinion as gospel and use whatever expense ratio he tells you to use. There is a balance to be found in investing when you work full-time, should you decide to get a little more active. Be your own TurnKey company - it's most fun!
@Sundeep Amin I don't think this is a "great" deal. I did little work and its good per my effort. I have a certain niche that I do go which are the higher priced properties even though the proforma rent to value ratio decreases. Its not all what it looks on paper. I have two reasons for this 1) better tenants/less headaches and 2) use of my finaite fannie mae loans.
@Dan Heuschele I used the same spreadsheet that does the whole Lifecycle Cost Analysis thing. But its pretty subjective. These homes typically do not have washing machines, garbage disposals, garage doors, or those annoying things that break per design.
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