Buying properties to simply break even?

Buying properties to simply break even?

Chandler, AZ · Member since 2016 · 109 posts · 56 votes

Hi all! 

I know what you all are thinking.."investing for 0 cash flow?" but looking at the current market in my area that's how the numbers seem to work. 

In my area, Phoenix Arizona (specifically Tempe, a college town) I'd be extremely lucky to find a 3 or 4 bed for 150k that needs work. Now, with a 30k rehab totaling 180k I'd be looking at rents around 1800 per month. Just to note, I haven't yet used the driving for dollars method which may change my outlook. (I will be doing this when I'm closer to buying)

So it looks like I'm just barely making that 1% rule of thumb marker. 

So for a easy example lets say:

Property: $180k 

Mortgage: $990 

Monthly rent at 1.1%: $1980

Annual income (minus 50% as a rule of thumb): $11880

Annual MTG Payment: $11880

Net Annual profits: $0

So here at 1.1% I'm breaking even, assuming 50% going to vacancies and expenses.

My long term goal isn't to cash flow necessary in the short term, but to have ~15 properties paid outright in 20 years while I work. 

That being said, would you recommend this as a model moving forward? Is that break even margin too close that I could actually move into negative cash flow?

Looking at 200 dollars negative cash flow for one property isn't a huge deal while the note is being paid down but 10-15 properties gets into the 20k-30k losses per year. Yikes!

Other considerations - were nearing peak market and these properties could go through a correction leaving my early investments underwater and rents lower adding to the potential for negative cash flow.

Thanks!

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Chris MasonPro Member
Moderator
Lender · CA · Member since 2015 · 9k+ posts · 10k+ votes
9y

Hi @Account Closed

Very high income persons will sometimes purchase break-even real estate because real estate is tax advantaged in the United States. 

Let's suppose your scenario numbers are exactly correct at $0 net, but it also yields $4500 of your income not being taxed due to the famous depreciation write-off, that otherwise would have been taxed at 40%. That would actually put you ahead $1800/year, in addition to whatever equity and appreciation gains you might have.

Let's scale that up, pretend you are a real estate mogul who runs for president and proudly declares that you pay "very little" in taxes. Maybe that $1800/year is more like $180k/year that you otherwise would have had to give to the IRS. And maybe you get too aggressive with this, and end up with a bunch of bankruptcies. But, I digress.

Back to normal person reality, in the Bay Area this isn't super unusual, but I have no idea what is and isn't normal in Arizona. Perhaps one spouse is a senior software engineer earning $400k/yr, and the other spouse's $60k/yr is going to be taxed at 40%, putting that spouse at $36k/yr net after taxes. Maybe, instead of busting his butt 40 hours a week for $36k, he instead does all the property management and real estate acquisitions, to help shelter his wife's senior software engineer pay of $400k/yr from taxes as much as possible, while still enjoying appreciation and equity gains.

See this reply in the discussion

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  • Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
    9y

    remember; RE is cyclic and values can go down too - - just look at Detroit.

    So basically you're willing to work (maintain, review applications, take complaints) for no return for how many years ..... ?

  • Anthony GaydenPro Member
    Rental Property Investor · Omaha, NE · Member since 2014 · 2k+ posts · 3k+ votes
    9y
    Tempe is a popular college town. I wouldn't depend on it, but appreciation will be a factor. Cash flow will be lower.
  • Chandler, AZ · Member since 2016 · 109 posts · 56 votes
    9y

    @Jeff B. 50% taken out is assuming mgmt costs.

    @Anthony Gayden Good point! 

    Another thing to add - to pay those notes off before 30 years cash flow is a necessity. 

  • Queen Creek, AZ · Member since 2017 · 15 posts · 12 votes
    9y
    Don't limit yourself to Tempe. I would look in other areas outside of Tempe, I have found deals and know a few people in the group I have started attending that are buying cash flowing properties. Some with $400-600 a month in cashflow. There is another gentleman in our group that finds houses that are in danger of being lost wether by foreclosure or being behind on taxes. The last one he found was his 3rd rental obtained this way and he gave the owner a check for $2200 after negotiations to walk away from the house. Ready to rent. Around 60k left on the mortgage and he said that was a little under half of it paid. The deals are there. I can find them I'm just trying to establish the funds to start buying myself.
  • Chandler, AZ · Member since 2016 · 109 posts · 56 votes
    9y

    @Michael Martinez Awesome! I'd like to connect with you and talk strategy for investing in the area. Are you typically looking in the central phoenix area?

  • Queen Creek, AZ · Member since 2017 · 15 posts · 12 votes
    9y

    I don't really limit myself to just central Phoenix my group that I've been going to really helps me with that also. I keep up on everything nearby chandler,gilbert,Mesa,Phoenix, san tan and some other areas. There is always an opportunity you just have to dig them out. Wether it's rentals or fix and flips or even using the brrr strategy. I've found deals that fit all 3. Feel free to message me or send me a colleague request and we can talk. 

    @Account Closed

  • Chris MasonPro Member
    Moderator
    Lender · CA · Member since 2015 · 9k+ posts · 10k+ votes
    9y

    Hi @Account Closed

    Very high income persons will sometimes purchase break-even real estate because real estate is tax advantaged in the United States. 

    Let's suppose your scenario numbers are exactly correct at $0 net, but it also yields $4500 of your income not being taxed due to the famous depreciation write-off, that otherwise would have been taxed at 40%. That would actually put you ahead $1800/year, in addition to whatever equity and appreciation gains you might have.

    Let's scale that up, pretend you are a real estate mogul who runs for president and proudly declares that you pay "very little" in taxes. Maybe that $1800/year is more like $180k/year that you otherwise would have had to give to the IRS. And maybe you get too aggressive with this, and end up with a bunch of bankruptcies. But, I digress.

    Back to normal person reality, in the Bay Area this isn't super unusual, but I have no idea what is and isn't normal in Arizona. Perhaps one spouse is a senior software engineer earning $400k/yr, and the other spouse's $60k/yr is going to be taxed at 40%, putting that spouse at $36k/yr net after taxes. Maybe, instead of busting his butt 40 hours a week for $36k, he instead does all the property management and real estate acquisitions, to help shelter his wife's senior software engineer pay of $400k/yr from taxes as much as possible, while still enjoying appreciation and equity gains.

  • Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    9y
    Originally posted by @Chris Mason:

    Hi @Account Closed

    Very high income persons will sometimes purchase break-even real estate because real estate is tax advantaged in the United States. 

    Let's suppose your scenario numbers are exactly correct at $0 net, but it also yields $4500 of your income not being taxed due to the famous depreciation write-off, that otherwise would have been taxed at 40%. That would actually put you ahead $1800/year, in addition to whatever equity and appreciation gains you might have.

    Let's scale that up, pretend you are a real estate mogul who runs for president and proudly declares that you pay "very little" in taxes. Maybe that $1800/year is more like $180k/year that you otherwise would have had to give to the IRS. And maybe you get too aggressive with this, and end up with a bunch of bankruptcies. But, I digress.

    Back to normal person reality, in the Bay Area this isn't super unusual, but I have no idea what is and isn't normal in Arizona. Perhaps one spouse is a senior software engineer earning $400k/yr, and the other spouse's $60k/yr is going to be taxed at 40%, putting that spouse at $36k/yr net after taxes. Maybe, instead of busting his butt 40 hours a week for $36k, he instead does all the property management and real estate acquisitions, to help shelter his wife's senior software engineer pay of $400k/yr from taxes as much as possible, while still enjoying appreciation and equity gains.

    Yep ... and if you get that appreciation and the values and rents go up, and the property starts showing more cash flow so you get taxed on it ... what do you do then? Well, then you cash out refinance the property to pull out the money not only tax free, but taxed advantaged since it is a loan and the interest is tax deductible.

    Or if you don't get the appreciation, you don't cash out refinance and eventually you are still left with a nice property in a nice neighborhood that is owned free and clear because your tenants have paid off the mortgage for you.

    This strategy is not for everyone, but it has its merits for the folks it does make sense for. Combine this with a nice short term forced appreciation equity bump, and these type of properties can be very profitable and attractive investments. The whole point is that cash flow is an important thing, but it is not the only thing ... when analyzing properties a savvy investor needs to consider ALL of the profit centers (cash flow, appreciation, tax benefits, and mortgage pay down) over the entire life of the investment (not just day 1 or year 1) and also consider the risks and headaches involved in obtaining those profits. 

    That is not to say that the scenario presented by the OP would necessarily be a wise investment for him or not, it is just to say that it is not wise to judge based solely on if it hits the 1% rule or not, the answer and analysis runs much deeper than that. 

  • Chandler, AZ · Member since 2016 · 109 posts · 56 votes
    9y

    @Chris Mason

    Thanks for the break down on the depreciation write-off! That was something I was overlooking in my analysis. Also I appreciate the delivery..sense of humor and good info.

    @David Faulkner Very good points in there as well much appreciated. 

  • Real Estate Investor · Palm Beach County, FL · Member since 2017 · 3k+ posts · 2k+ votes
    9y

    @David Faulkner Great insight yet again!

  • Investor · New York City, NY · Member since 2015 · 808 posts · 417 votes
    9y

    @Account Closed

    While I certainly wouldn't rely on it to pay the mortgage but I would note that expenses on "better" properties can be a lot better than say C class units. So just a blanket assumption of 50% might not be the right number esp if inventory is low in your area which can increase both turn times and length of stay. A property with less move-outs over its life should have lower expenses than one with a lot more move-outs. 

  • Chandler, AZ · Member since 2016 · 109 posts · 56 votes
    9y

    @Charles Worth

    This is why I love this forum. Great point! I will definitely consider this looking into future properties

  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    9y

    Properties that meet the 1% rule should cash flow just fine unless they are dumps or have unusually high tax rates.  

  • Chandler, AZ · Member since 2016 · 109 posts · 56 votes
    9y

    @Charles Worth In your opinion what is a better percentage to estimate with in a tight market, college town - median home around 200k?

    Also Thanks @Russell Brazil Good info, makes me more interested in 1% deals

    Thanks!

  • Investor · Portland, OR · Member since 2015 · 70 posts · 56 votes
    9y

    miss read

  • Shiloh LundahlPro Member
    Rental Property Investor · Gilbert, AZ · Member since 2016 · 3k+ posts · 4k+ votes
    9y

    @Account Closed deals that look to break even on paper will usually end up casflowing negatively when you make one of your first purchases because of all of the costs that you are not aware of when you first start to invest in rental properties. There are enough wholesalers in Arizona to find a property that would be better than 1%. You may just need to expand your location parameters.

    I would be happy to meet up with you at some point and talk about investment strategies. Send me a PM if you are interested.

  • Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes
    9y
    Dalton Hirst My perspective is that unless you're overly conservative with stress-testing your investment things will go worse than projected. In most cases the result is that "you make less money" but in a break-even you end up losing money.
  • Rental Property Investor · Phoenix, AZ · Member since 2013 · 919 posts · 911 votes
    9y

    @Account Closed  I know of no properties in Tempe (or even the phoenix area) that you can buy for 180k that will rent for $1800 a month.  Are you planning on renting rooms or house hacking?   ;-)

  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    9y

    @David Faulkner  cash out refi's are temporarily tax free.. LOL.. your basis is still your basis you pay tax when you exit.. but if you never exit and just let your family inherit well then yes its been tax free for you while your alive.  :)

  • Chandler, AZ · Member since 2016 · 109 posts · 56 votes
    9y

    @Alan Grobmeier 

    Thank you! My goal would be to buy at 150k plus the reno rolled into a 203k. I'm sure you have more expertise in this area, but I did see a 2 bed sell for 98k in Tempe very close to ASU.

    Of course, this doesn't quite fit for what I'm looking for (really want a 3 bed 2 bath). In your experience have you seen any properties go for around 150k that need a renovation? 

  • Rental Property Investor · Between Lexington & Louisville, KY · Member since 2013 · 11 posts · 2 votes
    9y
    I would find a different place to invest. Those margins could be better and make you more money in a different area. Breaking even works.. until it breaks you.
  • Rental Property Investor · Phoenix, AZ · Member since 2013 · 919 posts · 911 votes
    9y

    @Account Closed  Is it Guadalupe and not Tempe?  You need to be real careful with regards to "Tempe".  There are good areas, really good areas, and then bad ones.  At $1800 a month rent, you will have lots of problems.  That is way higher than the median rent for the area.  That means your place will need to be special.  And not just to you.  ;-). Imho you are looking for "nirvana", and it's not here.  I doubt you will be able to find an "all-in" house of 180k AND rent it for $1800 a month.  But good luck.  

  • Rental Property Investor · Phoenix, AZ · Member since 2016 · 23 posts · 11 votes
    9y

    @Account Closed Unless I am mistaken, a FHA 203k "rehab" loan is reserved for owner occupants. In my opinion, it not worth the risk to invest in a rental property using an owner occupied loan. However, if you live in the property for a year while the rehab is taking place, at that time you can decide to move out and make the house a full rental. However, you will need to refinance the property as a investment property if you want to take the loan out of your personal name (not required however). Hope this helps. PM me if you have any more questions. I currently have two 4br/2ba rentals in Tempe. One of them I am currently occupying as I finish the rehab now. Lastly, you would be EXTREMELY lucky to find any property in Tempe that meets the 1% rule but they are out there.

  • Chandler, AZ · Member since 2016 · 109 posts · 56 votes
    9y

    @Alan Grobmeier Thanks for the honest advice! What I don't want to do is overly assume and find myself in a worse position that anticipated..thats why I'm here :)

    Do you avoid buy and holds in the Tempe area for now then? I did see that purchase prices were much better even 2 years ago to fit the buy and hold model.

  • Chandler, AZ · Member since 2016 · 109 posts · 56 votes
    9y

    @Zack Niemeyer Awesome info! Looks like you're doing just what I'm looking into..living in while doing the rehab. I'll send you a PM!

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