Would you invest in a 3 or 4 Bedroom???

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Would you invest in a 3 or 4 Bedroom???

Kel S
Real Estate Investor · Toledo, OH · Member since 2008 · 234 posts · 53 votes

We looked at 2 houses today.

The first one:

One was a very small (780 sq ft) 3 bedroom. Build 1940's. The living room was tiny...12 x 11. Then 3 small bedrooms - 12 x 11, 10 x 9 and 10 x 8 and 1 bath. Beautiful new 1 1/2 car garage detatched. Excellent neighborhood with top schools in our area. Needs work though...ie; drywall, tub surround issue...possibly termites, looks like a couple old leaks area on the ceiling in one bedroom but roof looks newer. No central air.

The second one:

Large house (1640 sq ft) 4 bedrooms. Built 1920's. Living room, formal dining, kitchen and breakfast nook off kitchen on main level. Upstairs there are 4 bedrooms, 1 bath and a bonus room that is darling and gives you the feeling of being in a tree house :mrgreen:. Full finished (w/carpet) basement. One car garage. Great neighborhood...not quite as nice as the first house but the same excellent top school district. Needs very minimal work...some new carpet and paint. No central air. Not crazy about there only being 1 bathroom (upstairs) for this sized house.

Both houses are REO's and the banks are asking the same price for each of them. In the 40's.

Now my question is for all you investors. Which house would you want to have in your rental line up? The smaller one that you probably could pick up for less money but will have to fix quite a bit. Or the larger one that you will probably have to pay more for but less work on it.

Also another question; Which house do you think will rent easier? Obviously the larger one would be a higher rent but it's a big house and the utilities will likely be higher for the renters. Any thoughts? Is smaller (less rent) sometimes better? Would you be nervous to buy the larger one because of the size and possibly narrowing the rental pool of families looking for a house that size?

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  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    17y

    You left out the most important consideration - THE NUMBERS! What are the gross rents for the houses and what will the purchase price be?

    Mike

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  • Will BarnardPro Member
    Moderator
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    17y

    Kel,

    Get some feedback from local PM companies and realtors in regards to vacancy rates for 3 beds and 4 beds. Compare the numbers. 3 beds are usually the bread and butter, but your specific area may be otherwise.

    Also, the numbers matter most, so make sure the pencil before buying either of them.

    Podcast Guest on Show #130
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  • Kel S
    OP
    Real Estate Investor · Toledo, OH · Member since 2008 · 234 posts · 53 votes
    17y

    Both are listed for $48k and REO's. We would offer a lot less for the smaller house (upper 20's) due to the amount of work it needs. At this point I'm leaning towards not even bothering with the smaller one just because of the work it needs and hidden problems we could find. The bathtub surround is sort of warped so the seal is broken down near the tub. I tapped on it and all this what looked like tiny wood chips fell out into the tub. I'm thinking rot or termites.

    If we went with the larger home probably offer $35k. Not sure if the bank would accept that but doesn't hurt to try.

    The smaller house could rent for around $550-650 based on research of this neighborhood. At $550 month we'd figure in $200 for tax/ins/repair. So $350 to the positive. (Not factoring in the cost of initial repairs because not sure the extent yet). The larger home could rent for $750-$850. Minus $250 for taxes/ins/repairs and that would be around $450-550 to the positive. Only paint and some carpet for this house. So repairs would be minimal.

    Our offers wouldn't be contingent on inspections and would be cash.
    I don't quite have a firm grasp of the 50% rule that I've seen you all mention and not sure how to apply it to homes that are purchased with cash? Is there a calculation for these type of buys since there isn't any loans involved? We've figured out that it would probably take about 10 years to pay ourselves back in full for our investment and then after that besides taxes/ins/repairs the rest would be 100% positive. But not sure how I should be calculating to factor in paying ourselves back for the initial investment right now so I have a better idea of what amount we need to have as positive income.

    Thanks for the tip on contacting some PM's. That's a great idea because besides looking on Craigslist at the cost of 4BR houses in that area and the newspaper I don't have a lot to go on. I couldn't find any 4BR in that area in the paper and only found one (4br/1bath) available on Craigslist where they are asking $850 for rent. Outside of this area I saw quite a few 4BR for rent. So not sure if it's a good sign or not that there are a number of them in general but only 1 available in the area I'm looking at.

    Sorry for the War & Peace novel sized post.

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  • Will BarnardPro Member
    Moderator
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    17y

    The 50% rule or any other operating expense ratio you choose to use has NOTHING to do with debt financing or all cash. It only states that you take the gross rents and half that amount will be your estimated operating expenses. The balance left is your net operating income. From there, you arrive at your total cash flow if all cash, or deduct your debt payment, and then you have your final cash flow figure.

    Podcast Guest on Show #130
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  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    17y

    Kel,

    The 50% Rule simply states that throughout the United States, operating expenses run 45% to 50% of the gross rents. It is absolutely critical that you understand operating expenses if you are to be successful in this business.

    Let's assume that the rents is $800 per month on this house. The 50% rule would tell you that the operating expenses would be about $400 per month. Operating expenses consist of A LOT MORE than taxes insurance and repairs. A few of the other operating expenses are vacancies, management (even if you do it yourself), advertising, office supplies, entity maintenance, capital expenses (not technically an operating expense), legal fees, evictions, lawsuits, utilities (even if only during vacancies), entity maintenance, etc, etc, etc.

    Furthermore, even if you don't have a mortgage on the property, the money you spent to buy the property isn't free. It has an opportunity cost, which is the cost of the next best opportunity lost. In other words, that money could be making money and you need to consider that.

    Here is how I see the larger house deal:

    Gross Rents: $800
    Operating Expenses: $400
    NOI: $400

    Debt (or opportunity cost of money): $35K, 30 yr, 7%: $233

    Real cash flow: $167 (which is good)

    This assumes that there is no rehab or initial maintenance needed on the property. As you can see, that's far from the $450 to $550 positive that you were talking about.

    Good Luck,

    Mike

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  • Mark N.A
    Real Estate Investor · North Carolina · Member since 2008 · 1k+ posts · 483 votes
    17y

    Another factor you might wish to consider is the feasibility of upgrading the property at some point, and hopefully adding value and marketability. In your case that might be adding a second bath to the four bedroom

    Where I'm at a 4/1 would attract less desirable tenants at lower rents.

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  • Kel S
    OP
    Real Estate Investor · Toledo, OH · Member since 2008 · 234 posts · 53 votes
    17y

    Thank you guys for the input and explanation of the 50% rule.

    I was thinking the same thing about the 1 bathroom. Anyone have a rough idea of what it would cost to put in a 1/2 bath? The main floor has room for one.

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  • Mark N.A
    Real Estate Investor · North Carolina · Member since 2008 · 1k+ posts · 483 votes
    17y

    We just added a full bath to a 3/1. The plumber was roughly $1000 (would've been less if we'd gotten their proposal in writing, but we 'trusted' them). Fixtures roughly another $1000. Then we had the floor and enclosure tiled which made it look really good. Plus add in studs, drywall, insulation, door and paint and figure roughly another $1000.

    My partner/fiancee is a pretty fair carpenter so she did the walls, drywall, painting, etc. so we saved bucks there.

    IMO, a full bath is far superior to a 1/2 if you have the room

    Good luck.

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  • Howard Walter
    Member since 2008 · 17 posts · 1 vote
    17y

    If you have to ask all of the above do not
    get into rentals

    If you do not know the numbers you are
    going to get taken.

    The 50% rule is not accurate

    The $1000 ect ect expensse are to
    high no where near that how do I
    know I am do all kinds of remodeling
    to my investments monthly

    You better get your act together if
    u are going to do this

    SKI

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  • Jesus Garcia
    Rental Property Investor · Baytown, TX · Member since 2008 · 94 posts · 21 votes
    17y

    Putting in a 1/2 bath could be fairly simple as long as you have eeasy access to running the plumbing. You can buy a complete toilet for under $100. A simple vanity and sink with faucets you could get for under $150 and PVC piping is cheap and easy to work with. Adding a full bath is going to require a lot more work. I like you're idea of a 1/2 bath.

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  • Kel S
    OP
    Real Estate Investor · Toledo, OH · Member since 2008 · 234 posts · 53 votes
    17y
    Originally posted by Howard Walter:
    If you have to ask all of the above do not
    get into rentals. You better get your act together if
    u are going to do this

    SKI

    SKI,

    If I waited to get my act together....I'd never accomplish a thing in life. I'm not afraid of situations where I have to "learn as I go" even if it means making mistakes along the way. Hopefully it's a good sign that I'm here asking all of these questions of you fine folks in effort to avoid some of those mistakes.

    :wink:

    1Reply
  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    17y

    Ridiculous. The data from hundreds of thousands of rentals says otherwise. Taz just posted data from 30,000 units that verified the 50% rule. Finally, we've had a BUNCH of people on this site claim that the 50% rule wasn't correct and EVERY SINGLE TIME they were proven wrong when they posted the numbers.

    The $1000 ect ect expensse are to high no where near that how do I
    know I am do all kinds of remodeling
    to my investments monthly

    Of course, if you are doing the work yourself or have your own crew that works cheaply, the bill could be a lot less. On the other hand, depending on the layout of the plumbing in the house and the structure of the house; depending on the quality of the contractors you use; and depending on the materials you put in the bathroom; it could also cost significantly more.

    Kel, the key is that you need to know what it's going to cost YOU for what YOU are going to do.

    Good Luck,

    Mike

    0Reply
  • Ryan Pyle
    Multifamily Investor · Toledo, OH · Member since 2008 · 296 posts · 308 votes
    17y

    Kel, I have a bunch of rentals in Toledo. Here's what I can tell you. 2 bedrooms take a LONG time to rent, but you generally get tenants that are less transient. It can take up to a month to find a good tenant for a 2 bedroom.

    3 and 4 bedrooms are in much higher demand, but because they are bigger, repair and turnover costs are much higher.

    2 bedrooms are VERY difficult to re-sell. 3 and 4 bedrooms, if they are nice, will sell easily even in this market. I know you are buying rentals, but you may want to (or have to) to sell in the future and you want a property that you will be able to move.

    0Reply
  • Kel S
    OP
    Real Estate Investor · Toledo, OH · Member since 2008 · 234 posts · 53 votes
    17y

    Thanks Ryan. That is just what I needed to know.

    Well we put in an offer on the larger house and will see what happens. My husband really liked, but I would have prefer something smaller as a rental (3bd). But maybe I'll find after what you said that it will be better to rent. My husband believes that if the bank were to accept our offer that he can't imagine the house ever being worth less that what we buy it for. I found out that it was first listed in the $70's. The current 100% tax value says $115k. Anyway, we'll see what happens. Can't hurt to throw out an offer and see what the bank says.

    I do think we could rent it, but it may not be snatched up as quick as say a adverage sized 3 bedroom. It's a big house! And the 1 bath in such a large house really bugs me...must be a female thing but if I lived there it would drive me nuts to have to walk up stairs just to get to the bathroom.

    0Reply
  • Kel S
    OP
    Real Estate Investor · Toledo, OH · Member since 2008 · 234 posts · 53 votes
    17y

    UPDATE: Got a call this morning from our realtor that on Friday the listing agent received a FULL price cash offer on the house and the bank accepted.

    So back to the drawing board :wink: I'm actually not dissapointed really because I had issues with the house as far as the size and the 1 bath.

    Something else more ideal will come along I think. Though I will say that I'm not seeing the amount of new foreclosures listed like I was back in the fall. That would be a good thing though for the owners!

    0Reply
  • Will BarnardPro Member
    Moderator
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    17y
    Keep in mind that the thousands of units being referred to here come from multifamily apartment dwellings and not single family residences. Regardless, the rule can still be applied if one chooses. The data collected from Taz actually shows an "average" or "mean" range from 39% to 49%, so using a 50% OE rule would be very conservative and keep most situations out of trouble.
    Podcast Guest on Show #130
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  • Tom C
    Real Estate Investor · OH · Member since 2008 · 1k+ posts · 86 votes
    17y

    Great way to make first impressions Howard..

    Kel,

    Just for the future, a 4 bed will move quicker then a 3 bed and you are more likely to keep the tenant. Although be prepaired to deal with kids and the problems they cause.

    0Reply
  • Mamma Mia
    AL · Member since 2009 · 10 posts · 0 votes
    17y
    Where is this?
    0Reply
  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    17y

    Mamma Mia,

    Here it is: http://fieldguide.reitactics.com/operating-expense-study-using-2007-data-summary

    Will, that is factually incorrect. Both the average and median in all rent classes (anomalies removed) were between 46.1% and 49.95%. Since the 50% Rule states that throughout the United States, operating expenses run 45% to 50% of the gross rents, I'd say that the 50% rule is right on!

    Mike

    0Reply
  • Grand Wally
    Real Estate Investor · Louisville, KY · Member since 2008 · 159 posts · 13 votes
    17y

    MikeOH:

    That is factually incorrect to say this data is throughout the United States. I've always been a little leary of the 50% rule, now I'm even more so.

    How can a study be correct if it only includes 1/2 of a sample data set as it's measurement? (i.e., 26 of 50 states)

    Of the 26 being considered, how many of them are on the east or west coast where the cost of living, housing prices, etc associated with REI is way different the midwest or south?

    The 50% rule has it's merit as a conservative way to approach REI, but, again, I'm convinced that using it as the primary benchmark can create a situation where investors walk away from deals that end up being very lucrative.......

    0Reply
  • Lynn Z
    Member since 2008 · 689 posts · 23 votes
    17y

    I like what Dave Ramsey says about real estate as an investment. It takes "gobs" of money which he said most of the investors he knows doesn't have.

    I certainly respect advice from someone who went belly up in real estate --

    4 bedrooms in great areas in our city where there's a university have been renting for $1650-$2000 for some years now. A 3/1 will hardly rent and a 2/1 caps out around $750 no matter where it is.

    Rooms are the hot ticket right now. Even couples looking for a room.

    0Reply
  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    17y

    No, it is NOT incorrect to say that operating expenses throughout the United States run 45% to 50% of the gross rents. Taz's study simply verifies the data from HUNDREDS OF THOUSANDS OF RENTALS THROUGHOUT THE UNITED STATES. The 50% rule is not based on Taz's study (which only just occurred in the past few weeks), but on the large studies by the national apartment associations and groups. However, even though Taz's data was a much smaller sample (as you said), it does mirror the data from the larger studies.

    You can be skeptical if you like. You can pretend that your expenses are 10% of gross rents if you like. None of that changes the reality that throughout the United States, operating expenses run 45% to 50% of gross rents. If you disagree, post the data!

    The 50% Rule is NOT a conservative approach. Over a large number of units and/or over time, operating expenses will AVERAGE 45% to 50%. So, using 50% is certainly NOT conservative.

    Mike

    0Reply
  • Minna Reid
    Real Estate Broker · Jacksonville FL & Middletown, CT · Member since 2008 · 1k+ posts · 633 votes
    17y

    Wow guys - must every conversation turn into an argument over the 50% rule?
    Its been years I've been watching this battle here over the 50%. BTW In that same time, I have yet to see anyone disprove this rule.
    So unless you can in fact disprove it, lets try and give it a rest.
    Anyway just my 2 cents.

    0Reply
  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    17y

    Minna,

    You are absolutely correct, EVERY SINGLE TIME someone has claimed that operating expenses are lower than the 50% Rule, they have been proven wrong. Yet, people continue to try to disprove it, usually because they have an ulterior motive (usually selling properties at retail to newbies).

    However, there is no issue more important to a new landlord than operating expenses! Moreover, there is a ton of bad information out there regarding this issue (much of it from the so-called "gurus" and therefore everytime bad info is presented on the subject, I will be weighing in. We owe nothing less to the newbies here than to ensure that this issue is thoroughly discussed.

    Mike

    0Reply
  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    17y

    Those that can - do. Those that can't - teach others how to do it (even though they can't do it themselves). LOL!

    Mike

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