Cash flow question, plus more?

Question

At the risk of sounding like a complete rock, here is my question...

What is the formula for figuring out if rental property is worth it?  I realize this will vary for different areas, mine is TN if that helps.  I've seen many different answers on here that never really explained it all the way out for a newbie.  Let's just say I buy a $100,000 sfh and my mortgage payment (piti) is $1,000 a month.  Considering everything, what do I need to get in rent per month to make this a positive cash flow property and also what would I need to get to make this a VERY GOOD positive cash flow property?  And, how did you arrive at those figures?

My situation (condensed version):

I have already secured financing and have been looking for houses to fix and flip.  I've been looking for about a month with no real luck.  This is partially due to the fact that I am being overly cautious because this would be my first deal.  Just in the past few days I started thinking that maybe I should be looking for rental property and if I happened to find one to fix and flip then ok.  I thought it might be a little easier to find a property to rent and this would get me in the "game" and give me some experience.  Is this a naive view?  Any and all thoughts, ideas, wisdom or criticism is appreciated?

Thanks

Mark Y · Answer

Actually, I was mistaken. After some more research, rentals in Phoenix get about $.85 / sq. foot.

Mark Y · Answer

I'm going to my first REI meeting this Monday. Hopefully, I'll make some contacts with people who can help me along.

I found a realtor that "specializes" in investment properties. All I was given was a list of properties that are selling for appraised value. Not much use for what I intend to do.

I'll post my experience of the meeting after Monday.

Lynn Z · Answer

In my opinion the safest way to get started is to try and buy a FSBO that hasn't been flipped every two years and live in it.  Pay 20% down avoiding PMI and improve it with energy efficient windows, architectural roof, landscaping etc.  Minimum fix.   Add a bath if it only has 1, for example.

Get it in mint condition and sell it two years later for tax free money for a reasonable profit.  At the very least you'll perhaps cover your housing expense ie live free for those two years.     The entire time you're in this house, look for another deal or observe neighborhoods you think are going to appreciate.    As an alternative, you can hold your mint condition house by renting it for a few years when you move to the next one.

I have never found that there is an easy path to the financing part of this business.   There never seems to be enough money to go around.  In my area, rents are not $1 per square foot.  They are below that.  The only $2000 rent is being paid for by some doctor for a 6 month rental while he and his family wait for his new house to be built.

Frank Adams · Answer

This has turned into a heck of a good thread that flipster started. A couple of comments about comments.

Marky wrote;

I don't know the Phoenix area but my guess would be that PRICES are above $1/foot.

dal1 wrote;

Those are excellent ideas, but not the kind of things that will cause a house to appreciate at higher than market rate, except for the bath.

A roof over their head is the minimum that people expect from a house, it being dimensional instead of 3 tab doesn't bring a higher price.

In our part of the country "energy efficient" windows have about a 25 year payback in energy savings-so do it for your own "livability" factor but not for money.

Landscaping-like exterior, adds a lot of curb appeal, one of the reasons we were able to get our house below market-"barn red" paint and 20 years of randomly placed and randomly trimmed shrubs turned many buyers off. Probably can't be measured in pure $$ but will make living there more enjoyable.

Adding a bath is IMO (and statistically proven) a moneymaker, particularly if you can do most/all work yourself, partiuclarly the "finish" like tiling, because it's very labor intensive.

IIRC single bath houses have been considered "technologically" obsolete since the early '80 by the Amer. Assn. Archetects. One of the best ROI deals I ever did was add a 1/2 bath in the house that had a 8' X 10' laundry room accessible through the master bath.

The only thing I did besides paint the existing bath white was add the following;

Toilet-                  $5.00-yard sale
Pedastal sink        $20.00-discontinued at HD
Mirror                   $FREE (my favorite price) from the Realtor
Towel bars etc      $3.50-yard sale
Various PVC pipe, a toilet flange and PVC cement
                          $25.00 or so, I already had a lot of it and there 
                           was some in the shed at the house when I bought.
Permits               N/A       
Satisfaction of earning $17,500 for a few day's work

PRICELESS

all cash

Colin Turnbull · Answer

wow am i ever glad i found this forum before i bought my first rental i guess i have to play with these formulas more to get comfortable with analysing deals thx to all who posted and keep the advice coming!!

Account Closed · Answer

1. There is no real connection between a residential property's value and its ability to produce an income stream as a rental. Many appraisals do not even show an income based valuation.

SFR are valued based on comparable. The largest buyer of SFR are owner occupants so they set the value.

1-4 unit properties can have a loan with an owner occupant resident. Hence they are mostly valued based on the demand (comparable). As you get closer to a 4 unit the income from the rented units do matter to folks who are owner occupants.

2. Generally only commercial properties are valued based on income. Commercial multi-family properties means 5 units of more.

3. In the lower priced areas of a community where few owner occupants want to live many of the investors will only offer to pay based on the income produced. So, if you find a neighborhood that is 'mostly rentals' expect little to no premium for owner occupancy and values pretty closely tied to income.

In parts of the Midwest you will find many such areas. Even on the costs you will find such areas. Some of the time (not all the time) the areas are what might be where slumlords focus. In other places the economy is not very strong so the areas are not bad so not slum as much as areas that have people who earn very little and can not afford to buy.

If SFRs are valued based on comparable expect that there will be large areas where an income investor will never be able to find a deal worth holding long term unless you have very little debt on the property. In that case you are buying future appreciation rather than a good income based yield.

John Corey

Lynn Z · Answer

There was an article in the local newspaper about our local re club and the president was quoted as saying the majority of the membership didn't own one investment property.  Checking on what the president and his wife own--that would be 2 houses in the area.

The speakers they line up are full of bs mostly with quick talk about how they got to be wealthy. If you challenge them at all, someone in the leadership politely suggest you attend a breakfast meeting where more dialogue can be 
put forth.  Very suspicious.  these speakers should have experienced people asking questions --  I enjoy going and meeting people and listening to some of the speakers but newbies should be forewarned.  These clubs are struggling too and most people there come are just curious--not seasoned investors.

Michael Rossi · Answer

dal1,

There are really two sides to a lot of REIAs.

There is the majority of membership who are newbies.  The vast majority of these newbies will never be successful, but a lot of them will buy stuff including expensive courses, mentoring, and bootcamps.  A few will even buy a property.  There are always people at the REIAs who will take advantage of this situation and make a living off the newbies.  Many of the speakers at the REIAs are people who are trying to sell something to newbies.  We've had many speakers at REIA meetings that I attended that were obviously targeting newbies with their investment schemes.  In particular, I remember a speaker that was trying to pawn pre-construction deals in Florida.  Am I glad that I didn't fall for that?

Then, there is the small minority of the membership at the REIA who are serious investors.  These are the people who are actually doing deals and making money.  These are the people you want to meet at the REIA and the people that can truly help you.  A lot of my success has been the result of meeting a successful landlord at our REIA.  This landlord who gave me a LOT of great advice early on in my career (free advice).

Mike

Michael Rossi · Answer

The vast majority of people you meet at REIA's are newbies.  There is a tremendous turnover as some newbies lose interest, others pay too much for a property and fail, and yet other newbies come in to start their search for riches.

Your job at the REIA meeting is to determine who the SUCCESSFUL investors are and make friends with them.

In EVERY market, the vast majority of properties, including rental and other investment properties, are bought at retail.  It is difficult in all markets to find great deals.  That is why the vast majority of new investors fail.

I think that is a TERRIBLE IDEA!  Borrowing more than you need will almost guarantee that you will have negative cash flow on this deal (although it was probably negative anyway).  Why pay interest on money you're not using?  Very poor idea.

So, the question is how are these investors making money on their rentals in an overpriced market?  Or are they?

Mike

Mark Y · Answer

It was good. Very informative, although I have nothing to compare it against.

One of the things several people were talking about was the following example:

Purchase a $200k house from a distressed seller for $150k.
Take out a loan for $160k, getting a check back at closing for $10k.
Use the $10k as a safety net in case cash flow issues arrise. Damn sure don't spend it.

I ran the 2% rental / purchase price by some people. Meaning, you should be able to rent a house for $3000 / month if you purchase in for $150k in order to be on the safe side cash flow wise. While the idea is sound, it isn't happening anywhere in Phoenix. And I didn't get an ideas where it is happening either.

The going rate for rentals in the greater Phoenix area is about $1 / square foot.

The other thing that was interesting was investing in pre developed land.

Comments /opinions on the above would be great.