How on EARTH to get good ROI with expensive properties?

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How on EARTH to get good ROI with expensive properties?

Account Closed
Investor · CO · Member since 2016 · 36 posts · 8 votes

Would be EXTREMELY appreciative of advice.

I am currently looking to buy a SFH as my personal residence (to be made a future rental property once I move out). This is a 3BR/2BA house selling for for 550k. Even if I were to pay ALL CASH and immediately rent out this property I would only get about 3% ROI (less than 4%). This is TERRIBLE!!! Even when I inflate the rent price the ROI is HORRIFIC. It is NOWHERE near the 8% I could have gotten for my condo which I paid only 152K for which is now worth over 420+K.

1. I simply do NOT understand how the "1% rule in real estate" can even works on these more expensive properties!? I can easily meet the 1% rule with my condo but NOT the more expensive properties because the rent doesn't INCREASE enough to match the more expensive properties.

Because I can easily understand a 100K house which rents for 1k/month (there's your "1% rule met!"). But I simply do NOT understand how I see all these more expensive houses in the 500+K range being rented out to tenants... how on earth is the landlord is even able to make a single cent almost! Because that 500K property would have to rent out for $5,000/rent. RIDICULOUS. Not happening and I am in very expensive areas in very nice communities where housing is NOT cheap.

2. I was thinking of buying a 500K house (with a big down payment) and then in 2 years I would rent out this property when it's free and clear... but NOT if I am only going to get 3% ROI.

3. Another HUGE problem... I am going to end up in a situation where I have over 500+K equity TIED DOWN in this house and will not even be able to leverage it!!! Because I would be getting only 3% or 4% ROI with this property rented out... so how on EARTH could I ever leverage this property because I am not going to find any lender to lend me a loan for under 3%!

I could REALLY use some advice here.... I do not know what to do! It is urgent I buy a house to live in ASAP because, for the first time in my entire life, I am a tenant. Nothing against being a tenant but it is NOT for me and I am done paying rent watching it go up more and more and noisy neighbors driving me insane. However it it crucial that the house I buy now will be a GOOD rental property in the future... but I do not see how this is possible with a property at this price-point! :(

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Randall AlanPro Member
Investor · Lakeland, FL · Member since 2017 · 1k+ posts · 1k+ votes
4y

You sort of answer your own question, you just aren’t realizing it.  In short , not every property makes a good rental.  As you pointed out, the $100,000 property is probably a sweet spot.  What you fail to connect is:  that is what you need to be buying if available… because the $500,000 property wont function as well.  I graphed this out years ago.  My question was simply: How do I maximize the use of my investment  money… what property do I buy?  I took a $75k House, a $125k house, and a $200,000 house.  What the math showed was the cheapest house that could be rented for the most money is the best purchase.  The $200,000 house returned the most income, but it was eaten up with higher mortgage and insurance and repair reserves.  It was much better to spend $80,000 down on 4 - $100,000 houses than 2 - $200,000 houses; or in your case one $500,000 house.  The $75k houses performed even better.  The $75k house from 4 years ago is probably the $125k house today.

Your challenge seems to be only looking at $500,000 houses, I presume because that is the caliber of house you want to live in.  And that is fine.  The fault in your approach is forcing your house to be a future rental as your only option.  

A better possible play is that you buy cheap rentals and don’t try to make your $500,000 house a rental  later.  Instead, you hold it if real estate is appreciating and sell it when you want and pocket the profits. At least that would have worked until recently.. but now the negative pressure in the form of very high interest rates is going to slow appreciation.  How much is yet to be determined… will house prices decline?  Probably… economics says yes.  But then you have to factor in inventory… if supply is still constrained prices may just plateau if buyers can still afford the higher prices / interest rates. A lot will depend on how well the Feds balance their tightrope act of slowing down the economy. 

The other thing you have to factor in is that you are now buying at a very bad time.   Prices are high, the cost of money is way up, the home owners insurance market is crazy with increases.  Insurance prices have doubled in two years… oddly enough driven by the high value of the real estate.  If the house is worth double, you now have to insure it for double as well.  Each of those factors act to diminish your profitability on your rental investment. 

One option is to wait for a better purchase environment.  Never fun to hear, but the urgency to buy something soon is probably sabotaging the best use of your money - which may be to sit idle while you wait for the market to reset 

So determine if buying your $500,000 home as a rental is a valid plan - and if not - consider other options.  it makes no sense to get a 3% return with an inflation rate of 8-10%… you are losing buying power. 

hope it helps a little
Randy 

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  • John UnderwoodPro Member
    Investor · Greer, SC · Member since 2014 · 13k+ posts · 17k+ votes
    4y
    Quote from @Account Closed:
    Quote from @John Underwood:
    Quote from @Account Closed:
    Quote from @Justin Pearson:

    @Juliet Palfi Have you considered using seller financing of your hypothetical $500k house as an exit strategy once you decide to move on? If you are willing to live in a less expensive home then the cash flow from that long term note should be enough to pay down the mortgage on your next property and maybe some left over on top. Say you seller finance the 500k note and gets 3k a month in payments. Use that payment to pay down the mortgage on 2 cash flowing rentals and/or live in one. In this case you're using your property as the bank.

    Thanks for the advice! It appears that "seller financing" is the exact same thing as being the PML (private mortgage lender) on my property I sold? Isn't it difficult to find buyers who even want seller financing? How would I even go about advertising that I am offering "seller financing" for a property? I can imagine many people out there do not even know what that is? Sorry for so many questions... but why would someone want me to be the "bank" when they can easily get a unconventional loan if they can't get conventional? 

    I just got a unconventional loan and it was super easy (has 7% interest until I can hopefully refi to get lower %).... and if I am going to to be the PML I would NOT charge less interest rate than other unconventional lenders... plus I have NO idea how to get the paperwork done etc in order to be a PML....

    I know someone who had LOTS of rentals... then became the PML. It was less headache because then you don't have to worry about tenant headaches (if they don't pay you take your house back)... but what happens to all the tax advantages that rental properties have if you are the PML? They are gone! Not good!!! 

    If you offered owner financing you would attract plenty of buyers. Many people can't qualify for a bank loan for a multitude of reasons but would still pay back your loan on time. Just get a decent downpayment, have an attorney do the the paperwork for a subject to mortgage.

    Now may be a better time to be acquiring distresses LTR properties at bargain priced that cash flow better. Get em cheap and fix them up. I'm still finding motivated sellers or distressed properties that I can buy for under 30k. Get a handful of these and you'll be in early retirement with much less work than a STR. I have both and my LTRs pay all my bills plus much more. They have really appreciated and I have instant equity when I buy one of these on the cheap.

     Thanks for info! Stupid question... how would I go about being the PML (seller financing). I have no idea where to even start.. what paperwork is needed etc etc... being the PML seems like it would be complicated thing and I'm sure I would not even be able to answer any questions I am asked about it lol... it seems if I am the PML I cannot get any "hand holding" in the beginning until I am more experienced and better know what I am doing? Because right now I do not know my *** from a hole in the ground.


     Your attorney will create the mortgage and do all paperwork. 

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  • Jaron WallingPro Member
    Rental Property Investor · Indianapolis, IN · Member since 2018 · 4k+ posts · 4k+ votes
    4y

    @Account Closed "But I simply do NOT understand how I see all these more expensive houses in the 500+K range being rented out to tenants..." - This is happening everyday and even in cash-flow markets like my own. These buyers/companies are less concerned with cash-flow, more considered with hedging against inflation. Real estate is good for that but don't compare yourself to it. Stick with what you know, continue market research, network, and grow everyday. That's the fastest way to buy property #2. 

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  • Darius Ogloza
    Investor · Marin County California · Member since 2018 · 1k+ posts · 2k+ votes
    4y

    ROI means "total return on investment," not "dividend yield for 1 year" which is what you seem to be focused on. Moreover, calculating ROI requires a specific time horizon and adjustments based on relative risk of different investments.

    If your investing horizon is one year or less, and care only about dividend yields and disregard relative risk, you should buy stock.  Think of it, you could have bought 1,000 shares of Netflix last November for $691,000 and have the whopping sum of $172,000 today!         

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