Advise on an offer on a rental property

[Neetu Dsouza]

l live in Montgomery County Maryland where the property prices and rents are on a higher side. This would be my first investment property if the offer gets accepted.
I am looking at 2 properties:
1. I just went and looked at this townhome which is listed for 120k. It is a foreclosure townhome and the property is in very good condition. My realtor told me that I could get about $1400 - $1500 mo. The neighborhood seemed really shady. I was really hesitant when I looked at the people in that community.
2. Another property that is listed as short sale for $170k. It is a newer townhome in the suburbs and rent would be about 1400 - 1500 also.

It is a huge difference in price and I am not sure if any of above seem like a good option.

Thanks for your help.

[Jon Holdman]

Keep in mind the goal is to make money with your investments. If you can't find something that makes money, don't buy it. If "the best deal I can find" is a crummy deal, don't buy anything.

Now, long term appreciation can, in the long term, make money even with negative cash flow. And the DC market is currently one of the strongest in the US. That may or may not persist. But the fact it last sold for $272K in 2005 and you can now buy it for $120K doesn't really bode well, does it?

And even a break even property can be valuable long term once the tenants pay it off.

Are you going to manage it yourself or hire a PM? If you're hiring a PM, then the "50% rule" almost certainly applies. That says that over the long term and for a number of properties, expenses (you've listed some of those), vacancy (not included in your calculations) and capital (also not included) will eat up 50% of the scheduled rents. So, out of that $1400 in rent, you're left with $700 in "net operation income" or NOI. From that you have to pay the mortgage. With 25% down on a $120K purchase I get a payment of $483.14 a month for 30 years at an investor rate of 5%. So, that leaves you with true cash flow of about $217 a month or $2602 a year. On a $30K investment (actually higher with your closing costs), you're looking at about 8.7% cash on cash return.

Now, if you manage it yourself and handle minor maintenance you can earn a pretty good chunk of that "50%" for yourself. Perhaps a third or so. So, that's roughly another $233 or so a month or a total of a bit over $5000 a year. Generally property management is not too big a deal, but once in a while you have to deal with something. Filling a vacancy is probably the single biggest task.

Now realize that a lot of these expense can be very lumpy. The ones you've listed at the routine ones that come month in and month out. The cash flow you listed is what you will get in your good months. Once in a while, though, you will have some vacancy. Or, you'll need a new furnace. Or the HOA will give you a special assessment. Or your tenant will stop paying and force you to evict.