Understanding the price of rent based on the purchase of a house.

[Brent Steinhart]

I am new to all of this and I have been reading and trying to understand how to navigate taxes, purchasing, and establishing a rate for rent.

My big question is I have been watching Zillow and I see the purchase price of a house does not support the listed rent.

For example: I saw a house listed for 695k and I am not sure what it sold for but they have listed it for 2800 dollars for rent. If I run a mortgage calculator; the base payment would be 3700 dollars. P&I. Does not seem like a good investment? What am I missing? The property management company is A+ Property Management.

Look forward to hearing from someone on this. I live in Couer d’ Alene, ID. Resort town.

[Drew Sygit]

@Brent Steinhart

The Real Estate Crash of 2008-2010 caused real estate prices to crash across the country - but didn't affect rent amounts. This caused a historically unique opportunity for investors - they could buy Class A properties and immediately cashflow when renting them out.

This couldn't last forever, and it didn't, as excited new investors drove up prices.

Eventually, Class A property values increased to the point that even increasing rents didn't allow them to cashflow upon purchase.

So, the flood of new investors switched to buying Class B properties.

COVID created a chaotic spike in both the sale & rental markets, attracting even more new real estate investors. According to CoreLogic, in December of 2023, almost 30% of home sales were to investors!

Investment also spiked in Class A Short-Term Rentals (STR) and investors started paying higher and higher prices based upon anticipated STR rental rates, that exceeded sustainability based upon Long-Term Rental rates (LTR).

Now we're seeing investors pouring money into buying Class C rentals - but, many are getting burned.

In our experience & opinion, the main determinant of property Class is not location or even property condition, those are #2 and #3. The #1 determinant is the Tenant Pool.

If you don't believe us, try putting several Class D tenants in Class A apartment buildings and watch what happens. Or try the reverse - rehab a property in a Class D area to Class A standards and try to get a Class A or B tenant to rent it.

Unfortunately, many newbie real estate investors are jumping into buying affordable Class C rentals - expecting Class A results.

In our opinion, Class C tenants have FICO scores from 560 to 620 - where their chance of default/nonpayment is 15-22%. See the chart from Fair Isaac Company (FICO) below:

FICO Score	Pct of Population	Default Probability
800 or more	13.00%	1.00%
750-799	27.00%	1.00%
700-749	18.00%	4.40%
650-699	15.00%	8.90%
600-649	12.00%	15.80%
550-599	8.00%	22.50%
500-549	5.00%	28.40%
Less than 499	2.00%	41.00%

Source: Fair Isaac Company

According to this chart, investors should use corresponding vacancy + tenant-nonperformance factors of approximately 5% for Class A rentals, 10% for Class B and 20% for Class C.

To address Class C payment challenges, many industry "experts" are now selling programs to newbie investors about how Section 8 tenants are the cure. If only it was that easy. Yes, the government pays the Section 8 rent timely, but more and more tenants are having to pay a portion of their rent. Then there are the challenges with Section 8 tenants paying utilities and taking care of their rental property.

Investors should fully understand that Section 8 is not a cure-all for Class C & D tenant challenges, it's just trading one set of problems for another.

We see too many investors not doing enough research to fully understand all this and making naïve investing decisions.

Once you understand the above, you still need to find a property. You’ll have to do what investors did before the Great Real Estate Crash:

• Evaluating 100 properties, to identify 10 to make offers on, in the hopes one seller accepts.
  - Yes, this takes a lot of work!
• Network with wholesalers who can bring you “deals”
  - Many wholesalers are also newbies who have no clue what a real deal is and are just time-wasters.
  NOTE: We often see wholesalers re-marketing MLS properties at HIGHER amounts!
• Start using your own personal network to find motivated sellers.
  - Start posting on your favorite social media site what you are looking for – not once or twice, but CONSISTENTLY for 6 months! Give updates on properties you’ve looked at or analyzed to keep your audience engaged, so when they stumble upon a potential situation, you are the first one they think of.

Good luck!