How to Evaluate and Offer on Rental Properties

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This is perfect timing for me since I'll be meeting with a seller for the first time to look at a potential rental property this weekend.   It will be my first investment property.  

Similar to the comments already on the post...  This will be my first bigger pockets webinar and I'm extremely excited to grow my rental property portfolio that currently exists of 2 SF homes.  

Wondering if anyone has insight into this issue.  I'm in Phoenix looking for small multifamily complexes.  I'm finding a lot of properties that are selling but the numbers don't make any sense to me. I'm wondering how investors are buying these so they make sense? Are they buying them with 100% cash down? I

So my math says that this 4plex that rents for $1000 per unit/per month plus 240 per unit/per month HOA to take care of the landscaping etc..

So if you do $1,240 x 4 that's $4,960. After multiplying by .95 and .55 for vacancies and expenses it's roughly $2600 a month but if it sells for $620,000 then even a 30 year mortgage at like 4% with 20% down doesn't even break even.  

My guess is that an investor would obviously buy this differently than a traditional 30 year mortgage but I'm curious cause almost all of the small multi-families that I'm looking at are similar, even the ones that I get from wholesalers.

I guess my question is: Who is buying this type of property and how?  It's not a deal the way I do the math but deals like this are clearly a deal for somebody and I want to know how. 

I have been investing for 14 years and still don't understand why people buy properties like that. I buy in the Midwest. For a small four unit I generally get $400-500 per month in rent per unit. I can buy these for 25-35,000/unit. That math makes sense to me. That's why I have bought hundreds of these. There are definitely problems and the areas that I buy in Ohio. But with the high cash flow they can be overcome.

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Even worse in California.  Small rundown 2-bedroom Beach house in San Diego, which rents for about $3,000/month just sold for $1.2 million.  80% mortgage would be just under $6,000/mo and taxes add another $1,500.  Totally nuts.

I Registered for the webinar. yet, I was offered overtime at work as took it. I’m in the process of closing for my first rental and saving for the closing costs plus 6 month reserves. So yeah I need extra cash! My question is... is there an alternative time I can watch this webinar? I really want to attend! Thanks in advance for your response!

Originally posted by @David Forstadt :

Even worse in California.  Small rundown 2-bedroom Beach house in San Diego, which rents for about $3,000/month just sold for $1.2 million.  80% mortgage would be just under $6,000/mo and taxes add another $1,500.  Totally nuts.

Maybe it is being purchased with STR in mind. Our small beach property in San Diego (Mission Beach) rents at ~$10K/month using STR.

Add the historical appreciation and it could be a good purchase (Historically it would have been a good purchase but past performance is not necessarily a predictor of future performance).

Here is how it has historically worked out: Purchased (1999) for $375k which was very expensive (about 2.5x what same size unit would sell for 10-15 minutes from beach which is a worst multiplier than today), currently rents via STR for ~$10k/month, current value ~$1.3M. So great appreciation and great cash flow.

Risks: STR regulations. A down turn resulting in property and/or rent depreciation (Note there was the biggest RE down turn in history during the ownership of the historical example and it still has excellent property and rent appreciation).

Positives: As STR good cash flow. Great historical property appreciation. Great historical rent appreciation. Prop 13: the RE in example is taxed at a value below $500K.

I would not refer to a $1.2M purchase of a rundown beach cottage as "totally nuts" but I am currently not looking at any property in the city of San Diego with the idea of STR due to the STR regulations not being "finalized".

Just presenting a different perspective based on history.

@Jean De la cruz , We try to record every webinar, and if you registered, even if you cannot attend, you will get an email with the replay link. The replay link is only good through Saturday at Midnight, so make plans to watch it soon.

I keep seeing that everyone talks about 20% down, the banks I'm talking to in Ohio are requiring 25% down since I'm an investor and not going to be living in the purchased property....interested to learn some more about how everyone is getting around this...out of state lenders? Private lenders? Any insight would be helpful....Thanks!

@Dan Heuschele I would be interested in hearing more about your outlook on the beach - especially San Diego. I presently own a triplex in South Mission Beach purchased via short sale in 2011 for $675k which now has a value around $1.5m. No debt. The appreciation has been fantastic and rentals combining both LTR and STR have been consistent, but no way am I getting $10,000/month. STR also comes with very high cost in terms of turnover expenses and property management.

We are now re-assessing the investment because rental income is out of line with property value.  Do we sell and invest elsewhere?  1% rule could generate $15,000 in monthly income. elsewhere.  The poor current ratios also question the property's future appreciation potential.  Don't get me wrong - we love South Mission Beach!  But at this point I think we may be holding on based on our hearts and not our brains.

(The $1.2m property was a true flea-bag - not rent-able without significant rehab.  Even if cleaned up, monthly rate would not exceed $3,000/mo.  Potential for re-development into a multi-unit, but the holding costs would be extremely high.  We are presently looking for Bayside properties for such re-development)

Originally posted by @David Forstadt :

@Dan Heuschele I would be interested in hearing more about your outlook on the beach - especially San Diego. I presently own a triplex in South Mission Beach purchased via short sale in 2011 for $675k which now has a value around $1.5m. No debt. The appreciation has been fantastic and rentals combining both LTR and STR have been consistent, but no way am I getting $10,000/month. STR also comes with very high cost in terms of turnover expenses and property management.

We are now re-assessing the investment because rental income is out of line with property value.  Do we sell and invest elsewhere?  1% rule could generate $15,000 in monthly income. elsewhere.  The poor current ratios also question the property's future appreciation potential.  Don't get me wrong - we love South Mission Beach!  But at this point I think we may be holding on based on our hearts and not our brains.

(The $1.2m property was a true flea-bag - not rent-able without significant rehab.  Even if cleaned up, monthly rate would not exceed $3,000/mo.  Potential for re-development into a multi-unit, but the holding costs would be extremely high.  We are presently looking for Bayside properties for such re-development)

Your RE seems nicer than our RE (Your value is listed higher) but where we likely have an advantage is ours is a 2/1 duplex with each unit being real small (I think the bigger of the 2 is maybe 650'). So that >$10K/month is average month with STR year round both units. We are 4 or 5 properties from the beach and 2 blocks north of Belmont park. We may be the cheapest STR units that close to the beach. Our units are currently 100% booked through Oct and November will be all or mostly booked before November (rent is less in the off season but my month rent figure takes this into account as our summer rent is ~$18K (again including both units). So we achieve high booking rates even in the off season.

The Property Manager gets a significant take but we could not do it without property management.

So my fear is the pending STR regulations and what it will do to our profits. Similarly the STR regulations can hurt the value of the property. So those are sell indicators. But here is the big hold indicator: You have beach property in San Diego which possibly has the best climate in the US (at least it is up there). They are not making more beach property in San Diego. The supply is minimal. It is and should continue to be in high demand. So it is my belief that any resulting depreciation due to STR regulations will be short-lived.

No matter what occurs with the STR regulations we plan on holding the property. Ideally we can keep at least one unit STR but if we have to turn both into LTR we will still keep the property but obviously our cash flow will take a drastic hit.

Good luck

It looks like I missed this. As I am brand new here, if there's any way I can watch a replay or listen to it I would love a link.

Originally posted by @David Forstadt :

@Dan Heuschele I would be interested in hearing more about your outlook on the beach - especially San Diego. I presently own a triplex in South Mission Beach purchased via short sale in 2011 for $675k which now has a value around $1.5m. No debt. The appreciation has been fantastic and rentals combining both LTR and STR have been consistent, but no way am I getting $10,000/month. STR also comes with very high cost in terms of turnover expenses and property management.

We are now re-assessing the investment because rental income is out of line with property value.  Do we sell and invest elsewhere?  1% rule could generate $15,000 in monthly income. elsewhere.  The poor current ratios also question the property's future appreciation potential.  Don't get me wrong - we love South Mission Beach!  But at this point I think we may be holding on based on our hearts and not our brains.

(The $1.2m property was a true flea-bag - not rent-able without significant rehab.  Even if cleaned up, monthly rate would not exceed $3,000/mo.  Potential for re-development into a multi-unit, but the holding costs would be extremely high.  We are presently looking for Bayside properties for such re-development)

One item that I neglected in my original response is that the no debt implies not leveraging your assets.  In historically appreciating markets leverage is extremely beneficial.

A few scenarios all simplified such that no refinancing or reinvesting of profits takes place (which I would never suggest but makes the calculations easier: Realize in each case the cash flow and/or equity could be used to further gains):

- Purchase for $675K cash in 2011 now worth $1.5M ($825K value increase) for %117 increase of value of the cash. Note there has been good cash flow each of these years because no PnI. So actual ROI is significantly higher. It works out to a decent annual return but the market did exceptional in this example.

- Spend $675K cash in in 2011 high cash flow area that achieves 1% rule (6.75K month rent). In high cash flow areas the 50% rule is roughly accurate so $3.4K month cash flow. 6 years = $244K. Add 2%/year (not compounding because I am lazy and with this low percent it makes only a bit of difference) for inflation appreciation = $81K (even high cash flow areas often appreciate at inflation rate). Total $325K on $675K investment for a 48% return on the cash. Annually it is not a good return which shows that if you are in a low appreciating market you need to do better than the 1% rule to obtain a good return (I realize I am simplifying things and that the cash flow could be invested obtaining returns that do not show up in this admittedly simplistic approach but I also do not consider 10% return on something as active as REI to be a decent return). Note if you finance this or pay all cash the returns are similar.

- purchase $675K property in 2011 with 20% down ($135K) that has now appreciated to $1.5M. Granted the cash flow likely would be minimal if using only LTR in Mission Beach. So we will call the RE cash neutral for the 6 years (the only way this happened in reality was if it was significantly cash negative at purchase because the rents have risen ~50% in the 6 years). The $825K value increase reflects 600% return on investment (cash) which works out to a great ROI.

My point is that in high appreciation markets leverage helps the return significantly. By having $1.5M of equity in a property that is worth $1.5M there is no leverage helping to produce great ROI (rather than the good ROI that you have achieved).

Good luck

Thank you, Dan

I appreciate your taking the time to give a thoughtful response.  I agree that using leverage in an appreciating market can produce greater returns.  On the property in question this was not an option (for tax reasons).   For our next purchase, however, we intend to use unencumbered funds with modest leverage.

The question is whether the real estate will continue to appreciate.  Southern Californians know all too well the dangers of leveraged investments when property values fall.  We liked your observation that they are not making any more beaches in San Diego - that has tremendous merit.  On the other hand, I am increasingly convinced that this state has lost its mind. This may be a result of my working too much in San Francisco, but I have a genuine concern about irrational state regulations.

I am still intrigued by your ability to realize such great income streams through short term rentals.  I ran into a very good property management group called 710 Beach Rentals which may help produce such yields but I would need to do some remodeling to convert our year-round units into vacation rentals.  We are looking into that option now.

Originally posted by @David Forstadt :

Thank you, Dan

I appreciate your taking the time to give a thoughtful response.  I agree that using leverage in an appreciating market can produce greater returns.  On the property in question this was not an option (for tax reasons).   For our next purchase, however, we intend to use unencumbered funds with modest leverage.

The question is whether the real estate will continue to appreciate.  Southern Californians know all too well the dangers of leveraged investments when property values fall.  We liked your observation that they are not making any more beaches in San Diego - that has tremendous merit.  On the other hand, I am increasingly convinced that this state has lost its mind. This may be a result of my working too much in San Francisco, but I have a genuine concern about irrational state regulations.

I am still intrigued by your ability to realize such great income streams through short term rentals.  I ran into a very good property management group called 710 Beach Rentals which may help produce such yields but I would need to do some remodeling to convert our year-round units into vacation rentals.  We are looking into that option now.

The San Diego STR regulations are being worked which presents risk for STRs but I agree that currently the best cash flow is via STR. I would not spend much converting to STR until the STR regulations are finalized. STR does require more work so almost requires PM. I have seen the signs for 710 Beach Rentals so they are a big player in the PM business in Mission Beach. We use vacasa.

As for your lost your mind comment I have held a belief since the 1980s of how much higher can RE prices go?   The answer so far has always been still higher.  I realize it cannot continue indefinitely but no one knows when or where it will stop appreciating long-term. 

Good luck

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