I've been doing some financial analysis on potential deals to purchase my first buy and hold rental in the DFW area. I'm struggling to find scenarios that seem reasonably profitable to buy and hold rental property.
Here is a potential scenario that I came across. Let's say I can steal a $100K property for $50K all in (including closing costs and repairs) that I can rent for $1,000/month. Our property taxes are brutal here and are almost 2.75% of the county appraised value in Dallas. This would meet the 2% rule and should be a slam dunk, right?
Here are the details when I breakout the estimated cost:
Rent = 1,000
Vacancy (100) --> 10% of gross rent
Property taxes (229) --> 23% of gross rent (100K x 2.75% / 12)
Property insurance (100) --> 1% of property value
Prop Mgmt (100) ---> 10% of gross rent
Maint Reserve (100) ---> 10% of gross rent
CapEx Reserve (100) --> 10% of gross rent
Operating Income = 271 --> 27% margin %
Mortgage payment (240) --> used mortgage calculator $40K, 30 years, 6% (assumes 20% down payment
Monthly cash flow $37
Annual cash flow $372
Cash on cash return = 3.7% ---> 372 / 10,000 for 20% down payment
When I add up the monthly costs and maintenance/capex reserves, this works out to 63% of gross rent which is quite a bit more than the 50% rule .
Am I being ridiculously conservative here with my expense estimates or does our high property taxes make it that more difficult to find a profitable cash flowing rental property?
Depending on the location, I think you're vacancy is probably high. If you're going to do a decent rehab, you should be able to rent the property pretty quickly, and 2-year leases are becoming much more common around here.
Overall, you're experiencing the same thing a lot of us are. The market rents haven't caught up with property values. However, there are some opportunities for positive cash flow.
Are you restricted in what areas you're looking at? What about price point?
In addition to what Hattie said, I'm also questioning your 6% mortgage (seems high to me) and I'd look into lowering your home's tax assessed value.
I'm open to most areas that are decent. I was hoping to find something reasonably close to where I live so the property management will be easier. However, the example above is over an hour away.
I'm definitely open to suggestions. I was thinking about trying to find a multifamily rental near TCU to rehab and rent to graduate students. There are some pretty rough areas around there so I need to research the area a lot more. I've only been restricting myself to properties under $200K because I've heard that the rents don't keep pace with property values. I guess this makes sense why everyone at the REIA meeting I went to was focused on flipping houses.
I'm not convinced rents with rise enough to keep pace with values. There is still farmland in Plano that will probably be converted to subdivisions when the price gets high enough. There are still houses being built over an hour north of Dallas on 380 between Highway 35 and 75. Those housing developments are becoming cities. There is plenty of land to keep expanding into bordering counties.
Reducing the mortgage rate to 4% only reduces the payment by $48. I'm not confident that I can convince county appraisers that this house is worth less than all the other houses on the block. I've challenged the assessment on my personal residence and they have all the power. There were two foreclosures within 4 houses of me and they wouldn't reduce my value.
I would look at a single maintenance/cap ex reserve of 10%. Not one of each.
Concerning the property values: In Dallas county they will typically adjust it down to your purchase price if you file a protest. If you buy now, you meet the 1/3 over-valued criteria in the given example - especially if you are buying at some number below $50k (you mentioned some amount of repairs). If you buy Jan 1- May 31, it is even easier - I just send a copy of my HUD via their on-line system and they match the purchase price.
I have had Dallas County leave it at the lowered value for 2 years so far (the extent of my longest hold to date) before adjusting upward, and even then it has not hit anywhere near market value. Depending on your strategy (long-term hold, versus mid-term or shorter-term to 1031 exchange), you may get some extra juice for a few years.
By the way, you live in Collin County, and they tend not to give on values. I find Dallas and Tarrant pretty straight forward; Denton somewhere in the middle.
By the way - what is the expected rehab? If significant, you are probably not going straight into a conventional loan.
First of all, your tax value should be what you paid for that house (e.g. 50K). If it's higher, you need to protest that and use your HUD statement as a support of your claim.
Your insurance should be lower than insurance on a comparable personal residence because you do not insure for any personal property loss. That's covered by tenant's insurance.
You may still allocate for capex and maintenance but there is high chance that you won't need to spend any of that money in the first 1-2 years because you fixed everything there is to fix on that house. It has new appliances, new floors, new paint, maybe even a new HVAC if the old one was close to the end of its useful life span.
You may greatly reduce the vacancy factor if you start advertizing 2 weeks before the house is ready. This will allow you to collect tenant's applications and hopefully have a tenant ready to move in once the house is ready.
Hope that helps
You pay market for houses. The you can get the discount for a year or so but I am running into the problem that my cheaply bought houses are being reevaluate and getting his with high tax bills!
Honestly that is why I self manage, buy higher value houses in in appreciating areas that have low cash flows. I have looked at some houses in South Texas that meet the 1.5% rules and perform just like you have described. While I know many people hate California, Central Valley has become a favorite place. While they do have higher entrance requirements, the lower taxs and insurance are amazing long term.
I figured out what you are describing the hard way in Charleston. While we have done well, we have not done nearly as well as I as a neave investor predicted :)
I agree with @Elizabeth C. that you will only get the property taxes knocked down for a year or two. Then the appraisal district comes back and tries to get you back to market. This has been happening to me recently. My personal approach is to estimate that I can get the appraised value to about 80% of market due to the fact that it's a rental and I usually pursue the protest process when I think the district is being too harsh.
I agree with @Nick B. your insurance is way too high for $100,000 house. I do ACV (which is a personal choice and may not be right for you based on your circumstances), and it's usually around $50-60/month.
Ultimately, though, I think your conclusions are generally correct that DFW is not a good cash flow city for the simple reason (1) our taxes are too high; (2) values to rents aren't as good in some other cities. If you are going with a cash on cash metric, it's really hard to make what many would consider "good" cash flow if you want to be in good areas. (Forget about the 2% rule unless you want to be in a D neighborhood). If you're buying at the price you identify in your example, the bulk of your return is going to come in the form of equity pay down and appreciation. Obviously, there are exceptions to every rule.
@Elizabeth C., what do you mean by "you pay market for houses"? In Jeremy's example, he would buy a house for $50K that is worth $100K after repairs. Sure, you pay the going market price for the house in distress which is below the price of the same house in good repair. Hence the idea of buying "below market". Once you rehab that house you (hopefully) have created more equity than your rehab cost.
@Andy W. & @Nick B.
The county reevaluate your price for your house. It's why a homeowner who bought a house for 100k 30 years ago pays on the value now in most places. My house bought 90k house in Chalreston 2 years ago, now makes me pay tax on the value of 140k.
@Jeremy Peters There are some nice areas, with solid schools, that cash flow well. Parts of Keller are an example. I have recently gained access to some properties in those areas. PM me with your specific criteria, and I'll see if there is anything that would work for you. Also, I have a property in Plano I'm working to wrap up that would be above you ARV target, but the preliminary numbers show a monthly cash flow of around $350. Again, PM me if you have any interest.
@Elizabeth C. & @Jeremy Peters
It is definitely a good idea to run your analysis with the full tax rate. Just consider the lower taxes a bonus. For me, since we are in a "growth phase", it does help to have that extra cash rolling in for the first few years to reinvest.
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