First Deal?

Question

Asking Price: 50,000
Taxes(annual): 220
Insurance(annual): 450
Monthly Rents: 600

We have considered offering all cash.
If we take a loan, we are looking at around 200/month.

I already have 4 people interested in renting.

We are hoping to pick it up for 42,000 but are offering 38,000 to start.  I think I have finally found our first property.

Michael Rossi · Answer

"... but if you figured the payment, taxes, and insurance plus another $100 or so for other expenses it would be more workable, assuming you don't pay any utilities, trash or other monthly expenses."

Management is typically 10% of the gross rents, so just that one expense would be $60 per month.  You may argue that you're doing the management yourself, but all that means is that you're working for free (I don't work for free).  What about advertising?  Legal expenses?  Entity maintenance?  Utilities during vacancies?  Capital Expenses?  Damage done by tenants in excess of the deposit?  Evictions?  Court costs?  Setout fees?  Capital expense?  etc, etc, etc?

That's simply wrong.  As the rents go up, so do the expenses.  Insurance is higher on a more expensive house.  Taxes are higher.  Higher rents are normally commanded in nicer properties, which means the amenities are more expensive.  Vacancies cost more dollars because the rent is higher.  etc, etc, etc.  In other words, in normal rentals the 50% ratio is quite accurate over the long term.  We've had many people on here claiming they had expenses significantly lower than the 50% number and in EVERY case they were ommitting some of the expenses or considering them "off budget" because they don't occur very often.

Mike

Michael J. · Answer

That's what I figured. It will definitely be a safe figure. Not saying this one is a good deal exactly but if you figured the payment, taxes, and insurance plus another $100 or so for other expenses it would be more workable, assuming you don't pay any utilities, trash or other monthly expenses.

Especially if it is older and will need a lot of appliance and HVAC repairs soon in the future. If you can do those repairs it will save you a lot of money though.

Will Barnard · Answer

I often disagree with the 50% rule, but in tis case, it most likely will apply.
When you have gross rents of only $600 or less in other cases, the OE including, but not limited to, mortgage, taxes, insurance, management, repairs, & vacancy will surely add up to $300 monthly.

Remember, as Jon said, this is a screening tool only and is based on averages. Be definition of averages, some expenses ratios will be lower, and others higher. When you get into gross rents of $800 or more, the ratio of expenses drops due to the fact that some of the OE are fixed and do not increase simply because the rent is higher. On the flip side, lower rents can result in higher expense ratios.

Jon Holdman · Answer

Its just a simple expenses = 50% of rent rule of thumb.  Discussed in several other threads in gory and contentious detail.

Michael J. · Answer

Just curious, how do you determine $300 operating expenses? That seem kind of high. Since it is a single family the tenants should pay for yard care and utilities. I know you need to put something back for repairs but I wouldn't think you would need $300 a month, although it is probably an older house and may need repairs depending on how old the HVAC and other items are.

Will Barnard · Answer

Mike puts the return on the cash invested inside the cash flow projections. His thought is, if you put up cash, you want a return on that cash and thus figures in the cost as if it was part of the mortgage. You could also figure that return outside the investment, in other words, not include it as cost in your cash flow projection and have it as a seperate investment. either way, it is relative and ultimately, you want a return on it. Mike's version is a simple and easu way to figure that in by including it in the cash flow projection. Now you may want better than a 7% return on that $ and tehrefore must calculate that figure accordingly.

Eric Davis · Answer

Mike could you explain what you mean by having to account for the cost of the money.  I figured if we picked it up for say 40,000 and we can bring in 300/month.  We're looking at around 9% cash on cash return.  I should have also mentioned that the rehabbed houses in the area are selling for 80,000.  So I was thinking rent for 2 years with a little cash flow and then sell for at least 10,000 profit after we rehab.

The realtor told me that the seller is putting the price at what he owes.  So if I offer lower, we are talking about a short sale to even make it possible.   This is the cheapest property in the entire area, so I just don't see how it is possible to make the numbers work.  Thanks for the help again.

Tom C · Answer

Better check those taxes again.. Also, if you have 4 people already wanting to rent it. Sounds like you can up the rent.

Michael Rossi · Answer

This is not a good deal - I'd pass!

Here is how I see this deal:

Gross rents:  $600
Operating Expenses:  $300
NOI:  $300

Mortgage Payment ($42K, 30 yr, 7%):  $280

You've got to account for the cost of the money, whether you borrow it or not!

Cash flow:  $20 per month  (Not good)

It would be a much better deal at a purchase price of $30,000.

Good Luck,

Mike