Investor · Keller, TX · Member since 2015 · 81 posts · 22 votes
Hi Bigger Pockets - long time lurker. Part of my procrastination in buying SFR rentals in 2016 has been that my calculations show negative returns, thus no cash flow. The DFW market heated up rapidly in 2013-2016 and has cooled slightly over winter. However, housing is still very expensive and rental value has not kept up. Whether sales have peeked or not is another debate.
How do landlords manage to buy and hold rentals if the rental returns are sub the 1% rule? Some area's the rental income is as low as 0.6% - 0.8% of value and if you do the due diligence there is not enough in the rent to set aside for keeping you at the recommended minimum 50% expenditures. E.g. Vacancy (8.133%pa) Insurance (1% of value pa) Maintenance (10% of rent) Taxes (2.48% of purchase value pa) Management (??? 10% of rent)
Granted some expenditure above is subjective, but you still need to set it aside and this excludes servicing your mortgage. Unless you have a lot of equity in the property the numbers do not stack up. Property is sold the day it hits the marketplace and I am yet to find discounted property for sale to satisfy the 1% rule. So how do seasoned investors make money in this sort of rental market?
In my opinion, the 2% Rule is really only useful for lower priced properties in the $50-100k range. If you have a $50k SFR that rents for $1,000 that'd be a killer deal and meet the 2% rule of thumb.
But like @Eric Marofske said, in California it simply doesn't work. You'd need to find a $400k property that rents for $8,000 per month! And the second you find one of those let me know because I'll be the first to buy it lol.
Once you get past a certain price point, SFR becomes out of the question. You'll need to start looking to 2-4 unit multifamily. That's the only way to make some decent returns on the monthly cash flow.
Here in Sacramento and the Central Valley (Stockton, Modesto, Fresno) you can expect 0.60 - 0.70% on average, with the better properties being in the 0.80 - 1.0% range. RARELY will you see something crack the 1% barrier (at least off the MLS) and usually it's gonna need some serious rehab and remodeling. Highest I've ever seen was like 1.33% on a fourplex in Stockton, CA.
Hope this information helps! Start looking into 2-4 units and you're sure to find some deals!
I guess I’m a little confused by your question. Are you saying you performed some analysis on several sales in the area and determined that a high percentage of the owners are experiencing negative cash flow on their units? If so, that would seem to factor in many assumptions on the acquisition numbers of the properties. Has there been some investment figures that have been released for the DFW area that show downward trends on the rental market? Just trying to get an understanding on how you came up with many of your figures without knowing the acquisition figures, rehab info, contract info, sales comps, ect…for each property. You mentioned it yourself that many of these properties are selling the day it hits the market…that would indicate some serious activity in your market. Just thoughts…but perhaps more seasoned investors can add on.
Every market is different; some are generally stable and have lower price to rent ratios (eg the midwest) and others are the opposite (California, New York). If your analysis of your market is indeed accurate, then perhaps the current invests are shooting primarily for appreciation, or maybe they are willing to accept lower returns than you.
You might need to consider looking out of state to find a market more suitable to your investment criteria. Investors do this all the time!
In my opinion, the 2% Rule is really only useful for lower priced properties in the $50-100k range. If you have a $50k SFR that rents for $1,000 that'd be a killer deal and meet the 2% rule of thumb.
But like @Eric Marofske said, in California it simply doesn't work. You'd need to find a $400k property that rents for $8,000 per month! And the second you find one of those let me know because I'll be the first to buy it lol.
Once you get past a certain price point, SFR becomes out of the question. You'll need to start looking to 2-4 unit multifamily. That's the only way to make some decent returns on the monthly cash flow.
Here in Sacramento and the Central Valley (Stockton, Modesto, Fresno) you can expect 0.60 - 0.70% on average, with the better properties being in the 0.80 - 1.0% range. RARELY will you see something crack the 1% barrier (at least off the MLS) and usually it's gonna need some serious rehab and remodeling. Highest I've ever seen was like 1.33% on a fourplex in Stockton, CA.
Hope this information helps! Start looking into 2-4 units and you're sure to find some deals!
To add onto what Wes said and give you a better idea. Here in southern California (Orange County), you are looking at more of a 0.4-0.5% using that method and that is in the low B/C class neighborhoods. If you are looking at the A to A+ neighborhoods expect around 0.175-0.35%, as an investor it's not even funny. I have been looking at properties in the Dallas area, north of Dallas area, and have found properties that can give some decent returns. Just got to do some more digging, and re-evaluate the areas. Would you happen to be looking in A class neighborhoods or more B/upper C class neighborhoods.
I bought a condo in a A+ location in San Francisco during the 2008 collapse on short sale for $680k, rented $2850, for about 0.4%.....
So for a nice property in a good location, you will never see 1%.....
You will need to look into C locations to find your 1%....for example, C class in Phoenix will give you 1.5% today....check out 1609 w Glendale, Phoenix , AZ..... you will get 1.5% there
@Gary Baker, the short answer to your "How do landlords manage to buy and hold rentals if the rental returns are sub the 1% rule?" question would be: they've paid CASH!
So even netting just 60% of 0.6%/m rent return, gives the investor a 4.32% yield.
Which is still better than leaving their money in the bank. And appreciation is extra!
Another reason why those same properties show such terrible returns for typical investors (who only have say 20% deposit) - you're competing against well-heeled owner-occupiers! My 2c...
Gary Baker you haven't indicated where you are finding these sale prices but I am sure there are savvy investors out by you who are doing much better than the returns you are indicating.
The first thing you need to modify in your search is where and how you can acquire properties significantly below market value. Look for distressed plays such as death with the kids out of state looking for a quick transaction. They would happily accept 20-30% below market for a quick transaction that wouldn't require multiple trips for them.
Granted you might not have time to do the type of due diligence this requires; this is where wholesalers can add value because they look for these plays. Network with them and try to be the guy they call when a good deal comes up.
Best of luck!
Look in Arlington, Grand Prairie, The Colony, and McKinney. 1% rule is something that BP made up I think, but in the commercial world we use what's called a gross yield. Annual gross rents/price + repairs. You'll most likely find 13%+ GY in those areas.
The only reason I can see you buying rentals in a hot DFW market is for a long term hold (20+ years) or to package them up and sell as a portfolio so you can 1031 into a larger asset.
Gary Baker like many have said ^ above, it can be tough in places like California or DFW. Tough, but not impossible ! Just need to be a little creative!! Someone earlier mentioned off market deals, I would go with that route so that you can start finding deals below market value, and also consider a value add... not sure if you would be open to minor rehabs, but if you can buy an off market deal for a good discount, and then say add a wall and closet to turn a 1bdrm into a 2bdrm, you can add some serious rental boost to your property. Not easy but possible :) try to connect with someone who is already doing it, learn from them and also research zoning laws in your area. Good luck !!
@Gary Baker - the deals are out there, they just take some patience to find. We just wrapped up a BRRRR off-market deal on a house in Hurst. Came out at 1.1%, so I cannot complain (1.1% measured against purchase+rehab. Personally, I prefer to see 1% of ARV, which we were not at on this one, rather were at 0.90%, but close enough given the significant equity capture we had).
Scanning the comments, I think someone pointed out: the lower-end markets/houses will have better yields typically. So you may exceed the 1% in a place like Haltom City, where it may be more difficult in a Keller or Carrollton where values are much higher.
Many people operate on negative cash flow for tax reasons. In SF Bay Area CA it has always been negative until rent catches up. It is the appreciation potential in good neighborhoods that counts. Few investors will regret.
Many people operate on negative cash flow for tax reasons. In SF Bay Area CA it has always been negative until rent catches up. It is the appreciation potential in good neighborhoods that counts. Few investors will regret. I talked to my investor who bought several from me. He told me his holdings have tripled in value in 4 years.
WOW thanks for all the responses folks, I hope I tag everybody correctly, as there is so much to add and ask.
@Jay Dewberry
Jay, I have run basic calculations of my own against MLS ‘averages'. So I would take the retail price of a property and then compare with the average rental/sqf for that area. The market has been that hot now that houses are under offer the same day. The last six months I have seen a multitude come back after due diligence and FW I have seen some minor price corrections. I still don't see real value in SFR rental returns, but this is my limitation. I am an engineer, I over analyze everything.
@Eric Marofske Eric, the DFW market has had an influx of people for the last 8 years from all over and this has spurred a lot of development. I am weary of out of state properties, because of the huge differences in the law between each state. I mean you cannot even find consistency between different counties in a state. I might have to consider turnkey rentals with good management for the interim.
@Wes Blackwell Wes, the multifamily units here do not show up on MLS. I guess I need to find the right market place where these are listed. From other answers below it appears that the market lag in rental income requires you to either have equity or run the risk in the short term of capital expenditures killing any profit initially. I would like to stick to B areas and these houses have risen over the last few years from $60k/$80k to upwards of $150k; the rentals used to be +1% but they now lag if you are entering the market. @Daniel Y. Daniel, my criteria are B/B+ areas, although I have restricted my areas in the metroplex. I need to re-evaluate this strategy. A/A+ property for rental would require the long game of capital appreciation. It could be argued that $25k down in four $100K houses would be better than $100k down in a $400k home if the return is 0.6%pm. Spread the risk a bit. @Diane G. Dianne, your short sale is probably worth around $1.4 million now. Rentals in that market have also gone stupid so I guestimate your 0.4% is now closer to 0.75% of your original $680k. If you were to buy now the rental return would probably make even less now. If you still have that property, you have some nice equity. I have a friend invested in Phoenix, I will pick her brains. I know she had a lot of grief initially with management, but maybe that would be another avenue for me. I do like Phoenix. @Brent Coombs Brent, in an ideal world I too would pay cash, but it could be argued that a 4% yield is horrible and relying on capital gain can be dangerous; why so many people on BP have pulled out of the stock market is to achieve 8-15%. I suppose 4% as passive income during retirement might be a low risk strategy. @Amit Kal Amit, I am looking at the retail MLS. I am not savvy; I unfortunately was uneducated in the ways of the real world of finance and relied on the stock market. But after every crash for the last 30yrs I finally woke up to the fact that I literally have not made any real gains in the stock market in all this time. So in time for retirement, I now have to apply high risk strategies to help bolster an otherwise non-existent 401k. As for 20-30% below market value properties, I have only seen them in C/C- areas and I am uncomfortable/scared with this as not being savvy and streetwise. I am on a wholesaler email list, but honestly the ARV they give is too high and the repair estimates are very low. I need to get on a few more lists. @Mark Allen Mark, does your gross yield take into account your contingencies? I am conservative with this sort of thing as I hate “the A/C went out” surprises or that multi month vacancy or eviction possibilities. Holding property is fine so long as it is performing, but not for 20yrs as I will be dead before then. I do like the idea of packaging up a portfolio to break into large multifamily deals. @Alex Capozzolo Alex, value add is my forte'. I can ‘see' around corners when it comes to creating extra living space. Living most my life overseas has shown me many ways of utilizing space. We are spoilt here in the US with large modern homes. I have also given thought to buying land and applying for rezoning permission, although this is harder that it looks. I need to investigate this more as it might be an option to development rather than BRRRR @Andy W. Andy, I have been researching mostly the greater FW area. Driving around and deciding what areas are best suited. NRH, Haltom Watauga and some parts of Keller. Also East and West of the i30 but not as far over as Arlington. Not scared of serious rehab, it just must make financial sense. I work full time so I have to take into account the cost of hiring contractors. I also looked at north Dallas, but decided that the area was inconvenient and not practical, as getting across there for issues would be difficult during work hours (and then there is the infamous traffic) @Sam Shueh Sam, Property tripling in value is the very reason rental return is so bad. If you can ride a few years of storms then the longer term gains will always outweigh the low returns. I forgot all about tax. I will factor this in and see how my figures look after doing this, thanks.
As for advice…my beer tonight has this on the label “Life is Uncertain. Don’t Sip”. Talk about gulping from the BP firehose. Thanks folks
The comment you made about the properties not appearing on the MLS doesn't sound right... they must be listed on the actualMLS. Zillow, Trulia, and even Realtor.com can't hold a candle to the actual MLS search engine that covers the region you are in.
If that doesn't work, simply go to http://www.gfwar.org/ and click the red "Find a Home" button shown in the picture below. Then simply select "Multi-Family" from the top and perform your search. Ta-daa!
Usually every single MLS provider will have a website where you can access the MLS and perform searches similar to the way an agent would. You still won't get nearly as much information, but it tends to be better for investors than Zillow, Trulia, etc.
Ah, what I meant was there are not many showing up for sale on MLS for whatever reason. There are a lot of multifamily homes around DFW but a disproportionate number for sale on the MLS, so the owners are not selling or my guess is that they are mostly sold off market or via other avenues. I will have a look at your links, thank you
Agreed. Every market is different. For instance, Kansas City, taxes are much lower and our PM is 8%. Insurance is around $500 per property and vacancy numbers are low. We do also see cash flowing properties with built in equity and/or high appreciation rates.
@Gary Baker Thanks for the interesting post. I invest in single family properties in both NY and Ohio. Over the years I have found that the rules of thumb you refer to are primarily operable on lower end properties and do not account for paying a mortgage. Since i am a cash investor seeking immediate income I have focused on the Ohio market even though I am living in New York because this market can yield the results you speak of and better. Dayton OH for instance has a backlog of inventory and is an extreme buyers market. a $30,000 property will get $600 month rental income with taxes around $800 per year and insurance around $550. You can crunch the numbers and do the math yourself. In NY a property purchased for $700,000 does not cash flow well if at all with taxes close to $15,000 and insurance $4500 ( near the water) it will pay the mortgage with a rental income of $4500 and your tenant will build your equity so that after 25 years you own a valuable asset but doesnt do much for your current cash flow. They all have tax benefits that will positively effect your taxable income. It all comes down to your personal financial goals. Young investors with a long time horizon can do well to use leverage to build equity over time, Older investors like me who need to invest cash will need to go to lower priced homes to get better returns. I would however caution investors who seek these returns in lower priced homes. Even though I can find properties that will generate better returns they take considerably more management skill or they will turn bad very fast. Especially if you are an out of state investor. Also most of these properties are in areas that are being bought by other investors, so don't plan to flip these at a profit unless you buy distressed property, rehab them, get them rented and provide a turn key for investors who dont have the skill or the stomach for this type of investment.