Trying to find cash on cash
Real Estate Investor · roscoe, IL · Member since 2009 · 131 posts · 8 votes
Trying to find cash on cash
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Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
15yThis a mediocre rental regardless of the area, as a pure rental. Now perhaps there's something else going on, but as a rental, if this is the best you an do, don't buy rentals in this area.
First the payment part. I'll assume 25% down at 6% for 30 years.
Price: $125,000
Down:$31,250 (ignoring costs, about another $4000)
Payment: $562.08 (P&I only)
Now the rent side:
Rent: $1400
50% rule: $700 (vacancy, capital, expenses)
NOI: $700
Cash flow: $137.92/month
Cash flow: $1655.06/year
Cash on cash return: 5.3%
Now, you might say "that meets the $100/month goal". Only because of all the cash you have into the deal. Assume 0% down to evaluate the deal by iteself:
P&I payment: $749.44
Cash flow: $-49.44
The $187.36 difference is because of the cash you have invested. The property itself is a loser.
9 Replies
- Real Estate Investor · Weatherford, TX · Member since 2011 · 27 posts · 11 votes15y
The 50% rule says you can cover your PI payment w/ 1/2 the rent. Assuming 20% down and a 30yr note at 7% you would be under the 700 a month number. Your down payment would be 25k plus ~3-5k at closing. The PITI based on your info is around $980/mnth.
Ultimately you are the only one who can determine if those numbers sounds appealing to your investment strategy.
I don't know your area, maybe that is a good deal or maybe your money could go farther elsewhere. In my area those numbers sound fine, I just don't go looking for rentals in that price range.
Good luck.
- Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes15y
This a mediocre rental regardless of the area, as a pure rental. Now perhaps there's something else going on, but as a rental, if this is the best you an do, don't buy rentals in this area.
First the payment part. I'll assume 25% down at 6% for 30 years.
Price: $125,000
Down:$31,250 (ignoring costs, about another $4000)
Payment: $562.08 (P&I only)Now the rent side:
Rent: $1400
50% rule: $700 (vacancy, capital, expenses)
NOI: $700
Cash flow: $137.92/month
Cash flow: $1655.06/year
Cash on cash return: 5.3%Now, you might say "that meets the $100/month goal". Only because of all the cash you have into the deal. Assume 0% down to evaluate the deal by iteself:
P&I payment: $749.44
Cash flow: $-49.44The $187.36 difference is because of the cash you have invested. The property itself is a loser.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes15y
AMEN !
- Real Estate Investor · Garland, TX · Member since 2010 · 86 posts · 34 votes15y
Originally posted by Jon Holdman:
This a mediocre rental regardless of the area, as a pure rental. Now perhaps there's something else going on, but as a rental, if this is the best you an do, don't buy rentals in this area.First the payment part. I'll assume 25% down at 6% for 30 years.
Price: $125,000
Down:$31,250 (ignoring costs, about another $4000)
Payment: $562.08 (P&I only)Now the rent side:
Rent: $1400
50% rule: $700 (vacancy, capital, expenses)
NOI: $700
Cash flow: $137.92/month
Cash flow: $1655.06/year
Cash on cash return: 5.3%Now, you might say "that meets the $100/month goal". Only because of all the cash you have into the deal. Assume 0% down to evaluate the deal by iteself:
P&I payment: $749.44
Cash flow: $-49.44The $187.36 difference is because of the cash you have invested. The property itself is a loser.
Well said Jon,
I think what most people forget about the 50% rule is that it should always be calculated assuming 100% financing regardless of if that can be achieved or not. If a property cash-flows using this calculation, each individual can then decide if they want to "buy" additional cash-flow by putting down more money.
- Real Estate Investor · roscoe, IL · Member since 2009 · 131 posts · 8 votes15y
Thanks Eric, Jon, Joel and Stefan for the generous advise. Here I would like to bring a point which is sometimes overlooked in the analysis of rental property. Cash flow is one aspect of rental benefit. However this house was once3 230000 dollars. So if the housing market starts to come back say in 5-7 years (at least close to where it was before) then the appreciation of the house is something to consider. Also the fact the house is in a very desireable location with very school system is another positive. Third the house is just ten years old. So the maintenance in such houses are much lower compared to a fifty or hundred year old house. Are these point which I stated are something that should be in the equation of house analysis? I would like to invite your comments and correct me I am wrong. Regards.
- Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes15y
Jack -
All these things can play into your decision, but it's up to YOU to determine how much each plays into what you decided to do.
For example, the consideration of future appreciation: While you can certainly consider that the property used to be worth a lot more, that doesn't mean it will ever be worth that amount -- or anywhere close -- again. Maybe it will, maybe it won't. If you want to add the additional risk to your strategy by hoping for appreciation, that's perfectly valid, but remember that this is a risk.
As for it being near good schools, that information has pretty much already been factored into the equation when you determined the rental rates. I assume if it weren't near good schools, you'd be getting less than $1400 in rent and the property would be a worse deal.
As for the age of the property, 10 years is a tricky spot. If you plan to hold the property for at least another 10 years, expect that you will need to replace the roof, replace the mechanicals, replace the hot water heater (maybe twice), etc. These are costly expenses, and if you don't spend the money yourself, it will likely result in a lower resale price due to deferred maintenance.
So, the short answer is "yes," those things should all be part of the equation, but only you can determine to what degree they should factor in based on your level of risk, your level of comfort in your cash reserves, your goals, your needs, etc.
- Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes15y
Notice that I did say "Now perhaps there's something else going on". If potential appreciation is a factor, then it may still be a good investment.
The bubble was driven by very different factors than normal appreciation. The Case-Shiller index has data that goes back into the late 1800's. If you look at that data, adjusted for inflation, you will notice an interesting result. That is that home prices are flat! That is, the ONLY factor that affects home prices over the long term is inflation.
There are three exceptions in that long term data. One is the great depression. At that time, home prices took a nose dive and remained at a new lower level until the next disruption. That was at the end of WWII when lending practices were changed, making it much easier to buy a house. The third was the recent bubble. Here again, the change was driven by a change in lending practices, specifically (IMHO, opinions vary) the creation of CMOs (collateralized mortgage obligations). That is, the bundling of mortgages, slicing them into tranches and then claiming the top tranches were very solid and the low tranches were still very solid but had very high returns. Investors ate these up. That created more demand for these investments, which created more demand for loans to be generated which resulted in further loosening of lending criteria which led to the whole mess.
So, to say it was worth some high number during the bubble is like saying high tech stocks were worth some high number during the dot com bubble. Or that tulip bulbs were worth some high value during the tulip bulb mania. It has zero bearing on any possible future value.
Appreciation may well be a factor. But I for one won't take a bet that we're now at the bottom and will start trending up. Maybe we are, maybe we aren't. If we do start trend up, prices are going to rise, at most, a few percent a year. Unless you're 20 years old, maybe 30, I really don't expect you will see prices hit those bubble marks in your lifetime. I'm past the 50 mark, and I certainly do not have any such expectation. At 3% annual appreciation it will be 20-30 years before this house is worth $230K.
Maintenance is largely caused by tenants. One of my tenants gave notice, and my son and I went to check the house. The kitchen floor is new from 2008. Several of the tiles (commercial vinyl) are missing. Not only that, the underlayment (plywood) has been gouged out. A screen has been destroyed and one of the large mini-blinds is destroyed. In the year they've been there, the bath spout has had to be replaced and the toilet innards have had to be replaced. All new from 2008. A faucet has also needed replacement, though that was due to a defective design and Home Depot replaced it under warranty. So, yes, a new property has some upside on the maintenance. This particular house is from the late 40's and I know is going to need a $6000 sewer line at some time soon. I also put in a new water heater, heater, a big chunk of wiring and plumbing when I bought it. I consider all that to be part of the acquisition cost.
What is worthwhile to consider with a mediocre rental is that the tenants are paying off a loan. If you hold a break even rental for 30 years, you've put nothing in and have an asset you own free and clear.
On this statement:
Strictly speaking, the "50% rule" has nothing to do with the debt service. It simply says the expenses, capital expenditures and vacancy will take about 50% of the gross scheduled rent. The remaining 50% has to cover your debt service, and whatever is left is your cash flow.
Keep in mind that rule of thumb is for a lot of properties for a long time. Any particular property can be much, much worse and can be somewhat better in any particular year.
Lots of folk made lots of money speculating on appreciation, especially during the bubble. I don't expect to see that bubble come back any more than high tech stocks have come back or tulip bulbs have come back. So, if speculation is your approach, be very conservative.
Better to "force" appreciation by buying junker properties and improving them. Or, to be ahead of some factor that will drive prices up, like a new employer moving into an area.
- Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes15y
Jon, Jason and others have given teh OG poster some great feedback.
The 50% rule to calculate potential expenses is a great rule of thumb, however, I have found that in higher rent areas (such as $1400 monthly), your renter profiles are of much better quality and therefore do less tenant damage beyond the deposit, less evictions, longer lease holds, etc. So it is reasonable to assume that the expense ratio (if managed well) could be lower, but don't expect it to get much lower than 40% or you are just fooling yourself.Even with this in mind, if a buy and hold investment can not give you the $100 per door with using the 50% rule, you may want to look for a better deal.
As to your appreciation question, as Jason stated, it is certainly a valid strategy, but YOU must decide if that dice roll is worth your capital investment.
I would suggest putting this payment down on paper, then using a different strategy, find an investment opportunity which provides other results and compare them side by side. If one has a better cash on cash and similar future value plays, you may want to go with the second rather than the subject investment in question.
- Real Estate Investor · roscoe, IL · Member since 2009 · 131 posts · 8 votes15y
Thanks J Scott and Jon for more illumination of the issues I have raised. So I will give more thought to it before jumping into my decision about this property. To me cash flow is very important. Other things are impotant to lesser degree. Regards.
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