All Forum Posts by: MATT WARDEN

http://forums.biggerpockets.com/viewtopic.php?p=36675#36675

Work with a real estate agent for your first purchase, then. Find one who works with foreclosures. There are plenty of posts in this forum about other ways to find properties at large discounts.

PMI is a non-issue. If you have to pay it, you can usually roll it back into the mortgage, which means your monthly payment increases by a negligible amount (probably less than $10).

Also, if you purchase a property at a large discount, then you can avoid having a large down payment stuck in the property. For example, if you purchase at 70% of fair market value, you will likely have no problem having enough equity in the property at the time of the sale to avoid down payment (either immediately or after a refinance).

Unless every single person in Phoenix can make their mortgage payments, then this isn't true. What may be true is that it is a lot harder in your area. It might not be worth the effort.

Here in Ohio, there are a number of areas that pour out foreclosures and otherwise-distressed sellers. I'm focusing on one of these areas.

Aside from all the very good points mentioned in responses here, he also could have made a large down payment to lower his debt service to the point of cash flow.

You would need to rent at $2300/month. This would give you $150/month in cash flow, which is the minimum I would take with that much risk (debt service). How to arrive at this is very simple:

Expenses: E = .5GR

(GR is gross rent.) Half of your expenses will go right out the door in insurance, property tax, maintenance, eviction costs, legal fees, entity structuring, advertising, accountant fees, etc. etc. etc. The only expense not covered here is your mortgage payment (debt service). Please note that this is a long term average. You should not expect that this will hold true for one property in a given month. This is why using riskier calculation factors (like .4 or .45) is a bad idea.

Net operating income: NOI = GR - E

Net operating income is what you have left after expenses have been deducted.

Debt Service (mortgage): DS = $1000

Debt service is the name investors use for the mortgage payment.

Cash flow: C = NOI - DS

Cash flow is what is left after the debt service has been deducted from the net operating income. At this point you have deducted all expenses.

Desired C = $150

I would not bother with this investment unless I cash flow at least $150/month. Most investors would be looking for something around $200/month in cash flow for a mortgage this big. This is simply an assessment of how much return you want for a given risk. $100,000 in debt is a lot of risk, and you should be looking to earn around 2% monthly return on that risk. Note that this is not 2% return on your investment because you are not investing $100,000 (you are only investing your down payment, which is hopefully very small).

Thus:
GR = DS + E + C

Gross rent must equal the sum of debt service, expenses, and desired cash flow.

GR = DS + .5GR + C

This substitution is possible because E = .5 gross rents, as already defined above.

.5GR = DS + C
.5GR = 1000 + 150
GR = 2 * 1150 = 2300

Now, all that said, this is largely a useless exercise. You cannot set the rent. The market sets the rent. If you are doing this calculation, then you are probably looking at a bad deal.

What you should be doing is determining the market rent for your potential property. Then plug it into the equation to determine your cashflow:

C = GR - E - DS

or, reformulated:

C = GR - .5GR - DS
C = .5GR - DS

These are two different ball games. Rehabbing a property to flip and then renting that property out will break you. Tenants will destroy your property. If you are going to rent a property out, you want to repair it only to make it livable (not beautiful) and to avoid long-term maintenance nightmares (eg water damage).

First, never count on appreciation, especially in the current market. Second, I would recommend a Home Equity Loan for this purpose, as a HELOC would be unnecessarily risky for a one time purchase.

This one doesn't even require anyone to run the numbers to recognize it won't cashflow.

DON'T BUY RETAIL!

The sellers of that property are taking advantage of the fact that you are new to this.

Let's say he puts $50k down and then has a loan of $100k. That is approximately $650/month in debt service. This means he would still need to rent out at $1250/month to cash flow $100/month. Let's assume he can actually do that in his market.

Making all those quite liberal assumptions gets the OP a whopping $100/month on his $50,000 investment.

Know what else would get him $100/month? Putting half of that money into an ING savings account at (near) zero risk and full liquidity!

Just a few numbers to point out how you've got to be careful about playing the more-money-down game. I like MikeOH's analysis method that he has alluded to elsewhere, where if the property wouldn't cash flow at $0 down, then it's not a good deal.

Well, you are taking advantage of them. So, if that worries you, then you should probably look at other options.

Just to clarify, the 50% number is a heuristic based on analysis historical records. There is no real dependency between gross rent and expenses; it is just that the numbers seem to correlate in that manner. For example, if you are renting a property at $800/month, then the 50% number would estimate expenses of $400/month on average over the long run. However, if the market changes and you can suddenly rent this same property for $900/month, there is no reason to expect that expenses would suddenly become $450/month on average over the long run (unless, perhaps, property tax increases as well -- so it's not 100% clear cut).

Point is, it's a estimator. As has been pointed out a number of times, when you filter down to a good candidate property, you still need to perform due diligence and to run the numbers at a lower level of detail.

First, wanted to point out that rehab to rent and rehab to sell are in two different ballparks. Absolutely do not put extra work into rehabbing if you are going to rent. Your tenants will only destroy that work. Make it livable and fill the vacancy.

Second, assuming you could rent for $900/mo and assuming after-repair appraisal would be at least $75k, then I would pay no more than $60k on the property. Put the min down, use cash to repair, refinance and get your down payment right back out! (The $75k appraisal will give you 20% equity.)