You may have heard recently that this is a great time to purchase investment property. One reason for this is because you can now “cash flow” them again. That sounds like a pretty good idea, but what does that really translate into? What really makes this a better time to buy and hold investment property rather than 18 months ago?
I would like to give you a brief overview on the two major concepts of making money on investment property, and why it is a perfect time to acquire and hold an investment property.
Fix & Flip
I am sure many of you have heard of the term “fix & flip”. This is a good money making technique when the real estate market is steady and the volatility is predictable. The concept is to buy a property that is undervalued compared to the other homes in the area and fix it up. The typical targeted repairs are items like new floors, carpet, paint, window treatments, landscaping, kitchen & bathrooms cabinets, etc.. Ideally, these repairs take only 1–3 months, and then you list the property for sale at a much higher price. The goal is to make enough to cover your repair costs, the temporary mortgage payments, and walk away with $20K – $60K profit on that property. The key to success is to have the right property and to turn the property as quickly as possible.
Obviously, this doesn’t always work as planned, and sometimes you lose money on the deal. Factors that contribute to losing money on a Fix & Flip property are the repair costs being too high, the repairs taking way too long, or the property not selling quickly. Sadly, some Fix & Flippers got stuck with property over a year ago when the market turned, and either took a loss selling it below cost or turned it into a rental property. This is not the ideal strategy to own rental property, because most of these people are still taking a monthly loss renting these properties today. I feel that I am an authority on this topic, because I own one of these types of properties myself.
This is the concept used to identify property that will make good rentals. The word “cash flow” refers to the amount of cash a rental home generates and uses on a monthly basis. Cash flow can be used as an indication of a rental home’s financial strength. When it comes to renting out your investment property you would prefer it to have a positive cash flow, whereas you are making a profit on a monthly basis. Due to the high price of housing in some Metro areas it is more difficult to find homes with a positive cash flow, but it is not impossible. Here are some of the factors we look at to determine a property’s cash flow.
You should first calculate the monthly cost of the property (sometimes called the nut). You need to consider all costs associated with the property including the Mortgage Payment (Principal, Interest, Taxes & Insurance), Property Management Fees, HOA Dues, Pool Service, Home Warranty, Etc. This monthly cost will not only be covered by your renters, but will also have to be covered by you during times when the property is not rented. Also, take into account if you need immediate repairs to the home to make it ready for renters.
Next, you have to calculate how much you can rent the home for. I highly suggest using a seasoned property manager to help you in this analysis. Not only can this person help you identify the right rental rate, but can also help identify the current occupancy of rentals within the area. That should give you an idea of how long it will take to rent your property.
When you subtract the monthly cost (nut) from your potential rent you will get that property’s monthly cash flow number. Most people will gravitate towards properties with a positive cash flow – but some people will also consider properties that simply “break even” with the intent of selling them in a few years at an appreciated value.
Why is this a Good Time to Buy??
One of the biggest factors in finding property with good cash flow will be in the price of the home. Being that the mortgage payment on the property will constitute the largest portion of your cost, you want to find rentable property at a low purchase price. This sounds like common sense (Duh!), but a cheap list price doesn’t always mean it’s a good deal.
Today’s housing market has a record number of short sales, foreclosures, pre-foreclosures, distressed, and bank owned property! Some home prices in some areas are down over 30% from where they were 18 months ago. This could easily mark the low price point for home sales for the next few years. When you see the following scenario you might think that those properties are not really available. To that I can honestly say,… have you really looked? Because, you only need to find one property that works!
Here is a single family home (3bd/2ba) in Tempe, AZ near the light rail. It is bank owned and they are asking $150K (appraises at $205K) and they will pay all of your closing costs with a full price offer. The property is basically move in ready and needs a little paint. You pay 20% down ($30,000) & finance 80% ($120,000) on a 30 year fixed (6.75%).
The principal & interest payment is $778/mo + $50/mo home owners ins. + $92/mo property taxes = total PITI = $920/month. You also decide to have a property manager (a good idea) for $65/month, and you find no other monthly costs. Your net cost is $985/mo.
Your realtor does their research, and informs you that rent on a 3 bedroom within 2.5 miles of ASU should rent for $1,130/mo. And if you get it listed before August 20th, you should be able to rent in within 2 weeks.
$1,130 rent – ($985) cost = $145/ month in positive cash flow. This seems to be a pretty good scenario worth exploring. Here are the positives:
- You have the potential to make $145/month cash flow.
- You have a 30 year fixed loan, so every month your principal balance goes down.
- You have an great source of Tax deductions at the end of the year
- You have just acquired a property with $55,000 of equity in it.
The above example is simply one basic scenario out of thousands that exist. Investors can find the same scenario in most college towns. There are going to be plenty of properties that have a negative cash flow after thorough analysis. But, the key to finding the right cash flow property begins in the act of building a team and looking for them.
Investment property is not everybody’s cup of tea. However, if you have thought about it in the past, today’s housing market provides great opportunities to buy properties that “cash flow”. If you are waiting for the housing market to reduce inventory and “tighten up” to buy an investment property – you are missing the boat.
There are many other concepts and techniques that I did not touch on today that I will be happy to share with you if you have interest
- Buy investment property as a primary residence (2% – 5% down)
- Buy investment property as a second home (5%-10% down)
- Buy a multiplex (2 – 4 units)
- 8 creative ways to find your 20% down payment
- Purchase an investment property that needs rehab for 10% down
- Buy a new home and use your current home as a rental