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When buying a rental property should rent be 1-2%(purchase price) per month?


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2011 Jan 24, 10:31pm   2,896 views  17 comments

by burritos   ➕follow (0)   💰tip   ignore  

Cap rate of 10% doesn't even qualify if the above criteria is your target. On a separate RE investment forum I've been lurking they won't touch a property unless they're getting at least 1.5% per month. To me this seems very difficult. What do you all think?

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1   pkowen   2011 Jan 25, 3:01am  

1-2% of purchase price? Sounds perhaps slightly high but it implies that much of the bay area is a poor prospect. For the rental property I owned in the 90's, that's about what it was. The price was $80,000 and it rented for about $1200. The idea that you can buy a $500,000 + house and rent it as a business prospect is pretty ridiculous in my view. That'd be $7500/mo, right? Is that what they are saying? Maybe if you go by borrowed money amount, but then huge downs are required and there is opportunity cost for that money.

My landlord paid nearly $1 million, I guess they are collecting 0.2% from me? Something like that. But then the value dropped so maybe it's 0.3 or 0.4% now. Also I know they put a lot down, so they may have barely positive cash flow based on my rent.

Bottom line - if there isn't positive cash flow it's a bad investment. And if you can make more somewhere else, it's a sub-par investment.

2   burritos   2011 Jan 25, 5:34am  

These people on this board live by the "50% rule" meaning that the PITI should be 50% of rent. The rest is to provide for +cash flow, vacancies, mainteinance. When they say mainteinance this includes everything from toilet fixing to repairing the roof which according to them WILL happen. Aniticipating appreciation to them is not investing but speculating. From my impression, none of these investors are in the Bay area or within 40 miles of coastal California.

The average play for these guys is to pick up a property for 40-50k in some midwestern or southern urban city, rehab it for 10 k and rent it out for $700 a month. They sound intelligible so slumloarding isn't my general impression, but I guess it's possible.

On my recent purchase which was a 3 year old 3bed 2 bath sfh for 196k which I will probably rent for 1500k(which gives me a cap rate of 9%), they said no way is that a feasible investment. I pulled the trigger regardless cause I'm holding for the long term and not looking for the short term profit. Nonetheless, these guys seem to know what they're doing, and my going against their unanimous disapproval of the purchase has me second guessing.

3   Ptipking222   2011 Jan 25, 5:59am  

They sound like slumlords. A nicer property will have less maintenance issues/less problems with tenants. A good landlord can just pocket the rent check most months (minus what goes towards taxes and mortgage if there is one).

I checked out that forum awhile ago and the advice only seems suitable for multi-family units or slums.

4   burritos   2011 Jan 25, 6:08am  

Ptipking222 says

They sound like slumlords. A nicer property will have less maintenance issues/less problems with tenants. A good landlord can just pocket the rent check most months (minus what goes towards taxes and mortgage if there is one).
I checked out that forum awhile ago and the advice only seems suitable for multi-family units or slums.

Which site are you talking about? The board I've been lurking is biggerpockets.

5   FortWayne   2011 Jan 25, 7:45am  

You are overanalyzing it.

Profit = What you earn - what you spend. You can get more detailed version from loopnet answers.

After that it's what makes financial sense and security to you.

6   Ptipking222   2011 Jan 25, 11:34am  

burritos says

Ptipking222 says

They sound like slumlords. A nicer property will have less maintenance issues/less problems with tenants. A good landlord can just pocket the rent check most months (minus what goes towards taxes and mortgage if there is one).

I checked out that forum awhile ago and the advice only seems suitable for multi-family units or slums.

Which site are you talking about? The board I’ve been lurking is biggerpockets.

I dont' remember for sure...I think that's it. It's been almost a year, but everywhere I remember seeing 1-2% rule and 50% rule...have to figure same place.

7   coldstoli   2011 Jan 25, 4:35pm  

A cap rate of 10% is considered a consensus average for valuing property over time--much as it is for a business.

The vagaries attaching to a particular property (slum, middle class, high end) and financial conditions (interest rate, market appreciation or lack thereof) all have to be taken into account as well. But having said that, demanding the purchase price be paid off in 5 years or so seems absurd.

All part of the MTV generation that has freeze dried the thinking in this country.

8   Plawatty   2011 Jan 25, 11:41pm  

That's a pretty broad range. That would allow for rents to be anywhere from $1,000.00 to $2,000.00 for a $100,000.00 house, or a 100% difference. Who buys a business using a "rule of thumb" like that? No one. I just did a seminar today on valuing rental property, and using such broad "rules of thumb" is a quick road to ruin. When buying rental property, you're buying a business, and need to treat it as such.

Most people who buy smaller rental properties end up losing money because they have no idea what they're doing. Ask your tax preparer or a CPA what percentage of their clients who have small rentals actually make money. You'd be surprised. Precisely because of all the knuckleheads that are willing to lose money (or make next to none), most rental property is a really bad deal. You really need to run a full analysis of the projected (or actual) rents, accurately determine operating expenses including an escrow for future capital expenses, and then also determine the necessary immediate capital/repair investment to obtain the projected rents over time.

Also bear in mind that operating numbers alone do not tell the story. Almost every broker-produced prospect leaves out a capital fund, and this is by design. Businesses are often sold with money in the bank for various reasons (usually lending requirements). Rental properties almost never are. That's important. Two identical properties may both rent for $1,200.00 per month and have $700.00 per month in expenses. They are NOT necessarily worth the same amount. If one has a new roof, new water heater, and new furnace, it's worth more money than a property where those items are at 50% of their life expectancy. Is the guy with the half-junk bits and pieces turning over his capital expense fund along with the sale? I doubt it. So YOU need to subtract that from the purchase price. In addition to annual expenses, those are tremendously important numbers. If you fail to accurately depreciate the value of the existing capital assets, AND have on hand enough cash to fund repairs to bring the property up to 100% new condition (unless the property actually is new) you can very quickly lose your shirt.

9   burritos   2011 Jan 26, 1:35am  

My uncle bought his primary residence 20 some odd years ago for 175k here in Ventura county. He kept it and rented out when he moved to Newport. It's now worth 650k post bubble burst. He rents it out for $3100 a month(not a good cap rate). In 15 years it's only been vacant for only 1 month. Did he run the numbers? Did he do due dilligence on how else to maximize hi retirement investment? If he did he should have sold it a few years ago, he still should probably sell it now, but he doesn't need to and enjoys a reliable cashflow. He just bought and held and paid no attention with the ups and downs. Now is he a savvy investor? Hell no. Otherwise he would have bought at least one other home in the neighborhood. Is it just dumb luck that he's in this position?

10   burritos   2011 Jan 26, 2:14am  

SF ace says

Sure you can get a 1.5% per month cap rate. You’ll just not going to like the conditions that go along with it. Heck, you can get a cap rate of 3% a month if you want to own an eightplex in Richmond, CA’s iron triangle, perhaps the most dangerous area in NorCal. I can’t imagine how to deal with eight families that rents there though!
Burritos, you are a 300K a year executive, do you really want to deal with people making minimum wage or worse? I sure don’t, I rather get better homes so I get better pool of tenents, something that attracts middle class renters like teachers and someone with college degree. But you’ll give up some cap rates as they won’t be as severely discounted Most importantly, I strongly believe the areas with the lower cap rates will be the first to recover and least last to drop within the housing cycle anyway.
If I can get a 6% annual cap rate in places like Newport Beach, Palo Alto, that is better than whatever you have out there that may be 18% annual. But they don’t exist for obvious reasons.
So don’t let cap rate alone drive your decision. It’s just one criteria out of many. It needs to balance the quality of the tenents with enough value on cap rates.

Thanks SF. When you put it that way it makes more sense. I'm not an executive, but I get your point. Funny my realtor made the same point that I shouldn't be investing in lower end properties and thus dealing with "those" people. It sounded like elitism to me, but now it sounds more like minimizing hassles.

11   pkowen   2011 Jan 26, 3:53am  

burritos says

My uncle bought his primary residence 20 some odd years ago for 175k here in Ventura county. He kept it and rented out [..] Is it just dumb luck that he’s in this position?

Yes.

12   burritos   2011 Jan 26, 4:32am  

pkowen says

burritos says


My uncle bought his primary residence 20 some odd years ago for 175k here in Ventura county. He kept it and rented out [..] Is it just dumb luck that he’s in this position?

Yes.

Probably so. But do you consider people who become independently wealthy solely from maxing their retirement accounts for thirty years also lucky?

13   pkowen   2011 Jan 26, 7:47am  

burritos says

pkowen says

burritos says

My uncle bought his primary residence 20 some odd years ago for 175k here in Ventura county. He kept it and rented out [..] Is it just dumb luck that he’s in this position?

Yes.

Probably so. But do you consider people who become independently wealthy solely from maxing their retirement accounts for thirty years also lucky?

No. Well, somewhat. I have always maxed my 401ks and other employer assisted investment options. My 401ks (now IRAs) went up like rockets with the market. They also went down like lead balloons with the market. I have since changed my strategy in the market to something smarter than just parking money in mutual funds. I have not, however, ever viewed a house as a get rich mechanism. There are other good reasons to buy a house, certainly. Those few who have gotten truly wealthy off their personal residence were mostly lucky. They lived somewhere that had skyrocketing house prices. I owned houses in places that were not nearly as bubbled up. I lived there so I bought. I did not get rich off those houses. I also did not live in the bay area in 1980.

People who made a ton on real estate in the bay area are not exceptionally smart, savvy or anything else except they happened to buy a house at the right time (usually a long time ago) in the right place (some place that skyrocketed) - they bought usually why most people buy, because that's where they lived.

I love how some think it makes them smart though.

Heard a great quote, "You can run through a dynamite factory with a lit match and not get blown up.. That doesn't make you any less an idiot".

14   burritos   2011 Jan 26, 8:07am  

pkowen says

burritos says


pkowen says

burritos says

My uncle bought his primary residence 20 some odd years ago for 175k here in Ventura county. He kept it and rented out [..] Is it just dumb luck that he’s in this position?

Yes.

Probably so. But do you consider people who become independently wealthy solely from maxing their retirement accounts for thirty years also lucky?

No. Well, somewhat. I have always maxed my 401ks and other employer assisted investment options. My 401ks (now IRAs) went up like rockets with the market. They also went down like lead balloons with the market. I have since changed my strategy in the market to something smarter than just parking money in mutual funds. I have not, however, ever viewed a house as a get rich mechanism. There are other good reasons to buy a house, certainly. Those few who have gotten truly wealthy off their personal residence were mostly lucky. They lived somewhere that had skyrocketing house prices. I owned houses in places that were not nearly as bubbled up. I lived there so I bought. I did not get rich off those houses. I also did not live in the bay area in 1980.
People who made a ton on real estate in the bay area are not exceptionally smart, savvy or anything else except they happened to buy a house at the right time (usually a long time ago) in the right place (some place that skyrocketed) - they bought usually why most people buy, because that’s where they lived.
I love how some think it makes them smart though.
Heard a great quote, “You can run through a dynamite factory with a lit match and not get blown up.. That doesn’t make you any less an idiot”.

I don't think it's a vehicle for the average investor to get rich. I think of it as a way to hedge inflation and create cashflow down the road. I think the slumlords get rich. Or at least richer than they would otherwise be if they were just a full time handymen.

15   burritos   2011 Feb 18, 10:55pm  

Just an update. Our rental went on the market 2/11 for $1495. We had new tenants move in by 2/17. This project started 3/2010 and has now come full circle. Gonna wait till after tax season and see if we can pick up another. Happy hunting.

16   bob2356   2011 Feb 19, 2:26am  

burritos says

Just an update. Our rental went on the market 2/11 for $1495. We had new tenants move in by 2/17. This project started 3/2010 and has now come full circle. Gonna wait till after tax season and see if we can pick up another. Happy hunting.

Good for you. Picking up a rental every couple of years may not make the average investor rich but it's a solid say to diversify. Especially if you can do it in addition to maxing out your IRA. It's very tough to do. I've managed one every 3-4 years for the last 10 years. I'm in for the very long term, so I don't care if housing prices go down more in the 3-5 year window. I plan on having mostly paid off rentals once I retire (13 years) so I go with 15 year mortgages I am very willing to take minimal positive cash flow now which would be taxable at my top tax rate in order to have the full rental as cash flow after I retire when I will be in a much lower tax bracket. Having income from 9-10 properties at 1000-1200 a month each should be a pretty nice supplement to my SS and IRA's.

I've also just converted an IRA into self directed in order to buy another couple of properties. I'm making an offer on one right now for 130,000 that will net about 900-1000 a month after management fees (self directed must be at arms length through a management company), maintenance, taxes etc.. That's about 9% return which is a lot better than I'm getting in mutual funds.

17   burritos   2011 Feb 19, 4:45am  

bob2356 says

burritos says

Just an update. Our rental went on the market 2/11 for $1495. We had new tenants move in by 2/17. This project started 3/2010 and has now come full circle. Gonna wait till after tax season and see if we can pick up another. Happy hunting.

Good for you. Picking up a rental every couple of years may not make the average investor rich but it’s a solid say to diversify. Especially if you can do it in addition to maxing out your IRA. It’s very tough to do. I’ve managed one every 3-4 years for the last 10 years. I’m in for the very long term, so I don’t care if housing prices go down more in the 3-5 year window. I plan on having mostly paid off rentals once I retire (13 years) so I go with 15 year mortgages I am very willing to take minimal positive cash flow now which would be taxable at my top tax rate in order to have the full rental as cash flow after I retire when I will be in a much lower tax bracket. Having income from 9-10 properties at 1000-1200 a month each should be a pretty nice supplement to my SS and IRA’s.
I’ve also just converted an IRA into self directed in order to buy another couple of properties. I’m making an offer on one right now for 130,000 that will net about 900-1000 a month after management fees (self directed must be at arms length through a management company), maintenance, taxes etc.. That’s about 9% return which is a lot better than I’m getting in mutual funds.

You are reciting my game plan verbatim. Immediate cash flow and equity appreciation isn't that big of a factor to me. It's having cash flow at the end. IRA's, mutual funds and stocks are still my main source of net worth. The last 2 years they've been been outperforming my RE, but that's why I'm buying RE now cause it's low and I believe it'll go even lower. I don't see a significant upswing for 10 years. You need jobs for that and I just don't see where 15-20 million jobs are going to come from in the near future.

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