Real estate question

[LivingAlmostLarge]

To all investors I was wondering how do you calculate when it's worth investing in a rental?

Here are the numbers for mine. I am curious if it's solid investment. My landlord bought in 10/2014 for $440k. He's renting to me for $2400/month. I don't think he did much from then to now 8/2015 and had other tenants renting for $2200. I think just the carpet.

Is that enough of a ROI?

[Rachael777]

HI. A lot of investors look at 'Cap rate'

NET Operating income for the year
divided by sales price

Investors use different ways to get to Net

I use the following

GROSS RENTS MINUS maintenance/repair allowance, vacancy allowance, management costs (if any), taxes, legal allowance, marketing allowance, utilities (if any)

I was aiming for a 10% or higher cap rate in purchases.. Generally higher cap rates reflect distressed owners/homes or more work in some way (vacant at purchase, higher management costs/effort or need repair/maintenance)

My 6 homes were 25% cap rate. My 3 units were 12% cap rate.

I am willing now that I have the 6 homes under my belt and hopefully more money vs time and less appetite for risk to take properties with 9-10% cap rate in exchange for being in better shape upfront.

[97guns]

i didnt do any calculations but by just looking at his numbers looks like he is underwater, a rental should gross 1% of the value of the home by quick math

[Fishindude77]

If you are the only one paying rent in that $440,000 building your landlord has a losing proposition.

Don't know what taxes and upkeep cost in your location, but I would want to see an investment of that size generating roughly $5,000 - $6,000 per month rent.

[AnotherReader]

IIRC, you ended up in the Pacific Northwest, in a very hot market. My guess is your landlord paid cash and is betting on appreciation. This is a very poor investment from the perspective of cash flow. The gross rental income is $28,800, or 6.5 percent. By the time vacancy and collection loss, property taxes, insurance, and repairs and maintenance are deducted, he is making less than 4 percent. Less if he is paying for property management. If he mortgaged the property, his cash on cash yield is probably lower, as the leverage is probably negative.

[HappySaver]

Don't forget depreciation. The IRS will force you to take depreciation on your investment property when you sell it.

[97guns]

depreciation is a tax advantage to the landlord, taken every year. depreciation does not factor in when you sell

http://realestate.about.com/od/realestateinvesting/qt/depreciation.htm

[HappySaver]

depreciation is a tax advantage to the landlord, taken every year. depreciation does not factor in when you sell


http://realestate.about.com/od/reale...preciation.htm

Yes, it does. You are required to depreciate the property when you sell it even if you have chosen not to use depreciation as part of your annual expenses.

Re-read the last sentence of the article you posted: "However, depreciation also increases the capital gains tax paid by the investor upon selling the property by reducing the basis for figuring gain or loss on the sale or exchange."

[HappySaver]

LAL, the take-away is that investing is more complex than people realize, and profits usually come from investing in higher numbers of properties. Investing in one property where the entry cost is already high is unlikely to be worthwhile.

You haven't given enough detail to really work out the numbers. We don't know if you would have a mortgage, what the expenses would be, or what the condition of the property is. Also, what the rental market is like. The fact that you're thinking we might be able to judge ROI just based on purchase price and rent shows that you're not appreciating all the variables.

To give you a general idea, we own an investment property at roughly the value of the one you're talking about. Rent is slightly lower but not too far off (that's because we value excellent tenants and give them a slight break). The mortgage is very small (about 20% of the overall value) and the house is up-to-date, but still requires general maintenance in an area where labor is quite expensive. We make enough to keep a well-funded account for future house repairs. Hopefully that will turn into profit once we sell. But it won't be much. The reason we own the house is because we used to live in it. Accidental landlords. It would not have made sense to purchase it as an investment property, despite the fact that the rental market is quite hot here. As it is, we hope to just break even compared with our original purchase price, once we do sell.

If you're serious, spend some time on biggerpockets.com. They are the investment property experts. They seem satisfied if they net $100 monthly per unit.

Another must read is "Every Landlord's Tax Deduction Guide". That will walk you through all the ins and outs and is indispensable to a first time landlord.

[AnotherReader]

There is an excellent post on evaluating rental property pinned to the top of the Real Estate and Landlording category over at the Mr. Money Mustache forum. There is also a reading list. Suggest anyone interested in rentals look at that.

[LivingAlmostLarge]

Interesting. It's a single family home. I just wondered why so many landlords were buying property in the area in the past year and trying to rent it out. It is managed by a property manager. I assume the landlord bought it because they are making more rent than the mortgage? Or it might just be breaking even.

But I was wondering if it is a good market and that's why people are jumping on it. Turns out it's not. Interesting that people keep saying what a great investment it is.

[97guns]

I have a cousin that lives in Hawaii and he recently bought 2 rental homes, he's running a monthly negative on them and is hoping for appreciation to make his money

[AnotherReader]

There are a lot of unsophisticated investors out there that say real estate is a good investment with only a vague idea of how the numbers work. Look how many people post on this and other sites that they have a cash flow positive property because the rent is higher than the mortgage payment plus the taxes and insurance. Other people deliberately buy cash flow negative properties, believing the increasing rents and appreciation will make the investment profitable over the long term. What they are really buying is an alligator that they keep feeding in hopes it won't eat them. Sometimes places like Hawaii and San Francisco work out to be profitable long term holds, other times, they don't.

[LivingAlmostLarge]

AR those are great points. I've always been suspicious of friends who keep telling me we should buy and hold RE. That it's a great deal and we should buy our next house and hold our previous place as a rental. We've always sold (2x) because my DH feels it's too much exposure for us to hold that much of our net worth in real estate and we don't have the right cash flow to carry such properties. He'd buy an investment property but it's something we'll look into when we have more time to understand all these financials that everyone on this board obviously has well in hand. We do not, nor do we pretend to understand. I mostly nod and say I'm too lazy to be a landlord hence why we sell. I never try to point out the financials to others renting out their previous homes as to why it's not necessarily a good investment even if it just "breaks even on the mortgage."

FWIW, my mom is interested in buying yet again in Hawaii. I'm trying to convince she should rent instead of buying a 3rd place. I suspect from looking that home prices are way out of whack with rental income. My DH thinks rents will skyrocket and prices will come down drastically.

I'm not sure but right now in Honolulu the prices of condos are trying for $800k-$1m but they are renting for $2500-3500/month for 2 bd. Plus these are supposedly "newly" built condos not completely done and "sold" out but they are being rented out for less than the mortgage + HOA fees according to my calculation. Even in older buildings it doesn't appear to make sense to buy.

My aunts are both looking at downsizing as well (in Honolulu) and they've actually been given the advice by a financial advisor to rent their homes out and buy something else. I pointed out that the rents on their homes are not comparable, but they think it's easy money. I think this financial advisor is an idiot and will probably call that person so if I ever meet them. Yes they've sold my aunts, uncles, parents all those C shares in mutual funds. But all I ever hear is "oh well they are making me money."

I just worry my parents will fall into something I'll spend a solid year unraveling if things go poorly. And yes I will, I'm the only child of my parents and my dad turns 85 this year and my mom is 63 with no financial skills. Neither does my dad. Thank god they've always outearned stupid. But I know when it's just my mom i'll be managing all money, investments, homes, and taxes. I could be wrong and my dad could live another 15 years but I think it unlikely.