Rental Properties?

[lisg]

I'm exploring the idea of buying homes to rent. My initial thought is to use a property manager for many reasons including my lack of expertise and time. I'll be satisfied with approximately breaking even month to month with the payoff being when the loan is extinguished. To cover my risks, I'll get an umbrella insurance policy. Before I jump in to the business, would any rental home owners care to share if this is an attractive place to invest?

[gfp]

I'm sure others will chime in as well, but it really all depends on your local market and what you can find, close on, and what the economics of those actual properties are.  It can be a good business and there is a lot of bank leverage available.  I would say to shoot for better than "break-even" on monthly cash flow though.  Build in a margin of safety like anything else.

[Vish_ram]

Never ever use a property manager. You need to do this yourself, get a feel of the market, get to know the tenants, know the screening, eviction process etc.

 

I got so screwed using a property manager, who came with excellent referrals and reviews. He brought a criminal as a tenant and I didn't get a single month rent. I just went through eviction with loss of around 10K.

[DTEJD1997]

I'm sure others will chime in as well, but it really all depends on your local market and what you can find, close on, and what the economics of those actual properties are.  It can be a good business and there is a lot of bank leverage available.  I would say to shoot for better than "break-even" on monthly cash flow though.  Build in a margin of safety like anything else.

 

I also can't emphasize what globalfinancepartners says.  Every market in the USA is different...some markets are good, and others I think are terrible and a disaster waiting to happen, and of course most are somewhere in between.

 

One thing is that you will have a lot of unforeseen expenses, problems & issues.  Therefore you need to shoot for a bit better than breakeven at a minimum.

 

Also, you might get a property that is breakeven at the beginning, but maybe 2-3 years later you lose a tenant or have major repairs or the market moves, and now your breakeven investment is a solid loser.  Better to start with an 8% income that goes down to 2% vs. breakeven that goes to -6%.

 

I can also suggest that if you use a property manager, they are going to eat into your profits significantly if you are not careful.  If you are going to get more properties and make this a significant investment, I would go the "do it yourself" route.  You need to get the knowledge & experience if you are going to scale up.

[LC]

Agree with vish_ram. This is a type of business where you need to be involved: tenant screening is very important, and you can save a lot of cash doing basic tasks/repairs yourself. Also setting up the property to be tenant-friendly is important. That is, limit the amount of potential damage they can do.

[tombgrt]

What is the equity to loan ratio you guys are looking at when going for rent = loan payments or better?

 

Here that is very hard unless you take very little leverage.

 

[gfp]

Can't speak for others in other markets, but we usually finance 80-75% of the total (purchase price plus renovation cost).  With 5 year, 20 year amortization commercial loans it is 25/75.  30 year conforming financing is much better, but we can't always get it.  You can, of course, "create" equity though renovation and reappraisal, which can allow you to be a lot more creative with financing / refinancing.  Commercial bankers in my market are a lot more amenable to using your excess equity on other properties you own (and they finance) as the "equity" component of another deal than they are to doing any type of cash-out refinancing.  You can take cash out, but they don't like it and the rate is usually 50 basis points higher or something like that.

 

I would go for better than rent = loan payments.  A simple spreadsheet with actual property taxes (including any reassessment resulting from your purchase / improvements), actual insurance, flood insurance if applicable, an estimate of vacancy percentage (less on multi family, more on one or two unit properties), an estimate of ongoing maintenance costs, landscape maintenance, etc etc...  Shoot for at least some cash flow positive after all that and try to make it an acceptable return on the capital you will have tied up in the thing.

 

Sometimes you have to get creative in competitive markets.  Some of my friends in New Orleans are selling properties in New Orleans (which have appreciated to low cap rates) and swapping them into multi-family properties in other markets - usually with tax-free (defferred) exchanges.

 

What is the equity to loan ratio you guys are looking at when going for rent = loan payments or better?

 

Here that is very hard unless you take very little leverage.

[chesko182]

can anyone recommend some good books on real estate investing?

 

thanks

[Cigarbutt]

Went through this exercise a while back.

Examples:

http://www.propmgmtforms.com/forms/ebooks/guide-to-real-estate-investing.pdf

http://www.biggerpockets.com/ultimatebeginnersguide.pdf

 

You may want to look at:

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/getting-started-with-real-estate-investing-books-and-resources/msg261108/#msg261108

 

Also look for a private message with a potentially useful title which may not be so dumb after all.

[bizaro86]

I would make sure you buy with a margin of safety, breakeven isn't good enough. I think you actually need two different types of margin of safety when you're buying a rental property. Margin of safety based on the current value of the property (or possibly a realistic post renovation value) and margin of safety based on income.

 

I'm pretty glad I insisted on both, as I bought a lot of properties (relative to age/income/net worth anyway) in my hometown from 2009-2013. But my hometown is Calgary, and oil prices tanked shortly thereafter. Happily I sold a bunch in in the subsequent years, but the ones that I held are way down from the peak, both in market value and in rents. If I had bought breakeven properties, I would be losing a pretty material amount of money every month, instead of being breakeven now.

 

It's worth noting that basically everyone you talk to about this only gets paid if you do deals. That means your Realtor/Mortgage Broker/Property Manager/Lawyer/etc all have an incentive for you to do more deals. Its worth keeping that in mind, because its better (in my opinion) to buy less properties and get better deals.

 

Value investing still works in real estate, and there are no called strikes.

[LC]

Exactly. The entire RE industry is based around transaction frequency. Buy judiciously and do as much of the work yourself, if possible.

[bookie71]

One thing to keep in mind is that one bad tenant can destroy years of  good tenants. 

[BG2008]

My few rules

 

1) Determine what kind of market you're in

  a) Land Constraint with lots of growth? NYC, SF

  b) No land constraint yet shrinking?  Detroit

  c) No land constraint but growing?  Austin

2) What kind of city are you in? Does it seems to always dig itself out?  Does it have international appeal?  Think NYC, SF etc.  People just flock to them. 

3) Where in the market are you looking to buy?  Residential is the easiest.

4) Buying a single unit or multi? 

 

My recommendation

 

1) Learn how to read people.  I usually have open house and I have people come.  The people who complains right off the bat you don't want to rent to them because they will continue to complain and be a pain regardless.  Don't rent to a bunch of young people who are waiters/waitresses, they party non-stop and will destroy your place.  Learn to identify the people who have good work ethics and just want to be left alone.  In NYC, it's predominantly Mexican and Ecuadorian immigrants.  I don't do credit checks. I just talk to them about their jobs and how long they've been there.  If the guys has worked at a job for more than 2 years, he's usually okay.  You develop a "feel" for people and I have dodged a few bullets.  I've had 99% occupancy since I closed on the multi-family unit in March of 2008.  The high occupancy is also largely attributed to it being NYC and I own the cheapest housing stock.         

2) Learn how to fix broken stuff because cap rates are very low, the return you earn is from you doing the property management yourself

3) Section 8 is a tricky thing - Yes government is paying your rent, but I've heard too many horror stories.  Tenants just seems to know how to game the system.  It's perverse incentives.  I've heard of people stealing heating oil etc. 

4) Try to finance the property with 30 year fix rate mortgage that is Fannie and Freddie compliant.  Then you pretty own an asset that in theory should go up in value overtime while your liabilities gets shrink away with inflation.   

 

Location/Location/Location - If you don't know what's a good vs bad location, you're the patsy.  In NYC, it means being close to the subway station. 

 

Demographics - In certain area, gentrification can be a really big deal.  If you're buying into an area that is gentrifying, you could do really well.  If the area doesn't, you can be stuck holding an asset in a crummy area. 

 

Timing - Interest rates are going up - Maybe wait a bit?

 

Remember it's a local business and you need to build up expertise over time yourself. 

[netnet]

Since it's location, location, location in RE, where is a good location?

 

Some argue that buying any middle class area in the Bay Area is a good investment at any price. I can't believe that.  (On the other hand how could a suburban Palo Alto ranch house go from overpriced 15 years ago to ridiculously overpriced today, like 1.5 million plus.)

 

In the Bay Area, were I a RE person, I would look to buying lots or existing structures near the fire area.

 

Edited for clarity. thanks Fareast

[fareastwarriors]

Since it's location, location, location in RE, where is a good location? And I do not believe that any middle class area say in the Bay Area is a good location. (In the Bay Area, were I a RE person, I would look to buying lots or existing structures near the fire area.)

 

Why not?  I'm in the Bay Area and own rentals...

[premfan]

My few rules

 

1) Determine what kind of market you're in

  a) Land Constraint with lots of growth? NYC, SF

  b) No land constraint yet shrinking?  Detroit

  c) No land constraint but growing?  Austin

2) What kind of city are you in? Does it seems to always dig itself out?  Does it have international appeal?  Think NYC, SF etc.  People just flock to them. 

3) Where in the market are you looking to buy?  Residential is the easiest.

4) Buying a single unit or multi? 

 

My recommendation

 

1) Learn how to read people.  I usually have open house and I have people come.  The people who complains right off the bat you don't want to rent to them because they will continue to complain and be a pain regardless.  Don't rent to a bunch of young people who are waiters/waitresses, they party non-stop and will destroy your place.  Learn to identify the people who have good work ethics and just want to be left alone.  In NYC, it's predominantly Mexican and Ecuadorian immigrants.  I don't do credit checks. I just talk to them about their jobs and how long they've been there.  If the guys has worked at a job for more than 2 years, he's usually okay.  You develop a "feel" for people and I have dodged a few bullets.  I've had 99% occupancy since I closed on the multi-family unit in March of 2008.  The high occupancy is also largely attributed to it being NYC and I own the cheapest housing stock.         

2) Learn how to fix broken stuff because cap rates are very low, the return you earn is from you doing the property management yourself

3) Section 8 is a tricky thing - Yes government is paying your rent, but I've heard too many horror stories.  Tenants just seems to know how to game the system.  It's perverse incentives.  I've heard of people stealing heating oil etc. 

4) Try to finance the property with 30 year fix rate mortgage that is Fannie and Freddie compliant.  Then you pretty own an asset that in theory should go up in value overtime while your liabilities gets shrink away with inflation.   

 

Location/Location/Location - If you don't know what's a good vs bad location, you're the patsy.  In NYC, it means being close to the subway station. 

 

Demographics - In certain area, gentrification can be a really big deal.  If you're buying into an area that is gentrifying, you could do really well.  If the area doesn't, you can be stuck holding an asset in a crummy area. 

 

Timing - Interest rates are going up - Maybe wait a bit?

 

Remember it's a local business and you need to build up expertise over time yourself.

 

Excellent framework. Listen to this gentlemen. 

 

  Before purchasing a property it would be wise to have a network of maintenance people and i highly suggest a in house manager. Also there needs to be a value add  like turning a commercial property into a multi use property or

even turning a hotel into a apartment building.

 

Real estate means four walls be creative if the city/town approves  Much more could be said. That said, BG layed out a good primer on entry level thinking.  I hope my value add is reframing real estate as four walls. Its all four walls and knowing what your community needs well will help generate creative ideas on how to serve them with your four walls.

[netnet]

Since it's location, location, location in RE, where is a good location? And I do not believe that any middle class area say in the Bay Area is a good location. (In the Bay Area, were I a RE person, I would look to buying lots or existing structures near the fire area.)

 

Why not?  I'm in the Bay Area and own rentals...

I meant the obverse of what I think you think I meant-ouch that recursion is too much before lunch.  Anyway, there are people who argue that basically, buying anywhere in Bay Area at any price is a good investment, I was trying to counter that argument. I did not mean that buying anything in the Bay Area is bad. I have corrected my post.

[bookie71]

In the 1970's and early 1980's the mantra in Alaska was "Buy Anchorage real estate, it has never gone down and is going up at 1-2% per month" Then the oil prices dropped and we went into a huge recession. Over 1/2 the banks and credit unions failed. We lost almost 25% of our population. You could buy a house in decent shape for less than the lot cost originally.

Be very careful.

 

[AzCactus]

As a general rule do you prefer buying properties in better areas, but higher prices or lower prices but maybe not the best area?

[Broeb22]

I’ve only purchased vacant residential land, and my “strategy” was to buy in areas in Charlotte, near where I live, where some development was happening, I.e. houses being flipped new homes being built, etc.

 

This area Usually includes some less sophisticated owners (sellers) and people who are happy to get a little pop on a property that had been stagnant for many years.

 

So, I guess I tend to look for tweeners in terms of quality.

 

Another little goal of mine has been to buy a property with a lot of land attached. If you can work it so that you get a mortgage on the whole value of the house plus land(acreage), you own a levered investment financed with leverage.

 

Why is land leveraged? Think about a $100,000 house. The rule of thumb that I’ve read about a few places is that the land under a property is worth typically 20% of the total value. That’s a rule of thumb, so in cities land will be worth more as a % and in rural areas the land will be worth less. Additionally, the structure is itself a depreciating asset. So, when people say home prices are going up, it’s primarily the value of the land going up.

 

But in short, if home prices increase 2-3% per year, that $100,000 house is up to $102-103,000 and $20,000 is up to $22-23,000, a 10-15% increase.

[BG2008]

I’ve only purchased vacant residential land, and my “strategy” was to buy in areas in Charlotte, near where I live, where some development was happening, I.e. houses being flipped new homes being built, etc.

 

This area Usually includes some less sophisticated owners (sellers) and people who are happy to get a little pop on a property that had been stagnant for many years.

 

So, I guess I tend to look for tweeners in terms of quality.

 

Another little goal of mine has been to buy a property with a lot of land attached. If you can work it so that you get a mortgage on the whole value of the house plus land(acreage), you own a levered investment financed with leverage.

 

Why is land leveraged? Think about a $100,000 house. The rule of thumb that I’ve read about a few places is that the land under a property is worth typically 20% of the total value. That’s a rule of thumb, so in cities land will be worth more as a % and in rural areas the land will be worth less. Additionally, the structure is itself a depreciating asset. So, when people say home prices are going up, it’s primarily the value of the land going up.

 

But in short, if home prices increase 2-3% per year, that $100,000 house is up to $102-103,000 and $20,000 is up to $22-23,000, a 10-15% increase.

 

NYC, SF, and other gateway international cities are all about land prices and the inflation of future construction cost.  Typically, the land and the actual structure (foundation, wall, etc) don't depreciate and if anything appreciates over time because the cost of materials and labor to build that go up over time.  What do depreciate overtime are your appliances, roof, siding, windows, fixtures, flooring, paint, etc.  If you ask me back in 2002, I would've say buy the RE that pays 8% yield.  In 2018, I would say that buy the 4% cap rate stuff where you believe in 10 years the land value and the construction cost will be much higher.  In order to justify 4% cap rate, you have to have very special markets like land constraints plus job growth.  Once you get out of NYC/SF, you need to adjust your cap rate significantly higher. 

[Gamecock-YT]

I’ve only purchased vacant residential land, and my “strategy” was to buy in areas in Charlotte, near where I live, where some development was happening, I.e. houses being flipped new homes being built, etc.

 

This area Usually includes some less sophisticated owners (sellers) and people who are happy to get a little pop on a property that had been stagnant for many years.

 

So, I guess I tend to look for tweeners in terms of quality.

 

Another little goal of mine has been to buy a property with a lot of land attached. If you can work it so that you get a mortgage on the whole value of the house plus land(acreage), you own a levered investment financed with leverage.

 

Why is land leveraged? Think about a $100,000 house. The rule of thumb that I’ve read about a few places is that the land under a property is worth typically 20% of the total value. That’s a rule of thumb, so in cities land will be worth more as a % and in rural areas the land will be worth less. Additionally, the structure is itself a depreciating asset. So, when people say home prices are going up, it’s primarily the value of the land going up.

 

But in short, if home prices increase 2-3% per year, that $100,000 house is up to $102-103,000 and $20,000 is up to $22-23,000, a 10-15% increase.

 

Hopefully the light rail extension does for the north side what it has done to the south side. Property values are up 25-30% Y/Y in some places in south end/dilworth

[rb]

Why is land leveraged? Think about a $100,000 house. The rule of thumb that I’ve read about a few places is that the land under a property is worth typically 20% of the total value. That’s a rule of thumb, so in cities land will be worth more as a % and in rural areas the land will be worth less. Additionally, the structure is itself a depreciating asset. So, when people say home prices are going up, it’s primarily the value of the land going up.

 

But in short, if home prices increase 2-3% per year, that $100,000 house is up to $102-103,000 and $20,000 is up to $22-23,000, a 10-15% increase.

Interesting. However that logic only works if you have the opportunity to redevelop the property to build more units or turn it into a higher value property. Otherwise the calculus changes.

[rb]

NYC, SF, and other gateway international cities are all about land prices and the inflation of future construction cost.  Typically, the land and the actual structure (foundation, wall, etc) don't depreciate and if anything appreciates over time because the cost of materials and labor to build that go up over time.  What do depreciate overtime are your appliances, roof, siding, windows, fixtures, flooring, paint, etc.  If you ask me back in 2002, I would've say buy the RE that pays 8% yield.  In 2018, I would say that buy the 4% cap rate stuff where you believe in 10 years the land value and the construction cost will be much higher.  In order to justify 4% cap rate, you have to have very special markets like land constraints plus job growth.  Once you get out of NYC/SF, you need to adjust your cap rate significantly higher.

Based on the number of cracked foundations I've seen I would say that that foundations and walls do indeed depreciate.

 

Residential construction of the past few decades does have a limited life.

[DTEJD1997]

Hey all:

 

I would think that property in CA, and ESPECIALLY San Francisco would have to have a somewhat higher cap rate to reflect the odds of a really big earthquake hitting.

 

SF was wiped out a bit more than 100 years ago.  Are they overdue?  Hard to say, but the odds are greater than 0.

 

I also think that there is more/safer money to be made in other parts of the country (Midwest, South) where cap rates are MUCH higher.  I'm looking at some commercial properties that are at about a 9%-10% cap rate.  Greater chance those could go to a 8% cap rate than SF goes from 4% to 3%?

 

OR

 

What happens if the economy slows down/goes busto?  What if cap rates across the country go up 2%?  Everybody take a loss!  Losses are bigger in a 4% to 6% rate than a 9% to 11% rate.

 

We'll see!