Eventually you will need a new roof, new water heater, new furnace, etc.- the lifetime of these items can be estimated, and if the age is known a likely replacement date determined. Figure the cost of every item, divide by the expected remaining life, add them all together, and set aside that much each year, or be prepared to come up with it all at once. This is in addition to the type of expenses Newkid discussed.
Another strategy is to just dump your properties before these expenses come up, but any decent inspector will note these items and your property value will be reduced accordingly.
Or, just set aside a "random" amount, like 10%, and hope your reserves are sufficient to cover any unexpected expenses.
Thanks Chris. However, it is extremely hard to buy cheap in the Tri-state atea (NJ,NY, CT). 1% to 2% of purchase price is almost unheard of. This is why I focus my efforts in PA. You might hit 1% in eastern PA.
As I become more comfortable investing further away, I may look at states such as MI and OH. I feel I might be able to achieve higher returns and overcome my fear of not being close to one of my investments with the use of a good management company.
Some people out there float the idea of 2%, but for most areas of the US this is a pipe dream IMHO. Pos, a great book to check out is "What Every real estate investor needs to know how to calculate cash flow".
Thanks d_random. I am glad you recommended that book. I am currently overseas on a work assignment and have brought five real estate books with me. One of them is the one you recommended which I just bought so I am anxious to read it based on the positive reviews!
Quote: As for the 1 to 2 % rule, I have to restate that this is near impossible in the Northeast US unless you are buying a good property at a steep discount (maybe a family member sold it to you).
Deals with this type of cash flow are common in western new york. The MLS is full of them.
As Chris said, these are rules of thumb -- filtering tools to weed out the nonproductive properties from the ones you may want to consider purchasing.
Use the rule of thumb to identify your potential purchase candidates, then do a detailed cash flow analysis on each one. Make your purchase decision on the results of your detailed cash flow analysis.
The 2% rule is pretty accurate if you are using 100% financing. The 1% rule seems to work for properties purchased for $50K or less that you will self-manage in a strong rental market if slightly above breakeven cash flow will work for you.
I use professional property managers with management fees ranging from 7% to 12%. I buy a lot of condos so I have association fees to consider. I try not to pay more than $100K for anything I purchase, and I always use conventional financing at 80% LTV or less. With my buying parameters, a 1.5% rent to purchase price ratio seems to work for me most of the time.
As someone else has already said, you can make any property cash flow if you make a large enough down payment. You will need to do a detailed cash flow analysis to determine if the return on your investment is good enough for you to consider the purchase.
For a potential property purchase, I do a detailed cash flow for an eight year holding period. I assume 3% price appreciation over my holding period. Once I have done a detailed cash flow analysis, I ignore the 1% - 2% rule. I now have better numbers with a Debt Service Coverage Ratio and an Internal Rate of Return. Using 80% financing, I want a 1.25 DSCR or higher and a minimum 15% IRR to even make an offer to purchase.
By making a large downpayment, I can make the DSCR higher, but then the IRR is lower. A small downpayment lowers the DSCR but tends to increase the IRR. Using the two criteria together with the 1.25 and 15% thresholds, keeps me from paying too much or making too large a downpayment yet still achieve an acceptable positive cash flow.
I am. Even in my high cost counties in MD, my criteria works. I am not finding suitable properties to purchase that often. I am making a lot of 50% of list price offers on bank owned REOs. Maybe one will get accepted.
Instead of investing in MD, I have been buying in the Carolinas since 2004. I was looking at the Dallas/Ft Worth TX market for awhile but never got started there.
$500/unit is the normally used as the estimate for a unit in average condition. A newer unit will be less and a older unit will be more.
I reserve 10% of rents collected.
Chris
Eventually you will need a new roof, new water heater, new furnace, etc.- the lifetime of these items can be estimated, and if the age is known a likely replacement date determined. Figure the cost of every item, divide by the expected remaining life, add them all together, and set aside that much each year, or be prepared to come up with it all at once. This is in addition to the type of expenses Newkid discussed.
Another strategy is to just dump your properties before these expenses come up, but any decent inspector will note these items and your property value will be reduced accordingly.
Or, just set aside a "random" amount, like 10%, and hope your reserves are sufficient to cover any unexpected expenses.
Chris
Hey Chris!
You use 10% and 25% in various post. What am I missing? Or is the 10% built in to your 25% set aside?
Jim
25% is all expenses except PITI- vacancies, repairs, utilities, advertising, rental registration, inspections, www.etc.etc.etc.
Chris
Thanks Chris. However, it is extremely hard to buy cheap in the Tri-state atea (NJ,NY, CT). 1% to 2% of purchase price is almost unheard of. This is why I focus my efforts in PA. You might hit 1% in eastern PA.
As I become more comfortable investing further away, I may look at states such as MI and OH. I feel I might be able to achieve higher returns and overcome my fear of not being close to one of my investments with the use of a good management company.
Some people out there float the idea of 2%, but for most areas of the US this is a pipe dream IMHO. Pos, a great book to check out is "What Every real estate investor needs to know how to calculate cash flow".
http://www.amazon.com/Estate-Investor-Flow-Financial-Measures/dp/0071422579
Thanks d_random. I am glad you recommended that book. I am currently overseas on a work assignment and have brought five real estate books with me. One of them is the one you recommended which I just bought so I am anxious to read it based on the positive reviews!
Glad to hear it Pos! I hope you find the book informative, which one was it?
What exactly are you guys basing the 1%-2% rule off of. How do you figure it on a property?
Monthly rent is 1%-2% of total cost of property- puchase price, rehab, closing costs, etc.
Chris
Quote: As for the 1 to 2 % rule, I have to restate that this is near impossible in the Northeast US unless you are buying a good property at a steep discount (maybe a family member sold it to you).
Deals with this type of cash flow are common in western new york. The MLS is full of them.
Pos,
As Chris said, these are rules of thumb -- filtering tools to weed out the nonproductive properties from the ones you may want to consider purchasing.
Use the rule of thumb to identify your potential purchase candidates, then do a detailed cash flow analysis on each one. Make your purchase decision on the results of your detailed cash flow analysis.
The 2% rule is pretty accurate if you are using 100% financing. The 1% rule seems to work for properties purchased for $50K or less that you will self-manage in a strong rental market if slightly above breakeven cash flow will work for you.
I use professional property managers with management fees ranging from 7% to 12%. I buy a lot of condos so I have association fees to consider. I try not to pay more than $100K for anything I purchase, and I always use conventional financing at 80% LTV or less. With my buying parameters, a 1.5% rent to purchase price ratio seems to work for me most of the time.
As someone else has already said, you can make any property cash flow if you make a large enough down payment. You will need to do a detailed cash flow analysis to determine if the return on your investment is good enough for you to consider the purchase.
For a potential property purchase, I do a detailed cash flow for an eight year holding period. I assume 3% price appreciation over my holding period. Once I have done a detailed cash flow analysis, I ignore the 1% - 2% rule. I now have better numbers with a Debt Service Coverage Ratio and an Internal Rate of Return. Using 80% financing, I want a 1.25 DSCR or higher and a minimum 15% IRR to even make an offer to purchase.
By making a large downpayment, I can make the DSCR higher, but then the IRR is lower. A small downpayment lowers the DSCR but tends to increase the IRR. Using the two criteria together with the 1.25 and 15% thresholds, keeps me from paying too much or making too large a downpayment yet still achieve an acceptable positive cash flow.
Hope this helps.
Thanks NewKid. Although, are you still using your criteria in the current market?
I am. Even in my high cost counties in MD, my criteria works. I am not finding suitable properties to purchase that often. I am making a lot of 50% of list price offers on bank owned REOs. Maybe one will get accepted.
Instead of investing in MD, I have been buying in the Carolinas since 2004. I was looking at the Dallas/Ft Worth TX market for awhile but never got started there.
PosCashFlow, the contact info in your PM was filtered out.
ryandick, try again....
.
Flow the long haul ARM concern me.
Look at the last couple year and how the rates moved.
With all the new closing costs and if you have decent rates right now, I doubt it would make sense.