I was reading the awesome thread started by G_Alexander, and thought I would throw this ideal out there for people looking to buy an apartment building with as little out of pocket money as possible.

I'm going to cut to the good stuff and avoid the fluff, in a nutshell, you can get FHA loan, government backed financing, to purchase a multi unit property, less then 4 units, if you live in one unit and the other 3 out you should break even and/or cash flow depending on your purchase price, rehab?, expenses. If you decide to live in one unit you will get a great interest rate plus you may be able to put down as little as 3.5% down payment.

Let me put this in prospective, right now money is cheap at banks, ie low interest rates, problem is trying to get a loan is harder now days, and if you want to purchase an investment property the bank, around me, usually want 20% down. Some banks want up to 25%! While other banks have stopped totally on lending on investment properties.

Make sure you have all your ducks in order, with regards to personal info, w-2, bank statements, personal financial statement. Good luck roc

I agree roc with some additions. These instructions seem to be intended for new real estate investors(REI's)so we need to clear up any confusion.

As far as terminology goes, yes these are apartments you are talking about but the business generally refers to 4 unit buildings as quadruplexes(quads), 3 units as triplexes, and 2 units as duplex. If the property has 4 units or below it is considered for a residential mortgage and, if owner occupied, can qualify for some very favorable mortgage terms.

If the property has 5 or more units it is generally considered to be a commercial property and would need a commercial loan. The process and paperwork is different.

I am sure there is more to add.

To add onto Rocs post. I have talked to a few different lenders and this is what I found. Wells Fargo will only do 3.5% down through an FHA owner occupied loan for single family homes and duplexes. They told me I would need 10% for anything larger than a duplex. Then I called Bank of America and they informed me that they offer FHA owner occupied loans for 3.5% for singles to quads.

Problem with that approach is you have to live in it, which limits how you can buy.

If you buy below market value you can get into properties with pretty much all OPM.

I don't really recommend leveraging on rentals to highly though, they really do work the best as a place to park money and generate a good return. But like anything YMMV.

I don't know much about the RE rental industry, but I have a friend that tied up 60k on a house that cashflows him only like $200 per month. To me that is SUCH a shame, I have secured $200/m for more than one year cold by spending a week on the phone selling. It is hard work, but to me is easier than tying up 60k for it.

Thoughts?

I am just trying to learn the motives.

Why start with a small 2-4? Why not start with something bigger. If you have a manager dealing with everything, there isn't much you need to do after. Usually you need 20% down, sure that might be a lot to obtain to get a loan for something bigger but find peoples to do it with. If you find a good property that the numbers make sense on, an investor will invest. It might just take a few till you find one who will do it though. For a first deal, offer them more. Tell them you will put X amount in and find/do the deal, but they will get some extra % on top to balance the risk.

hatterasguy said:

Problem with that approach is you have to live in it, which limits how you can buy.

If you buy below market value you can get into properties with pretty much all OPM.

I don't really recommend leveraging on rentals to highly though, they really do work the best as a place to park money and generate a good return. But like anything YMMV.

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Just curious, why park your money in it? Leverage and buy more. That is what all the big investors around here do. They leverage anywhere from 50-90%, although I would not suggest leveraging too much, leveraging is definitely the way to go though. You can buy way more real estate and interest rates are so low right now, great advantage.

JScott said:

Expense ratios for a typical single family house will generally fall in the 45-55% range (or gross rents), so if the house was purchased for cash (no debt service) and only cash flows $200/month, that means that the gross rents are likely only about $400/month. To buy a house for $60K that only generates $400/month in cash flow is horrendous. I can't imagine any experienced investor would do that.

At a minimum, many investors want to see at least 1.25% of the purchase price in monthly rent, so at a minimum, a $60K property should generate at least $750/month in rent. Using the 50% expense ratio assumption, that's $375/month in cash flow (net operating income), which is $4500/year. That's a 7.5% cash-on-cash return.

Most experienced investors want at least 1.5% of the purchase price in monthly rent, in which case, a $60K property should generate at least $900/month in rent and $450/month in cash flow. That's a 9% cash-on-cash return.

These returns all seem small (and they are), but if you use leverage, they get much better. That 7.5% return when your monthly rent is 1.25% of the purchase price will increase to over 13% if you get a loan with 20% down (4.5% interest, 30-year fixed). That 9% return when your monthly rent is 1.5% of the purchase price will increase to nearly 21% with the same loan as above. Positive leverage can really bolster returns, which is why most serious investors will leverage their properties (there are also good tax and asset protection reasons to leverage your properties).

Personally, I don't hold a lot of rentals, but if the right deal comes along, I will. I just recently purchased a 3 br/2 bath house built in 2001 for $36K. I put $3K into the rehab (paint and appliances) and rented it for $900 month. That's a 14% return unleveraged, and I'll probably refinance and pull out $35K, which will take my cash-on-cash returns to over 70%. To me, that's a good rental property.

And the best part is, there's no downside risk -- unless market rents dropped from $900/month to under $450/month, the property will be cash flow positive and I'll make money on my investment. And, if rents ever drop by 50%, there will be bigger problems in the world than my cash flow...

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This almost sounds like another language to me. I get lost trying to follow what all the stats you project. Nonetheless, very interesting and I appreciate the information from someone that is in the trenches actually doing this. Thank you.

JScott said:

Expense ratios for a typical single family house will generally fall in the 45-55% range (or gross rents), so if the house was purchased for cash (no debt service) and only cash flows $200/month, that means that the gross rents are likely only about $400/month. To buy a house for $60K that only generates $400/month in cash flow is horrendous. I can't imagine any experienced investor would do that.

At a minimum, many investors want to see at least 1.25% of the purchase price in monthly rent, so at a minimum, a $60K property should generate at least $750/month in rent. Using the 50% expense ratio assumption, that's $375/month in cash flow (net operating income), which is $4500/year. That's a 7.5% cash-on-cash return.

Most experienced investors want at least 1.5% of the purchase price in monthly rent, in which case, a $60K property should generate at least $900/month in rent and $450/month in cash flow. That's a 9% cash-on-cash return.

These returns all seem small (and they are), but if you use leverage, they get much better. That 7.5% return when your monthly rent is 1.25% of the purchase price will increase to over 13% if you get a loan with 20% down (4.5% interest, 30-year fixed). That 9% return when your monthly rent is 1.5% of the purchase price will increase to nearly 21% with the same loan as above. Positive leverage can really bolster returns, which is why most serious investors will leverage their properties (there are also good tax and asset protection reasons to leverage your properties).

Personally, I don't hold a lot of rentals, but if the right deal comes along, I will. I just recently purchased a 3 br/2 bath house built in 2001 for $36K. I put $3K into the rehab (paint and appliances) and rented it for $900 month. That's a 14% return unleveraged, and I'll probably refinance and pull out $35K, which will take my cash-on-cash returns to over 70%. To me, that's a good rental property.

And the best part is, there's no downside risk -- unless market rents dropped from $900/month to under $450/month, the property will be cash flow positive and I'll make money on my investment. And, if rents ever drop by 50%, there will be bigger problems in the world than my cash flow...

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You can learn a lot on this forum!

On a side note regarding apartments buildings and for this discussion I mean duplex and up, make sure you have some experience dealing rentals before you jump into apartment buildings because believe it or not its a different animal then say a single family house.

For one thing there is the management issue, there are more tenants living under the same roof, and if you don't think tenants won't talk to one another, you have your head in the sand. One roof is great, until you have to spend 30K to replace, one heating system, one A/C unit is great, until your heater gives out in the middle of winter and its 15 degrees outside. What I'm trying to say is work your way up slowly and DO YOUR DUE DILIGENCE.

Also one more tidbit, this is from my local market, from a management perspective, depending on how many units you have it will really dictate what type of management you will find, i.e. the more units you have the easier it will be to find a competent property management group, and I'm not talking about 20 units, more like 100 units. Good luck

Kak said:

I don't know much about the RE rental industry, but I have a friend that tied up 60k on a house that cashflows him only like $200 per month. To me that is SUCH a shame, I have secured $200/m for more than one year cold by spending a week on the phone selling. It is hard work, but to me is easier than tying up 60k for it.

Thoughts?

I am just trying to learn the motives.

Click to expand...

JScott is right on the money.

$2400 a year profit on $60k is a 4% operating margin which is terrible imho.

To keep things in perspective, when I was buying 2 bed 2 bath condos in Phoenix. I paid $40k per condo and rented them out at $700 per month (1.75% of price) gross. Minus PM ($55/mo), property tax ($40/mo), HOA ($175/mo), insurance ($30/mo), plus plus (i.e., vacancy/fix/rent, maintenance, accounting, banking) we're talking about a $350 per month in operating profit or $4200 a year or 10.5% operating margin.

Fast forward a year, the rent is still about the same but the condo has appreciated to $55k crushing the operating margin to 7.5%. As prices continue to rise, the margin will continue to fall until a point is reached where I need to do something - either 1031 or re-fi/slap mortgages on them to pull equity.

I also bought 3 bed 2 bath homes. Best was one I bought in Tolleson for $55k that is rented at $850/mo (1.5% of price). Slightly lower operating margin - say 9%. But has appreciated to $110k, so better appreciation. Which is a double edged sword since a doubling of appreciation is a halving of operating margin - down to 4.5%.

In effect, buying 1 condo and 1 home isn't fantastic for free cash flow (~$750-$800 per month) on a monthly basis nor has the capital appreciation been spectacular (~$70k), but it has all been work-free. Basically means that after buying just those 2 units, I can spend time doing something else while those 2 units just grow and throw off some pocket money. That's my perspective/mindset anyway.

NB: I bought more than 1 condo and more than 1 home of course, but the general idea is the same: very little work after buying and setting them up with the PM/tenants, some pocket money per month, capital appreciation due to housing crash/low prices, automatic cash/appreciation generator until re-fi.

NB 2: JScott is right about needing monthly rent to be 1.25% or greater of the purchase price. Many ignorant realtors use 1% to put buyers into terrible properties. During the recession/depression I got 1.5% to 1.8%. I'm sure other buyers saw even better. In fact, JScott's house got 1.22%+ which is like finding a white elephant roaming around Scottsdale. Depressions are merely opportunities to bag fast/easy money.

NB 3: JScott is also correct that when operating margins are crushed (e.g. halved) when prices normalize and rise by doubling, to counter this would be to mortgage the property to shrink the equity involved in the home to restore the margins. The pulled money can then be used to do it all over again. It's quite mindless, but I'm not one to turn down free money.

50% is a nice comfortable leverage level.

Problem with borrowing to much is you can find yourself caught short when the market turns and go bankrupt. Lots of big guys in 2008 found this out the hard way, even some on the RD site which had trailer's full of exotic cars.

Growing in this business is a balancing act. You want to grow your company, but not put yourself in such an exposed position doing it that a market correction will ruin you.

Here is an example of a rental property I'm building now and hope to have rented for $2,500-$3k a month by the summer when its done. ( I hear rental numbers in this range, will advertise for $2,800 the middle of it)

I got a pretty good deal:
Land $18k
Construction costs $150k

Total investment $168k.
Current FMV if I were to sell it, I'd list it for $399,900 and take the first good offer over $390k.

Its a new house so maintenance costs for the first 10 years are very low, and I'm renter proofing it. IE all hardwood floors no carpet, etc. 4 bed 3 bath colonial.

I'm going to finance $125k out threw my bank, so I'll have just $43k of my money in it. I plan on putting all the rental money towards the note to pay it off as quickly as possible.

Not bad, I have a two family I'm building in the fall with similar numbers, and a 13 unit condo project I'm hoping to buy out from someone next year.