Steps to Successfully Buying Your First Investment Property

[PEERless]

the buyers would need to come up with $165,000 out of his pocket...Most people don't have that kind of money sitting around.

If I had $3500/month for rent, I'd hope I had that much available.

You're certainly more aware of your market than I. I can't imagine throwing almost $50 Grand per year into a rental! The market must be very scary down there.

Conceding that...

Why buy one $490K rental instead of two $245Ks? Or four $120Ks? Is the promise of a high end tenant that tempting? If the equity worth the risk of no cashflow?

(FYI, I'm just playing devil's advocate, and parroting a friend who made fun of me for buying one $175K instead of three $60Ks. I'm a smaller fish, but it's the same game.)

 

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[phlgirl]

Imirza -

If you are able to get properties to cash flow in a higher end market and are certain that the tenant pool is solid, I say bravo. When I first started investing in RE, it was in a higher end market like that and I loved it. They are still my favorite buildings and I plan to have them for a very long time.

You do need to have a healthy reserve. I like to have several months of mortgage payments and serious consideration for repairs.

I would really test that rental market, if I were you - particularly if this is going to be your first investment purchase in that area (I have no idea whether it is or not). I have been known to post test ads on craigslist – even post sample ads in newspapers to check out the volume and type of callers. It is not a mistake you want to get caught holding – even if you could move into it as a solution, that should not be part of the plan, u know? Without sale as a possible 2nd exit strategy, you want to be really sure of your rental market.

What you say makes sense. I have friends in high end homes who are choosing to rent. Not necessarily due to being locked out by jumbos, but due to the volitility in the market.

Are people moving in or out of the area? Job growth, population growth, etc. In what direction is that headed?

Just some thoughts. Best of luck with it.

 

[imirza]

Sure thing PEERLess.

Let me break down my reasoning

1. A luxury $490k home is going to appreciate a lot faster in the long run that an average $250k home. I once had a client that bought a home for $480k in 1994 ( in Beverly Hills). The house appraised for $1.8 million in 2004. 1.3 mil appreciation in 10 years. The area I am buying is not Beverly Hills but it is one of the nicest areas with one of the highest median incomes in Phoenix. You don't make millions in real estate through cash flow. You make it though appreciation. Buy homes that are going to appreciate the most.

2. An borrower can't have more than 10 mortgages on his credit report at once per bank guidelines. So instead of 'wasting' mortgages on $250k homes, I might as well aim for more expensive homes.

3. My cashflow would be worse buying a $250k home. Homes in that price range rent for no more than $1500. The 490k home will rent for $3500 by comparison.

4. I personally know 2 people around this area that are renting homes in the $3500-4000 range. In one case the person sold his home at the market peak and is renting it back from the buyer. There is definately a market for high end rentals.

5. There are lots of $250k homes on the market for rent. The sheer number of homes in this price range means owners have to undercut each other to get it rented. Some of these $250k homes only end up renting for $950 per month.

 

[Runum]

imirza on your point number 3 are you comparing gross rents and calling that cash flow? Forgive me if I am misinterpreting what you mean.

 

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[imirza]

Runum,

A $490k home that rents for $3500/month will cashflow better than a $250k home that rents for $1500. The 1st home is nearly twice the price of the 2nd home but rents for more than twice the rent for the 2nd house.

 

[Runum]

Disagree with you on that point. There are other variables to consider. Down payments, different rates of interest, length of notes, different HVAC systems resulting in differing maint expenses. I would imagine that landscaping and other maint. expenses would be higher as well. Also forgot about insurance and taxes being higher. Cashflow is after all those are deducted.

 

[imirza]

Thanks Phlgirl

Its a growing area. Population is expected to grow 50% in the next 15 years. Population has doubled over the last 8 years. Lots of jobs. Many are medical and financial related.
2 new hospitals opened up last year. Many white collar professionals and self employed entrepreneurs in the area.

 

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[imirza]

Runum,

All utilities are paid for by the tenant. Maintenance of the backyard is also done by the tenant. All of this is written in the lease. I have a current rental and my tenant takes care of everything and pays for all utilities. The only thing I pay is mortgage, taxes , insurance and home owners dues.

 

[Runum]

Sorry I was editing as you were typing. Cool that those costs are included into the lease. We also agree insurance and taxes will be higher for the more expensive property. What about different financing terms. Would they be the same?

 

[imirza]

Financing costs would be slightly higher but the higher rent would more than make up for it.

 

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[Runum]

Well man I'll quit badgering you about this. Seems like you have figured it out. That's what makes all of this dealing and sharing ideas so cool, we can keep each other on our toes. I wouldn't invest that much money into one SFH property but then, again, I don't know what you do know. That's very OK. I wish you well my friend. I hope you make a fortune on it. Good luck.:cheers:

 

[imirza]

Thanks Runum

I really enjoyed the badgering. I want people to rip my plan apart so that way I can see the holes in it and find ways to fix them. I like knowing all the things that could potentially go wrong and figure ways to prevent them from happening.

I completely understand your perspective on property prices. I used to live in Austin, TX where you could get mansions for $200k. Then I moved to Los Angeles where you couldn't find studio apartments for $200k. It was a HUGE price shock needless to say !!

 

[andviv]

I agree with Runum, it is clear you have done your homework.
I don't know if I missed it in here, but how much are you planning for reserves?
That is the only remaining point in my opinion. Keep always in your mind that one single month of vacancy will probably wash out your yearly cashflow. If you have that also cover then it seems like a solid plan. I remember you said the offer was accepted, when are you planning the closing?

 

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[imirza]

andviv, the financing option that I am using will give me cash back. Enough for a years worth of payments. I plan on closing late April. In the mean time I am doing due diligence and covering all the bases. Going through with this deal depends on me getting approval for this type of financing. If things change and I can't get the financing program that I want, I will not go through with the purchase. I am structuring everything so I that I have very limited downside.

 

[snowbank]

Snowbank - it rents for over $3500 a month. There are not a lot of luxury rental homes on the market so it should rent pretty quick - no more than 3 months. There is a demand for luxury rentals because qualifying for a loan is harder so people rent or lease to purchase instead of buying. You have plenty of upper middle class white collar professionals here who have moved here recently and choose to rent first before buying. I can also offer them a lease to own option.

Even if it does have a good rental market, I'd still be a little bit worried about having a vacancy with that high of a mortgage with only 1 unit to bring in income. Like when SteveO talks about having vacancies with multi-units, it doesn't really effect him at all because the other units bring in enough income to cover the rent if a couple units go vacant. I have one property near the U of A that I was told I should have no trouble renting to students, and I actually had it vacant for several months before I found a decent renter. It didn't hurt me that much because I had money to cover the mortgage, but if you are banking on this mainly for appreciation, I'd just make sure you have enough money comfortably put away if it sits vacant, and I'd make sure you'll still be happy with the investment if in 2-3 years the market hasn't picked up at all and it's still worth what you paid.

 

[imirza]

Snowbank ,

I am working on a financing option that will give me cashback to cover atleast a years worth of payments. So even if the home sat empty I wouldn't lose money. Buying this home depends on me being able to secure this cash back financing. If I am unable to get this type of financing I will not go through with the purchase. There are plenty of fish in the sea. In the current RE market all I care about is structuring deals that work completely to my advantage.

 

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[PEERless]

1.You don't make millions in real estate through cash flow. You make it though appreciation...
3. My cashflow would be worse buying a $250k home. Homes in that price range rent for no more than $1500. The 490k home will rent for $3500 by comparison.

imirza on your point number 3 are you comparing gross rents and calling that cash flow?

Kiyosaki calls appreciation the fifth best reason to buy rental real estate. The other four are cash-flow, depreciation, amortization... and something else (help me out).

Anyway, comparing gross rents is a misleading stat. Let's hear what the difference between the possible incomes of those two properties. And thanks for being a sport.:eusa_clap:

 

[imirza]

Comparison of properties

Property one : Purchase price $250,000

Loan $ 250,000
Interest Only loan @ 6.5% : $1354.17
Taxes ( 1%) : $208.334
Insurance ( estimated ) : $60
HOA : $100
Management : $75 ( flat fee)
Total costs : $1,797.5

Property would rent for $1500 (at most)

Cash flow would be $1500 - $1797.5 = ($297.5)


Property 2: Purchase price $ 490,000

Loan $490,000 I/O@ 6.75% = $2,756.25
Taxes (1%) = $408.33
Insurance(estimate): = $100
HOA : = $150
Management = $75 (flat fee)
Total cost = 3,489.58


Rent conservatively for $3500 - 3,489.58 costs = $10.42 cash flow

In example 2, I estimated the rate to be higher due to a higher loan amount. I am actually working to qualify for a program where I will be getting cash back. A years worth of payments will be covered via this cashback feature.In the first example I am using $1500 as the rent though this is a best case scenario. Even with this estimate the 2nd example looks better. The interest only feature will be for 5 years. I could also do it for 7 or 10 if I want. The goals is to sell the home within 5 years for a higher price.


Regarding appreciation, I think this is the best reason to own real estate. Why would you buy real estate if the value was not going up ? Has anyone made millions let alone billions in real estate via cash flow and depreciation alone ? The wealthiest real estate investors live in areas like California and NYC which have also had the fastest rates of appreciation over the last 50+ years. California and NYC are some of the worst markets for cash flow but its the appreciation that has made these investors the money.

 

[snowbank]

Snowbank ,

I am working on a financing option that will give me cashback to cover atleast a years worth of payments. So even if the home sat empty I wouldn't lose money. Buying this home depends on me being able to secure this cash back financing. If I am unable to get this type of financing I will not go through with the purchase. There are plenty of fish in the sea. In the current RE market all I care about is structuring deals that work completely to my advantage.

imirza,

it really doesn't seem like the best idea. with your the logic you're using to justify this deal, it would make sense to do like 50 of these deals, and if the market goes up, you are rich, and if the market stays the same or goes down, you are bankrupt. it doesn't cashflow, and you aren't paying down the mortgage, so basically you are hoping the home goes up. i really strongly feel that "hoping" while investing is not a good strategy. look at steveo. he can have exactly what you want from this deal(appreciation), but he doesn't have to hope it gets there. he knows it will be there based on his numbers and what he knows he can do. he will also be cashflowing while he is waiting for the appreciation to take place. i know of some other people who used this strategy(buying places hoping they'd appreciate, with no cashflow), and the market in the last year or 2 has obviously gone down quite a bit, so I can't imagine what happened to all those "investments." your play here isn't cashflow, and it isn't appreciation, it seems like just a 'gamble for appreciation.' being in the gambling world i assure you i could find you a more +ev gambling situation than this.

 

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[snowbank]

Comparison of properties

Property one : Purchase price $250,000

Loan $ 250,000
Interest Only loan @ 6.5% : $1354.17
Taxes ( 1%) : $208.334
Insurance ( estimated ) : $60
HOA : $100
Management : $75 ( flat fee)
Total costs : $1,797.5

Property would rent for $1500 (at most)

Cash flow would be $1500 - $1797.5 = ($297.5)


Property 2: Purchase price $ 490,000

Loan $490,000 I/O@ 6.75% = $2,756.25
Taxes (1%) = $408.33
Insurance(estimate): = $100
HOA : = $150
Management = $75 (flat fee)
Total cost = 3,489.58


Rent conservatively for $3500 - 3,489.58 costs = $10.42 cash flow

your management fee is way low and you forgot to include maintenance/repairs. also, you forgot to include vacancy %. even with the numbers fudged this seems like a bad deal. with the correct numbers you'll be well into negative cashflow.

 

[biophase]

Imiza,

My opinion of your deal is that its marginal. Here is why:

1) $0 cashflow with interest only.
2) Getting cashback at closing to cover vacancies is not equal to not costing you any money. The money is still leaving your pocket.
3) One major appliance failure and you are losing money on this investment. You have no budget for repairs (Appliances, pool cleaners, landscaping problems, HVAC)
4) High end rental market is pretty tough and suprislingly competitive. Put an ad on craiglist before you close and see how many emails you get just to get an idea.
5) Like you said, you may not be buying under FMV. In 12 months, you can be at FMV with a $0 cashflow property.

What I'd like to see is:
1) Try to get at least $0 cashflow with a 30yr fixed loan. Then you are paying down principle. If all hell breaks loose your worse case scenario is that you have a free and clear house in 30 years.
2) Add some dollars for maintenance and repairs
3) Test out the rental market with ads

or

If you are really purchasing six-figures below FMV, flip it. I know that's easier said than done.

 

[imirza]

Snowbank,

What I am doing is buying distressed real estate in a market with strong long term fundamentals. I would consider this gambling if I didn't understand the market. What I know of this market is that an extra 100,000 people are expected to move here over the next 15 years which is a 50% increase in population. What I do know is that the current depressed real estate prices is a function of excess supply and not enough demand. Excess supply is caused by rising number of foreclosures and bank REOs. Lack of demand is due to the current credit crunch. Once the foreclosure and credit crunch issue is resolved properties will appreciate. Its only a matter of time. By my calculations 3 to 5 years at most. Phoenix has historically been one of the fastest appreciating cities and the trend will continue. The current market conditions is a simple supply demand issue. Nothing is fundamentally wrong with the market. By fundamentally I mean industries are not closing down and leaving Phoenix like say the manufacturing industry in Detroit. Future growth is strong. The current challenging RE market is a great time to pick up bargains. Once the market stabilizes I cannot imagine people giving away real estate like they are today. What I am doing is no different from what Warren Buffett does with stocks. He buys great companies that are undergoing tough times and buys them at bargains. What I am attempting is the same with real estate. Buy great pieces of real estate at bargain prices in a distressed real estate market. The price of this house in question is already off 50% from the peak of 2 years back. I am buying way below current market value and current market value is already depressed and way below peak prices. So while prices can continue to fall, the market value of this property would need to fall over 25% in order for me to 'upside down' As long as I have the ability to hold the property for atleast 3 years which I do, I expect to be fine.

 

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[MrPink]

Good points snowbank and biophase!

Based on the figures shown, I would stay away from purchasing these properties.

You may not make millions with cash flow, but it will allow to be in the game until you want to leave. By being able to sell on your terms, who are not motivated and can attain a good price for your property resulting in the realization of the appreciation.

I would not even consider a property that doesn't rent for 1 percent of the purchase price 250k - 2500, 450k - 4500.

I would be interested in hearing from someone that is currently successful in renting for under 1 percent of the purchase price.

Finally, I am not a hater and would love to hear more numbers on how you can make these properties work - if not - then find others and keep moving forward!

Mr. Pink

 

[imirza]

Snowbank,
The management fee is $75 a month. I have spoken to them. They are the biggest SFR management Co. in Phx - www.gorenter.com. True I didn't factor in vacancy, but I was comparing 2 properties - a 490k vs a 250k one. I currently have a rental which I have had for a year without any vacancy. Its in a great area with high demand. If you know the area well and demand is high you can always have the place rented out year long.
True I haven't factored in maintenance/repairs. But my contracts state the renter pays for the repairs . If the toilet gets clogged it their problem. They obviously did something to get it clogged up in the first place :smxF: Obviously if the roof caves in then thats an issue I deal with. But the smaller stuff/appliances are their problem since its all brand new and shouldn't have defects to start with.
Biophase,
The property in question was built in 2004. Appliances have hardly been used if ever used. I don't expect it to breakdown. I have factored landscaping into cash back . Like I said if this property does not rent I have enough cashback to pay more than a years of payments. I expect the property to rent. Cash out of my pocket ( from the cash back) will be no more than 12k per yr at most (I expect it to be 6k). Plus I can invest the surplus funds at 15% or more. I expect to sell the property for atleast 150k more than I payed for it in 2011.
Yes the luxury rental market is competitive in Scottsdale. Its not competitive here where I live however. Lot of high end jobs and white collar professionals looking to rent upscale homes. Bio, you are more than welcome to come check out the place since you live here in the Phx area. Send me a PM and we can set up a time. Its worth looking at :jiggy:

Mr. Pink, you need to go live in California . 1% of purchase price will never work there.
I tried that back in 2001 and didn't find anything. I didn;t by RE in LA because I was trying to follow this stupid 1% rule. Conventional RE methods don't work in fast appreciating area. If you can find me a SFR or condo that rents for 1% of purchase price in a decent part of LA I will seriously have a sex change operation

 

[MrPink]

I think 1 % (conventional RE methods) would work even better in fast appreciating areas.

I think you are right in that 1 % won't currently work in CA - I think it be considered late in the most recent CA boom. (aren't you considering AZ?). Since the prices of CA real estate have greatly increased in the last 20 years.

I am too conservative to pay for appreciation and would need some cash flow. However, maybe I am missing out on opportunities sticking to this logic. I will have to think about this new perspective.

Where are you getting your information that the demand will increase so rapidly?

Mr. Pink

 

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[snowbank]

Snowbank,

What I am doing is buying distressed real estate in a market with strong long term fundamentals. I would consider this gambling if I didn't understand the market. What I know of this market is that an extra 100,000 people are expected to move here over the next 15 years which is a 50% increase in population. What I do know is that the current depressed real estate prices is a function of excess supply and not enough demand. Excess supply is caused by rising number of foreclosures and bank REOs. Lack of demand is due to the current credit crunch. Once the foreclosure and credit crunch issue is resolved properties will appreciate. Its only a matter of time. By my calculations 3 to 5 years at most. Phoenix has historically been one of the fastest appreciating cities and the trend will continue. The current market conditions is a simple supply demand issue. Nothing is fundamentally wrong with the market. By fundamentally I mean industries are not closing down and leaving Phoenix like say the manufacturing industry in Detroit. Future growth is strong. The current challenging RE market is a great time to pick up bargains. Once the market stabilizes I cannot imagine people giving away real estate like they are today. What I am doing is no different from what Warren Buffett does with stocks. He buys great companies that are undergoing tough times and buys them at bargains. What I am attempting is the same with real estate. Buy great pieces of real estate at bargain prices in a distressed real estate market. The price of this house in question is already off 50% from the peak of 2 years back. I am buying way below current market value and current market value is already depressed and way below peak prices. So while prices can continue to fall, the market value of this property would need to fall over 25% in order for me to 'upside down' As long as I have the ability to hold the property for atleast 3 years which I do, I expect to be fine.

I totally agree with your points in your post here. About Phoenix, about buying when the market is down, etc... I think you should really get all the numbers, including maintenance, repairs, management, vacancies, etc... and then break down how good of a deal it will be. Also, what's your plan if the market doesn't change in 3-5 years. If I were you and considering buying this property, I would break down numbers based on if the market did improve, and if the market didn't improve.

 

[PEERless]

I would not even consider a property that doesn't rent for 1 percent of the purchase price...I would be interested in hearing from someone that is currently successful in renting for under 1 percent of the purchase price.

Wow! That's a lot of money. Shows how different markets can be! I feel "successful" with my condo, and I'm nowhere near the 1% rule.

$175,000. $870/mo mortgage. $900/mo rent.

Granted, I would feel good about my investment, even if i had the pay the mortgage for myself, just because of the other benefits of REI.

 

[biophase]

Biophase,
The property in question was built in 2004. Appliances have hardly been used if ever used. I don't expect it to breakdown. I have factored landscaping into cash back . Like I said if this property does not rent I have enough cashback to pay more than a years of payments. I expect the property to rent. Cash out of my pocket ( from the cash back) will be no more than 12k per yr at most (I expect it to be 6k). Plus I can invest the surplus funds at 15% or more. I expect to sell the property for atleast 150k more than I payed for it in 2011.

Imirza,

I'm not discounting your analysis, but to simple saying that this and that are new so they won't break is unrealistic. I've purchased alot of new construction and things do break. They usually break after the builder's warranty has run out.

Here are a few examples:
- Hose bib outside leaks, water logs drywall on the inside of home until one day paint begins to peel.

- Big rainstorm reveals a window leaks upstairs, goes unnoticed until you seen water on the inside of your downstairs window.

- Pool cleaner gets clogged, pool pump runs all day and burns out.
- Pool lights burn out

These are all major repairs, +$300 that can happen in the newest of homes.

If you're plan is to sell for +$150k in 3 years, these little things won't be much to you. But what if you happen to be upside down in 3 years, you're cashback is gone and you're IO loan adjusting and you have to make repairs.

The reason I bring this up hard right now is that I know a bunch of people telling me this same story in late 2005. They bought below FMV, got cash back enough to hold 2-3 years. Well it's 3 years later and they are at market or even below FMV. They have no reserves and negative cashflow because rents have dropped. Not a good situation to be in.

BTW, I have one alligator that I'm feeding now. Same situation as your $490k, except I got it 3 years ago. At the time I bought it there was over $150k equity. Today, I'm looking at -$30k equity. It broke even on Day 1, now it's close to -$600/mo. I should have flipped it for +$70k on day two.

 

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[tbsells]

Excellent thread! I'm enjoying the intelligent debate. I think both sides have made good points. Nothing to add at this time.

 

[unicon]

Appreciation remains gambling and cash flow remains investing. There is a mentality thing here, a negative cash flow property can be an albatross when sentiment changes you can't get rid of it fast enough. Cash flow investing is also long term training in doing it right. Appreciation cannot even approach the long term power of cash flow investing, its like a railroad train picking up speed. You also take out tax free money at a compounding rate, etc, etc, etc. You need to make your early deals the hard way in searching and negotiating the right deal. Heck we could have a depression in a few weeks and many more downsides could multiply.

Secondly even though I could afford your house to rent, I as an investor would never pay such rent. I would live more conservatively, the doo dads are meaningless compared how I could multiply the 3500/mo. You are counting own part arrogance and ignorance to rent that house in that area (compared to beach front in california).

Your comparison between the 2 seems ok in that you have a quantum jump in quality and can survive payments for the short term. However you are buying yourself a job, you are not using your mind totally, you are leaving your brain on the table before the finish line. This is a rationalization when you attempt to justify it relative to cash flow investing.

Finally properly define that you are still gambling and go into the deal knowing if you made money it was more luck than learning. Face up to it because in the long run yu will have to work harder to get rid of the bad habit.