What’s a Good Deal on a Rental Property? Here’s My Formula:

Fellow blogger The Small Investor asked me on a previous post if I would be willing to outline how I find my rental properties and specifically what returns I’m looking for based on rents, purchase prices, repairs etc. I mentioned some stats briefly in another post,  but I’ll attempt to get a little more in depth here.

NOTE: I’m in Atlanta. This formula varies widely across the country. One of my best friends works in real estate in Los Angeles, and her investors typically get a much smaller return on their investments. I love Atlanta because it’s incredibly affordable. I love calling it our home and I love investing.

My particular strategy is buy and hold. When I first got into real estate here about 6 years ago people were flipping, wholesaling, buying notes, and also doing tons of mortgage fraud. Now none of that works quite as well. Can you flip in Atlanta? Of course! I know people who do. It’s just not my thing right now. My view is I could flip and make a fast 20k, or I could rent and make that same 20k in 2 years, and another 10k every year after that for the same investment. Slow dollar quick dime.

Used to be that we had a 1% rule. In other words, buy for 100k and rent for $1000 per month. This was pretty typical of what was considered a good investment. Now that doesn’t work quite as well. I’ve found that there is a general correlation here in Atlanta between return and risk. The crumbier the neighborhood, the higher return if you can get it. Buy a quadraplex in a nice area, and you’re probably going to get closer to the old 1% rule.

I have a colleague who bought a house in a really terrible area of Atlanta a few months ago for $3500. She put about 10k into it, and gets $500 a month in rent. I do not have the stomach for the neighborhood, but she does and can make it work.

My sweet spot it in an area of a city called Decatur where my goal is to buy (aquisition cost plus repairs) for between 40-50k and get between $900 and $1100 per month in rent. I own two of these currently, I’m about to start the process of buying a third.

To answer Small Ivy’s question – I have not had mortgages on these two. I am doing a cash-out re-fi on the first one to buy a third. However, if I was buying with mortgages I would absolutely have to do BETTER than just making the mortgage, taxes and insurance on the rent.

Here’s the breakdown so far:

Rental #1 – Cost ~50k total (purchased for 27k, put around 23k in.) Monthly rent $950 – Property manager $95 – Taxes $70 – Insurance $70 (The tenant does the lawn maintenance.)

Rental #2 – I did better on this one. Cost ~ 48k total (Purchased for 43k, put 5k in) Monthly rent $1050 – Property manager $105 – Taxes $120 – Insurance $65 (Tenant maintains lawn).

So monthly, if there are no repairs and no mortgages, I would make $1475. I am closing this week on the cash out on Rental #1 and getting 30k, which will cost me an extra $200 a month but will enable me to buy #3 along with the savings I have. Once I get number 3 out of the gate I’m hoping to do approximately 2k per month AFTER expenses.

I have seen quite a bit of information from seasoned investors that say over time, typical costs of maintenance, taxes and insurance will cost you approximately 50% of your rent, so over a period of years if your rent is $1000 you should typically expect to spend about $500 of that, NOT INCLUDING any loan costs.

Some people would say get rid of the property manager and do it yourself, but frankly I think she’s worth every penny. She’s gotten me two amazing tenants on 2 year leases. I wouldn’t have known the first thing about screening them and would have lost far more than she costs in time and days on market for rental. The other cost not stated in the monthly cost is that the initial fee for rental is one month’s rent, which has to be factored in to your total return.

If you are really just barely making the mortgage and expenses I can’t see doing it. You need to be making actual passive income regardless of whether the property value goes up. If you can’t do this in your area, consider investing elsewhere or try to get a screaming deal.

Hope this helps! Let me know if I didn’t answer anything.

Property Value Twist

I’m under contract for Rental #3. I have a purchase price of 25k. I was expecting there to be around 15k in repairs putting me at a 40k price for a lower rent than my other properties at $850 per month.

Two problems came up today that I’m concerned about.

#1 – The repairs are going to be a lot more than I’d expected at about 25k. There are roof and mold issues that are going to need some very expensive repairs.

This I could deal with if I got a good enough price reduction. The next issue is the biggie.

#2 – The appraisal came back on Rental #1 ( which I’m mortgaging to buy #3) at only 45k.  At a 75% mortgage plus closing costs I’m walking with about 29k. And #1 is in the same area as #2 and slightly larger with 1 more bedroom.

If you’re an investor by now you’re putting together the pieces. The whole point of mortgaging these properties was to be able to at least buy one more with each mortgage. The closing costs are relatively the same for higher priced vs. lower priced properties, so I’m paying a higher percentage for lower amounts. If a better property than the current one I have under contract will only appraise for 45k, then putting even 40k total into this one seems a little silly IF I’m planning to mortgage it, which I am.

There are other areas of town where there are a wider spread of values, making it easier to have “instant equity”. I don’t like those areas as much for steady rental, but if I’m only going to mortgage 6 and buy 8 more in the next 2 years I just don’t think I’ll have enough cash if I’m only getting 30k out of each one that’s mortgaged.

Plus there was a dead bird in front of the garage today. This just doesn’t seem like a good sign.

UPDATE 10-30 I ended up cancelling this contract. The seller wasn’t willing to go down in price and there are other deals where the repairs wouldn’t be so incredibly extensive. Sheesh. A ton of time for me and the contractors for nothing.