Real Estate Investing - What metrics do you use?

[thelopez2]

Originally Posted by lurtsman

I've been contemplating buying some investment property near where I live so I could manage it myself. However, doing a little "research" has left me with widely varied criteria for use as a "rule of thumb", some of the metrics being used appeared completely absurd.

So, I thought I'd hit up the real estate forums and see what other landlords are doing for evaluating properties, and how they find them.

Rent to cost of purchase?
Monthly cashflow after PITI compared to initial investment?
Using a formula that adjusts for expected income/losses (depreciation) on tax returns to estimate after tax ROI?

How do you estimate rent? Do you simply use rents for that area based on sqft and adjust for the sqft of the property, or do you start with something like that and then make adjustments for things like garages, lot size (since the initial number may include condos)?

Would you search the MLS? Do you have realtor friends that call you when they hear about something that seems to be priced too low?

Are there any books that were very helpful to you in getting started in your investing career?

If you limit yourself to the local market, the market will dictate the prices. You can create a usless rule of thumb but it will basically remove you from the market. Ask a agent for some multi units that have sold. Those listing usually have the rents published, from there you can calculate the GRM for an area. That is simply the market price and rate. IF the GRM is 12 then chances are everyone is paying right around 12, if you find something at 10, then you just got a deal and can possibly resale it at 12. IF you paid 14 times GRM, you paid a bad price, but there may be other factors involved.

Buy properties with negative cash flow does not scale very well, yet people do it just because they are speculating on appreciation or using a tenant to pay off most of the monthly payment and consider it a retirement plan after 30 years.

Put yourself in a renters shoes and see what the market rents are on craigslist. If the unit is rent control , it doesn't matter what market rents are since the rents are locked in

Price per Sq FT, isn't a factor, 1500 versus 1650 won't necessarily yield another 10% in rent. A rental is shelter, bedroom, and bathroom, and maybe a office.

If you are considering factoring in depreciation, it is a paper loss, that you might have to pay taxes on later.

You are buying property to either 1) Have positive cash flow 2) someone to service the mortgage while it appreciates and you sell it 3) Have someone help you buy a asset which after the mortgage is paid off, will have positive income.

There is a cash on cash return
There is a ROI on equity return.
It is all about risk tolerance and market conditions.

If someone pays all cash for a home, their Cash on Cash % return will probably be lower than if someone put a lower down payment and borrower at a cost lower than the cap rate.

When they have 100% equity, there is very little leverage , the appreciation is the maximum ROI on your equity. If you only had 10% equity, but the property appreciated 10% , your equity doubled versus just move 10%.

The rule of thumb, is to make money on the buy not the sell of a property.

[tommy64]

Originally Posted by lurtsman

I've been contemplating buying some investment property near where I live so I could manage it myself. However, doing a little "research" has left me with widely varied criteria for use as a "rule of thumb", some of the metrics being used appeared completely absurd.

So, I thought I'd hit up the real estate forums and see what other landlords are doing for evaluating properties, and how they find them.

Rent to cost of purchase?
Monthly cashflow after PITI compared to initial investment?
Using a formula that adjusts for expected income/losses (depreciation) on tax returns to estimate after tax ROI?

How do you estimate rent? Do you simply use rents for that area based on sqft and adjust for the sqft of the property, or do you start with something like that and then make adjustments for things like garages, lot size (since the initial number may include condos)?

Would you search the MLS? Do you have realtor friends that call you when they hear about something that seems to be priced too low?

Are there any books that were very helpful to you in getting started in your investing career?

random rambling thoughts from a landlord/investor guy:

i like 2 bedroom single family homes in urban areas that are close to public transportation/jobs. the typical wage earning tenant can afford $800 - $1000 per month in rent. that means the house shouldn't cost more than 80k - 100k to put on the rental market. the closer to the city center the more rent it'll pull, all things being equal. i'm in a 200,000 population city and think population density is vital.

as far as rent amount, set it low if you want to be a discerning screener, or charge high if you don't mind churning tenants through. that'll depend on the condition of the dwelling.

if a house has more than 2 bedrooms it usually means more people, possibly younger kids, and it's much more wear and tear on a building than a couple with maybe one kid. you don't want to rent to a motley crew of 5 rowdies. one story homes are much easier to repair and maintain, especially with regards to plumbing and wiring.

i am narrowed down to 2 zipcodes in my area, the owner to rental ratio is important, you want to find a sweet spot where the majority of homes are owned, but not so upscale as to be priced out of the rental market. the condition of neighborhoods that are mostly owner occupied is usually better for obvious reasons. renters simply don't care about keeping the garbage/riff-raff out because they're gonna eventually move anyway.

i also make note of new construction in an area, specifically commercial. when a retailer like a grocery store or a home depot, or even a small 6 unit retail space goes up, it speaks well of the area. this element alone speaks volumes about a whether an area is moving up or declining.

i have a realtor i use who has a lot of experience with investment property, but i bought my first ones on my own, dealing directly with the listing agents. but i do recommend using a buyers agent.

when buying property, bear in mind that the average wage earner is probably going to be the tenant. if the property looks suitable and affordable to that demographic, it's worth looking at. if the average 30 year old wage earning couple making 50k between the 2 of them isn't going to want to live there, you're probably gonna be suckin' air.

it's also a good idea to live at the dwelling for at least 6 months. you can only get a feel for the place if you're living there. you'll know the house and the neighborhood intimately if you live there for a while. and if you don't like things about the house after you've bought it don't hesitate to sell it and move on to something better.

financing is important to cashflow. if you can't get a low rate (4% or less) pay cash. if you can't pay cash, wait 'til you can. positive cashflow is the lifeblood in all but a few special cases.

[davecj]

In order of importance to me:

Basis
Cash flow
Exit strategy

[parentologist]

We look for properties where five years of rental income (calculated as 9 months/yr of rent, leaving 3 months for taxes, maintenance, water/sewer - so essentially 45 months of rent) will equal the purchase and renovation price of the property. For example, we buy a triple decker with three 3BR apts. It costs us 100K to buy, and another 30K to renovate. It generates 3K/month in rent, and nets about 27K/yr. So over 5 yrs, it theoretically generates about 135K, or about the purchase and renovation price of the property. The only area where we can get this rate of return is a nearby town with a large stock of tenement housing, and a large population that lives on welfare, section 8, and disability payments. We consider this a 20 percent return on investment, plus we enjoy doing it. We figure that this will provide an income stream in retirement. BUT - we know the market very well, spouse is extremely handy, can do most of the work himself, and we have licensed plumbers/electricians whom we can call on for help at reduced rates when necessary.

This is not a business to just jump into. We've made a lot of mistakes, some of which have led to horrible problems with criminally bad tenants. The book Landlording is the best resource we've found to help people to understand the basics. Many people whom we know who have tried doing this after having attended some get rich quick seminar end up losing money and severely regretting having ever bought a rental property. Don't do this if you're not very handy. Don't buy far away from home. Don't do it if you don't enjoy this sort of thing - it's so not worth it. Don't do it if you can't be a detached hard person about evictions, sob stories, etc.

[mateo45]

Originally Posted by MrRational

Or like most people... do you want both?

Rule #1... the rent has to cover the nut.
The nut may vary... but whatever it is it still has to be paid.

Forget "formulas", I'm with this! And BTW, if this is your first go-around being a Landlord, don't underestimate the "learning curve", which also includes knowing the local tenant/landlord laws, the eviction process there, finding a good attorney (who specializes in helping landlords!), and knowing the expected "clientele" in your target area (are they yuppies, blue collar, immigrants, students, whatever).

BTW, I personally prefer renting out single family houses and duplexes, to apartments… there's way less turnover. Also as already noted, checkout Craig's list for an indication of rents on comparable properties and locales. But keep your rents as competitive as possible, which gives you a wider selection of applicants to select from. Finally, never underestimate the "people skills" required, whether dealing with late rents, interviewing prospective tenants, or responding to emergency plumbing problems on the weekends (when they invariably seem to occur)!

Although otherwise, you'll quickly discover that rental properties are indeed a goldmine for tax deductions!