Updated October 8, 2021
These are the first questions every new real estate investor asks when they find their first potential investment.
• Do I wait to make an offer?
• Is it too risky?
• Should I wait until the pandemic is over? (ok, not always, but right now, the pandemic is a factor)
What are the metrics and goals you want to reach as a real estate investor? A rental property is not a depreciating asset like a boat or car. It is not as volatile as the stock market. When you invest in real estate, you put your money in a real, tangible asset, which makes your investment less risky than some other investments you might consider.
If you find a potential investment property, do you wait or do you leap?
Do the Math to Determine Cash Flow
If a realtor is listing the property for sale, the listing information should include current rent per unit – If not, contact the realtor for those numbers. You'll also need to know if utilities are separately metered so that you can have the tenants billed directly. If so, you’ll need to account for the utilities for common areas. If not you’ll receive the bill and decide if you are going to include that in the rent or if tenants will pay you extra.
Armed with these numbers, consider the property’s cash flow: Work out the potential mortgage based on your purchase price and down payment. Your net cash flow should be positive and somewhere around what you are expecting to profit on each door. Some investors mix up the gross revenue, or the total amount they collect in rent as cash flow and forget to subtract all of their expenses and debt service payments, to arrive at their net cash flow.
To figure out your net cash flow:
Start with the gross rent – the total of all rental payments each month. Subtract your mortgage plus PITI (principal, interest, taxes, and insurance) – these are your fixed expenses for the property.
Then subtract anything else you pay for as a landlord, such as utilities and property management fees. You also need to deduct a reasonable monthly repair allowance plus a monthly vacancy allowance..
If this cash flow amount meets your criteria, you now have a good basis for what you can offer as a purchase price.
Here’s an example for how a duplex might cash flow:
The current rent for each unit is $650, to generate income totaling $1,300. Tenants pay their own utilities, and there is no common area.
|
|
Amount |
Notes |
|
Mortgage with PITI |
$815 |
|
|
Utilities |
$0 |
|
|
Monthly repair allowance |
$101 |
Use a 1.5x monthly rent rate to get a yearly total/12 |
|
Monthly vacancy allowance |
$58 |
According to the U.S. Census Bureau, the rental vacancy rate was 6.8% in Q2 of 2019, this will vary depending on your area. |
|
Property Management |
$65 |
Property management can vary from 6-12% across the US) |
|
Total |
$591 |
|
Based on the math, the monthly cash flow is $591 for two units, $295.50 per door.
If this cash flow fits your buying criteria, you are looking at a good deal.
The most significant variable is the rent amount – and that’s a number where you have some control. Don't necessarily assume the current rent is the right amount for that location and that property. Rentometer is an excellent tool to capture and compare current rental rates across a neighborhood or city.
Consider the local economy
2020 has been a trying time for the economy overall, and property owners are feeling their share of the pain. Many tenants have lost jobs during the quarantine and have been unable to pay rent. In most cases, property owners still have to carry the full mortgage and PITI. Of course real estate investors could not have predicted a situation that has unraveled so quickly. It does hold that if a local economy was strong before the pandemic, it has a better chance to bounce back after restrictions ease. There are too many variables to count, but an investor should always consider the local economy's diversity. What types of industries employ the most workers? If possible, look for an area with 3 or 4 main industries, so if one employer or industry gets hit harder, your tenants will still have employment opportunities.
Set aside a reserve fund
Every property owner needs a reserve fund, and a bank or mortgage lender often requires documentation of such a fund before they extend a loan to you. The amount necessary will vary, depending on your bank’s policies and the type of mortgage you qualify for as an investor. A good rule of thumb for a reserve fund is six months of PITI of funds on hand. Applied to the example above, a reserve of $4,890 would be necessary.
Do I wait to make an offer?
Timing depends on your position as an investor. If you have the cash reserves, qualify for financing, and the property meets your cash flow criteria, make the offer. There is no better time to invest in real estate than today. As soon as you own the property, you can start receiving cash flow and building equity.
Is real estate investing too risky?
According to a survey by avail.co in 2017, independent landlords owned 24 million units across the U.S. Millions of investors assessed their risk and became landlords. Consider your own tolerance for risk, and weigh the additional benefits of owning an investment property.
In addition to cash flow and building equity in an asset that will appreciate over time, landlords enjoy many tax benefits. Legal website nolo.com points out ten deductions available to landlords:
• Interest payments
• Depreciation
• Repairs
• Personal property
• Pass-through deductions
• Travel
• Home office expenses
• Employees and independent contractors
• Insurance
• Legal and professional services
Real estate is a great investment for those looking for a long term buy and hold. Do your due diligence when it comes to considering the purchase of a rental property. If the purchase meets all of your criteria, move ahead with confidence. If the numbers don’t quite add up, there is no harm in waiting – another deal will come around, or you can go out and find one when you are ready to take the plunge.
Visit rentometer.com to learn about current rental rates and decide if a property is worth your money, time, and effort.