Everybody has their own strategy or rule of thumb. Mine is pretty common.
If you live in a four plex, only the other three units are treated as rentals. If you live in a duplex, only the other unit is treated as rental. All the math pertains to the rentals. If you want to “live for free” in your unit you will have to use your cashflow for that.
If you have 100% financing, you will get break even cash flow when the CAP rate is equal to the Loan Constant (Annual Loan Payment/Beginning Loan Amount). Obviously you would like to have positive cashflow, so the CAP rat should be higher than the Loan Constant. With a down payment the break even cash flow occurs when the CAP rate equals the LTV times the Loan Constant. For a 30 year fixed at 7% the loan constant is 7.98% (any loan calculator on the internet should confim this.)
CAP(italization rate) is the annual return if you pay cash for a rental.
CAP = Net Operating Income/Purchase Price
Net Operating Income = (Annual) Rent* Occupancy - Expenses
You can invert this formula to figure out the purchase price
Purchase Price = NOI/desired CAP rate
The higher the CAP rate, the lower the purchase price.
If that was too brief of an explanation I have the following YouTube videos that go into more detail. Not my fault if you go running, shrieking into the night at the sight of algebra.
Real Estate Math (you can turn the music volume to zero if you want.)
I posted a question last week, but there have been new
developments in my situation. My wife and I are retired. We
have 30K in savings and make 2.5K a month after taxes. Not
too good, I realize.
It dawned on me that I could buy a multi-unit building, live
in one of the units and collect rents. This would build
equity, provide cash flow, tax benefits, and improve our
situation over time.
My pre-approval is for 200K contingent on property taxes and
rental income. This would be FHA and I could put down as
little as 3.5% to hold onto my cash reserves. What do you
recommend I do. I don’t want to fall flat on my face and
lose everything. What kind of offers should I be making.
Should I go for a duplex? Should I go for a 4 plex.
If anyone has a strategy on how to proceed “safely”. Please
let me know. What kinds of calculations can I make to
arrive at a scientific offer price…that protect me, but do
not necessarily “low ball” the seller.
Posted by greengable on August 22, 2010 at 15:04:31:
Looks to me like you’re a little “thin” to be thinking of spending $7k* or more in cash and getting into $193k or more in debt right now.
I’d think about teaming up with some experienced REI where both of you working together, with a well-written LLC agreement, buy a rental, fix cheap and run it and hold until you can sell for profit, then doing it again.
By that time you’ll have some needed experience and be better able to know what you’re doing w/o a partner or co-investor.
Or find a little OK mobile that you can buy and fix for no more than $10k including 3 or 4 M worth of MHP lot rent, then sell for $15-25k…w/o your signing big note.
I can tell you a number of real sad stories about inexperienced REI wanna-be’s who’ve got over their heads and into big trouble because they did NOT know what they were doing, did not add up the right numbers, etc. and I hate to hear of any newbie about to do the same thing.
*By the time you’d close, you’d probably have spent more than $10k so look at all numbers closely and hard before you buy.
