Posted by LK on September 03, 2006 at 21:42:15:
Make your profit and equity when you buy the property to ensure your rent numbers work out. If you are just renting a second home it really doesnt matter, but if you are buying and holding to build wealth, you have to buy right.
Questions on Buying a home for Rental Property - Posted by Shane McKenna
Posted by Shane McKenna on September 01, 2006 at 21:50:45:
I just bought my first house back in Feb. of this year and I now I am looking into purchasing a town home as a rental property.
My budget is around $825 for a mortgage, and roughly $75 a month for PMI that puts me around $900 a month mortgage. Taxes I am budgeting $3,000 a year and I’d rather pay those in June and September vs. monthly. Same with property Insurance, roughly $600 for the year. That puts me around $3,600 a year for Insurance and Property Taxes.
Say I rent the home out for $1,200 a month. After I pay my mortgage and PMI that leaves me with $300 a month positive cash flow to save for taxes, or put away for any repairs. Once I pay the yearly taxes and the Insurance that $300 a month cash flow or ($3600 a year) is gone and I have made $0 profit. Now imagine if the house went 2 months without being rented, or I have to repair a leak in the roof for $2,000 or I spend $1000 to get new carpet or upgrade the kitchen. I am now money in the whole.
A few questions come up when I crunch my #?s.
Thanks so much for the time,
Shane
Thank you for the Replies. Any suggestions? - Posted by Shane
Posted by Shane on September 03, 2006 at 15:20:22:
You ALL brought up great points, thank you all very much for the replies.
One thing mentioned I thought of but forgot to jot down was association fee’s. If I get a town home vs. a SFH that is another $50-$100 a month or $600-$1200 a year in my budget. Also vacancy and advertising I now have in my budget. Say the house doesn?t rent for 2 months that is 2 months I will have to pay the mortgage on and not get any income…
I looked into town homes in my area renting and depending on the location and size they are going for between $1,100 and $1,500.
What I DON’T want to do is need to have an interest only mortgage to generate some income. I’d like to get a little cash flow, and also pay down the principle.
But it is tough when you need to budget in the taxes, PMI if any, insurance, and association fees, maintenance, and then a few months rent IF it is vacant. Then on top of that, you have to have money set aside for any repairs.
Any other suggestions you can think of?
Thank you,
Shane
Re: Questions on Buying a home for Rental Property - Posted by Natalie-VA
Posted by Natalie-VA on September 03, 2006 at 10:24:01:
Shane,
Make sure you don’t work the numbers backward when you start to look for properties. In other words, don’t take your scenario and decide that you will need rent of $1400 to make it work. You’ll need to find out the market rents first, and then see how the rest of your numbers play out.
I hope this makes sense.
–Natalie
Re: Questions on Buying a home for Rental Property - Posted by Frank Chin
Posted by Frank Chin on September 03, 2006 at 07:20:00:
Shane:
The big unknown is vacancies, and damage caused by tenants so a major rehab is needed, throwing your budget off by months. You not only would have to spend on a rehab, but out 3 months rent, or more.
Which is why tenant selection, and selecting those who can stay two or more years is important, versus some who’ll stay a mere several months, break the lease and run. Usually, in cases like these, and you have to paint to re-rent, the painting alone eats up the security deposit if you keep it.
For condos and townhouses, a major assessement can throw you off. I owned a condo where they talked about a 10K assessment for a new roof for quite a few years.
Frank Chin
Re: Questions on Buying a home for Rental Property - Posted by BTI
Posted by BTI on September 02, 2006 at 11:47:30:
Shane
You have received some good answers, I would like to add just one factor I always use in evaluating an investment property. I always factor in a cost for having the property managed by someone even if I am going to do it, many times I have turned over a property to a professional management company so I had already covered that expense in my planning plus if your doing it you should get paid for it.
I also always figure in a commission if I’m going to flip now or later even if I intend to sell it myself, you never know. If you sell it you have earned it, pay yourself.
BTI
Re: Questions on Buying a home for Rental Property - Posted by Mike-Oh
Posted by Mike-Oh on September 02, 2006 at 07:01:06:
Shane,
Throughout the entire United States, operating expenses (including capital expenses) run 45% to 50% of the gross rents. So, half of the gross rent goes to expenses and the other half remains for paying the mortgage (P & I) and profit (positive cash flow).
In your example, if the rent is $1,200 per month, then $600 would go toward expenses and you’d have $600 with which to pay the mortgage. Unfortunately, your mortgage payment is $900, which means that you’d be losing about $300 each and every month.
My only other comment is on negative cash flow. NO, it is not alright to have a negative cash flow property. Cash flow is the life of any business and without it your business will not succeed. It is a common mistake to think that the negative cash flow would only last a year or two. What would change? I know a lot of gurus say that rents will go up over time, but they forget to mention that expenses also go up over time, frequently outpacing the increases in rent.
Will equity in the house make up for negative cash flow? Maybe or maybe not.
Good Luck,
Mike
Re: Questions on Buying a home for Rental Property - Posted by LK
Posted by LK on September 02, 2006 at 06:12:23:
Most of your questions have been answered, but I will add the following that may help.
On the properties Im purchasing to rent I calculate the mortgage payment and add the expenses; insurance, taxes, maintenance and vacancy (12.5% - 15% of gross rent). I also plan for at lease 10% of gross rent for cash flow to allow for the unexpected. This can be adjusted due to your loan terms.
In your case above, you are at $1200/mo before adding maintenance/vacancy expense. That would put you at about $1350/mo to avoid “negative” cash flow.
Just my opinion and the way I do it. You may want to run it by an accountant.
Re: Questions on Buying a home for Rental Property - Posted by Dons
Posted by Dons on September 02, 2006 at 04:44:06:
Shane,
Dave T gave you excellent answers. One thing I will add is to remember you will also have HOA (Home Owners Association) dues with a condo. This pays for exterior maintainence, snow removal, grass cutting, parking lot repair, etc.
It will amount to anywhere from $75 or a $100 a month to as much as several hundred a month. This is an expence you won’t have with a single family home.
Also with a condo there can be sudden, large assessments added to the HOA dues when it’s time for a major repair like a new roof. This won’t happen if the HOA is well managed and builds long-term repairs into the monthly dues.
Don
Re: Questions on Buying a home for Rental Property - Posted by Dave T
Posted by Dave T on September 01, 2006 at 23:59:29:
Let’s assume that you own this property free and clear – no mortgage payment. Your net operating income is whatever amount is left over from your rental income at the end of the year after you have paid all your ownership and rental operating expenses.
As a general rule, with debt service in play, you need your net operating income to be at least 1.25 times greater than your debt service. This small cushion usually allows your property to be self supporting.
Yes, it is generally true that condos appreciate slower than townhomes and that a SFR will appreciate more quickly than a townhome. While generally true, there are exceptions in certain markets. Condos are now “in vogue”. Expect condos to appreciate faster in some markets than a SFR in the same market.
Usually, no. The hazard insurance premium for a rental dwelling policy will be lower than homeowner’s insurance on the same property. For the rental dwelling property, you are not insuring “contents”. Your renters will need their own rental insurance policy if they want coverage for their own personal property.
Yes, that is true. Insurance premiums (both hazard insurance and mortgage insurance) are not Schedule A deductions on your personal residence, while they are allowed expenses on Schedule E for your rental property.
Maintence keeps things in working order or good condition. The semi-annual service contract you have on your HVAC is maintenance. The annual fire inspection where you recharge your fire extinguishers and replace the smoke detector batteries is maintenance. Even, the weekly grass cutting and seasonal shrub trim is maintenance. You should be able to predict these costs and determine how much to expense each month.
A repair fixes something that is broken. Your annual repair costs often depend upon your renters. With only a single occupant, I would expect a much lower annual repair cost than if renting to a family with children. You just have to make educated guesses – like 10% of your rent – the first year or two, then use your actual repair costs as a guide for future planning.
Personally, I maintain a large cash reserve and don’t really “budget” for repairs.
You need to look at Schedule E (1040). All your rental income and rental expenses are reported to the IRS on Schedule E. From your rental income, you are allowed to offset all your property ownership costs as well as the out of pocket costs of operating a rental property. You are even allowed to take an expense for something that does not take any money out of your pocket – depreciation.
After you have subtracted all your expenses from your rental income, you either have rental income or a rental loss. Income is taxed as ordinary income at your tax bracket rate. Rental losses can be used to offset other ordinary income on your 1040.
The IRS has publications dealing with reporting rental property income and expenses available on their website. You can download these for free.
Yes, plan for zero. See the previous response. Property taxes offset rental income dollar for dollar, resulting in a lower taxable rental income.
Depends upon your financial situation. A negative cash flow just means a larger tax loss for your rental property operation. Not everyone can use the tax loss, and not everyone has the financial strength to sustain a negative cash flow for that long.
I personally don’t purchase a property if I can’t get a positive cash flow from the start without resorting to financing tricks like interest only mortgages or negative amortization loans.
Appreciation does not always happen. When it does, it is not always quick.
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