Tuesday, February 11, 2020 / by AJ Shepard
When you invest in real estate, you make your money when you buy. The buy and hold strategy of real estate investing is a basic concept. Buy a property, rent it out for more than your monthly expenses, and collect cash. The biggest factors to this strategy are: buying properties for a good price in a good location and accurately estimating expenses.
Buying a Good Deal
Find a property that is purchased below market value is the most important variable when investing in real estate. If you overpay for the property when you buy, it will cut into potential profits. Buying properties that are in a good location will help keep your rental units occupied.
You found a property for a good price and in a good location, now how much is it going to cost every month? The most common expenses associated with real estate are the principal and interest payments for a mortgage, insurance, taxes, maintenance, and utilities. Since these numbers will differ from market to market, I always recommend using conservative estimates. If the property is projected to cash flow positively using conservative estimate it will perform even better if expenses end up being less than you projected.
Cash Flow Example
For this example, let's use a 3 bedroom / 2 bathroom property that is being bought for $400,000 with a 20% downpayment loan program with a 4.5% interest rate. The loan amount will be $320,000 property taxes are $6000 annually with no HOA dues, and insurance is $1000 per year. The monthly payment will be $2200 per month which includes the principal and interest, monthly property taxes, and monthly insurance costs. The market value of rent for a 3 bed / 2 bath in this location is $2700 per month. At first glance, this property will cash flow $500 per month ($2700 rent - $2200 monthly payment.) However, there are sometimes additional expenses to consider. Will the tenant or landlord pay for utilities? I recommend having the tenants set up the utilities in their name(s) so they are responsible for the cost. Most of the time the landlord will pay for the monthly landscaping if the property has a yard. Let's assume landscaping is $100 per month. After all these expenses, this property will cash flow $400 per month. Rental income is $2700 minus $2200 for the monthly payment minus $100 for landscaping.
Is This a Good Deal?
Depending on your market's appreciation rate this could be considered a good deal or bad deal. If your market has a strong appreciation rate, I would say this is a good deal because the landlord will collect $400 per month and the property will appreciate over time making the asset worth more year over year. Typically, rents are increased every year as well so the landlord can expect more monthly cash flow in the future.
Now if your market does not have a good appreciation rate, $400 per month of monthly cash flow may not be the best use of your capital. $400*12 months is $4800 per year. Divide that by your cash investment of $80,000 (downpayment) and you get a 6% cash on cash return. For a market that is not going to appreciate well, 6% may not be your desired cash on cash return.
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