Home Buying in 03801>Question Details

Funsuzee, Home Buyer in 03801

I;m thinking about buying a rental property - what is the magic ratio of investment to income?

Asked by Funsuzee, 03801 Sat Jul 17, 2010

What kind of rent would you need to get in order to have a rental property. I'm thinking in 15 years or so, we'd use this property for our summers in portsouth. Thanks!

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7
Are you looking at a single family? If so, and you want to use it during the summers as a vacation place for yourself then obviously you are severely limiting you tenant pool as people can only live there 9-10 months a year. Where do they go in June/ July? Portsmouth is not an area with a lot of college students- where this theory might have worked a little better. Just a couple thoughts...
I own a couple investment properties; and also am a mortgage loan officer in NH. If you need any help, feel free to contact me. Thanks and good luck,

Ken L.
0 votes Thank Flag Link Sun Jul 25, 2010
Hi, Funsuzee:

While rules-of-thumb are often tossed around when discussing investment property such as gross rent multipliers, cash-on-cash yields, etc., the only surefire way to understand what you are getting into, how it affects your personal financial situation, the affect of possible risks and to avoid pitfalls is to do a detailed analysis of the revenues and expenses and consider the after tax consequences.

I will be happy to screen candidate properties with you. This will put all of them on a baseline for your financial decision making. My practice is real estate. If you need financial, legal or tax advice, you will be able to take what I do to your advisors in these areas for further guidance.

Warm Regards,

Chuck Braxton, REALTOR GRI
603/677-2154
cbraxton@rocherealty.com
Web Reference: http://ChuckBraxton.com
0 votes Thank Flag Link Wed Jul 21, 2010
You'll need to buy a property at a price where it will yield a positive pre-tax cash-flow (PTCF [preferably at least $100/door]). This means that your adjusted gross income (the gross rent adjusted by the vacancy rate and other income) minus your expenses and debt-service should yield you at least $100/month per unit.
0 votes Thank Flag Link Sat Jul 17, 2010
Couple of ways to approach it.

First: No magic ratio. Just an iron law: Income exceeds expenses. Is the house bringing in more in income than it's costing you? You may want to involve an accountant, since there are various factors to consider such as depreciation (it really doesn't cost you anything, but can reduce your taxable income) and your income tax bracket.

Second: Return on investment. The point here is that you're going to take a chunk of money and invest it. Maybe you'd invest it in the stock market. Maybe in CDs. Maybe somewhere else. Or maybe in real estate. So let's say you have $60,000 to invest and there's a house worth $300,000. That's 20% down. And suppose you have a positive cash flow every month of $500. Is that a good use of your money? Well, you're earning $6,000 a year on a $60,000 investment. That's 10%, and in today's market that's pretty good.

Third: Return on equity. And that's kind of what Ellen and Doc were getting at when they referred to a decline in effective return. When you start out, using the example above, you'll have $60,000 in equity in that $300,000 property. (OK, CPAs, I know I'm oversimplifying a bit.) So initially your ROE is 10%. And let's assume that you're happy with that. But fast forward a few years. The value of the property has gone up, increasing the equity. You've paid down the mortgage some, also increasing the equity. Let's say the property is now worth $400,000 and the mortgage is paid down to $200,000. You now have $200,000 equity in the property, but you're still only getting $6,000 a year. That's only a 3% return. Now, realistically, you'll probably have raised the rent some. To get back to return to that initial 10% ROE, you'd need to be bringing in $20,000 a year, or $1,667 a month. That's not very likely. So at some point--let's say when your REO drops to 5% or 6%--you might want to do as Ellen and Doc suggest.

So, check with an accountant.

Hope that helps.
0 votes Thank Flag Link Sat Jul 17, 2010
Don Tepper, Real Estate Pro in Fairfax, VA
MVP'08
Contact
Many investors think the sweet spot is Rent = 1% of Purchase price - for example, a $110,000 home that gets $1,100 per month in rent. That's usually a good starting place, depending on your market. But, as always, the devil is in the details. Ask your agent to to a complete after-tax analysis that includes HOA dues, Taxes, Utilities, Depreciation, Repairs and Management fees, etc. Then compare apples to apples. Include both cash flow and expected return if you sell it.

Also, most rentals reach a point where they start to decline in effective return, at which point, it is advisable to consider trading up. You can do that with a 1031 Exchange, or if you own the property in your IRA, you can trade at will without tax consequences. One caveat - if you do that, don't plan on using it for a personal residence, or you could lose all the benefits due to self-dealing.

I've included a link to a site that gives a more thorough explanation of the process. As is true of all investments, you have to know the numbers and know what makes sense in your market (or have an agent who does).
0 votes Thank Flag Link Sat Jul 17, 2010
If you are serious about this my advice is to sit down with a lender who can answer all of your questions, get you pre-approved, and help you obtain the loan.
Web Reference: http://www.WarnerKing.com
0 votes Thank Flag Link Sat Jul 17, 2010
If you are serious about this my advice is to sit down with a lender that can answer all of your questions, get you pre-approved and help you obtain the loan.
Web Reference: http://www.WarnerKing.com
0 votes Thank Flag Link Sat Jul 17, 2010
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