Guess what? We did it again. We bought House #4, which represents our 6th rental unit in total!
“Whoa, Paula, this is getting ridiculous.”
Yeah, I know. Let’s meet the new rental, shall we?
The Rental House
First, the stats: It’s a 3-bedroom, 2-bath single-family house. Sound familiar? Every single-family residence we’ve purchased has matched that description (except this one, which is a 3 bed, 1.5 bath).
Why? 3/2’s hold wide appeal, since they meet the needs of so many people: couples, roommates, small families, and sometimes even single people if the price is right.
The house barely needs any immediate repairs. It only needs about $3,000 worth of upfront work, which makes it the most rent-ready property we’ve ever bought. Eventually (within the next 5 years) we’ll need to replace the roof and upgrade the kitchen. But for the moment, the house is move-in ready.
Check out the pictures:
The house is located in an up-and-coming neighborhood. It’s the type of place where ramshackle, boarded-up vacant homes sit next door to posh new construction.
Ah, real estate is fascinating, isn’t it? I used to think there were “good neighborhoods” and “bad neighborhoods,” with plenty of space in between. But in an emerging neighborhood, “good” and “bad” is literally a house-by-house matter.
The neighborhood features old Fords propped up on cinder blocks, next to vegan raw food cafes. Go figure.
First of all, before I get into the price, let me take a moment to emphasize how tough it was to find this deal. Remember the last house that I didn’t buy? That whole incident took place back in – what, early April? Ever since then, I’ve treated searching for houses with the seriousness of a second career.
If you’re serious about real estate investing, know this: searching for properties is a job. You’ll reject hundreds before you find the right one. (In that regard, I guess it’s like swiping faces on Tinder?)
Okay, here are the figures:
“Real” Purchase Price: $120,000 (purchase plus initial repairs)
Rent: $1,300 per month
(UPDATE July 2015 — We’ve raised the rent to $1,500 per month.)
Right away, what do you see in those numbers? This house meets the One Percent Rule, meaning its monthly rent is at least 1 percent of its purchase price. (For this house, the monthly rent is 1.1 percent of the purchase price).
As long-time Afford Anything readers know, I won’t look at a house that doesn’t meet the One Percent Rule.
Bear with me while I veer onto a tangent about that rule for a moment …
One Percent Rule
Why is the One Percent Rule so critical?
If the monthly rent is 1 percent of the purchase price, then your GROSS return is 12 percent annually. But vacancies, maintenance, repairs, taxes, insurance, and management will take a huge bite out of your gross profits.
There’s a broad rule-of-thumb known as the “50% Rule,” which states that over the long-term, roughly half of your rent will get consumed by operating costs. Let’s crunch some basic numbers:
You collect 12 percent of the property value in annual rent. Half is consumed by operating overhead; you’re left with a 6 percent cash flow return. The house also appreciates at the rate of inflation, 3 percent. Your total return is 9 percent per year. That’s a decent return. But if you dip any lower than a One Percent Rule property, you risk getting sub-optimal returns.
(UPDATE July 2016: Here’s a more comprehensive explanation about why the One Percent Rule matters.)
Real Costs of This House
What does the math look like on this property? Let’s check it out:
Potential Gross Income: $15,600 (at $1,300/month rent)
Minus Vacancy: $780 (at 95 percent occupancy)
Effective Gross Income: $14,820
Let’s subtract costs:
Management: $1,482 (10 percent)
Repairs/CapEx: $1,200 (One percent of purchase price annually)
Mortgage: $7,416 (Fixed, 30-year loan on $90,000 @ 4.25 percent, PITI)
Total Expenses: $10,098
Drumroll, please ….
Passive Income: $4,722 per year!! Wahoo!!
I’m happy with this investment, as you can guess. We already found a well-qualified tenant, who moved in shortly after we closed the deal.
UPDATE July 2015: We still have the same tenant! In fact, he just renewed his lease for another year (at a $200/month price increase), bringing him to a 3+ year tenancy and counting.
Every time I buy a rental property, I have to face the question: “Keep buying more? Or start paying these down?” I never know the answer. My focus might shift to mortgage pay-down rather than property accumulation … maybe.
Although I might search for just one more. 🙂
“OMG, Paula, you’re getting out of control.”
What do you mean?
“’Just one more’” is what addicts say.
I know, I know. 🙂