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 for 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, and small families are all eligible renters. Even single people sometimes rent 3/2’s 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 turnkey 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.
Wanna see? Check out the pictures:
(If you’re reading by email, click “display images” to see the photos)
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 endlessly fascinating, isn’t it? In the established suburbs where I was raised, 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, searching for houses has felt like a demanding second job.
If any of you are serious about real estate investing (in a major way), know this: Searching for properties is a job onto itself. You’ll reject hundreds before you find the right one. (In that regard, I guess it’s like swiping through 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 that 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 the yearly rent is 12 percent of the purchase price. 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. Let’s assume two scenarios:
#1: You live in a state with massive property taxes. You have pricey insurance. You get overloaded with repairs, maintenance and vacancies. These costs consume 50 percent of your gross rent.
You’re left with a 6 percent cash flow return. Plus, the house appreciates at the rate of inflation, 3 percent.
Total return = 9 percent annually.
#2: You live in a state with a low property tax rate and cheap insurance deals. Repairs, maintenance and management are cheap. Vacancy is low. The tenant pays for all utilities and yard care. Your expenses consume only 33 percent of your gross rent.
You collect 8 percent cash flow (that’s like buying a dividend stock with an 8 percent payout!) The house appreciates at the rate of inflation.
Total return = 11 percent annually.
Not bad, eh? That’s the magic of the One Percent Rule.
Note: I’ve laid out this math assuming that you paid cash for the deal. Why? Because you should evaluate investments separate from its financing terms. This way, you can compare two houses with different financing terms and make an apples-to-apples comparison.
Furthermore, you can see how well the house will perform when the mortgage is paid off, which is the ultimate goal.
Real Costs of This House
How does the math change when financing gets added in? Let’s check out this house:
$15,600 (at $1,300/month rent)
$1,248 Vacancy (Assuming an 8 percent vacancy rate)
$1,560 Management (Assuming a 10 percent property management fee)
$1,200 Maintenance/Repairs (Assuming 1 percent of the purchase price per year)
$7,416 Mortgage (Fixed, 30-year loan on $90,000 @ 4.25 percent, including property taxes and insurance)
Total Expenses: $11,424
Passive Income: $4,176 per year!! Wahoo!!
We’re ecstatic about this house purchase, as you can guess. We already have a tenant living there, and – knock on wood – he seems like an ideal tenant (great job, etc).
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.
It’s clear that these deals are getting tougher to find. Two years ago, you could throw a dart at a real estate listing and score an awesome deal. These days, you’ll devote hundreds of hours to combing for a needle in a haystack.
We’re very happy with the six rental units that we’ve accumulated during the Great Recession (one triplex and three single-family homes). But the Great Recovery is now rearing its ugly head. That’s bad news for buyers. Our focus is going to 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.
**Note: In my experience, a 3-bed/2-bath home is the most awesome type of single-family house. If you’re renting out a multi-unit building, like a 3-plex or 4-plex or 100-plex, then buy a building in which each unit has only 1-2 bedrooms. Here’s why.