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:
Tools scattered everywhere. This is what we call “Friday night!”
Neutral paint, beige carpet, white trim. It’s cookie-cutter, which sells better.
Hanging window treatments. Ah, isn’t real estate glamorous?
How do you take an interesting photo of an empty room, anyway?
Old vanity; new topper, faucet and hinges. It’s a cheap facelift!
Completely irrelevant photo of my new kitten. Isn’t she awesome?!
Location
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.
Costs
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. 🙂
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Okay, can’t help it. Gotta comment on the kitten since I have 2 cats. Is this a rag doll by any chance? One of mine is….
@Tina — She’s a rescue cat — her whole litter was abandoned on a farm, without a mother cat. The kittens had to be bottle-fed until they were old enough to be weened. The litter is SO different-looking, though! She’s the only one with ragdoll-like features. The rest of her siblings are either tabby cats or have a patchwork-type of coat. (We chose her specifically because we loved her ragdoll features. Especially those blue eyes!)
Provided you don’t decide not to look for one more, will you really be paying down a mortgage vs. investing in hopes to earn a better return? I am extremely happy I bought my rental when I did with rates increasing. I am faced with the exact same dilemma. More rentals? Pay down mortgage on my dwelling? Invest?
@Ryan — Great question. I wrote a post recently about the choice between paying off a mortgage or investing. I think there’s plenty of merit to both, so our strategy is to max out our retirement accounts (for the tax benefits, as well as the investing benefits) and then use any excess money to pay down the mortgages.
The great recovery has been in our area for a while now. The deals are gone, and the duplex we snagged has a market value over twice what we paid for it in 2010. Yay, I guess? But I wish we could have gotten more locally while the getting was good.
Best of luck finding your 1 more! =)
@Mrs PoP — I know exactly how you feel. The value of my real estate has gone up, raising my net worth in the process. But I’m not excited. (Well, okay, maybe I’m a little excited). But that excitement is tempered by the knowledge that now it’s harder to acquire more.
That said, there’s ALWAYS opportunity. We just need to stay alert and ready.
Thanks for the wonderful article! I too am a landlord, but I own a good chunk of a townhome complex (family owned). I’m curious why you don’t look for bigger/smaller places – is the return not as good?
Are bigger families/groups of roommates typically worse tenants, or are they less reliable? Are smaller places not as profitable?
Thanks for any insight you might have! 🙂
@Ashley — In my area, I don’t see enough of a rental price difference between a 3-bed and a 4-bed/5-bed to justify the additional purchase price of a larger home. I’d be better off saving that additional money for the purchase of another home. In the area where I invest, 2-bed to 3-bed homes have the best probability of meeting the One Percent Rule. (Of course, that’s specific to the neighborhoods where I invest).
That’s specific to single-family residences. If you’re investing in apartments or multi-plexes, I think one-bedrooms are the best. Normally, you’ll find single people (or occasionally couples) renting apartment/multiunit buildings, while I’ll find couples and families renting single-family residences.
Hi Paula,
Congrats on your 4th place! Your real estate empire is coming along nicely 😉
I have a question for you regarding property management. Perhaps you could respond in the comments or in an upcoming article. Here’s the question…
Above and in previous articles you have allocated 10% for property management. If I recall correctly, though, you have been doing the property management yourself so far. Now that you’ve got four properties and you’re starting to travel again, have hired a dedicated property manager? If not, how do you manage the properties when you’re traveling?
I ask because I’m planning to purchase some rental properties soon (I also live in Atlanta), but I travel a lot — for 4-6 weeks at a time. While I’d like to do the property management myself, it seems impossible to handle something like a leaky water heater if I’m thousands of miles away. So for me, a property manager seems like an essential part of the equation. But it’s also a bit troubling because I’m not sure how to find one I can really trust.
Anyway, I’d like to hear more about your experiences and thoughts regarding property management.
Thanks for the great blog!
-Rick
@Rick — Great question! Yes, I always budget for a property manager, even if I do the work myself. After all, I’m creating a job. When it’s convenient for me to fill that role, I can “hire myself” and “pay myself.” (It’s active income, not passive income). When it’s not convenient for me to fill that role, I can “quit my job” and hire someone else to replace me, without impacting my bottom line.
I did recently hire my first property manager, for one of my houses. House #2 is located about 30 minutes away from my home. That means it takes me an hour (round-trip) just to drive there and back, which means that managing that particular property is incredibly time-consuming (because of the commute time). So I outsourced that house to a property manager a few months ago … and it’s a fantastic experience! I don’t have to worry about fixing the dishwasher, collecting rent or repairing the garage door.
I agree that a property manager sounds essential for your situation. This book is the best resource that I’ve come across for learning how to hire a property manager. The first half of the book discusses property management in general; the second half discusses how to hire it out.
Congrats on the buy! I’m a fellow Atlantan, and I have to ask what part of town is giving you the best hope for finding deals like this? I’m not a home investor (except for my own) but your enthusiasm makes me curiouser and curiouser…
@Bob — Honestly, good deals are exceptionally rare in Atlanta these days. Most of the real estate investors that I know — myself included — are searching outside the perimeter, if not in a completely different city/state. I looked as far away as Woodstock, GA while I was searching for a house. Atlanta has turned into an overheated, tough market, and I think the best deals (for rental properties) are OTP.
If you want to stay ITP: I know a few people investing in the Adair Park / Peoplestown area, but I don’t have the stomach for that. If you can find a good deal in the West Midtown / Bolton area, snag it … there are still good deals there, though they’re increasingly competitive.
Congrats! I’m surprised you could find a property in such a good condition with such a healthy cashflow in this kind of market.
I’m into real estate investing myself and I’ve had to focus only on foreclosures and short sales with extensive rehabs lately. Our latest project is a $50k house with a $43k rehab. It’s a solid building, but has the most ridiculous layout I’ve ever seen, with doors that lead to nowhere and windows being blocked by badly-planned additions. One room has entire walls and floors covered in leopard print velvety fabric and the walk-in closet to this room is covered in the same fabric, only in zebra print! Too bad we have to deal with faceless corporate types in distressed sales because I’m seriously curious about the previous owner now.
Also, completely irrelevant comment: your kitten is adorable! Those blue eyes! Ragdoll?
@Deane — To be honest, I’m surprised I found it, as well. It’s rare (in today’s market in Atlanta) to find a good-condition property at a reasonable price. I looked at a lot of overpriced turnkey properties, and a lot of junkers, before I found this one.
I’d LOVE to see photos of your new prokect … particularly the leopard-print room. I’ve seen a lot of weird things in real estate, but that sounds like one of the strangest!
And thanks for the comment on the kitten! She’s a rescue cat, born on a farm in Colorado. Her mother abandoned the litter, and a rescuer bottle-fed the surviving kittens until they were old enough to find homes. The kitten flew out to Atlanta on a Southwest Airlines flight! She’s got kitty frequent-flyer miles 🙂
Congratulations! You’re on your way to be a real estate mogul.
And now you’re talking to yourself, too. 🙂
Congrats on the purchase! We just bought our 4th house (if you count the one we live in), getting work done on it now, with a tenant moving in on Aug. 1… the same day our first mortgage payment is due. 🙂
Including the two apartments we have in our house, we now have 5 rental units. We don’t count our “unit” as a 6th rental unit, since we have no intention of moving and renting it out. While our house is technically a 3-unit, it feels more like a great 3-bed, 2.5 bath house that happens to have two one-bed, one-bath apartments up on the 3rd floor.
@Rich — I know the feeling; that’s exactly how my triplex feels! It feels like a great 3/2 house that happens to have two other units attached. I count it as a rental, only because we share it with roommates (we occupy one bedroom and rent out the other two bedrooms). Congratulations on buying your 4th house / 5th unit … and on your awesome timing with the new tenant!
Always inspiring!
Thanks for being an inspiration, Paula! My partner and I are currently building our first home here in Australia. We had to get the loan in his name because my credit rating is horrid and the bank pretty much laughed at me when they saw it. I’m desperately trying to repair it so that we can start buying investment properties next year. I’m 24, he’s 25 and I want us to be well on the way to being financially set up by the time we are 30!
Jess — You’re on the right track! You’re buying investment properties, repairing your credit, and doing it all in your early/mid twenties. Nice job! If you stay on this road, you’ll be in a great financial spot by the time you turn 30. 🙂
You guys are on fire, congratulations! I am looking into US property as a way to diversify so your posts are always super helpful.
Awesome! I was so stoked when I received the email that you purchased another property!
Congrats and kudos to you…and something tells me that you’ll be purchasing at least one more within the next six months! =) You have it in your blood.
@Chante — I suspect I might be at risk of buying another house in the next 6 months, as well. It’s definitely an addiction …
“’Just one more’” is what addicts say. – if we could switch addicts from heroin to landlording, we’d be doing a great thing, eh?
Nice house, and I know that ‘home’-work feeling on some Friday nights. Looks great, congrats!
Thanks PK! Yeah, I seem to have an over-spending problem. I buy too many houses!
Hi Paula,
Congrats on the new property! I live in San Francisco and homes under a million are hard to come by here in the Bay Area-I could never, ever find a property that meets that 1% rule. I want to build passive income but don’t know if I will be able to via real estate investing-do you have any recommendations for me?
Thank you,
Isabel
@Isabel — If you really want to be in rental properties, I’d invest outside the Bay Area. Expand your search outward, either to other parts of California, or out-of-state completely. I know plenty of investors who live in the New York but make their investments in Cleveland or Cincinnati or Atlanta or St. Louis or Birmingham or Cheyenne … whereever they find the best deals and can understand the market.
Here’s a post I wrote on this topic: http://affordanything.com/2012/12/11/real-readers-ask-what-if-i-cant-hit-1-percent/
Otherwise, if you decide not to invest in rental properties, I’d focus on maxing out every tax-advantaged brokerage vehicle that’s available to you: 401k’s, IRA’s, HSA’s, 529 plans. If you’re young (20’s/30’s) and you won’t panic during a downturn, invest aggressively in broad-market stock index funds. You’ll get the double-benefit of tax advantages plus market returns.
Congratulations on another find. Best of luck with the mortgage pay down strategy, as well.
I just want to being up the other side of the equation and a looming possibility that real estate faces. First off, I want to say that I think real estate is one of the, if not the best investment vehicle that exists.
BUT! I want to encourage all those thinking of going into realestate in the neat future to read “AfterShock” by David Weidemer. Weidmer presents some compelling arguments on how rising interest rates will be good for real estate investors in the short term, but damaging in the long term by limiting peoples ability to access loans–>hence less buying–>Decreased demand for family homes–>Finally decrease housing prices (Equity). Again, I love real estate, but it is worth an investigation.
@Omar — That’s why I firmly believe that you should never buy real estate for it’s potential appreciation. ONLY buy for cash flow. Appreciation is a bonus; nothing more.
Killing it! Congratulations on your home purchase.
Thanks Michelle!!
I’d love to see a post or a comment from you on what legal structure you use to hold your investment properties. If you pay yourself to manage a property and consider it active income, does that mean you are an S corporation (or some other type of corporate structure)? I would love to be able to hire myself and therefore have the ability to contribute to an IRA. Currently, my tax guy tells me I cannot, as my income is “passive” (no matter how many hours I spend tending to my rentals).
Congrats on buying another rental home! My wife and I are saving up to buy our third rental by the end of next year. Wishing you much success.
Congrats Paula! I aspire to purchase rental property #2 in the next year. Do you usually purchase each rental home under your own name? Or under an LLC? How do you find funds for down payments on each home? I have rental property #1 paid off in full and thinking about getting a home equity line of credit (heloc) to buy property #2. Just wondering how you and Will went about accessing funds. My husband and I have been saving money from our take-home pay; it just seems to be a long and sloow process. Thank you much for any advice!
Jeni
@Jeni — Generally speaking, LLC’s are good for protecting your personal assets in case of a lawsuit, BUT some banks are loathe to lend to LLCs or to let an LLC refinance. If you choose to go that route, make sure you’re working with a banker who has a lot of experience working with property investors.
Alternately, you can keep the properties in your own name in order to get an easier time financing, but compensate for that risk by purchasing a giant liability insurance policy. We have a $1 million policy and we’re thinking of bumping it up to $2 million.
Here’s a great forum thread on this topic: http://www.biggerpockets.com/forums/311/topics/66725-how-many-of-you-hold-your-rental-properties-in-your-name
P.S. Oh yeah — and we’ve done a combination of saving from our take-home pay for down payments as well as refinancing with the equity in our existing homes. We’ve done it all!
I wish I lived in a cheaper area – the 1% rule is pretty much impossible where I live. That’s a pretty awesome deal you got!
Brian — You can always invest out-of-state! There’s no rule saying you’re limited to only investing in your backyard. 🙂
I loved this post! The one percent rule is definitely one to live by. I’ve recently been combing through deals in the PHX area trying to pick up a 3/2 SFR and have found you are exactly right, good deals are hard to find… Many properties in my area are selling above asking price and w/ under 14 DOM.! Congratulations on this new add to your portfolio, looks as though the hard work has paid off once again. KUDOS!
I just stumbled across your blog and so glad I did. Congrats on the new property!!!
Thanks Erin!!
Are the 6 units in an LLC? or do you own them outright?
Awesome! Congrats on the new property! I just closed on Rental #3 and am working diligently to save for #4. Hopefully by the end of the year.
You’re such an inspiration 😉
@FI Fighter — Congratulations on closing on Rental #3!! That’s excellent!! I’m a firm believer that rental properties are one of the BEST paths to financial independence.
btw, how many rentals do you plan on acquiring total? My goal is to get to 10 by the end of 2015, hopefully.
@FI Fighter — My goal is to have enough properties that I’m earning at least $50,000 annually in passive income. (If I do the management myself, that’s “active” income, not passive. I’ll pay myself a 10 percent management fee, but that money counts as “active” income — not as “passive” income.)
Right now I’m collecting roughly $25,000 annually in passive income. So I need to double that — either by doubling my number of properties, or by paying off the mortgages. I’ll let the market conditions influence that choice.
Paula – Congrats on your 4th rental! That’s awesome!
Question: how would buying in a more expensive area alter what you’re doing?
I live in Seattle. Great economy with very strong employment bases in both tech and union (ports, Boeing, etc.) companies. Pay is very good in the area and the recession didn’t/hasn’t hit as hard here as in most places.
I have one rental property that would be cash flow positive on a 30 yr loan. But converted to a 15 year as a forced savings of sorts. So, it’s costing about $200/mo out of pocket, but this is offset by interest deduction and depreciation.
Anyway, this house is a 2B/1bath, 720sf. Market value is probably $140K-$150K. I’m collecting $1,225 in rent.
BUT, this is about the cheapest house you could find within 15 miles of downtown Seattle. Realistically, you’re looking in the $180K-$200K min. And anything within 10 miles is $300K+.
Rents are strong in the area. But no where will you get 1% rent for the purchase price.
OTHER THAN move :-), how would you build your portfolio in this scenario? Thanks a lot! And, well done! – Thomas
Congratulations on your new property!
Hi, I am from Singapore and would like to purchase some properties in USA. Will anyone be able to help?
I like what you guys are up too. Such clever work and exposure!
Keep up the fantastic works guys I’ve included you guys to my
own blogroll.
I’ve been reading through your articles “House #1”, “House #2”, etc. And they’ve been a great read! What I would love to see is a link at the end of each article (or 2nd part of the article) to the next house. I keep having to navigate back to your homepage to read the next one! Thanks.