I personally am marketing several low priced rental properties and I received an email from a MAREI member who has been around MAREI for several years, but has not completed a lot of deals. He was registered on my website KCInvest.com as a buyer with criteria for what he would like to buy. One of our $12,000 properties that is rented for around $400 fit his stated criteria and he emailed me he was thinking about buying it.
So is a $12,000 house a good deal?
Short answer, it depends. I am not saying a $12,000 rental property is not a good investment, but for a brand new investor with limited funds it might be something you need to think long and hard about.
So what are some of the pitfalls.
Short of Funds: This is a perfectly functional rental property, but I am willing to bet that at $12,000 that there are many things that could use some work. Furnace might be 10 to 20 years old. Windows are probably there, but could use being replaced. Roof may be working fine, but is one good storm from needing replaced.
So what happens to the new investor that scrapes together the $12,000 to buy the rental property. He buys it, the tenant stays and is happy and keeps paying rent. He collects rent month #1. He collects rent month #2. Then the furnace stops working and the only way to fix it is to replace it. Cost for a new furnace is $2,000. Where is it going to come from? If he has no reserve for contingencies, then the tenant leaves and until the furnace is fixed, no new tenant is going to move in an pay anything.
Management: What a new investor may not realize that buying a house with an existing tenant can be a great experience and then again, there might be a reason the current owner is selling. Just because the current owner says the rent is $400 does not mean the tenant is actually paying it. And the only way to find out for sure is to buy it and try to collect.
The tenant might also be a great tenant for the previous owner because they rule with an IRON hand. But a new investor landlord is probably going to be tested by the tenant to see how far they can go before rent payment is enforced. If I were new to landlording I would look for a property that is rented and professionally managed that I could buy and keep management in place and the tenant never even knows the property was sold.
OOPs. : So what happens if things in life change and you suddenly need that $12,000. You have to sell the house quickly to get your cash back. You might only be able to sell quickly for $5,000. That’s why when we talk about working the numbers you want to work them for the worse case scenario.
You want to buy a property for 65% or less of the market value. So if a property – today as it stands should sell through a Realtor in a 120 days for $20,000 with a quality paying tenant. The most you could pay for it is $13,000. However that is not worse case scenario. What would that house sell for today if it were sitting vacant? Maybe $18,000. Then the most you could pay would be $11,700.
The formula we all talk about is 70%. For nicer properties in nicer areas, you might be able to take that up to 75%, but for the lower end properties, you want to go the other way to 65% or even less.
So to that new investor who is thinking about a a $12,000 rental property. First make sure the numbers work.
- Find out what you could sell it for on the open market.
- Inspect it to see what repairs are coming up that you need to have money in reserves for that furnace that could shoot craps tomorrow.
- See what the most you can pay for it might be.
- Investigate hiring a property manager.
Also don’t forget all the fees that need to come out of that monthly rent: 10% vacancy off the top, probably another $50 a month for maintenance, another 10% for property management, real estate taxes, hazard insurance, and setting aside funds for major repairs coming up.
So if a house has $400 a month rent, that would be $4,800 annual
- Less 10% vacancy: $480
- Less $50 a month for maintenance: $600 (toilets, windows, plumbing issues, etc)
- Less 10% property management: $480
- Less Real Estate Taxes $500
- Less Insurance $500
- Fund set aside for major repairs another $50 a month: $600
So out of $4800 annually, you reduce that by $3,160 leaving you with $1,640 in annual income. Not bad for something you can put in the hands of the property manager.
But make sure the roof, furnace and other major systems are going to last for a while as you build up that contingency fund or set aside extra funds right now.