Investing in Small Rental Homes:

I recently worked with an investor who withdrew from buying a great one bedroom condo that he was going to use as a rental. He withdrew because he was going to have negative cash flow the first few years that he owned the property.

What really surprised me about the situation is that the investor was buying the condo with a no-money-down loan and despite putting none of his own cash in the property; he still expected to break even right from the start!

This is kind of like buying a cow for the milk, but not being willing to feed her!

The same goes with buying small rental properties, (the kind of properties that an average person could afford).

If you were to make a 30% down payment on a rental property, (the kind of down payment the banks usually want on investment properties) you would likely get a small amount of positive cash flow right away.

Consider the purchase of a nice $150,000, single family home with 4 bedrooms and 2 bathrooms that could be rented for $1100/month.

Here is what could happen when you make a large down payment and what would happen with making a small or no down payment:

Example #1: A large down payment & positive cash flow:  “Joe Investor” makes a 30% down payment ($45,000) when buying his $150,000 rental home. This leaves Joe with a mortgage of $105,000.   At a 6.5% interest rate, Joe’s monthly payment with taxes and insurance would be about $788. Let’s assume maintenance and vacancy costs of $170/month. Joe’s total monthly cost of owning the property would be $958/month.   The difference between the rental income of $1,100 and the expenses of $958 gives Joe $142 in positive cash flow.   If the home went up in value 2% the first year, Joe will have made $3,000 in appreciation + $1700 in positive cash flow.   Joe’s total return on the $45,000 he invested would be: $4700 ÷ $45,000 = 10.5%

------------------------------

Example #2: No down payment, and some negative cash flow:     “Jane Landlady” has great credit, but not a lot of cash, so she decides to buy her $150,000 rental home with no money out of pocket. Her mortgage payment is $1,073 per month (PITI).    Like Joe, Jane also has vacancy and maintenance costs of $170/month.   Jane’s total cost of owning the home is $1,243 per month. Jane is receiving $1,100 per month in rent.   Jane has to take $143/month out of her pocket to make up the difference between the cost of owning the property and the rental income she receives.   Jane’s rental home also goes up in value 2% ($3,000) during the first year.   Jane’s total investment into the home is $143 for 12 months, or $1716.   Jane’s return on her cash investment:  $3000 ÷ $1716 = 176%.   Needless to say, Jane is very happy about this.

Jane will probably have several years of negative cash flow before she can raise the rents high enough to cover her costs. The good news is that her return on invested dollars (the “negative” cash flow) will always be dramatically higher than Joes.

--------------------

P.S. What if Joe & Jane both stop making payments on their rentals due to not being able to get their homes rented? Who will be the first person the bank forecloses on?

Not Jane, she has very little equity. It would cost the bank money to take back (“foreclose on”) and resell Jane’s rental home.

Poor Joe though, the bank wants his rental house bad. There’s lots of equity in Joe’s rental house. The bank isn’t going to lose a dime foreclosing on Joe’s rental house

Joe loses his rental home to foreclosure and Joe kisses his good credit, goodbye.

Jane’s no down payment strategy has bought her a little extra time and that might be just enough time to let her save her credit and save her rental home from foreclosure.

 Copyrights Reserved. January, 2005.

No copying or reproduction is allowed without express consent of Don Glasgow (435) 619-3664

---------------------------------------

URL: http://

Description:
Don Glasgow
St. George GMAC Real Estate
1060 S. Main St. #200
St. George, UT 84770
(435) 619-3664
Email: DonGlasgow@stgeorgegmac.com