Your Strategy

[jlspartz]

Mike, that is what I am looking to do.  I don't mind hard work.  I get bored with something if I don't constantly learn and am not presented with challenges.  I know a lot of people speak highly of your book, which is where your comment about the 50% rule comes from, right?  I will be reading it, after I finish 6 others.  I am gaining a base knowledge on all different aspects of REI right now, and then I'll be focusing on the specific way I'm going.

Dave, thanks for pointing out property values effect on cash flow.  That was my observation looking at the market, but haven't gotten deep into formulas yet, so didn't know if I was calculating that the same as others.  In order to go down to 50K/property, that means high traffic high crime areas averaging around 4 times the national average (which means I can probably get bad tenants really quick) or rural areas (which probably means I could get stable tenants but would take long).  At 80-100K, which are good deals on the market not great deals off the market, there are some properties that are in-between (in cities that are average crime - going for low end 1000, average 1200, and high 1500 per month, with affordable rent averages between 1100-1400).  I'm talking SF, deals are better for multi-units.  And vacancies are 2-4% per city with average crime, and 7-10% for high crime areas.  Any nice area, which is half of the local market, homes start at 200K.  So, which route is more commonly preferred?  Stay in an average area?

[Dave T]

In order to go down to 50K/property, that means high traffic high crime areas averaging around 4 times the national average (which means I can probably get bad tenants really quick) or rural areas (which probably means I could get stable tenants but would take long). 

You have to adapt your investment strategy to your local market.  As a general rule, I don't buy any property for my rental portfolio that I would not live in myself and not be afraid to park my Town Car outside.  The stragegy I outlined works for any portfolio of properties priced from $50K and up.  $50K is just the minimum entry price for the sequential refinance strategy to generate $25K in tax free annual income.

In my market, the opportunities are in foreclosures or at least they were plentiful before the government mucked things up with the bailout.  Six months ago, $160K properties could be bought for $65K (all cash, no contingencies, 15 day closing).  Comparable properties (as REOs) are still for sale in the same market, but now the prices are $95K and up.

A foreclosed townhouse is currently available for $92500 and is just a couple doors down from the identical unit I sold for $210K back in 2005.  In a couple of months, if it has not sold by then, the lender will probably accept $65K. 

Rent for this property will be in $1050-$1200 range -- plenty of cash flow with the financing available today.

[HighPoint]

My strategy has been to focus on properties that will need a minimal rehab. For me that has been $15,000 or less. And the properties I purchase are generally $75,000 or less.

I purchase the property with cash, you could use several different sources for this I use the equity in my home and my savings, but you could use whatever works best for you. Of course before I actually sign a contract I do a rehab estimate beforehand. I then figure this into the offer.

For example...
If I look at a house listed for $55,000 and the rehab is $10,000 and the ARV is $85,000 then the most I'll offer is $50,000. However, I'll actually start my offer lower, of course the interest on a property will dictate the "rules" here. So for the sake of the conversation here I get the house @ $45,000.

After the rehab work is done I have roughly $55,000+ into the house. Then I go to the bank and refinance my purchase. The bank does an appraisal and comes back @ $85,000 and loans me 80% LTV on ARV. I finance $68,000 and cash out $13,000 or just lower the LTV for a better cash flowing property. So, I have a new rental property that the tenants pay off for me, I'm only 80% into the house and then I get ALL my money back after the refinance to do it all over again.

Keep in mind, this is a rough sketch of things, but it gives you the basic idea of how I do things.

[Damivon]

Dave T,

I think it will be even better: buying 50k properties / 20% down means a 40k /30 year mortgage.
In 12 years about 40% (12/30) of this mortgage is paid down by your tenants giving you the opportunity to get that 16k (40%*40K)out of the property without any needed price increases :-).

Greetz, Raymond

[Dave T]

Raymond,

Loan amortization is not as linear as you suggest. 

In the first years of a typical 30 year mortgage, most of your monthly payment is interest, not principal.  After ten years, you will have reduced your loan balance by only 19%, and just 24% after twelve years.  It will take you twenty years and two months to cut your loan balance in half. 

The first two thirds of your loan term only pays off half of your original mortgage balance.  The last ten years of your 30 year mortgage pays off the last half of your loan.  If you have extra money to pay down your mortgage balance, extra principal payments will pay off your mortgage faster if paid in the first years of your mortgage term than at the end of your mortgage term.

For example, let's say you have a $100K mortgage loan at 6% fixed for 30 years.  You have an extra $5000 and nothing better to do with it, so you want to use that money to pay down your mortgage.  Adding that $5000 to your first mortgage payment as additional principal will take pay off your mortgage 44 months early.  If you have been paying on your mortgage for 20 years, then adding $5000 additional principal to your next monthly payment only pays off your loan 14 months early.

[Damivon]

Dave T,

This is absolutely true for an annuity mortgage! I was talking about (here in The Netherlands, don't know if you have something likewise??) the fixed principle repayment mortgage where I repay the same principle amount every month and where the interest payments decrease over time.
The principle would apply for both kind of mortgages though but in you're example you could "only" get 9.6K out of the property without any appreciation.

Greetz, Raymond

[Dave T]

Raymond,

The fixed principal loan is not offered in our US markets.  Let me revise my earlier comment.

Loan amortization is not as linear in the USA as you might experience in the Netherlands.

The fixed principal loan would only appeal to US consumers who keep their homes forever and eventually pay off their loans.  Although the total cost of financing would be lower pver the life of the loan than with the loan structure we have, most US borrowers would find their monthly mortgage payments less affordable with the fixed princpal mortgage.

For example, the $100K loan at 6% paid back over thirty years will cost the US borrower $600 per month, each month for the life of the loan.  Since the average US borrower sells their home every five to seven years, so they are looking for the lowest monthly payment they would have to make in order to live in the most expensive house they can afford.  If a fixed principal loan were used to finance the home purchase, the US borrower's first monthly payment for the same loan would be $778.  The family that can only afford $600 each month will have to settle for a smaller home, or purchase in a less desirable neighborhood.