Guys, I’ve been buying real estate rental properties now for almost 10 years. I’m going to teach you a few things I look for when purchasing a property.
1% Rule
The 1% rule is the quickest metric you can look at and in fact I still screen properties by this rule today. What it means is that you will be able to rent a property out for 1% of the purchase price. This assures you are getting a decent cash-on-cash return.
Example: You see a house priced at 200,000. You will need to look at other rentals in the neighborhood and decide if you will be able to rent that house for 1% of the purchase price, or 2,000 a month.
Cash-on-Cash Return
After passing my quick 1% rule screen I then go into a deeper look at the property and determine what the cash-on-cash return will be. I look for a 10% cash-on-cash return. In higher growth areas I realize this isn’t possible. Since there’s not much growth here I’m getting good cash flow. It’s a tradeoff.
I have a spreadsheet that I made to enter these numbers in to calculate quickly for me. If anyone is interested I can add a link to it.
Cash-on-cash return = profit / cash costs
Here’s an example of a property I just looked at:
Cash Costs –These are the out-of-pocket cash expenses you will incur. These costs include closing costs, down payment and any out of pocket repairs you need to make before renting.
Purchase Price – 170,000
Repairs – 500.00
Closing Costs – 5,100
Down Payment (25%) – 42,500
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Total Cash Costs = $48,100
Financed Amount (25% down payment) – 127,500
Monthly Expenses – This one is self-explanatory , total monthly expenses
Interest Rate – 5.75% for this example
Monthly Taxes – 334.58
P&I Monthly – 744.06
Property Ins./mo. – 107.25
HOA Dues – n/a
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Total Monthly Expenses w/o Maintenance – $1,185.89
Maintenance/Vacancy Costs – This one can be a little tricky. A lot of people like to estimate 20% here to be safe. Depending on the age of the property and location I make a determination here. I used 15% for this property. That means I allocate 15% of the monthly rent into an account to cover any future maintenance or vacancy expenses.
Maintenance/Vacancy (15%) – 270.00
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Total Expenses after maintenance/vacancy costs = $1455.89
Expected Rent – 1800
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Monthly Profit = $1800 – $1455.89 = $344.11 or $4129.32 yearly
To get your Cash-On-Cash return just take the $4,129.32 and divide by your total cash costs of $48,100.
Cash-on-Cash return – 8.58%
As you can see, this property passed the 1% rule of estimated rent above 1% of purchase price. However, the cash-on-cash return is just 8.58%. This was a property I looked at back near the end of last year when interest rates were higher.
At an interest rate of 5% instead of 5.75% , the Cash-on-Cash return boosts to 10.07%!
So basically I’m also watching interest rates to meet my criteria. If I can get this same property at a 5% rate then it meets my criteria of a 10% cash-on-cash return.
If this is helpful let me know, or if there is anything else I can explain let me know as well. So far this simple process has served me well.