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More questions answered

March 24, 2013

A couple of weeks ago I had a reader e-mail me with several questions. These have sparked a few ideas for future posts, but I thought I would post a portion of his Q&A for others as well.


Do you have a minimum rent multiple that you use when deciding to purchase a home and make an offer: i.e. rent should be 1.3% of purchase price or something of this sort?  Do you use this rent multiple to determine if a property will cashflow?

I call this a “Rent Ratio” and I use 1.5% as my target. I have seen 1% and I have seen 2% among other investors. For my area 1.5% gets me the Cash flow, property class, and neighborhood that I like. Sure I could reach 3% if I buy a trailer for $15k and rent it for $475 per month. I am just not going to do this.

I see on your site where sometimes you settle on a purchase price that is anywhere from 15%-30% below asking price.  What do you use to determine your offer?  I’m amazed that banks would accept an offer 30% below asking price.  How many homes do you make offers on before one is accepted at such steep discounts?  Do you mainly go after bank owned properties or do private sellers I accept offers this low as well?

I use my cash flow formulas to determine my purchase price. I have bid over list in several instances and less than half of list in other instances. Some banks just put $99,900 list on most of their properties with no real analysis. I don’t put much stock in a list price.

 It gets to a point where I feel I am not looking for properties, I am looking for sellers that have a property they do not want. This is what these wholesalers are doing with their bandit signs and “we buy ugly house” billboards. They are looking for deals with big margins. These are the deals you want…If you can be patient and wait till you find one, this is going to be your best buy. You do have to be careful here as I have found many of these require more rehab than I want to do. Remember, we both have full time jobs. I don’t want to do $20k in rehab just so that I can get a great deal.  I will pay a bit more and accept a 10-12% CAP instead of a 15-20%.

I know you meniton a 10% CAP rate, and I understand what a CAP rate is, but I am unsure of how to calculate expenses.  I’ve seen rules of thumb for expenses (taxes/maintenance/vacancy/etc.) as much as 50% of gross rent.  Is this somewhat acurate?

The 50% rule ends up being a bit conservative (especially if you self manage) but it’s not far off based on my experience. 

How do you calculate CAP rates on single family home properties when expenses are variable and depend to some extent on chance as an AC unit, roof, water heater, etc. could require replacement at any time?

Several of these expenses are fairly consistent once you get started. After I narrow down the neighborhood, then I will know how much the property taxes will be (BIG dollars here in Texas). Insurance is also consistent or you could just call your carrier and get a quote. For maintenance I assume $100 per month. Some properties go over this amount others go below, but it’s a good estimate. My CAP rate calculation assumes the home will be vacant one month out of the year. In my experience to date my longest vacancy was 28 days and this was in January/February and we had 2 snowstorms with over a foot of snow during that time. I use this very conservative estimate as I include the make ready expense on the vacancy. I also like to assume something for capital improvements or the larger items you mentioned. This improvement figure varies depending on the age of the property and the scale of the intial rehab done.

From → Planning

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