The Right Economy To Buy Rental Houses

I was asked by a fellow REALTOR about the best economy in which to buy a rental house.  I had to stop for a second and realize how silly the question really is. At least in my mind.

Now.  This one.  This is the best economy to buy a rental house.  Or the next economy.  Or the one after that.  Or the one 5 years ago!

Yes, those that bought investment property in 2009-2011 are doing great compared to now.  But, frankly, if you bought your income property correctly, even if you purchased in 2006-2007 when price versus value was sky high, it was a great time to buy a rental house.  (Those people may have bought high, but it’s 7-8 years later and tenants have been paying down their loan balance, etc.)

There is no time like the present to start your retirement savings.

Yes, your returns will fluctuate depending on your interest rates (if financing) or your local city’s vacancy rates.  But people always need to live in houses. People will always prioritize housing.  Heck, I’m so old I remember my parents buying houses with interest rates in the mid teens.  Yes, 14.5% interest.  (I just heard a 30 year old ask “What the F@&%?)

Start your retirement TODAY.  If you have the funds for some real estate in your retirement mix, start today.  I’m just sayin’.

Stupid Tenants? How About Stupid Owners?

Property managers and rental property owners love to talk about how stupid tenants can be.  Well, it’s my experience that investment property owners can be equally stupid.

NOTE:  Yes, my use of the word stupid is meant to illicit a response. Perhaps ignorant would be a better word. Webster describes ignorant as “lacking knowledge or information as to a particular subject or fact”.

Landlords and Owners, here is something you need to know: Tenants that move at the end of each lease cost you money!

It’s my general rule of thumb that you need to keep tenants on average about 18 months to make sure you are making money.  Especially if you are using a property manager.  Why? There are so many costs to changing over tenants.

• Vacancy
• Utilities
• Paint, carpet, repairs
• Lease out fees if using a property manager

I see owners squabble over repairs that will cost them $175-$200 and piss off tenants because they won’t fix something.  Then the tenant leaves, they end up with 30-45 days of vacancy, some electric bills to pay and more.

If your rent rate is $1,100 /mo and you take in to account some of the other expenses you may have cost your self $1,500 – $2,000 over a $200 repair.  Is that good math?  Am I missing something?

This isn’t a rant.  But I see it happening right now with an owner who is new to investing.  I am not mad at him.  I actually am trying to educate him.  But I seem to be losing the battle sometimes.

Investment Property Case Study

Real estate investment gurus love to talk in terms of “no guarantees”, pro formas and about deals from 10+ years ago. But I want to give you an Investment Property Case Study from right here in the Kansas City real estate investing universe.  The following is real though I will not give addresses or client names, etc.  Not only is it real, it’s still going on right now.

THE SET UP
In 2011 I had two fund managers from the Los Angeles area of California come meet with me about investing in rental property here in Kansas City.  They wanted returns formulated on rents being two times investment.  That is to say they wanted an all in price (purchase, closings costs, rehab) to be $40,000 if the rents were $800/mo.  Easier said than done in any neighborhood you’d actually want to live in.

So I took them out and showed them around.  Then I sat with them and asked me to make it more of a 1.6 ratio or 1.7 to get in to better neighborhoods with better houses and better schools. After showing them what I could do, I went to work.

ACQUIRING RENTAL PROPERTIES
From May of 2011 to March of 2013 we acquired 56 rental properties.  Most were in 2011-2012 when the market was just waking up from it’s downfall in 2008-2010. What would these numbers show if we had started acquiring in 2009!!!????!!! Most of the properties were 3 bedrooms with 1-2 baths.  All were in Missouri in Kansas City, Raytown, Independence, Grandview, Gladstone, etc.

PURCHASE, REHAB, RENT
After the closing we would set to work rehabbing to rental standards.  Then rent at or slightly below market as quickly as possible.  With this strategy we’ve been able to hold these properties to about 6% vacancy.  All investment properties were paid for with cash.

THE MATH
I’m not going to break down everything. Not for this post.  But most of the expenses listed below were generated in the first 30-40 days after purchase…during the rehab portion of the property life. The rest of the expenses have been since they have been generating income with tenants in them.  Expenses include repairs, rehabs, insurance, management, utilities when vacant…literally everything except taxes, which will add up.  The income has been generated from the first tenant through to today.

THE RESULTS
Here you go.  This is why owning rental property is a great investment.

Purchase & Closing Costs          $1,944,191
Expenses                                       $1,267,330
Total Investment to date    $3,211,521

Total income to date             $1,212,159  

CURRENT VALUE
The current value is based on comps with minimal additional repairs/improvements to the income property.     The cost of sales would have to come off the value including but not limited to repairs for inspection requirements, realtor fees, closing costs including title fees, etc.  Figure about 12% -15% cost of sales with all that in mind.

Current Value                          $3,807,500

Now there are differing ways to calculate your returns and I’m not going to go in to details because of the spread of months between the first and last purchase, time line of the repairs, etc.  But no matter how you look at it the real estate investors that came to Kansas City have come out okay.

Fusing these two sets of results is my favorite way to look at it.

Current Value                                $3,807,500
Purchase Price + Initial Rehab  $2,792,623
Cost v Value Differential     $1,014,877

Total income to date                   $1,212,159
Expenses since rehab                 $ 420,398
Positive Cash Flow                 $791,761

As I said there are professional accountants out there that will give you several different formulas and of course all of this does not include the property taxes, as I noted above.  Those taxes could add up to a takeaway of about $90,000.  I just don’t want to take the time at this time to go in and add them all up. But in any case, those numbers are significantly better than the numbers my IRA returns.  🙂

Now, you may not have $3M to invest. Neither do I. But you can do one house. Or two.  Get started today.  Your retirement will thank you later.

If you have any questions about investing in real estate here in the Kansas City area, please, do not hesitate to contact Chris Lengquist at 913-568-1579.

Raytown Investment Property For Sale

This Raytown home is for sale and would make either a great home for a new person or family looking to build memories and a life, or to continue it’s service as a wonderful rental home making good returns a given.

This ranch home features 3 bedrooms and 2 full baths and a very roomy garage.  You’ll find beautiful hardwood floors and spacious rooms and closets.  Partially renovated in 2012 and sitting on a nice corner lot.  The house is offered at $74,750.

For you real estate investors out there the last tenant was there from 2012 until July of 2014 and liked the house but needed to move closer to their new job.  Rent was  $895.00 a month and $875 – $895 would be the expected range for any new tenants.  The house has been professionally managed and financials for the last 2 years would be available with any acceptable offer.

To see more pictures of this house follow this link: Raytown Home For Sale

House was current and active in the Heartland MLS as of July 29, 2014.  Any future dates this house may or may not still be available.

Chris Lengquist
KWR, Diamond Partners, Inc
Olathe, Kansas
913-322-7500 o
913-322-7515 d

Real Estate Investing Versus The Stock Market : Part 2

Yesterday I did a post describing the benefits of a rental property after 20 years of ownership.  Please read Real Estate Investing Versus The Stock Market : Part 1 for the entire scenario and to catch up to where we are today.  Because today we’re going to ask what if you had taken that $38,500 ($35,000 for the down payment and $3,500 for closing costs) and left it in the stock market versus investing in a rental house.

THE INVESTMENT
I will readily admit to not being as in tune with the stock market as quite possibly many of our readers. I do real estate.  So that makes sense.  Yes, I have an IRA.  Yes, my wife has a pension with KPERs. Yes, I have other investments (though not large) in mutual funds and one other well known stock.  The point is,  I don’t eat, breath and live in the stock market.  And I don’t believe most working professionals have the time or expertise to follow the market on an hourly or even daily basis, either.

So we’re going to say that your $38,500 is in a nicely performing mutual fund (or stocks, heck, I don’t care.) that after all the buy fees, sell fees, yearly fees, etc, is yielding you a nice return of  9% per year, for the next 20 years.  I’m told, and have researched, that 9% is a good return number to be expected.   (Are you getting 9%?)  Yes, I am well aware that spikes and dips can happen.  But how is that any different than real estate?

So, using a very simple investment calculator math you simply take that $38,500 at a 9% annual return and you end up with a balance of $215,770.

REAL ESTATE VERSUS STOCK MARKET
Looking at yesterday’s real estate returns after 20 years (but not calculating increases in rent or tax benefits and conservatively adjusting for additional obsolescence) we had a total benefit of $216,611.

The same $38,500 invested in the stock market over the same period of time became $215,770.

PICK’EM?
Can we agree here that the difference is not that great? But what if…?

RISING RENTS
Rents rise and fall like housing prices…and the stock market.  Let’s just say that rents rise over the years at 2%, or slightly less.  Not unusual. Well, with that being the case, we have a different ball game.

Remember, our Part 1 scenario considered the cash flow before taxes to be $1,536/yr based on a rent rate of $1,575.  Now lets say that we calculate the rent rises.  I won’t bore you with all the math, but it takes our total 20 year cash flow before taxes number from $30,720 to $63,150.  That’s another $32,430 in favor of the rental house.

MOVING FORWARD
Listen, in my experience real estate is not as easily liquidated and carries more risk.  However, it is easily leveraged by real estate investors with good credit and assets and you can harvest the equity out of this house 10 years in to create a second income property with similar numbers.  Now the game has changed!

To be fair, stocks/mutual funds take less management, are easier to liquidate or buy/trade, and carry a whole let less risk.

And, let’s be clear, I own both rental property and mutual funds/stocks.  My preference after I have maxed out my IRA (and that of my wife) each year is to put the money in to real estate.  Just makes more sense to me. Why?

1. Real estate has better returns.
2. Real estate has better tax advantages.
3. Real estate can be passed on capital gains tax free.
4. Real estate can be leveraged.
5. Some one else (tenant) is providing some of the equity growth.
6. I have more control over house or property manager than I have over a far away company making widgets.

I could go on and on.  I am not saying don’t invest in the market.  I am saying, you should also be investing in real estate.

 

 

Real Estate Investing Versus The Stock Market : Part 1

I have not done this for a while so it’s time to do it again.  Let’s look at real estate investing versus the stock market.  You may want to get comfortable and get out  a calculator to follow along.  Part 1 isn’t  a short post.  But when it comes to your retirement, shouldn’t you invest a few minutes to see whether you should leave that $35,000 in the stock market or to put it in rental housing?

OVERALL SCENARIO
Let’s say you are 45 years old with a plan to retire in September of 3034 at 65 years old.  You are maxing out your IRA contributions every year (Roth or Traditional, I don’t care) and/or are using your employer’s retirement plan.  Still, you have extra monies that you invest passively in the stock market in some mutual fund that isn’t giving you the results you are after or desire or heck, you just want to diversify.

In our scenario about to unfold you will need approximately $38,500 in cash to pay for the down payment and closing costs. The mortgage company will insist that this not deplete all your “on hand” cash so you’ll still need another $6,000-$8,000 in reserves easily accessible.

THE INCOME PROPERTY
First let’s look at the income property we are going to acquire.  It’s a “typical” lower bell curve house in Johnson County, Kansas, a “better-off” suburb of Kansas City, Missouri. The house would most likely be in Overland Park or Olathe.  Quite possibly it will be a 3-4 bedroom, 2-2.5 bath split level home with a 2 car garage in either the Shawnee Mission or Olathe School Districts. Good school districts. We’re also going to say, for the sake of this argument, that the home is a turn-key investment property that is professionally managed by us.

The negotiated purchase price will be $175,000 plus roughly $3,500 in closing costs since you will be leveraging with a 30 year mortgage at 5.75% with 20% down ($35,000) and, hypothetically speaking, closing on August 30, 2014 making your first payment due on October 1, 2014.  Therefore, your house payments will be $817.00 for principal and interest only.

THE INCOME
A house such as described should rent for about $1,575 all day long with good demand and, in our current rental market, with less than 30 days of vacancy.  That translates to a $18,900 a year in income. No.  You do not get to spend all that!  Because first, there is vacancy.

THE EXPENSES
Our Kansas City area property management company, KCPropertyManager.com has over 200 homes in our portfolio and we can tell you that on the Missouri side vacancies run about 7-8%.  On the Kansas side, at least right now, vacancies are running closer to 3-4%.

But that is not all, we cannot forget about taxes, insurance, repairs, sinking fund (for future repairs like roofs, appliances, etc, and fees for utilities and professional property management as well as any other miscellaneous costs.  Now, I can break all those down for you. However, as a Kansas City real estate agent who helps real estate investors every day, I can tell you that rental property expenses run anywhere from about 30-34% for self-managed homes to 35-40% for professionally managed homes.  Sure, any particular year can be slightly better or worse, but those are the averages I’m finding here in Kansas City.  (It’s also a function of what neighborhood you are in…but that’s a blog post for a whole other day.)

CASH FLOW BEFORE TAXES
I have written many times about the 4 Benefits of Real Estate Investing  so you can go back to those posts to see the details. CFBT = NOI (net operating income) – Annual Debt Relief.  For our example Kansas City rental property here the Cash Flow Before Taxes is roughly $1,536/yr.  Or a whopping $128/mo.  Vacation baby!

Uh, no.  The cash for this particular house is enough to cover all the expenses and build a very modest reserve as time flows by.  But you are not going to Europe for a month with the cash flow.  We’re talking about Buy & Hold Retirement real estate investing here.  Not cash flow hunting.  If you want cash flow, we need to either put more money down or look over to the Missouri side at a lower price point.  But then you’ll lose much of benefits 3 & 4 that are still to be discussed.

After 20 years of this your income property would have generated $30,720 of cash flow benefits (before taxes).

PRINCIPAL REDUCTION
Ah, yes.  My favorite benefit of real estate investing.  Each month your tenants pay their rent they are also paying down your mortgage!  Your rent house, the one not kicking off very much cash flow, after twenty years has a principal reduction, courtesy of your tenants over the years, of $65,571.

That’s more than twice your cash flow.  Now we’re getting somewhere.

TAX BENEFITS
This one may be tricky for me to extrapolate 20 years without spending my life writing about it.  But the first year tax benefits should be about $350.  As a reminder Tax Benefits are

NOI – Interest paid (per year) – Depreciation (per year).

Suffice it to say that with each passing year your CPA will make sure he is reducing your overall tax burden as much as current tax law will allow.  You can always subtract the interest and there is a specific depreciation schedule that extends over 29.5 years.

For our purposes in this entire argument, I’m going to pretty much null this investment property benefit.  Oh, make no mistake, it’s real but for the purposes of our argumentative experiment we’ll just consider it gravy.

APPRECIATION
Did you live through 2007-2011?  Here in Kansas City it was more like 2008 – 2012 when all you east and west coast readers caused our money supply to just stop!  So appreciation is not a God given right when you own real estate of any kind.  We learned that up close and personal. Right?

Historically, however, we know that real estate tends to be a great hedge against inflation.  Here in Kansas City in Johnson County, Kansas real estate prices tend to float just above inflation.  For  our argument here, we’re going to say that our economy for the next 20 years will be pretty much like it is today.  (Quit laughing.  I cannot tell the future any better than you can. I know darned good and well there will be rises, dips and the unforeseen.)

So, with all that said, let’s say that the income property in question appreciates at 3% per year.  That would be a fair slow growth number for the Kansas City area.  (Check out the last 10 years on average.)  After twenty years, our rent house that you purchased for $175,000 would now be valued at $316,000.  That’s a gain of $141,000.

TOTAL BENEFITS AFTER 20 YEARS
Cash Flow Before Taxes     $30,720
Principal Reduction     $65,571
Tax Benefits     n/a
Appreciation     $141,000
Total Benefits   $237,291

I HEAR YOU!
I already know some of your objections. So let’s do it.  (Even while conveniently forgetting that rents quite likely go up over the years…but we’ll not even count that…just like the tax benefits.)

Additional repairs.  My calculated expenses ratio accounts for the property to pay for most of is own obsolescence and make-ready turn overs.  But housing can take hits planned or otherwise.  So let’s subtract an additional $8,000 for a roof, $4,500 for heating and a/c, $800 for a water heater and $5,500 to fix a bunch of wood rot and get a good paint job.  That’s a total of $18,800.  Heck, let’s throw another 10% on top of that and make it $20,680.

Sales costs. Well now, this could get complicated.  Are you going to sell outright, pay the capital gains and the depreciation re-capture?  Not advised.  Are you going to refinance and pull the money out to do other things like vacation, re-invest in other housing or stocks?  1031 Tax Deffered Exchange?  Or, are you going to let it go and form trust wherein you can leave this property to your kids or heirs, capital gains tax free, upon your passing?  These are all scenarios that may very well be different 20 years from now than they are today.  So I am not going to figure in sales costs…but not to worry.  I won’t figure in sales costs on the stocks and/or mutual funds, either.

THEREFORE
If you take your Total Benefits – Additional Repairs you have an Adjust Benefits Total of $216,611 after 20 years of ownership of this investment property.

PART 2 TO FOLLOW…

 Chris Lengquist
Keller Williams Realty
Diamond Partners, Inc
13671 S Murlen Road
Olathe, KS  66062
913-568-1579

Kansas or Missouri? Where to Invest

Kansas City is a wildly diversified city, economically speaking.  I have written in the past about the differences between Kansas and Missouri.  And it’s worth the read if you are not familiar with the area.  But time and time again I need to let out of state investors know that there is and should be an expectations difference when it comes to investing in real estate in either Kansas City, Missouri and it’s Missouri suburbs or the suburbs on the Kansas side.

Missouri real estate investors should expect slightly lower entry points, price wise, for the comparable properties on the Kansas side as well as a little higher cash flow, cash on cash returns, etc.  But appreciation on the MO side usually lags behind the Kansas side.

The Kansas side usually has a little higher prices and the returns are slightly lower on the cash flow side.  But in general, it is EXPECTED that you’ll have great appreciable growth as time goes on.

Why?

School districts.  The Kansas side has the better schools, by in large.  Especially in Johnson County, Kansas.  Lee’s Summit and Blue Springs on the Missouri side are pretty darned good, too, and therefore their prices are a little higher and returns a little lower when you compare them to other Kansas City, MO suburbs.

It’s really very complicated to select the right areas for your Kansas City investment property.  So much goes in to picking the right rental house;

• What return do you expect?
• What kind of house (multi family, single family, ranch, etc) do you want?
• What kind of tenant are you after?
• What price point are you looking to be in?
• Cash flow or appreciation?  A mix of both?

I could go on and on.  Just make sure you understand the pluses and minuses of each side of the state line.  Both are great states.  You just need to know what you are getting in to and where you are getting in to it.  🙂