Real estate helps create a lot of millionaires but it's definitely not easy. There are many pitfalls and the best way to reduce the chances of falling in one is by getting educated.
A major pitfall for new investors is believing that cash flow is whatever is left after collecting rent and paying the mortgage. This could not be farther from the truth! Cash flow is what remains after paying the mortgage, property taxes, maintenance, vacancies, insurance, utilities, and putting away reserves for big ticket items that WILL come up in the future.
There are two rules of thumb used to quickly analyze a rental property.
The 2% rule suggests that a property with a monthly rent equal to 2% or more of the purchase price is likely to cash flow. For example if the monthly rent is $1000 and the purchase price is $1000/0.02=$50000 or less then it is likely that this property will put money in your pocket.
The 50% rule suggests that the total expenses excluding debt service for a rental property over the long run will average 50% of the total rental income. This means that a property with a monthly rental income of $1000 will cost 0.5x$1000=$500 per month with $500 left for debt service payment.
Few properties in the Capital Region pass the 2% rule but that does not mean that they do not cash flow. We find that the 50% rule is more flexible and the better of the two rules.
It is very important to understand that these are rules of thumb and not scripted in stone. There are very cheap properties in bad neighborhoods that pass the 2% test but fail to cash flow due to extremely high maintenance costs, loss of rent, and high vacancy while waiting to find a decent tenant. Likewise there are properties that pass the 50% rule but fail to cash flow because all the utilities are included so the monthly costs are higher than 50%.
We mainly use the 50% rule as a quick filter while looking at a bunch of deals. If dividing the total rent by 2 and subtracting the mortgage gives you a negative number it is safe to say that this property will burn a hole in your pocket. Decisions to buy should always be based on actual income and expenses but using the 50% rule makes you faster at looking at deals. Once you have all the deal channels open, you will have to screen and analyze 10s of deals quickly so picking up those rules of thumb will definitely become handy.
This should get you thinking in the right direction when it comes to analyzing deals even if you are not a buy and hold guy/gal. If you wish to dive into real estate it's worthwhile to be fluent in as many exit strategies as possible and keeping a property as a rental is a common one.
Feel free to post any questions in the comments!
A major pitfall for new investors is believing that cash flow is whatever is left after collecting rent and paying the mortgage. This could not be farther from the truth! Cash flow is what remains after paying the mortgage, property taxes, maintenance, vacancies, insurance, utilities, and putting away reserves for big ticket items that WILL come up in the future.
There are two rules of thumb used to quickly analyze a rental property.
The 2% rule suggests that a property with a monthly rent equal to 2% or more of the purchase price is likely to cash flow. For example if the monthly rent is $1000 and the purchase price is $1000/0.02=$50000 or less then it is likely that this property will put money in your pocket.
The 50% rule suggests that the total expenses excluding debt service for a rental property over the long run will average 50% of the total rental income. This means that a property with a monthly rental income of $1000 will cost 0.5x$1000=$500 per month with $500 left for debt service payment.
Few properties in the Capital Region pass the 2% rule but that does not mean that they do not cash flow. We find that the 50% rule is more flexible and the better of the two rules.
It is very important to understand that these are rules of thumb and not scripted in stone. There are very cheap properties in bad neighborhoods that pass the 2% test but fail to cash flow due to extremely high maintenance costs, loss of rent, and high vacancy while waiting to find a decent tenant. Likewise there are properties that pass the 50% rule but fail to cash flow because all the utilities are included so the monthly costs are higher than 50%.
We mainly use the 50% rule as a quick filter while looking at a bunch of deals. If dividing the total rent by 2 and subtracting the mortgage gives you a negative number it is safe to say that this property will burn a hole in your pocket. Decisions to buy should always be based on actual income and expenses but using the 50% rule makes you faster at looking at deals. Once you have all the deal channels open, you will have to screen and analyze 10s of deals quickly so picking up those rules of thumb will definitely become handy.
This should get you thinking in the right direction when it comes to analyzing deals even if you are not a buy and hold guy/gal. If you wish to dive into real estate it's worthwhile to be fluent in as many exit strategies as possible and keeping a property as a rental is a common one.
Feel free to post any questions in the comments!