STOP! Don't Buy That RENTAL PROPERTY [EPISODE #112]
The Big Idea
We don't disapprove of buying rental property. FAR from it! Just be smart about it and pay the right price!
Points To Ponder
- You may have the impression that Bryan doesn't approve of owning rental property. FALSE!
- Just pay the right price for it... as low as possible!
- Never pay above retail, and pay below retail when possible.
- CAP rates don't matter for an individual property and may just be a smokescreen to mask a bad deal. CAP rates are only a legitimate evaluation technique for multifamily, commercial, and multi-property portfolios.
If you’re thinking of buying a rental property right now, STOP! Do you know what you should ACTUALLY pay for that property? I’m Bryan Ellis. I’ll tell you how to know if you’re overpaying RIGHT NOW in Episode #112 of Self Directed Investor Talk.
Welcome, my friends, back to another exciting edition of the podcast of record for self directed investors the world over!
Let’s talk about rental properties, shall we? Many of you have the impression that I disapprove of owning rental property, or that I somehow disapprove of the notion of “turnkey” rental properties, in which you buy a rental property from a company who also stocks the house with a tenant and selects a property manager so that all of that stuff is in place without your having to do anything.
Both of those things are wrong. I absolutely approve of owning rental property. And I absolutely approve of solid turnkey rental deals.
But let’s be careful to pay the right prices, ok? Remember: The core value of a self-directed investor is to RESPECT YOUR OWN CAPITAL… and the most basic, fundamental way to do that is to NEVER, EVER pay too much for an investment.
So what is the right price to pay for a rental property?
Let’s start with what ISN’T the right price.
Do this: Before you buy your next rental property, call up a real estate agent in the area. Ask them what that property would sell for on the open market. Whatever they tell you is a good approximation of the retail value of that property.
The right price for you to pay for a rental ISN’T the retail value. You must pay LESS than that.
My friends, remember this: you will be successful primarily as a result of getting good deals. What makes for a good deal? Property bought below it’s retail value. How much below? I’d say 10% below is a good starting place. 15-20% or more is better. But what does NOT make any sense is to pay full retail value for that property. Paying retail is for bush league investors who don’t know what they don’t know. That’s not you… now you know better.
But I’d like to give you a warning. Many people selling turnkey rental property will try to confuse you by basing their pricing on something called cap rate, or capitalization ratio. Honestly, if you hear the word “cap rate” in connection with single family houses, somebody is probably trying to confuse you. It’s VERY, VERY easy – repeat, VERY easy – to do some financial magic such that it looks like your “cap rate” is very high, at 12-15% or more. They want to do that because it’s easy to justify charging higher prices for the property when you perceive the rate of return to be stronger.
My friends: Repeat after me: Cap rate doesn’t matter. What DOES matter is the REAL VALUE – what would the house sell for on the retail market? And then, you ALWAYS pay LESS than that number!
Folks, this is one of those places where your intelligence actually puts you at a disadvantage. If you’re like 95% of my audience, then you’re a smart, successful person who is probably an engineer or a sales person or a computer programmer or a physician or some other type of professional who is very good at your job, and it’s likely you have a high income. It’s also likely you’re not a real estate expert, and that’s OK!
Here’s the thing: Like me, and like everyone else, you simply don’t know what you don’t know… and like me, you may be inclined to think that because you don’t see any holes in the argument being put in front of you, that there are, therefore, no holes in the argument. And buying a turnkey rental property presents a fertile ground for you to be confused while falsely feeling very confident. What happens is that you are redirected to focus on other issues like CAP RATE or the potential for tax savings through depreciation or discussions about the difference between “nominal” and “actual” dollars, and of course, why real estate is such a great hedge against inflation.
My friends, all of that is interesting stuff, but it’s not relevant at the point of your portfolio balance. All of that stuff exists in EVERY real estate deal… not just the one they’re trying to sell you.
Can I show you how I might evaluate a deal? This, by the way, is a real deal… it’s actually available right now.
So this is a little house in a strategically VERY attractive area of the country. The property is solidly worth $95,000, arguably even $100,000… and that’s based on comparing it to other houses in the area, not based on any cap rate-related sleight of hand. It’s totally rent-ready and rents for $850.
Here’s a really simple analysis:
$850 rent means $10,200 in gross income per year.
By the time we factor out property taxes, insurance and property management, you’ll net $8,186 per year. So what’s your ROI?
Well, that’s the interesting thing. If you’re buying this from a typical turnkey rental company, you’re going to pay – repeat after me – FULL RETAIL or higher. In this case, that would mean $100,000 or more.
Not here. You’ll get this property for $80,000 – a full $15,000 to $20,000 below it’s REAL value.
And based on that price of $80,000, your cash-on-cash yield will be 10.2%!
Folks, that’s cash-on-cash of 10.2% - and that doesn’t even include the substantial EQUITY position that you’ll have from day 1!
Now, let’s be clear: That’s the pre-maintenance profit. There WILL be maintenance costs. Likely less to begin with and more as the property ages. And I’ll tell you… you’d be VERY wise to set aside the entire first year of cash flow for use as rental reserves. That’s an aggressive approach… but it’s one that will make sure you don’t find yourself in trouble.
So what makes this deal a good deal? Well, it’s a very attractive price – well below retail value – the cash flow is very solid… and… it’s in a great, appreciating area! This one is really attractive. I think that buying a turnkey property 10% below retail is a really good start… but when they’re 15-20% below retail like this one… well… it’s a no-brainer.
And do you see that I didn’t have to try to confuse you with discussions about tax benefits or inflation rates… and a really big one – I didn’t try to tell you that equity doesn’t matter, and that you should look ONLY at your results in terms of cash flow. Whenever you hear that one, my friends, you should RUN.
Sure, you get tax benefits with this property, just like every other property in America. Sure, this property is a hedge against inflation, just like the property you’re considering from a turnkey property provider. But the difference is – this is ACTUALLY a really good deal… and you simply don’t need a degree in finance to understand that.
Remember the S3 Investment Criteria, my friends: Simple. Safe. Strong. This investment is SIMPLE… it’s a rental in an appreciating and growing market! It’s SAFE… you’ve got a solid equity position and very good cash flow from DAY #1. And it’s STRONG – strong cash flow, strong equity, strong market.
This one, I believe, makes a LOT of sense.
Incidentally, this property is a real deal and really available. It came across my desk this morning. We only get about 10-15 deals like this a month where you get a GREAT cash-flowing rental property with a vetted tenant and solid property management… along with a GREAT below-market price. In fact, many of our deals are so inexpensive, that you’re getting the house BELOW what it costs to build, and you’re getting the land, effectively for FREE!
So, those deals tend to go very, very quickly. Are you interested in getting into some GREAT turnkey rental properties that actually MAKE SENSE… Well, my friends, I’ve got them! If you’ve got at least $100,000 of capital – which is about where most of these properties are priced – and you’d like to be on the Self Directed Investor rental Top Picks notification list, just text the word TOPPICKS to 33444. That’s just one word, with no spaces. Text the word TOPPICKS to 33444 – but only if you’d like to be notified as we receive access to great turnkey rental properties you can buy well BELOW retail cost… in other words, truly SMART deals!
My friends, invest wisely today…and live well forever!
Bryan Ellis is host of Self Directed Investor Talk, America's #1 radio show and podcast for affluent self-directed investors. He's also an expert in self-directed IRA's, solo 401k's and turnkey rental property investing... at least, that's what his wife tells him 🙂 He's a contributor to well-respected publications like TheStreet.com, Entrepreneur and ThinkRealty. Bryan lives in metro Atlanta, Georgia with Carole Ellis - his wife, business partner and best friend - and his 4 children ranging in age from 2 to 19.