What to Purchase - In this episode, we discuss in depth what to purchase to invest in RENTALS. The price, location and condition is the name of the game!
David: Alright guys, welcome back. This is the Discount Property Investor podcast. I'm your host David Dodge with co-host Mike Slane.
Mike: Hey guys, thanks for joining us today. Super excited to be recording with Dave. This is one of the things we like to do, we don't have enough time for it, it seems like. We get out there and look at properties; that's fun too but it's nice to get in here and chat about real estate with one of my partners, I enjoy doing it--.
David: Yeah, me too.
Mike: I'm happy to be here today. So hopefully you guys are killing it in wholesaling, this is the Discount Property Investor podcast like Dave said, we focus primarily on teaching people how to get started in real estate investing, and the first way is through wholesaling, that's what I always recommend. It's a great way to learn your numbers, then get your feet wet in this investing business, without having a
ton of capital.
David: It's true.
Mike: Again, a great way to get started. Today we are talking more about rentals, we are going to continue our little series on the BRRRR strategy. Today we are talking about what to buy, right? That's kind of what we are going to delve into?
David: Yeah, the last episode we talked about how to buy rentals essentially. We kind of gave you a big picture of how to buy. So today we are going to dive into what to purchase a little bit deeper.
David: We talked about location, we talked about the city and county laws. Research your market to pick the area that makes sense for you. So we are really going to dive into that today. So we are obviously out of St Louis Missouri, if you have been listening you should know that. Let's talk about location, Mike. So we have rentals in our city. They are located in the north county region, south city region primarily. We have some sprinkled out in other areas. Why do we have most of our rentals in those two areas though, Mike? Why does that location matter for us?
Mike: Absolutely. So that is a great question, and I will even expand it a little bit further as to why it makes sense for other people too.
Mike: So we invest in those two particular areas in St Louis because the numbers work. We know our numbers--.
David: Know your numbers.
Mike: -- And we can make cash flow in those areas.
David: It's proven because we are doing it, so doing one on the street nearby is going to be simple, versus trying to go somewhere we don't know anything about.
David: Location, location, location.
Mike: It's not to say you can't make it in other areas of St Louis, absolutely you can. These are the areas we are having success with, so we are putting our money there.
Mike: So why does it make sense? Because we can get a positive cash flow, a return on our investment in that area. So what you're going to do, if you live in a-- let's just call it an expensive market versus a less expensive market. If you look at the west coast, so California, they have in our opinion, because again we are midwesterners; they have crazy expensive real estate out there, right? So I mean you are looking at $500,000 two bedroom one bath little bungalows or whatever. That is not how we live here. That type of property wouldn't make sense to buy as a rental in most cases. Again, to come up with the money to buy a $500,000 house is going to be a lot harder than to come up with the money for a $100,000 house. The rent-- again I'm not--.
David: Isn't going to be five times.
Mike: I don't suspect it's five times, that's the big problem. You are probably going to be paying $4000 a month. You also have places like New York, you have rent controls. Again, I am not super familiar with it. But you can't increase your rent over a certain level. So it causes all sorts of issues, same thing with San Francisco. You can't-- I'm digressing. Get back to focusing on the fact that we like the midwest, you should look for regions that make sense to invest in from a cash flow perspective. So what does that mean? It means you have to look at the purchase price, figure out what you can finance properties for, break down what your monthly payments are going to be, figure out your taxes and insurance costs on it, and your estimated rates.
David: That's it, that's all you need.
Mike: You are going to look at those numbers--.
David: Fine the estimated cash flow which is basically all the money that comes in, pays all your expenses and there is some left, that's the cash flow. So you want to have an estimated cash flow of at least $250, why? Why does it near to be at least $250? Well because you are going to have vacancies, you're going to have maintenance and you are going to have management expenses. So if you want to make it be profitable and actually turn this into a business and not a hobby, you need to have at least $250 because there are going to be periods of time when it's vacant, you have no money coming in. So you need to have cash flow, the extra money saved to cover the mortgage in those months. You are always going to have expenses of dealing with things when they break, and you are going to have to pay somebody to manage it, or you can manage it. So that third expense may or may not be there. But as you scale, you are going to have to pick between managing your properties or hiring a manager, so there will be a cost at some point with that. Wouldn't you agree, Mike?
Mike: Oh absolutely yeah. So we use a property manager. We have got to a point where we need someone else to help us--.
David: Well that and it's hard to do both. You can't be in acquisition mode and management mode. So maybe at some point, we will open our own company; who knows? But right now it works great for us to have somebody help with the leasing and the day to day management and rent collection, because we are focusing our efforts on buying more.
Mike: Absolutely, it's a full-time job just managing--.
Mike: Right, 100%. So okay we are talking about what to purchase, let's circle back again. We kind of talked about location, why we think the Midwest is a great area to invest in the type of property-- let's touch on that a little bit. We like single-family homes, right? So single-family homes are traditionally one of the best things to invest in. I think it has been a 6% return from the 1960s to-- prior to the bust or so. Then again obviously after that prices started climbing again slowly.
David: 6% a year, that is pretty awesome.
Mike: Right, and that's yeah inflation-adjusted and all that. It's pretty good stuff.
David: Well Michael, last episode we mentioned that you had a friend who had a strategy on buying on bedrooms. We don't, our strategy is the opposite of that, but that's okay, that particular person had picked a niche. However, we do own one-bedrooms in a multi-family setting.
Mike: We do.
David: There is a big difference between a single-family rental and a multi-family rental. With multi-family, you get to dollar cast average all of those items by the bedrooms. We talked a little bit about that in the last episode too. So if you have one roof with ten individual units, that is a one-bedroom unit, that changes a lot of things. We actually own a ten family that has a one-bedroom unit, but it is one roof. So type of property has a lot to do with what kind of investing or investor you want to become or do.
Mike: Absolutely. That's--.
David: That might be a cash flow play on a multi-family unit. However, the pros and cons of multi-families versus single families are the barriers to entry are obviously going to higher typically when you have a multi-family because you have a lot more plumbing, a lot more electrical, the cost is going to be higher. One of the major cons in my opinion is the liquidity of those deals. Single-family houses are going to be very easy to sell because you have a lot of buyers out there that are looking. You have people that are wanting to buy and just move into, investors and so on and so forth. Multi-family investments; typically the owner of those buildings don't live in them. It's always going to be an investor whenever you dealing with larger properties. A duplex maybe not, you might have somebody that wants to move into a duplex and rent out one of the sides, but it doesn't really happen that way when you get up to four, eight, and six families and so on and so forth. So the type of property is something you kind of want to figure out what works for you. If you're just getting started we recommend sticking to single families. They are easy to manage and they are easier to kind of work the numbers on if you're a beginner.
Mike: Yeah I think it is probably easier to get a loan on them honestly-- I think a bank is going to have more comfort with you taking on that type of risk, but it depends on your experience level.
David: Absolutely. Figure out what kind of investing you want to do and stick to it, love that. We talked about basements and garages pretty in detail last episode, so we will push past that. Mike, next I think when it comes to what to purchase, the price, alright? Everyone is always going to be thinking, well what do I look for in terms of price? Well, that depends on you. But the purchase price is very important, wouldn't you agree?
Mike: Oh it is probably one of the most important things.
David: Absolutely. So this kind of circle back to knowing your numbers, and maybe you determined your purchase price by looking at all your other numbers first; that's okay. You can first say, okay, I think in this particular area I can get this rent, okay? Typically in our area we need to be at 1% of the purchase price in rent. So if I am looking at a property and I'm like, I think I can get $900 a month in rent for this. Well the absolute most I can be into this property for is 90 grand, the absolute most in my market. In your market it may be a little different, but it's a great rule of thumb, it's called the 1% rule.
Mike: I love that one. I love that you-- we talked about purchase price, because I was just thinking about that kind of saying, there are three things in real estate-- and there are only really three things; the price, the location and the condition, right? So you can't change the location.
David: You can't change that.
Mike: But you get to pick all these things though, right? That's what's cool is upfront before you buy it, you are picking all these things that you want. You say, well I don't pick the price, but you do. You pick the property then you get to negotiate the price.
Mike: So again, it is pretty neat stuff. So price is very important, but it is going to be based on the rental income in your area. So you have to determine-- again, if it makes sense in your area. Is this purchase price going to be supported by the rent? Does the rent cover--?
David: And is there a demand for renters in that area?
Mike: Very good, very good point.
David: So one thing that we didn't touch on in detail last episode was the condition. We mentioned it, but we didn't go deep into the condition.
Mike: This is important.
David: This is very important. So if you are new to rental investing; the location is obviously very important, the amount of rent is very important, then, of course, knowing what you're looking for, the type of property, bed bath count, having metrics in place. Next is the condition, okay? The condition is going to change a lot of things because this can affect how much you can offer on the property. Whenever we look at the property, we start with the end number in mind, okay? We use a simple formula called the MAO formula. Basically what it says is that I can offer this amount of money for a property based upon what it is going to be worth once it is fixed up, or rehabbed to a rent quality, okay? Multiplied by a discount rate which we are going to get into as well, but that can change, minus the repairs. So the repairs are basically the thing that is going to change the most. If I am going to look at every house on a street and they are all three-bedroom houses, I can essentially assume that the after repair value of all these houses is going to be relatively the same.
Mike: Yeah it's pretty similar. A very good example, we were analyzing a property this morning, and we looked at one on the same street a couple of weeks prior, and thought it was going to be pretty similar to this one. This street, it's all-- all about 900 to 1000 square foot houses.
David: Two bed one bath.
Mike: Very small, some of them have garages, some don't. I mean that is pretty much all you've got on this street.
David: It's all you need to know essentially.
Mike: Location is the same--.
David: ARV is the same.
Mike: ARV is going to be the same, so our after repair value-- but the condition--.
David: The discount rate will be the same because of the location. But the condition is the one thing that varies from house to house.
Mike: That's what I think-- so the condition is going to effect though that other variable price. Those two are very intimately tied together, that's something that takes a while to get a real handle on--.
David: So let's review our formula. What's the most I can pay for a property? It's based on the condition. So the formula is your MAO, your max allowable offer equals your ARV, or the after repair value, multiplied by .7 or .8, a discount rate depending on your area, minus those repairs, okay? So yeah love it, Mike. So the condition is going to vary greatly from property to property. So if the condition is move in ready, well that is not really that big of a deal in the equation. However, if that property needs 10, 20, sometimes even $30,000 worth of work in order to get an occupancy permit so you can rent it, well that is going to decrease your offer by 10, 20 or even $30,000-- which is going to be equal to the amount that you would have to spend to get it occupancy ready.
Mike: That's the beautiful thing about wholesaling too. If--.
David: They are intertwined, yeah.
Mike: If you have followed with us along, you started learning your numbers by wholesaling properties. You went out and made offers on properties, you have got some under contract, and you start marketing to other investors; other investors say no way your rehab number is too low. That $20,000, you think I can rehab a 2000 square foot house that needs a new kitchen, three new bathrooms for 20,000? You're crazy. That might be true. Again, you are going to learn your market by doing some of that wholesaling. So the condition is the biggest variable, we highly encourage you to get out there and network and do some wholesaling to help you network, and learn, and sell properties, and find out what a good deal is in your area to get started. I just love the fact that's where we have both kind of started from, we knew we wanted to do rentals, and start wholesaling here in St Louis, picking up quite a few more. Yeah it's really fun, guys. It gets to be fun.
David: Absolutely. So the rehab estimate is really what we're looking for whenever we talk about the condition. How much is it going to cost to fix that property up? That way we can use the rest of our formula to determine how much we are going to purchase the property for. So the purchase price I am going to go out on a limb here and say, that it is a-- the answer to a problem that I am going to solve. Basically we are going to use an equation to determine what that purchase price is, every single time. It's a variable that is going to change based upon the condition of the property. Last but not least is the rehab plan. So we are going to want to put a plan in place once we determine the condition, once we determine the condition-- so we can get that property fixed up and ready to be leased out.
Mike: We are going to go way into depth on that one when we talk about rehab. We will go into all sorts of different ways to estimate repairs and figure out what your rehab costs are going to be.
David: I love it.
David: Alright guys, until next time that was an episode on what to purchase, wanted to get into a little more detail about that, thanks for listening. Check out freewholesalecourse.com if you haven't been there already. We wholesale and buy rentals, so we basically keep the best, sell the rest, we encourage you to do the same. Wholesaling is a job, it does require a lot of work, so put that work to use by buying rental properties so you can actually make money while you sleep. Alright guys thanks for listening, until next time.