Real Estate: To Buy or Not To Buy
We are always interested in real estate. But the question is always, what makes this house a good buy? What is the compelling reason it begs to be purchased? We located a house that appears to be a good purchase.
Why This Real Estate Is Good
1. The city it is in has an “anchor”.
This is a university town. The university will always be there. Both students and those who work at the university will always be looking for good, inexpensive places to rent.
2. The house has an anchor.
3. The house is located within walking distance of one of the big schools in the university.
4. The house is in a subdivision within walking distance to two shopping centers with grocery stores and restaurants in it as well as the school.
5. The house is underpriced and would easily carry a mortgage and the expenses of renting a home.
6. The prior owners put in a new heat pump so it should be energy efficient.
7. The timing is good as many students have not yet signed leases for the upcoming school year.
8. The house has a 1 car garage but there is enough space for 4 cars to park.
9. Students would love the house.
Why This Real Estate Is Not Good
1. The house was built in the mid 60’s and needs a new roof.
2. Since the house was built in the 60’s it is dated.
3. The electrical system needs to be looked at carefully. The house has fuses and not a breaker box so this may need to be updated.
4. The driveway may need repairs in a few years.
5. It may be advantageous to construct a fence for the back yard. Note: A fenced in back yard makes a house easier to rent as many individuals love to keep dogs.
6. The home just went on the market and an offer must be made in one day.
The numbers will either verify or invalidate our first impression.
We could rent the home for a minimum of $1200 per month as it is a 3 bedroom 2 bath home. It has 1288 square feet so is not too small. Other homes in the area are renting for anywhere from 1100 to 1500 per month. To be conservative we will assume that we can easily rent the house for $1100 per month. The house is offered at $138,000. Quite a few buyers are interested in purchasing this home. We may be able to purchase it for $139,000.
Assumptions: purchase price $139,000, 20% down, interest rate 4.25% for 30 years with 20% down, rents received will be $1100 per month, ten percent of rental income allocated for vacancies and ten percent for repairs.
Now “run the numbers”:
- rent $1100 X 12 = $13200 annually
- vacancies 10% = $1320 annually
- repairs 10% = $1320 annually
- property taxes = $1500 annually
- property insurance = $900 annually
- mortgage on $111,200 loan = $547 times 12 months = $6564 annually
- -$13,200 p (total rental income)
- -$1,320 (estimated vacancies)
- -$1,320(estimated repairs)
- -1,500 (property taxes)
- -$900 (insurance)
- -6,564 (mortgage payment)
- +$1596 net to lessor annually
- downpayment = $27600
- closing costs = 4% of loan = $4,448
- new roof 5000
- painting house 1200
- plan on fixing electrical next year
- plan on adding a fence next year
- total out of pocket = $38,248
The rate of return on your invested funds are $1,596/$38,246 = 4.17 %.
In today’s environment, this is a good rate of return.
You must also figure the amounts out of pocket for prepaid taxes and insurance. However, we do not add those to our calculations for the rate of return as we “assume” the payments are made annually for this calculation. If you prepay, then you will not be paying monthly for the expenses so the rate is the same.
Also, take into consideration that the vacancy and the repairs may or may not be as high as 20% a year. Also if we can rent the unit for more than $1100 per month our rate will go up. There are many unknowns and these are just best guesses.
If the real estate appreciated to $165,000, which is what homes in the area are selling for and you sold it for that less 6% sales commission, you could receive 155,100 for the home that cost you $141,500 (138,000, plus the out of pocket expenses of $6,200 (roof and painting)). If your repairs were at a minimum and the market called for the 165,000, you could possibly make 13,600 less the closing costs for the house. If you paid cash and the closing costs were minimal, you made a great profit for purchasing the home. It all depends on the timeline.
If the house did not sell as you had budgeted, you can still live in the house until the tide turns. It is always a risk you must analyze the facts.
Do you need a house? Can you pay cash or at least put 20% down for the loan. Do you have the staying power to stay in the house an extra year if that is what it takes? Do you think the market for real estate is going up or down?
Read “Buying Rental Property – Desirable or Detrimental?” to get more information about buying real estate.