One Dollar Allowance

Choosing Properties

Mr. ODA has regular emails come in with new listings in the areas we’re interested in. While some of our houses are 2 bedroom, we find it easier to rent 3 bedroom houses. We also are looking to the possibility of resale, which is better for the 3 and 4 bedroom houses.

First, we look at the condition of the property. We’re interested in properties that can be immediately rented, meaning we’re not looking for remodel projects. Most of our properties purchased required no work to prepare it for a renter, and they are typically recently updated. When I say these houses were recently updated, they weren’t top-of-the-line finishes.  Here’s an example of one we purchase 4 years ago, and the pink knobs are still there!

There are a few properties that took slightly more work. We purchased one property that required a whole-house paint job (including trim work) that took a week doing it myself. We also attempted to rent another property with old carpet on the main floor. The potential renter asked if we’d be willing replace it or refinish the floors; we ended up taking a week to refinish the floors, which has paid off in the long run.

Typically, we’re going to replace appliances, paint, and scrub the place down to prepare it for renting. We’re not looking to overhaul the building or do massive capital improvements for that first renter. However, I’ll note that it doesn’t mean we don’t eventually do that. Just this past year, we had several roof replacements/repairs, plumbing replacements, and HVAC repairs.

We want the house to be in good condition to keep a renter there (we’ve actually had very low turnover), make it easy to re-rent it when there is a vacancy, and to make it attractive for any future sale. We’ve noticed that homes that were typically owned instead of rented are in better condition than if it was managed by a landlord. We seem to struggle wanting to move forward with houses that are currently rented because of all the deferred maintenance.

We have been under contract on multiple houses that we walked away from after the home inspection (e.g., knob-and-tube wiring, vertical clearance requirements on stairs, remnants of a previous fire found, poor patch work). Don’t feel like you’re in too deep if the inspection comes back to show a lot of improvements are necessary. It’s a hard mentality to talk yourself (and your partner) through because you’ve spent time looking at the house, reviewing rental comps, possibly reviewing current lease agreements, and spent the money and time for the home inspection. But keep in mind that it’s not worth purchasing the house and spending more than you’d like to keep the house standing and rentable.

Then, in broad strokes, we’re watching the 1% Rule. This means the monthly rent should be 1% of the purchase price (e.g., a purchase of $100,000 house should yield $1,000 per month in rent). Review current rent prices in the immediate vicinity. We’ve purchased houses in areas that have several rental properties, so it’s been fairly easy to identify a rate based on the number of bedrooms and bathrooms, as well as the amenities we can offer (e.g., appliances, lease term, parking availability). In future posts, I’ll provide the details of each of our purchases.  

Here’s a break-down of our current properties related to the 1% Rule. 

You can see that we didn’t hit the 1% on 5 of them. The first had a tenant when we purchased it 4 years ago; we’ve risen the rent once and plan to raise it to $1200 at the renewal term in July (so raised the rent $50 every two years). The bottom two were in a market that we were unfamiliar with, and even though we thought we would yield $990 easily for rent (yes, is still below 1%), the houses were in excellent condition, so we looked to the future value in the decision making. Unfortunately, we didn’t close on these until September, which is difficult to find renters. We didn’t have many showings at ~$1,000 rent. We ended up lowering the rental price by offering an 18-month lease so that the future rental timeframe was in the spring, and we offered the rest of October as free.

Mr. ODA developed a spreadsheet to calculate all the costs associated with owning the house, which helps determine whether the house fits our portfolio goals, especially if it doesn’t exactly meet the 1% Rule. This spreadsheet makes assumptions for routine maintenance costs, capital improvement costs, vacancy assumptions, insurance, mortgage interest, etc. Calculate the monthly rent less than the monthly cost of each of these assumptions to arrive at the monthly cash flow. Annualize the monthly cash flow, and then divide it by the down payment and closing costs to arrive at a ‘cash-on-cash’ return, which we’re looking to be at least 8-10%.

Next, we examine the neighborhood. We have thresholds for prospective tenants, which typically yields to a middle-of-the-road neighborhood. We’re not looking for a perfect, upscale neighborhood to own a rental because these types of homes rarely meet the 1% Rule. I utilize Trulia to examine the crime rates of the area. We want to offer homes that are in reasonable city locations.

I had fully vetted one house and determined it was worth our purchase. A similar house, with an upgraded kitchen, was for sale a couple of blocks away. I assumed it was the same neighborhood and didn’t do my due diligence. The house showed very well online, and we had several showings from qualified individuals, but then they’d check the house details, only to find out that it was in a high crime zone. We ended up having to lower our credit score threshold to find a renter (compensating with additional security deposit), then had difficulties for over a year collecting her rent, which really should have been expected. We have since sold off that property. 

If all these steps, including the cash-on-cash evaluation, should take about an hour. If we get this far, we go see the house. If the house is in the condition we expect it to be based on the pictures, we make an offer. Our Realtor will write up that offer the same day. Recently, many houses have been in a multiple-offer scenario. This is another trap to not get sucked into. After so much time vetting the house, it’s easy to be attached, especially if you find very favorable data (e.g., you can get rent higher than 1%). It’s not worth owning the house if you have to purchase it at a higher price than you’re comfortable at; it must be a business decision, purely based on the financials.

Keep an eye on listings daily or weekly to keep a pulse on the neighborhoods you’re interested in, evaluate the property condition, consider the 1% Rule and evaluate the detailed financial cash flow, don’t skip the home inspection nor should you ignore the results of it, and keep it a business (not emotional) decision.