3 Reasons to Consider Trash Flow
Yeah, yeah…we all want the “cosmetics-only” rehab in the great area that we can turn over in 14 days, sell in 20, and make $60,000 in net-net profit just like on Flip This House.
The problem is, it’s not 2006 and we don’t live in San Diego. Here in flyover country, that house is only worth $120,000, and it costs the same $15,000 to do that paint/carpet/kitchens/baths/windows/siding job on our starter homes as it does on the $300,000 starter in Southern California. Only after finance costs, sales costs, and taxes, WE’RE gonna take home more like $20,000 than $60,000.
Not that rehabbing and retailing isn’t a great business: It is. But it’s also time-intensive, cash-intensive, and, most importantly, IT DOESN’T BUILD LONG-TERM WEALTH.
The last time you did a retail-resale deal, how long did that $20,000 profit check last? 2 months? 3? Or did it get half eaten up by the NEXT retail deal, that had an unexpected termite infestation or collapsed sewer line or other unpleasant “rehabber’s surprise”?
If you’re one of our many buyers who are obsessed with the next 5-figure check, it might be time to take a look at the far less sexy but far more steady “trash flow” rental business.
Before you stop reading (because there’s no way you’re going to own properties in THAT kind of area), let me show you what you’re missing out on:
Reason 1: Well-managed properties in lower-end areas are a source of steady, high returns. In the Cincinnati area today, it’s entirely possible to buy AND renovate a single family home in a border zone area (lots of section 8, a fair number of board ups, but not a “war zone” where you’d be taking your life into your hands to try to collect your rents in person) for around $35,000.
It’s also possible to RENT those properties, depending on the size, for $700/mo+.
So let’s say you bought a house 3-bedroom house in, say, one of the nicer parts of Avondale, for, say, $7,900.
Let’s further imagine that you spent $15,000 more making it rent ready.
With holding costs, you’d be in that property for roughly $23,000.
If you made it safe and attractive-see previous blog post for what “safe and attractive” means in a border zone-you’d be able to rent this house for a minimum of $650/mo.
With taxes of $52/month and insurance of $35/mo AND a maintenance/vacancy reserve of $130/mo, your expenses, assuming you paid cash, are $217/mo, leaving you with cash flow $433/mo.
$433 x 12 is $5,196/year, a return of 22.6% on your $23,000 investment. Interested yet?
I know, $433 a month forever isn’t as attractive as $20,000 in your hand right now. Oh, and you don’t want to manage tenants in Avondale, ’cause you live in West Chester, and you’re picturing constant trips to the inner city to collect rents, deal with maintenance issues, and so on. Oh, and you don’t want to sink $23,000 into a property and leave it there forever. So let’s look at some alternative scenarios for this one:
a. Don’t use your own money. There are plenty of passive investors out there who’d love to provide the $23,000 to buy and rehab this house in return for half the cash flow (giving him an 11.3% cash-on-cash return PLUS 1/2 the equity and appreciation PLUS 1/2 the tax benefits, if he can take them. You’ll have nothing in the deal except the time to find it, rehab it, and manage it. And there’s still no mortgage payment-this isn’t a loan, it’s a partnership. So what’s your return now? Huh? Huh? It’s infinite-and your cash flow is still $216 a month, plus you still own half the equity, plus you still get 1/2 the tax breaks.
b. Learn to be a real landlord. I’ve had just as many-if not more-management hassles in $180,000 rentals as in $25,000 rentals. The keys to easier management and maintenance are 1) screen your applicant thoroughly and 2) get the property fully stabilized before you rent it. If you have to drive to Avondale to collect your rents, you’re doing something wrong. If you’re at the property more than once every 4-6 months to fix something, you’re doing something wrong.
c. Get a property manager. It’ll cost you 10% of your gross rents, plus a rent-up fee of 1 month’s rent when you lose a tenant, plus 20% more in maintenance costs if you have him handle the maintenance, but even so, you’d still net (in the example above)
$650 gross rent
-$87 taxes and insurance
-$143 maintenance and vacancy (22% instead of 20%)
-$65 in monthly management
-$54 rent up fee (assumes the property goes vacant once a year)
$301/mo in net cash flow, or a 15.7% cash on cash return
Reason 2: If you do this right, you can actually RETIRE someday. At the moment, cheap properties with high cash flow are pretty easy to acquire: we have deals that meet or exceed these returns all the time. In fact, some of our multi-families EXCEED these returns. One that you’ll probably miss out on because it will sell while you’re reading this has the following numbers:
Purchase price $12,900
Repair costs $25,000
Total investment (by you or someone else) $37,900
$1,200 gross rent
-$60 utilities (owner pays water and sewer)
$782/mo, or $9,384/year, or 24.75% cash on cash return
Let’s assume that you, again, use a partner’s money to buy this property and thus collect just $4,692 a year in income from this 2-family. How many would you need to own to have a fully passive income that you could really live on. 10? 20?
Think about it: with 20 such properties, you could earn over $90,000 a year in income-the equivalent of renovating and reselling 4 1/2 houses in the Cincinnati market, only WITHOUT having to find the next deal, rehab the next deal, and sell the next deal. And should you choose to hire a property manager to deal with your tenants and toilets at that point, well…I think you could afford that. Landlords can retire and still make money. Rehabbers can’t.
Reason 3: You’ll do good in the world. There is a very serious shortage of quality affordable rental property in the tri-state area. Drive through any border zone area, and you’ll see how many perfectly good rentals are vacant, NOT because there aren’t people who want and need to live there, but because they’re bank owned/in foreclosure/owned by out-of-area hedge funds who just don’t care.
If you don’t believe me, buy one of these properties and start fixing it up. A dozen prospective occupants will stop buy during the rehab process and ask when they can move in. No kidding.
By taking these trash flow properties out of the hands of absentee corporate owners and turning them into habitable rentals, you’ll house a family, return a property to the tax rolls, employ people, improve the area, and, by the way, make a whole lot of money.
Yes, there are some things to learn about tenant screening, management, and appropriate maintenance and rehab of these kinds of properties. But they’re cheap (at least for the moment) easy to acquire (we sold over 20 to landlords in 2011 alone, all at rock-bottom, below even the ‘market’ prices), in high demand, and great passive income and wealth builders.
So get off your high horse and nose around some of these less-sexy but, in the long term, more-profitable deals. You’ll be glad you did.