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Guest host Leonard Baron, a real estate professor at San Diego State University and principal of LPB Services, a real estate consulting firm, tackles your real estate questions today as part of Savvy & Sage: Buying and Selling in 2009.
Here was the first question that came in, from discdude on this post:
Leonard, the “experts” say it might be a good time to buy investment real estate. But leaving aside whether it’s the right time, let’s say someone does want to buy a house or condo to rent out. What are the current minimum percent down (equity) requirements by banks? And let’s say I don’t have that amount, should I partner with friends / family? Do you recommend this, or should I just continue to accumulate cash and get in later? So many partnerships seem to end up in disputes, I’m not sure what’s the best way to go. I guess the real question is…how to start when you don’t have much to start with…and I’m not looking to get rich quick.
Your quote, “I’m not looking to get rich quick” tells me you will be rich because you clearly know there are no get-rich-quick schemes! To get wealthy, one needs to do the hard work it requires to earn long term wealth … and real estate is hard work. Twenty percent is typically needed.
Partnering can be good, just make sure the partner has the same goals/ideas in mind on split of work, holding period, etc. If you can get funding from family (better a loan from them) where you make the decisions and you live with the results good or bad — that may be better. Give your family a fair rate of return on their money/loan and give them a realistic repayment schedule with interest — in writing.
Let’s answer, “Is it the right time?” Well … it depends. I think it is a great time to buy — in certain areas of town.
But what is a good deal? You need to pencil it out. The main question is not the price, but how much cash do you need to buy it (That’s also known as your equity — your down payment, closing costs, financing costs, and rehab budget.) and what is your investment rate of return?. For example, on a $150,000 condo, equity would be $30,000 down payment or 20 percent, $4,000 in closing/financing costs and probably $5,000 rehab/paint/carpets for total equity of $39,000.
Next take your estimated monthly rents (you can get at zilpy.com) and subtract all of the monthly expenses (mortgage payment, insurance, taxes, repairs estimate, miscellaneous), and how much money is left over? (You can download a simple investment analysis spreadsheet I’ve made for this purpose on my website — Investment Property Analysis.) So if the monthly cash left over is $250, multiply this by 12 months and you get $3,000 per year of “net cash flow”.
Divide this net cash flow by your equity to get a rate of return – in this case $3,000 net cash flow / $39,000 equity = 7.69 percent “cash on cash” return. Then compare that to what you might be able to get from a bank if you just put your money in an account. A risk free bank account can give you 2.5 percent return, so shoot for above that. Real estate has risks, so you must be compensated — I shoot for 5 percent to 7 percent or more.
By the way, the best cash flow deals in San Diego County are in the moderately priced, low vacancy areas that have had the most foreclosures (Oceanside, Vista, Santee, La Mesa, east San Diego, parts of Chula Vista — and not in prize areas like the beach.) Zilpy.com will also show you vacancy percentages: 5 percent or less is great. So pencil out your deal — a negative 10 percent is not too appetizing. A positive 7 percent smells and tastes pretty good!
If you have more questions for Leonard Baron, please leave a comment or e-mail firstname.lastname@example.org.