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Single family rental home in suburbia USA |
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(Drag your mouse over the house) |
The most conservative rental housing investment is a single family home in a stable suburban neighborhood. It also usually has the highest appreciation rate over the long term. Unfortunately, it will produce the lowest cash on cash return in early years. We use a 3 bedroom single family rental for our example here because it greatly simplifies the numbers we have to consider. Other analyses at this site deal with multi-family and rental housing complexes.
Check out your local rental housing market and see how it compares to our example. Look at our cost estimates, then plug in numbers that would be more appropriate in your area. The formulas in the example will apply to any numbers for any property you think you would like to own. ( Note: prices have appreciated since we wrote this page more than three years ago. You should now add about 15% to each number, but that doesn't affect the result.) This is based on a typical 3 bedroom one family older home in Middle Town America. You will often be able to find shabby looking examples listed for sale with your favorite broker from the thirties to mid forties. Assume that you are able to skillfully negotiate a purchase price of $35,000. You could expect to immediately spend an additional $5,000 upgrading electric, plumbing, painting and doing initial repairs. Banks require at least 30% down on investment property ($10,500 down plus $5,000 repairs) so your investment in our example will be $15,500.
Two figures will tell it all: On line 12, you'll have the annual return you can expect on the cash you invest, after tax. Real estate investors in most parts of the country want to see at least double the one-year CD rate, (about 9%) so on line 13 check the cash on cash return on your investment. If that figure is 10% or more, it may be a good investment. Remember, your cash income and overall rate of return should rise substantially because of inflation and leverage. This kind of an analyses should help to assure that your heart doesn’t override your brain and pocket book when selecting a property to buy. Good luck.
| 1- |
Scheduled annual rents |
$550 per month |
$6,600 |
| 2- |
Deduct an allowance for vacancies and uncollected rents |
typically 5% to 10% |
-$330 |
| 3- |
Net rental income |
line 1 minus line 2 |
$6,270 |
| 4- |
Operating expenses like repairs and maintenance |
use 10% of net rents |
-$627 |
| 5- |
Property taxes and insurance |
18% to 20% of annual rents |
-$1,254 |
| 6- |
NOI - Net Operating Income before mortgage expense |
line 3 minus line 4 & 5 |
$4,389 |
| 7- |
Annual interest (8%) on the mortgage amount, $24,500. |
usually 70% of purchase price |
-$1,960 |
| 8- |
Cash flow before tax |
(line 6 minus line 7) |
$2,429 |
| 9- |
Depreciation |
$40,000, less 10% for value of the land, then divide by 27.5 years Tax Loss |
-$1,455 |
| 10- |
Tax loss or gain |
line 8 minus line 9 |
+ $974 |
| 11- |
Annual tax loss or tax due |
line 10 multiplied by your combined federal, state and local income tax rates. Approx. 22.5% |
$219 |
| 12- |
After-tax cash flow |
line 8 plus or minus line 11 |
$2,210 |
| 13- |
Cash-on-cash return |
line 12 divided by cash invested $15,500 |
14% |
| 14- |
Projected one-year gain in value or sales price |
Value multiplied by an estimated increase in value- at least 3% a year. Purchase price plus improvements = $40,000, times 3% |
$1,200 |
| 15- |
Projected total after tax return for the first year |
Line 12 plus line 14 |
$3,410
or 22% |
Our example produces an excellent 22% after tax return on your investment in rental property the first year. Because the investment is leveraged, (30% of your money moved 70% of the bank’s money) even a small amount of inflation results in a dramatic increase in your return. The number we used for interest reduces each year and adds to your return.
However, we did not pay you for your work in finding, financing and then managing the property. Single family rental housing investments may only make sense in the first few years you own them, ... if you are willing to work for little or nothing ... for a while. There are a great many other ways to enhance your after tax return that are explored in detail in other areas of our Web site. However, if your investment doesn’t come close to a positive cash flow, without tax ramifications, it is probably best to keep looking. Oh, I almost forgot, a bad tenant who destroys your property - and forces you through the legal system - will also affect your return. ... As will city hall, if you let them. See our page on Political Action. Also See: Financial Analysis of Income Property |