August 24, 2010

Thinking Aboug Buying a Foreclosure as Investment

Recently I read in a local newspaper that foreclosures have increased in the suburbs in my area.   The foreclosure rate in my city has been below the national average but now it looks like some cities in our vicinity have seen the foreclosure rates go up lately .   This prompted me to go check out the real estate for sale listings to see what kind of prices the foreclosures might be selling for.   I found some pretty cheap foreclosure and short sale properties in our area that might make good rental investments.   Usually houses have been selling for $200k or more in my city for a basic 3 bedroom starter house.   However I found several bank owned and short sale listings for  sale in the $115k to $150k range.

A few years ago I wouldn't really have considered buying a single family home in my area as an investment because prices had gotten so high that they didn't work out financially as rentals.  But now that prices are down its looking like there are some buying opportunities particularly in the distressed properties.

But how do the numbers really work out?   I'll use the basics of the ideas from my older topic How to value rental property prices   and run some quick numbers to see if these properties are feasible investments.   I'll take a look at the more expensive house at the top end of that range  at $150,000 as a starting point for example.

Purchase and Financing Costs

I assume that we'd have to put down 20% to buy a place.

Purchase price : $150,000
Down payment : $30,000
Mortgage : $120,000

Loans for investment properties have higher interest because the owners are more likely to default in general.  When I searched for quotes as an investment property the rates were 0.5 to 1% higher than what you might see for a primary residence.   I found a range of rates based on different amount of points paid.  For a 4.75% loan we'd have to pay $3,413 in fees/points for total closing of about $4,700.

SO I figure we could probably get into a place with $30,000 down and closing of about $5,000.    That would mean about $35,000 out of pocket to buy the property.    Then we would probably have to put some money into it to get it in shape to rent.  That might take a few thousand more give or take depending on what needed done.  Lets figure a budget of $5000 for repairs and improvements.   All together that would be a total of $40,000 out of pocket to buy the property with 20% down, pay closing and fix it up to rent.

Total cost to buy and fix up property = About $40,000

The 4.75% loan for a mortgage of $120,000 would give us a monthly payment of $626
Taxes and insurance would run around $200 a month more.   If we have escrow then we'd be looking at a total payment of about $826 a month give or take.

Setting the Rent

Previously I discussed How to set rent rate for a rental.   I'll use those methods to roughly figure what we could expect to get for rent.   I used Rentometer and Craigslist to check out comparable rents in our area for 3 bedroom single family homes.   Rentometer said that 90% of 3 bedrooms are over $950 and 80% of them are over $995.   Looking on Craigslist there are very few single family homes under $1000 but theres a few out there.    I think that a rent in the $950 range would be about right.  It may be at the lower end but that would make it easier to attract and retain tenants.

Cash Flow

Rent = ~$950
Mortgage / taxes/insurance = ~$826

We would not pay for utilities and there should not be other ongoing regular costs.   That gives us about $124 monthly cash flow.   But with misc. repairs and expenses that would probably get eaten up.  We'd also have to figure in some level of vacancy, though I would hope we could keep it rented 100% but thats not possible forever.

Overall the monthly cash flow would be roughly neutral.   

Tax and Equity

There are other financial benefits though.   We would also have depreciation from the home that would help save us money on our taxes and portion of the mortgage would be paying ~$150 a month towards principal.  Between the tax break and the principal that would be in the ballpark of $3000 positive per year.   Thats not a bad annual return on $40,000.

Bottom Line:  It looks like these properties might make acceptable rental investments.   They aren't super bargains by any measure but it would be possible to come out ahead with such a purchase if we find the right property for the right price.

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