2Br 1Ba with Tenant---Just $9200 Down!

Renovated with Long term Tenant

1151 Nelson Avenue, Indianapolis, IN

2Br 1 Ba
Rented for $675
Under property management
Over $200/mth cash flow (after mortgage
38% cash on cash return!


  
To See More Properties, CLICK HERE

How To Choose an Investment Market and Minimize Your Risk

OK, everyone’s heard the old saying that “Location, Location, Location” is the most important factor when buying real estate right?  But what does that really mean? What about a location should you know before buying a property for long term rental? Buying because the property’s in your own home town, or because your Uncle George lives in the same city and he can keep an eye on it are the wrong reasons. Most people want to buy close to where they  live, but buying in a local market with poor returns can be inherently more risky than buying in an out of state market with strong returns.  The key to success is to minimize risk first and then maximize your returns. So how do you do that?

Start By Defining Your Goals

Before you even start considering locations, you need to figure out why you’re investing and what your objective is. Some markets are great for appreciation but not so great for cash flow. Others produce great cash flow but appreciate at about the same rate as the end of the last ice age. Deciding which is most important to you is the starting point. You’ll also want to identify some basic criteria. Some investors will only buy homes of a particular age. If you won’t buy a home more than 20 years old then you probably want to avoid Pottsville, PA where the median age of a home is the oldest in the nation. Once you’ve defined your goals, then you’re ready to start figuring out what cities or areas will fit those goals.  It’s a big country so where do you start? 

You’ll start by analyzing the macro level economic fundamentals of a city. Next you’ll study the housing market of the city. 

Start Big And Work Your Way Down

You’ll want to start at a macro level and drill down.  The way to do that is to identify some Metropolitan Statistical Areas (MSA) that look interesting to you.  The Federal Government defines a Metropolitan Statistical Area as one or more adjacent counties that have at least one urban core area with a population of at least 50,000. There are 366 such MSA’s which leaves you with no shortage to choose from!

Once you’ve identified some potential MSA’s you’ll need to start analyzing the economic fundamentals of the area. What you’re trying to determine is the overall health of the city. Here are the most important things you’ll want to know.

How many people live there?

You need renters so you want a city with a lot of people in it. This gives you a large, diverse population as your rental base. I like cities with at least 500,000 but some investors are ok with 100,000 or 200,000. The main thing is you don’t want a small podunk town that doesn’t show up on Google Maps.

Is the population growing or shrinking?

This is one of the most important considerations when choosing a market to own buy and hold property. If the population is decreasing, you not only have a shrinking pool of renters, it’s a sign of fundamental economic weakness of the area. Thriving, healthy cities don’t have declining populations. Look for cities with population growth that exceeds the national average. You’ll also want to know where the people are coming from. If it’s simply because birth rates are exceeding death rates, that doesn’t help much. New household formation is what is most important. What you really want to see is a net positive migration where the number of people moving in to the city is more than the number moving out. This is a pretty good indication that the city has something to offer to attract more potential renters.

What’s the unemployment rate?

Employment is another major indicator of a cities economic health. If people don’t have jobs, they can’t pay much for rent.  Again, look at the unemployment rate against the national average. You’ll not only want to look at the current unemployment rate, but look at its trend for the last 12 months. If the unemployment rate is below the national average today but shows a rising trend while the average is declining, that could spell trouble. Conversely, if the unemployment rate is higher than the average but is dropping more quickly, there may be some positive underlying economic factors occurring that you’ll want to understand.

It’s also important to look at not just the unemployment rate but also the absolute number of people employed. The unemployment rate can be misleading. Because of how the government measures unemployment, it is quite possible for the unemployment rate to drop while the number of people working declines. The number of people working is what really counts. You’ll want to see the number of seasonally adjusted, non-farm labor employees and whether that figure is growing or declining.

Where Do All These People Work?

What industries employ the greatest number of people and how diverse are those industries? Cities with a high concentration of workers employed in a small number of industries are at risk of economic downturns in those industries. Find out who the major employers are and how many people they employee. How many are Fortune 500 companies? What is the financial performance of these employers?  Are businesses moving in to or out of the city? Have any announced any major expansion plans or reductions? Is the state and local government pro business? What is the corporate tax rate of the state and what is the state and local government doing to attract new business?

Are People Making More or Less Than Before?

Look at per capita and median household incomes. Are incomes going up, down or are they stagnant? Again, cities with thriving economies have rising incomes and are producing higher wage jobs. If the number of people employed is rising but average incomes are declining, it means that the new jobs being produced are mostly lower wage jobs. So, it’s not just the number of jobs that’s important, it’s the quality of the jobs.

How Big Is the Economy?

Gross Domestic Product (GDP) is a gauge of the size and health of an economy. GDP represents the value of all of the goods and services produced over a certain period of time. Most people are familiar with the national Gross Domestic Product, but this data is available for each Metropolitan Statistical Area. You’ll want to see what the absolute GDP is in dollars and also, what the growth rate is over the prior period. The higher the growth rate, the healthier the economy. Avoid markets with declining GDP over a long period of time. Cities with large populations typically have higher GDP than smaller cities. It’s helpful to look at the GDP per capita of a city. Markets with GDP growth that exceed the national average and high GDP per capita could be good choices.

How Much Crime Is There?

This isn’t quite as obvious as it seems. Every market is made up of smaller microcosms and has both high and low crime areas. It’s not enough to say that a particular city has a high or low crime rate. You need to understand which are the areas that are safe and which areas you don’t dare walk in at night. Crime rates vary from neighborhood to neighborhood and even street to street.

Is It a Landlord Friendly Area?

You should get to understand some of the landlord/tenant laws and who they favor. You don’t want to be a slumlord, but if your tenant hasn’t paid their rent in 6 months, how easy is it to get them out? This is one of the biggest fears among new investors and rightfully so. Everyone has heard horror stories on how long it took to evict a deadbeat tenant .States and local governments vary significantly on landlord/tenancy laws. Make sure they’re favorable to you as an investor.

Property Taxes

Taxes are a significant part of your operating expenses. Some cities are much higher than others. Minimize your taxes and maximize your ROI. Taxes are based on the properties assessed value. Check with the County Tax Assessors office to find out when the property was last assessed and what the possibility of getting it more favorably reassessed.

Do People Own or Rent?

Markets with a lot of renters obviously give you a larger pool of potential tenants. Some markets have higher ownership rates than others. Look for strong renter markets. Markets with high foreclosure rates tend to have a high rent rate as former homeowners have become displaced and are now renters.

What’s The Price to Rent Ratio?

Owning rental property is all about cash flow and ROI. High cost markets are not good for buy and hold because of their low price to rent ratio. Look for markets with a minimum of a 1%-1.5% price to rent ratio. The best place to determine market rents for an area is to look at different property management websites and internet rental sites to see actual available rentals.

Are There A lot of Vacancies?

Some markets have had so many vacancies that they are bulldozing neighborhoods to reduce the cities geographic footprint. This probably isn’t the best market to invest in. Look at what the rental vacancy rate is in your target market. Once again, look at the trends. Are vacancy rates increasing or decreasing? How do they compare to the national average?

Housing Price Trends

What’s happening with housing prices? Are they going up or down? Look at the trend of median prices in the market. Nearly all markets took a beating in 2008. Look at how much prices dropped from their peak to their low in your target market. Some markets lost nearly 50% of their value while some lost less than 10%. Where are prices now in relation to their high and low? The ideal time to buy is when prices have reached bottom and are just beginning to recover. You NEVER want to buy at the top of the market like so many people did in 2006. If you’re hearing a lot of buzz about the latest “hot spot”, it’s probably already too late because everybody and their brother are already buying there. You need to be at the forefront of market trends not just following the herd.

So how do you identify the early signs of a recovery or market boom? In the remainder of this article, I’ll discuss the key housing metrics that are leading indicators that a market is about to rebound.

How Many Homes Are on the Market?

Look at how many homes are currently on the market compared to the same period a year ago. More homes on the market could mean that the housing market is losing steam and fewer homes are selling. Also, look at how many sold and how many are pending compared to the previous year.

Month’s Supply of Inventory

This is basic supply and demand economics. The months' supply is the ratio of houses for sale to houses sold which indicates how long the current for sale inventory would last given the current sales rate. In a slow real estate market, there are more homes available for sale than there are buyers, and conversely, more buyers than there are sellers in a strong market. Because this is a slower moving indicator it can be a good forward indicator of the direction and potential magnitude of future pricing.  Economists believe that 6 to 6 ½ months of inventory is considered market equilibrium—the point where supply and demand are balanced. At the height of the housing crisis, national housing inventory rose to over 12 months. It’s important to keep in mind that every market is local and the national level doesn’t necessarily reflect your market. As you see inventory levels and months’ supply dropping, it is an indication that the market may be moving towards a seller’s market.

How Long Is It Taking To Sell?

Days on market (DOM) is a measurement of the average length of time homes take to sell. Are houses sitting on the market a long time or selling as fast as they hit the MLS? You’ll want to see what the trend is in your market. If average DOM is dropping, it is an indication of strong sales demand and price increases to come.

Are Sellers Getting Their Asking Price?

The asking price to sales price ratio is an indication of how much sellers are having to discount their price to sell their homes. If you see this ratio tightening, it’s an indication that the market is gaining strength and sellers are not having to discount so much.

Who’s Buying All These Houses?

It’s important to know who is buying. Are they investors or owner occupant buyers? Heavy investment activity in a market can artificially drive prices up dramatically without being a reflection of the health of that markets economy. As investors begin to exit markets, there is the potential for another market bubble. These markets may be well suited for 3-5 year equity gains not be good for long term hold. Timing is key in investor dominated markets. 

All investments have risk, but if you do your homework well, you can minimize the risk of out of state investment and open yourself up to some fantastic opportunities that might not be possible in your own hometown. If you're and out of state investor, I'd love to hear how you chose your market and the research you did.

Cash-flow or ROI--Which is More Important?

At first glance, this question doesn't seem to make a lot of sense you might say. After all, doesn't high cash-flow mean a high ROI? Not necessarily. Why? Because ROI is a function of acquisition cost whereas cash flow is strictly a function of income and expenses.

Too often, investors get hung up on CAP rates and cash on cash returns and lose sight of what really counts--how much cold hard cash they're taking to the bank.

New investors often have some ROI figure in their head--however arbitrary it might be--but are much less clear on their cash-flow objective. I frequently hear investors say something like "I want a minimum of a 10% CAP rate" however, rarely hear them say "I want a minimum of $300 per month cash-flow and I want the property to pay for itself in 10 years or less".

ROI is a basic tool that investors use when evaluating and comparing competing investment options. It's a useful metric to measure an investment's gains against its cost, however it doesn't give the full picture. After all, often times, the property with the highest ROI is the one with the lowest cash-flow as the three scenarios below show. So which is the better investment?

                                         Scenario A                  Scenario B               Scenario C
          Purchase Price             $80,000                        $70,000                  $55,000
          Monthly rent                  $1000                           $850                       $750
          Net operating income      $7100                          $6500                     $5600
          CAP Rate                      8.9%                            9.3%                      10.2%

If you made your decision based on CAP rates alone, Scenario C would be the best investment even though it has the least cash-flow out of the three options. Although scenario A has the lowest ROI it would give $600 per year more than Scenario B and $1500 per year more than Scenario C.

Investors are commonly confronted with this dilemma when evaluating different classes of properties with varying acquisition costs. For instance, it's quite common for a B class property to have higher cash-flow and a lower ROI than a C class property due to its higher acquisition costs as in the scenarios above.

To decide which is the best option for you, you'll need to start by clearly defining your investment goals and answering these questions:

1. Is your primary goal cash-flow or appreciation?
2. How much capital do you have to work with?
3. Are you financing or paying cash?
4. If financing, when do you want to pay it off?
5. How much cash-flow do you want?
6. Do you need cash-flow now or in the future?

Know What You Want

If appreciation is your goal, you might have to settle for a lower ROI. Some of the "hot and glamorous" markets that are seeing rapidly rising prices are also seeing return on investments from cash-flow being driven down. It's important to know where your yield is projected to come from. So, when evaluating properties, you'll want to see a pro forma projection of the expected yield from both cash-flow and from appreciation. If the appreciation isn't expected to come for several years as in some markets, you'll want to evaluate the Net Present Value (NPV) of that future equity gain against alternatives providing more immediate cash-flow. Net present value is a financial principal that says receiving $1.00 in a year from now is not the same as receiving $1.00 today. Many times, the net present value of future appreciation doesn't stack up so well against a high cash flow property with little or no appreciation.

John is considering two very different investment options below. One option offers strong appreciation potential with break-even cash-flow while the other offers good cash-flow but no appreciation. John wants appreciation, and because he didn't learn his lesson from from the crash of 2007, he is willing to accept a break even-cash flow or even a small negative, counting on values to go up in 5 years.

                                                                       Option 1                       Option 2
                           Purchase price:                     $100,000                       $60,000
                           5 year cash flow                        $0                              $15,610
                           5 year appreciation                  $24,890                             $0
                           Total 5 year return                $24,890                       $15,610

John likes Option 1 which is a B class type property with good appreciation potential over 5 years. Option 2 is a less glamorous C class property with little appreciation but with strong cash-flow. As you can see above, Option 1 is expected to return $24,890 over 5 years while Option 2 is expected to return $15,610. So which one should John choose?

At first glance this looks like a no brainer. After all, Option 1 clearly produces more of a return than Option 2. But does it really? To fully understand the returns from both options, we need to look at the present value of the returns over the 5 year period. Fortunately, there are some cool calculators that will do that for us.

In the table below, you'll see that the returns are distributed over the 5 year period much differently. Most of the appreciation from Option 1 won't be realized until years 4 and 5, whereas the cash flow from Option 2 is fairly constant over the same period. This time value must be considered.

                      Investment     Yr 1        Yr 2       Yr 3       Yr 4       Yr 5       Total      NPV
Property A      $20,000     $1,000   $2,020   $3,090   $7,430  $11,350   $24,890   $2,097
Appreciation
Property B       $12,000     $3,000   $3,060   $3,120   $3,180   $3,250   $15,610  $2,280
Cash flow

When you evaluate the net present value of both investments, you'll see a much different picture. Although Option 1 provides the greatest returns in 5 years, you clearly see that Option 2 has a present value of $2,280 compared with $2,097 for Option 1. As you can see from the example, when factoring in time value, future appreciation potential isn't always as appealing as it might appear.  

How Much Do You Have to Invest?

The answer to this question will often decide whether you buy a property with high cash-flow or high ROI. If you have limited capital, you'll be constrained in the type of property you buy. It may be that you can only afford a lower priced property which typically has lower rent and cash-flow but higher ROI due to the lower acquisition cost.

Financing or Cash Buy?

How you buy will determine your cash-flow. By paying cash your cash-flow will be much higher than if you finance because you won't have debt service but your capital will be tied up limiting your ability to build your portfolio.. By using leverage, you can have the best of both worlds. Instead of CAP rates of 8-10%, you can have cash on cash returns of 20-25%. Because you'll be stretching your purchasing power by financing, you'll be able to buy more and better properties with higher rents, thereby giving you higher cash-flow.

How Soon Do You Want to Own It?

If you are financing, you'll want to have a goal for how long it will take to pay off the mortgage. Investors frequently finance with a 30 year mortgage and then give little thought to paying it off sooner. If you're 30 years old and don't need the cash flow right away, that might be ok if you don't mind paying the bank all that interest. If you're 50 years old and counting on the cash flow for your retirement, you might want to think about how to pay it off sooner. As part of your overall investment plan, you need to figure out how soon you want to own your investments free and clear and evaluate whether a property will pay for itself through cash-flow within your desired timeframe.

How Much Cash-flow Do You Need?

Determining how much cash flow you need is one of the first things you need to do. This will drive your entire investment strategy. It's one thing if you want a little extra cash flow to pay for nice vacations and those toys you can't live without and something entirely different if you want to replace your income and quit your job in 5 years. Knowing how much income you need to generate will determine the size of the portfolio you need to build and the types of properties that you buy. If your goal is to have $5,000 per month of passive income and the average property produces $500 per month in cash-flow then you know you need a portfolio of 10 properties to produce the income you want.

When Do You Need the Cash?

Timing of your cash-flow needs is a factor that must also be considered. A 30 year old investor just starting out has much different cash flow needs than a 55 year old investor nearing retirement age. In the early years, building a portfolio is generally your first priority and cash-flow is secondary. For the investor needing to replace their income after retirement, maximizing cash flow income becomes the primary goal. Assets in typical retirement accounts like IRA's and 401K's generally do not generate enough income to live on without having to draw down your principal, therefore, converting assets to income is most important in the retirement years. Self directed IRA's allow you to purchase real estate within the IRA and are a great way to fund a real estate portfolio that will produce a high income stream to fund your retirement without drawing down your principal.

Personally, I subscribe to the old adage that says you take dollars to the bank and not percentages, so I'm more interested in cash-flow than ROI. That's not to say that I don't think ROI is important however. ROI is just one of the metrics you should consider when doing your due diligence on an investment property. If you're looking at several investments and all meet your minimum ROI objective, the one that produces the most cash-flow regardless of ROI is the best choice in my opinion. What do you think and what's most important to you when comparing investments with different returns? I'd love to hear your thoughts.

3Br 2Ba Turn-key--Newer Construction with Great Cash-flow

This 3Br 2Ba was built in 2000 and is freshly renovated. Located in a nice Indianapolis suburb, it will rent for $1000 per month and will be under professional management. This is a true turn-key, passive income investment with a great ROI.

Prairie Meadow Dr. Indianapolis, IN

3Br 2Ba
1,127 sq ft
Built in 2000
Projected rent $1000
Cash-on -cash return 22.5% (financed)
Price $84,000

Own it for just $16,800 Down!

For a pro forma cash-flow projection and interior pictures call me at (317) 623-1414

3 Reasons Real Estate is a Better Investment than Stocks

In the current economic climate, most people are struggling with where to put their money that will give them a decent rate of return and prepare themselves for retirement. Most IRA's and 401K's took a beating in the crash of 2008 and have yet to return fully to their levels of 4 years ago. Compounding this problem and making retirement a bleak prospect for many, the Dow Jones is no higher than it was 12 years ago. This means that if your 401K or IRA has matched the performance of the Dow, your retirement account is worth no more than it was over a decade ago. There's no question that real estate was severely impacted by the recession of 2008 also, but I'm going to share 3 reasons why I think real estate is a better investment in the long haul.

1. Better Return on Investment

The chart to the left shows how stocks have performed compared to real estate since 2000. With a 43% return rate, real estate has clearly outperformed all 3 major stock indexes

2. Cash flow

Real estate returns are made up of both equity appreciation and cash flow from rental income. Unlike stocks, real estate still produces returns through rental income even if there is a devaluation of the asset.

3. Leverage. By financing real estate, an investor can achieve high rates of return on a small amount of their own money. For example, a $50,000 investment in stock with a 5% annual rate of return will generate a gain of $13,814 over 5 years. An investment property acquired for $50,000 that appreciates 5% will generate the same $13,814 gain, however since the real estate was acquired with financing and a $10,000 down payment, the cash on cash return over 5 years is a whopping $138% and that doesn't even include the rental income generated during that time.

Most financial managers and fund managers recommend stocks because it's what they know and what they get paid on. If you're not satisfied with the performance of your retirement fund and want to explore the world of real estate, check out our website to see how you can get started,

How to Invest in Cash-flow Properties