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The Rental Condo Cash Flow

by retirebyforty on January 10, 2011 · 48 comments

in retireby40's investing fundamentals

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rental condo cash flow

It’s Monday again, but it’s not all bad. If you haven’t seen it yet, check out my Overheard In The Break Room animation to get a little laugh in the office.

This post is a follow up to my Fundamental Investment #8 – Real Estate. In 2010, we decided to look for a small investment property while the market is still down and found a foreclosure condo. This condo needed new paint, blinds,  and some minor work, but overall it was in good shape. We’ll rent out this condo for now and will most likely convert it to personal use later on.

We put in an offer and it was accepted by the bank at 140k. I cleaned up the place, put on a new coat of paint, and just rented it out recently. Here is the monthly cash flow on this condo.

Rental + $1,050

Mortgage – $570 (principle + $120, interest - $450)

HOA - $320 (This is high, but we pay for location. Also, there will be less work and I will try to manage this property myself.)

property tax - $256

insurance - $35

Total cash flow = 1,050 -450 – 320 – 256 – 35 = -$11

Assuming no maintenance or repair, each month we’ll need to put in $11. This is not too bad because soon, the amount toward principle will go up. In a year, we won’t have negative cash flow anymore.

In addition, when we file our taxes in April, we can take depreciation on the property. I’ll describe it very briefly. Depreciation is an IRS tax deduction that you can take on investment property. In our case, a rental condo can be depreciated over 27.5 years. This means that each year, we can deduct $5,090 (140k/27.5) from our taxes.

Some problems: The HOA fee is very high for this property. We’ll work with the HOA to at least keep it stable. Property tax is also high for this condo. I filed an appeal to lower the tax, but I’m not optimistic. I’ve only heard of rejections and the tax keeps going up. The rental income is a bit low at this time. I’m pretty sure I can get $1,100, but I’m renting to someone with a very stable job and they’re planning to stay for 2 years so I am hoping it will be smooth.

5 years projection: Rent $1,200. Amount toward principle will be around $150.

Cash flow in 5 years = 1,200 – 420 – 320 -256 – 35 = $169

The other costs will probably increase a bit too, but this still looks better than -$11. We didn’t take vacancy rate into account in this calculation.

If we add a bit to the principal every month, the cash flow will improve much quicker. Should we pay down the principal on this mortgage? I am not a real estate expert so if you see any problems with the numbers, let me know.

ps. We own this property 50/50 with my brother.

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{ 45 comments… read them below or add one }

Moneycone January 10, 2011 at 5:49 am

RB40, what is the fixing-up cost for the property? Is this being factored in?

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retirebyforty January 10, 2011 at 9:57 am

I haven’t added up all the bills yet, but it was a little over $1,500 to fix up. I did most of the work myself since it was mostly cosmetic. The biggest cost was the blinds. I’m not too worried about repair cost because I’m assuming this is a one time cost. I’m more worried about vacancy rate, but hopefully I don’t have to worry about that for at least 2 years with the current renter.

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jrod March 2, 2014 at 9:29 pm

“Assuming no maintenance or repair”.

Lol, why would anyone ever assume this?

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retirebyforty March 2, 2014 at 9:54 pm

It was remodeled and everything was new. Now it’s getting older and will probably need some more work soon. Rent is up to $1,210 now.

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Jessica07 January 10, 2011 at 9:28 am

As long as you have good reason that the property tax shouldn’t go up, hold your ground and be persistent. :) My family has to do the same thing rather frequently. I’m not a real estate expert (by any sense of the word), but if you can pay down the principle, do it. There’s no need to pay the additional interest if you don’t have to. (Just my opinion.)

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retirebyforty January 10, 2011 at 9:59 am

Thanks for your advice. I’ll definitely keep bother the tax appeal board. We’ll try to pay down the loan a bit this year since we are able to.

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Squirrelers January 10, 2011 at 10:30 am

Looks pretty good. For a true investment assessment, I would include costs to fix up the place, expected vacancy costs, and repairs/maintenance. There will likely be some repairs/maintenance, even though common areas/external issues might be covered by the HOA. My experience being a condo association President revealed a bunch of issues that can arise.

How much could you raise the rent, once this lease is up?

Anyway, it looks like a solid investment for you, particularly with the principal being paid down. I have given this type of investment some thought in the past as well.

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retirebyforty January 10, 2011 at 1:15 pm

Yes, my book needs to include more details.
I think the repair will be minimal since this condo was completely revamped in 2007. All the appliances are quite new and hopefully will last another 4-5 years. I’ll keep good book on this and update the post in 2 years or so.
The rent can probably go up to $1,100 with not much impact to vacancy rate.

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Everyday Tips January 10, 2011 at 11:45 am

Personally I would pay down that mortgage so that you can build some equity. I hate how much of a house payment goes toward interest during the first years of the loan.

I looked into buying a condo down in Florida that would be like a vacation rental in an association. But the fees were ridiculous, so walked away. I think I would have done well in the long run (hopefully) with equity as these condos once were going for 400,000k and now are around 118,000. But, I didn’t want to be stuck with that high fee. (Around 600 dollars/month).

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The Passive Income Earner January 10, 2011 at 12:55 pm

Pardon my lack of knowledge with investing in real estate but I always expected the rent to cover the cost (including mortgage principal).

My math would look like this:
1,050 -570 – 320 – 256 – 35 = -$131

Shouldn’t the investment be self sufficient. It looks like you are subsidizing them for renting your condo. On top of that if I was to evaluate the purchase, I would include an 10 % vacancy and maintenance cost. I would have asked for 1300$ in rent or about. Not sure what comparative rents are.

Just sharing my view on real estate investing without any practical experience.

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retirebyforty January 10, 2011 at 1:22 pm

I’m not an expert either so I sent Freddie at Invest with Passion a request to come by and give some feedback here.
The rent does not always cover the cost. I know another guy who has rentals and this is also the case with his properties. It takes time for rental property to make money. It depends on the market too.
I didn’t take the amount going to principle into account because it effectively goes straight to build my equity/net worth. I will need to take into account the vacancy rate.

The comparative rents are about $1200 with incentives like one month free rent.

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The Passive Income Earner January 10, 2011 at 7:13 pm

Thanks for the reply. I agree with a comment below that you took action and it’s much better than no action and I congratulate you on it!!!

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LifeAndMyFinances January 10, 2011 at 1:30 pm

Great job taking action on this property! Yes, the cashflows are negative, and there will most likely be extra expenses along the way, but at least you took action! There are so many people that would look at a million properties and never pull the trigger on any of them.

I’m very excited to learn from your experiences!

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Marc January 10, 2011 at 2:49 pm

Looks like your cash flow is correct. Typically HOA fees don’t go down but do go up. You stated that the HOA fees are high as you are paying for “location”. If you are paying higher HOA fees for location there is no reason you can’t get more rent for “location”. Remember, real estate is about location, location, location. Once this tenant moves out you need to increase rent. I don’t like to increase rent on a current tenant unless you want them to vacate the property. Make sure you start putting money aside for maintenance expenses, even if you have to take that out of your pocket. I don’t know the age of this condo, but what if the water heater goes out? You will be stuck with a bill. Look at comparables for rent in the area. Email me if you would like more help, assistance or advise.

Marc

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retirebyforty January 10, 2011 at 8:29 pm

Thanks for your advice Marc. I will increase rent once the current tenant move out. The appliances were all installed in 2007 so they should be good for a while. I will open an account to put aside some cushion like you recommended.
The rent in the area is about $1,000 to $1250. It’s a bit of a range.

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Sandy @ yesiamcheap January 10, 2011 at 3:32 pm

How did you pay for the property? Do you have a mortgage? Also agree with Mark here on possibly getting a higher rent? You might not be able to if the tenant pays for all utilities and based on the size of the condo. Since you own the condo 50-50 with your brother do you both take the deduction split down the middle? So curious. Thanks!

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retirebyforty January 10, 2011 at 8:31 pm

We got a mortgage. The tenant only pays the electric bill. I think I can get $1,100 with not much problems.
As for the tax, we’ll probably need to hire a tax guy this year. I was thinking I’ll take the whole tax thing since I’m doing the management. I’ll send him a check afterward.

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krantcents January 10, 2011 at 5:25 pm

Congratulations! Although you have a small cashflow loss, you are able to shelter $5K each year. That does reduce your taxes and it is real money in your pocket. My suggestion is don’t spend it. You may need it for repairs! It is very difficult or impossible to make the numbers work for such a small property. This seems like a reasonable risk. Good luck.

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retirebyforty January 10, 2011 at 8:33 pm

I’m definitely going to bank that return into a cushion account. Once the economy comes back, I should be able to charge more rent or sell it for a profit. Thanks!

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Darwin's Money January 10, 2011 at 7:38 pm

Not that I’m a real estate expert (or investor), but I have several friends that are. A couple points they live by:

Never start off with a cash-flow negative property.
Don’t pre-pay principal.
Extract cash as quickly as possible and reinvest in more properties.

It’s served them well since rents have continued to increase (they are primarily at college campuses which have had pretty good pricing power).

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retirebyforty January 10, 2011 at 8:35 pm

Can you elaborate a bit on what you mean by extract cash? Do you mean refinance to take cash out?
This condo is actually right next to a campus, but I’m a bit leery about renting to students.

Do you know why they don’t pre-pay principal? I haven’t pre paid any amount yet and was thinking about pre paying a bit every month.

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Roshawn @ Watson Inc January 11, 2011 at 7:51 am

I’m glad that you have started this process. As you pay down the mortgage (pre-pay or not), your cash flow will improve, as will the amount that you charge for rent.

It’s too bad about that HOA: they are expensive!

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Money Reasons January 11, 2011 at 2:26 pm

The guy that I know who does real estate pretty offered that same advice as @Darwin’s Money. I think by extract Darwin means that once there is equity in the place, us that money to buy other properties.

My buddy also prefers duplexes and larger structures.

Congratulations on your purchase, sounds like you have it all planned out… :)

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retirebyforty January 11, 2011 at 4:17 pm

I read a bit about refinance to acquire more property, but it seems like over leveraging to me. I mean if I did that in 06/07, we would lost tons of money. I guess I’m pretty conservative when it comes to rental.
I am working on acquiring a 4 plex this year and the number should be better than the condo. We’ll convert the condo to personal use later so as long as we’re close to even money, I’ll call it pretty good.

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Kellen January 11, 2011 at 4:03 pm

Thanks for sharing this. I’m looking into buying a house in my neighborhood and renting out the extra bedrooms. Mortgage vs rent would definitely be cheaper with roommates, but I’m worried about any extra costs arising from home ownership, plus covering the mortgage when the rooms are vacant.

Do you have any suggestions for finding renters, or how to determine what a normal vacancy rate might be in the neighborhood?

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retirebyforty January 11, 2011 at 4:14 pm

Kellen, that’s a great idea. We did this for a while and some of my friends also did this.
Make sure you can cover the mortgage even if there are no renters. Renters are just gravy.
We had a pretty easy time finding roommates because we work in a big company and there is an email list we could use. The renters with good jobs were very trouble free. I don’t think the normal vacancy rate apply to a room rental, but you can call up a local property management company and ask about their vacancy rate. You can also try craigslist, but then you probably need to screen really well.

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youngandthrifty January 11, 2011 at 4:25 pm

Here in Canada, you are allowed to use the interest paid on the mortgage to deduct your taxes generated from the income flowing from the tenant. Are you allowed to do that in Portland too?

Congratulations on your purchase! It will be fun- you’ll have stories to tell about your tenants now :)

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retirebyforty January 11, 2011 at 4:37 pm

Yes, we have the same rule in the US. We can also take depreciation like I detailed above. A rental property is a great tax shelter.
I already have tenant stories and it’s only been a week…. I’ll collect the stories and make a post. :)

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101 Centavos January 11, 2011 at 6:43 pm

I’d like to add a pithy and insightful bit of advice, but I’m completely retarded when it comes to rental property. I personally know people that manage multiple rental properties, make decent cash flow out of it, and apparently still have time for a life. How you do it, is beyond me.

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retirebyforty January 11, 2011 at 10:39 pm

I don’t have much of a life right now with a full time job, blogging, and dealing with this one rental condo. It’s winter so there is not much to do anyway. It’ll be hard when summer arrives.

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Buck Inspire January 13, 2011 at 11:45 pm

Sounds like you’re on your way! Not a big real estate buff, but just curious, how was your place’s market price compared to before the bubble burst? Did you take a long time to decide and what led you to finally deciding buying this one? Here’s to positive cash flow this year! :)

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Debt Free Divas January 13, 2011 at 11:57 pm

We did the same thing in 2009. We bought 2 for under $50K in Chicago. Unfortunately, we did not do our homework and one has a restriction on renting…so we’ve been carrying the cost since then. Not my best hour. The other is great. Our carrying cost with HOA is $450 and we rent for $900. The only problem is our tenant has a penchant for payment late. Now that they are on auto debit, hopefully that is a problem of the past.

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retirebyforty January 14, 2011 at 3:30 pm

Sorry, you couldn’t rent out the condo. Hope you can use it for vacation or something.
I am hoping for a trouble free tenant, but we’ll see. Is trouble free tenant an oxymoron??

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BeatingTheIndex January 15, 2011 at 5:54 am

As long as you’re lucky with your tenant paying on time, 11$ is a very small price for the cash flow you will be getting in the future. It also helps that you’re a handy man which keeps expenses relatively subdued.

Real Estate is a slow but a sure way of getting there!

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retirebyforty January 15, 2011 at 8:12 am

The tenant works at my company so I know he is getting paid pretty well. If he’s late, he’ll have to pay the late fee.
I think Real Estate is also a good hedge against inflation.

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Invest It Wisely February 2, 2011 at 8:55 am

That rent seems to be excessively high given the property price. The HOA fee is even more excessive given the same! So long as the place doesn’t cost you too much cash. The problem in Canada now is that many valuations are high so renting doesn’t make as much sense, though depending on which formulas you use the rent/property price equation is not far off from par in my area.

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retirebyforty February 2, 2011 at 9:55 am

The place was originally sold for 240k in 2006. The rent is a bit high, but it’s right downtown so the location is very convenient. The HOA is very high, but there is not much we can do there though.

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Will @ HackingTheBank.com February 11, 2011 at 7:40 am

I’m really interested in seeing how this works out over time, especially your tenant relationships and how much time you have to put into this. I’d love to do something similar in the future. Please keep us updated.

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Melyssa February 25, 2011 at 11:21 pm

Ah, yes the depreciation. When we close on our new home (fingers crossed) and rent out our current home, the rent will not cover the mortgage. So we’ll be in the same boat as you. (We’ll have to compare notes.) But we all have to start somewhere right?

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Area December 10, 2012 at 9:44 am

I’ve read HOA fees are tax-deductible?

If so, this should significantly help reduce your tax burden.

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retirebyforty December 10, 2012 at 2:43 pm

Yes, the HOA fees are tax-deductible. That’s nice, but it’s still a pain to pay every month. :)

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Area December 11, 2012 at 6:07 am

Good news. And yes, I can imagine they are a pain.

By the way, great blog.

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Andrew R. Hillman January 8, 2013 at 6:38 am

Appreciate the read. I’m doing my diligence before potentially purchasing a condo. My goal is to rent it out. Things look positive so far, but it’s a short sale and the bank is playing games now asking for more than it was even listed for.

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retirebyforty January 8, 2013 at 11:36 pm

Good luck. Our short sale took over 6 months to wrap up as well. It’s not a fun process.

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Jacob May 24, 2013 at 1:01 pm

Not sure if this is being monitored any more but I love real estate investing so I want to add my own two cents purely for the therapy of it. I think unfortunately this was not a good purchase.

First, I ran a bunch of scenarios through a mortgage calculator and couldn’t figure out how you have a payment of $570 on a 140k purchase price. I’m assuming you put 20is % down? I was able to get closer at that point but not the same break downs of principal and interest.

Second, you want rent to cover EVERYTHING. In your scenario you are missing out on nearly all of the benefits of rental property. The benefits are cashflow, equity creation (through principal buy down), depreciation, and appreciation. You are getting $0 cashflow, low rates of equity creation (because of 30 year note), you will get depreciation which is nice but should be seen as only icing on the cake. Then property should build weath with or without it. Also you will get appreciation but to me appreciation is purely icing as well. On average over a long term you are only going to average 3-5% appreciation (which will also drive up property taxes). 3-5% is not worth the hassle of owning a rental.

As I look at it you are taking advantage of the 2 least important ways that rental property benefits your networth but missing out on the HUGE ways in which rentals make it worth the hassle.

Lastly, you are going to have vacanies if you don’t take those into account then you are in real trouble same with some amount of maintenance. Lets say you get that property to the point of cash flowing even $100/month. If you are vacant for even 1 month out of the year you have eaten up nearly that whole years worth of cash flow.

Here is an example of a property I purchased. This is what you want to be looking for.
Property: Duplex
Purchase price: $52,000 ( I live in Topeka, KS.)
Downpayment $10,400 closing costs of $3,000
Rental income: $500 per unit for $1000.
We put 20 percent down and got a 15 year mortgage at 4.125%
Principal and interest will be about $310 ($229 to principal)
Taxes and insurance will be another $150
Vacancy and Maintenance (30% of income) $315
Total expenses: $775
Monthly cash flow: $225 ro $112 per unit.
Cash on Cash ROI: $225 a month is a 20% return on my 13,400 invested.
Principal buy down gives me an additional 20% return ($229 per month is roughly the same return as the rental income.

This is how you get rentals to create a retirement for you. You force them to give you 30% and up return on your investment. This sort of return makes manageing them a bit more tollerable.

Now these numbers may be unique to Topeka but I doubt it. As purchase price goes up so do rents. Either way don’t take on the hassle of manageing rentals for some measly 5 or 10% return. You make 100’s of offers until 1 is accepted and that one will grow your networth and set you up to purchase the next and the next and the next.

Cash flow and equity are king. Those are the most important. The appreciation and depreciation are just icing.

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