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. Q1 2008 2-21-08:- The 5% Annual Projected Income Rule Home Page
The rule suggests that if a home is bought for investment, in one year you should make at least 5% profit in "projected rentals" after ALL the expenses. Expenses will vary; you must consider management costs of the property, tenant vacancies, and misc repairs. Management is usually 10% of the rentals. What's interesting is that although most people borrow to buy investment residential housing, achieving the 5% rule is next to impossible if you have to carry a loan on the property. As a result, the rationale for accepting a negative cash flow is to expect equity appreciation.
Housing markets must return to 1999 levels for housing to become attractive again. Using the following basic guideline:
Annual Projected Rents minus ALL Annual Cost and Carry = Some Positive Number (Y). Positive number should be at least 5% of initial invested (X). If Y is ever a negative number, the property is a poor investment. Period.For the following examples, disregard tax deductions, because for an investor with more than 2 homes it wont apply, and tax benefits (interest deductions) assume an income to deduct from.
EXAMPLE: if you bought a condo for $200,000, put 20% down (to avoid PMI), that's $40,000 invested. 5% of 40k is about $166 PROFIT per month, after all expenses, with the loan. Sounds easy, right?
The loan is 160,000 @ 6% fixed investment rate would be $800 per month (interest only, no equity paid, that would be much more than $800/mo), plus the HOA (variable) of $150, state tax 1% (if in California) $2,000 per year ($166.66 per month. If the property was in Texas, the tax would be like 2.7% of base annual, or $5,400 or $450 per month), and the management fee 10% of rental (variable).
You can see where this conclusion is going. Rents for this condo would AT VERY LEAST have to be $966.66 to break even. That's not counting any fees besides interest on the loan and property taxes at 1% annum. So to meet the 5% rule with this example, you have to have a property fully leased year around for $1,132.66 per month to justify buying in this market. Tenants damage property, meaning you are forced to make repairs, and in high foreclosure markets (like today) rentals trend towards glut.
Residential housing as an investment is difficult to justify in a 'negative equity expectation market'. Buying a home is not really an income producing investment if you have loans on the property: its more of a liability. I suspect the term 'investment' was introduced by those "in the business" of real estate, to add another tier of consideration for residential buyers.
Most homes on the market, even with reduced prices, don't 'pencil out' as an investment. If you do buy, you need to be sure your in a solid, stable rental area. And most premium locations where you can actually have a tenant year around, your not going to get that property for $200,000. You are losing money with a loan on this deal in today's market: because there is no positive equity expectation. -comment-
--->For info on the author of this blog: the party animal turned economist! Home Page
**ARTICLES**
. Q1-Feb 10 '08: - The Perfect Storm of Economic Downfall . Q1-Feb 21 '08:- The Counter Intuitive Market Force: But Housing is the Exception . Q1-Feb 21 '08:- The 5% Income Rule . Q1-Feb 21 '08:- A Compelling Argument for Alternative Investments , Q1-Feb 26 '08: True Market Analysis, or Self Interest? . Q1- '08: No Recession, but Deflation? . 3.17.08: Next for the Economy: The Greatest Bull Run in History?
Realtech Partners, Inc. © 2008. All Rights Reserved. Disclaimer Palm Springs and San Diego county land, and Las Vegas investment residential. "the party animal turned economist!"™ is a trademark.
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