How to Analyze a Buy & Hold Real Estate Investment Property

posted Apr 8, 2016, 10:07 AM by Joshua Durrin   [ updated Apr 8, 2016, 10:11 AM ]

Listing price is no indication of performance, though finding a below market property is one of the first things people look for when looking to “invest” in real estate.  Well, let’s take a look at a real life example that appeared to have potential on the surface but after closer inspection turned out to be another over-inflated property. 

One of our birddogs with “Boots on the Ground” turned us onto a listing they came across that at first glance appeared to have some potential.  It was a duplex with a listing price of $165,000 that brought in $775 a month for the larger 2-bedroom unit and $575 a month for the smaller one-bedroom unit.  Given the area it was in, those were pretty close to market rates for rent.  Right off the bat, though, to assess this purchase price quickly, I applied our 1% rule and looked for a ratio of monthly rent to purchase price of about 1%.  2% is really the target as a rule of thumb, but investors all over the nation admit that that ratio is rather difficult to find, particularly in CA.  So, 1% is considered reasonable among most CA investors. 

The gross rents, amounting to $1350 monthly, divided by the $165,000 purchase price puts us at a 0.82%.  That’s actually not too bad.  However, it’s not the 1% I’d look for in this area.  Plus, having spoken with the agent, he mentioned that the unit was in decent condition and had a roof that likely will need replacement in 5-7 years.  So the property was close to turn-key, but not entirely.  I needed to squeeze a few more tenths out of the purchase given its condition. 

Without pictures of the interior or inspections, however, I could only guesstimate what the costs would be based on conversations with the agent.  Let’s assume that the renters will stay put for the time being but budget in some turn-over costs within the next 3 years of about $3000 per unit plus the cost of the roof over the next 5 years (about $4000) for a total of about $1800/year in capital expense costs, or $150/mn.  I’m likely going to realize at least one month of vacancy over the next year in at least one unit as well.  Let’s assume the larger unit goes vacant for the sake of being conservative thus adding $775 per 12 per month span, or $65/month in vacancy expenses.  Taxes I estimated to be around $160/mn and insurance about $100/mn.  Water, sewer, and sometimes garbage are often paid by the landlord and I could only guesstimate that to be about $50/mn on average at this point as well.  I’ll set a maintenance budget of around $50/mn and plan for a property management fee of about $100/mn so that I don’t invest my way into a new full time job accidentally. 

With the costs of ownership approximated, to own this property I’m looking at a cost before mortgage expenses of $675 per month.  That falls in line reasonably with the 50% rule for rental properties where costs are typically 50% of the rental income you receive.  That leaves me with $675 a month in “profit.”  Now, were I to pay cash for the property outright, I’d have all of that as monthly income.  However, that may not be the best use of my money.  I have to look at a few other metrics to determine if paying all cash is the best investment option for me. 

The objective for me is to make my money work it’s hardest.  An infinite return on investment is the best return, agreed?  Well, to do that, I’d have to make money while not putting any money down… which is possible… meaning that my cost basis was $0.  Any growth having put $0 into the investment is infinite (the ratio is actually undefined mathematically, but that’s getting a bit too nerdy for our purposes here).  At the opposite end of the spectrum, if I to pay all cash for the property and minimize expenses I would also be enabling all of the income to go toward boosting my rate of return.  This can only be an infinite return if the income is infinite… which is not actually possible.  For the practical scenario, if I paid the asking price of $165,000 (excluding closing costs) to make $675 per month, or $8,100 annually, I’d yield a cash-on-cash return of less than 5%.  Well, that return stinks quite honestly.  I’d rather leave my money in the stock market and bank on the average annual return of 8-12% per year depending on the information sources you use as a reference. 

Alternatively, if I keep my cash dollars invested to a minimum, I increase my potential cash-on-cash rate of return.  For this property, if I seek to put the minimum down while still having the tenants pay off the mortgage for me, I reduce my cost basis and effectively maximize my rate of return for the dollars I invest thereby making them work the hardest for me.  In this case, let’s say I put down $16,500, 10% of the asking price.  Doing so, that price leaves me in a negative cash flow position by about $155 per month after paying all expenses and my mortgage costs.  So, it doesn’t make good investing sense to purchase this property at asking and still call it an investment property.  It’d be more of a “liability property” at that purchase price. 

I seek anywhere from $100-$300 per door per month on a buy-n-hold property.  Given the seller’s market we’re in currently, I’ve had to target the lower end of that spectrum.  Since this is a duplex, I assumed $200 per month in cashflow for this to be a good investment deal for me.  That means I have to find a way to reduce the monthly expenses so that the investment returns $200 net profit per month.   Recalling that our max potential income per month is $675 (without reducing ownership expenses somehow… and be careful of doing eraser math here), a mortgage amortized over 30 years with a payment of $475 per month amounts to about $88,000 at today’s interest rates.  Thus, my monthly cashflow goal is accomplished if I can leverage $88,000 of the total purchase price. 

To get to an $88,000 mortgage, I have to come up with the difference from that baseline to what the seller will accept.  Looking at my goal of maximizing my cash-on-cash return, ideally I’d put about 10% down, the going rate for conventional mortgages on investment properties these days.  Using 10% down, that means my purchase price would be $98,000 in this case and my cash-on-cash return would be 24%, or $200 per month annualized relative to my $10,000 down-payment. 

Now we’re talking! A 24% realized rate of return is pretty great!  However, it still isn’t my maximum allowable offer.  I still have some wiggle room to negotiate if I stick to my metrics.  In my case, I want my dollars invested to beat the stock market.  With the market earning 8-12% annually over the last 100 years, I’ve set my minimum cash-on-cash return goal to 15%.  The 10% down-payment gets me 24%.  So, I can actually afford to pay a higher down-payment to sweeten my offer for the seller if I need to and still accomplish my investment goals.  I do still, however, need to stick to an $88,000 mortgage regardless in order to cash-flow monthly. 

To get to my maximum allowable offer I figure out how much cash I can invest while still achieving 15% with $2400 in annual earnings.  Dividing $2400 by 0.15 gets me to $16,000, meaning that I can put as much as $16,000 down and leverage $88,000 for a total purchase price of $104,000 (less purchasing costs).  That’s $6,000 higher than the minimum down payment option and allows me some more negotiating room when approaching this seller. 

Bear in mind also that there are three contributions to my true return on investment for this type of property.  The first is the actual cash-flow per month which is really the return I use to assess the purchase price as that's the liquid portion of the return, the portion I realize each month.  However, having a rental also means that someone is paying your debt down.  For this scenario it would be approximately $900 of the principle balance paid down over the course of the first year.  Thirdly, we benefit from market appreciation.  Using a conservative annual estimate, we could expect an annualized appreciation in the property value of about 4-7% year over year, or $5,200 in the first year.  The appreciation is specific to each market, mind you.  However, for me it’s important that I use a long term historical average, not the growth from last year, as this a buy & HOLD property I’m evaluating.  Also, while I don’t bank on appreciation, I can and do use it to assess the true return on investment.  In this case, summing the portions of cash-flow, debt pay-down, and appreciation results in $8,500 in true gain in the first year.  Thus, our true rate of return (including non-liquid gains) is $8,500 divided by our initial $16,000 investment, or 53%!!!  Now that’s the mark of having your money work for you instead of you working for your money! 

Unfortunately, the market where this property is located is a bit hotter for sales than the rental opportunity supports for our liking.  I presented the listing agent with the offer but it wasn’t accepted.  It was crucial for me, however, to maintain a positive relationship with the listing agent for when things change in the future.  I’ll continue to follow up with the listing agent periodically now that they know my criteria.  In this business, especially at this time in the market cycle, it is very rare to land anything on first contact.  So, while we weren’t able to land the property here, we were able to build a relationship with another professional in the industry and position ourselves very well for the next dip of the market cycle.

Well, what say you? 
What are some of the metrics you’re applying in your market and how successful have you been in your market? 

The Four Pillars of a Good Investment Market

posted Mar 22, 2016, 5:34 PM by Joshua Durrin   [ updated Mar 23, 2016, 7:53 PM ]

Diversification is the key to any good investment strategy.  Expand your base into different markets.

A common theme at the local REI club meeting in the current market I’m in is that there are no good deals available right now.  I’ve fallen into the trap of that depressed mindset myself on a number of occasions.  The truth of the matter, however, is that there are indeed good deals out there today, they just may not be worth the effort to attain. 

The consensus among my peers is that our local market is saturated with investors and novices alike leading to bidding wars on properties that appear to fit the bill for a good investment opportunity.  Couple the competition with a bustling local economy and a shortage of homes available and you have a case and point for the basic principle of economics, prices rise when demand is high and supply is low.  Thus, the competition is the scapegoat for the prices being through the roof and investors, in desperation, become speculators. 

The true investor must adapt to the current market in order to succeed.  Admittedly, while it is still possible to get a good deal in my local market, the effort to find it makes it next to impossible to sustain oneself as an investor.  Effort may be much better spent finding a new market to invest in where your dollar will go much further and more importantly, where you can help more people get out of their real estate bind that need it. 

What are the criteria that define a good market for investors?

A good real estate investment market meets four critical criteria.  A good market will have little chance of depreciation, lots of available deals, low competition, and multiple employable exit strategies.

        1.        Little chance of depreciation

Mortgage insurance companies hedge their existence on analyses to determine market risk.  Fortunately for us, they make this information public.  The mortgage insurance industry determines their risk for default on a loan in a given area using the Mortgage Risk Index.  The Mortgage Risk Index is a measure of the risk of depreciation for a given market over the next two years.  Values are published at  At this site, you’ll find a long list of markets with their respective risk rating.  Where the market has been determined to have a high risk index, the analysis indicates that real estate in that area is overpriced and poised for a large decline in values if subjected to similar financial crises as experienced in 2007.  An MRI value of 10%, for example, indicates that 10% of the loans in a given group would be expected to default in a severe stress event like that experienced in 2007.  Markets with MRIs higher than the national average may indicate that prices are overinflated due to high incomes or an influx of newly employed buyers that are driving prices up.  High MRI’s may also mean that there are more first-time home buyers than secondary-home buyers, meaning that the quality of the loans are worse as a whole with low down payments and low starting equity positions.  Either way, that means a seller’s market, which makes for more competition and greater risk for loss than in a buyer’s market.  Perhaps in these markets it’s best to spend your energy finding a different market.  Where the market is shown to have a lower risk as compared to the national average, these properties are considered to be at a rather stable price point or even better, at a point where there is still plenty of room for growth.  It doesn’t necessarily mean that the market is a hot one though. 

Another important input to assessing the downside risk is the local market economy.  The investor should get to know some basic demographic information to learn the potential of the market.  The local economy can be assessed from household income, population growth, unemployment rate, job growth, housing inventory, rental rates, and median home price.  A plethora of demographic information including rental rates can be found using the US Census Quick Facts page at,06013.  Simply go to the page and select your city, county, or state and browse the table of information.  From the data published, the investor can get a feel for the area he’s looking at and whether it’s a demographic he’s looking to invest in.  Likewise, they can compare historical data to more recent data to see if the trend in up or down.  For instance, are jobs increasing year over year?  Is there an influx of residents?  What are the predominant age groups, retirees or families?  These data can help you identify if the market fits your niche or not. 

        2.       Lots of available deals

Once the investor has identified markets with good potential and low risk, the next step is to evaluate whether there are deals available in the market.  They might start by looking at other key criteria within a given market like housing affordability and high rental rates.  Housing affordability is publicized monthly by the National Association of Realtors at  One can search by metropolitan area or nationally.  The metropolitan area list is quite extensive fortunately.  Where the housing affordability index is 100 it means that a family earning exactly the median household income can afford a home priced at exactly the median home price (assuming a mortgage payment of no more than 25% of household income).  Where index ratings are higher, it means the family making the median income has more than enough to qualify for a home purchase at the median home price, conversely for the lower index ratings.  At the time of this article, the home affordability index for the San Francisco Bay area is 72.6, meaning that families that make the median income (or investors looking for deals) would find it quite difficult to buy a property. 

One can also get a feel for the housing market by comparing the median household income to the median home price.  Dividing the median home price by the median income enables one to produce a measure of affordability.  Where the result is less than 3, that market is likely to have plenty of affordable homes available.   One can find more recent housing price data on Zillow at

Rental rates are published from a number of sources.  The Department of Housing and Urban Development (HUD) publishes recent rental rate information.  Simply go to and search for the county or metro area of interest. 

To use the rental data meaningfully, one would divide the average annual rents into the median home price from any of the sources to come up with a median rental rate of return.  This is one element to the total overall return one can expect from their investment property (remember, total return includes rental income, equity appreciation, and principle pay down).  Using an example from Alameda County at the time of this publication, the median rental income is $1,325 per month, or $15,900 annually whereas the median home price is $509,300.  If one accounts for typical expenses at 40% per se, then the resultant net annual income (excluding debt service payments) would be $9,540.  The resultant net rental rate of return is 1.9%.  That’s a pretty horrible return by itself for most investors.  To be profitable in a market like this, one would likely have to put forth a great deal of effort to find or create a good investment deal or be willing to take a great deal of risk in hopes for huge near-term appreciation.  Remember though, investors don’t bank on appreciation, speculators do. 

Related Article: Investing or Speculating? Your Call.

        3.       Low competition

Competition drives prices up.  Getting back to basics, where supply is short and demand is high, prices will rise.  When an investor puts an offer on a property that is competing with several others, the investor is wise to simply hand over the property and find another one.  Let the hobbyists or the owner-occupants get it. 

In the current Bay Area market, homes with any potential are bombarded with offers, often 15% or more over the list price.  Where investors need to make a profit, hobbyists and owner-occupants don’t necessarily.  They may have a family member that they’ll be “renting” their house to who’ll do some of the rehab while they’re there or perhaps they plan to do a live-in-flip that’ll take a bit more time.  Or perhaps they’re a novice investor looking to break into the “hot market” and are willing to sacrifice some of the profit in exchange for the experience.  Unfortunately, real estate investing for me is a business and the numbers have to work in order for me to sustain my business and continue to help people with their real estate problems.  Not to mention, usually when a market is labeled as “hot”, it's often too late for the serious investor to get into it.  The serious investor has likely already tapped into it and moved onto the next. 

When the competition heats up and multiple offers are going onto properties, bidding wars ensue, and houses are selling for way over asking price, that’s a bad market to in.  Find another one.   

Investors are in the best position when they are the only offer on the table.  They have much more leverage in negotiations in that scenario.  Often times the most desirable areas to work or live are the ones with the most competition, for instance, those that were very hot during the boom such as areas of CA, Vegas, Florida, and TX.  Less dense areas typically have less speculation and competition which often results in lower purchase prices for distressed properties.  Smaller cities even amongst those surrounding the bustling hotbeds of activity may present much better opportunity for investment with far less competition.  So, perhaps try looking at the outskirts of the major metropolitan hotbeds as a start. 

        4.       Multiple Employable Exit Strategies

Having multiple exit strategies is critical to mitigating risks of losses and/or surprises after an acquisition.  Flipping older homes, for instance, one often encounters those hidden surprises lurking behind the walls or under the floors that can cost thousands of unplanned dollars to fix.  It may mean that the investor has to hold the property longer than expected.  In this scenario, the investor may look to refinance into a more affordable payment and rent the property either traditionally or with a lease option.   

Conversely, if the investor cannot locate a decent property management company or good tenants for a property they had planned to rent, they can flip or wholesale the property assuming they’ve purchased it at the proper discount (buying right with equity built in).

The savvy investor will consider multiple exit strategies in their acquisitions to mitigate the risk that the first exit is unsuccessful.  Simply put, multiple exit strategies will give you peace of mind throughout the improvement of the investment.  Returns in real estate require work, management, savvy, and problem solving.  Many of the high priced “hotbeds” are difficult to cash flow across several modes of exit.  It may come as a surprise, but many deals with tremendous equity, tremendous cash flow and multiple exit strategies are often found in the places most people aren’t looking… the outskirts or even smaller local cities. 


The best markets for real estate investors are those with 1) little risk of depreciation, 2) lots of available deals, 3) little to no competition, and 4) multiple employable exit strategies.  An investor that has found these four pillars of strength is well-positioned to experience incredible returns on their efforts and investments.  Of late, the Bay Area has been one of those hotbeds that was hot during the last few years but feels pretty tapped out to me.  The competition is plentiful and showing signs of foolishness engaging in bidding wars and inflating prices while banking on future appreciation.  The MRI is higher than the national average and the affordability is deeply stressed.  For this investor, the deals are somewhere else. 

This investor will be applying the learning here to find new markets to explore.  We’ll be looking for minimal chance of home values decreasing, tons of available deals, low competition and ability to find deals with tremendous equity and tremendous cash flow.  I’ll keep you posted as things progress. 

In the meantime, be mindful that the success of any deal is still specific to that property and not to the market as a whole.  So keep your ears and eyes open even in the worst of markets.  You may still find that diamond in the rough.  Just be careful about over expending your energy and capital in markets like this one.  If you're not careful, it could mean the end of your business. 

Thanks for reading and please share your own thoughts.  Until next time…

OMG! This is Flipping Hard!

posted Oct 14, 2009, 11:16 PM by Joshua Durrin   [ updated Dec 10, 2014, 8:40 PM ]

Challenges with Seasoning of Title when Flipping

While "flipping" is only a portion of our business, I'm often met with some surprise due to the perceived difficulties in complying with modern government mortgage guidelines when discussing the strategy with others. It's common knowledge among those in the industry that "flipping" houses has its challenges and risk. However, there’s a lot of confusion about overcoming some of the guideline hurdles when "flipping" property to an FHA buyer.

What is the FHA 90-Day Rule?

Well, prior to February 1, 2010, FHA had a very strict rule that paraphrased could be stated as, “If you buy a property, an FHA buyer can't purchase from you for at least 90 days after the original purchase.” Some even interpreted the guideline to mean that the property couldn't even be under contract until 90-days after the transfer was recorded.

Lenders did this in part as a means of mitigating the risks associated with unrecorded transfers. However, as of February 1, 2010, that 90-day seasoning restriction was waived.

What's the Current FHA Guideline?

As of February 1, 2010, FHA now allows investors to resell their properties as quickly as they choose to FHA buyers. The new rule was extended to the end of 2014 so far. That said, however, there are some new rules that FHA has put in place for "flippers." Two important ones for investors to note are as follows:
  1. All transactions must be arms-length, meaning that there must not appear to be any dishonesty taking place between the buyer and the seller. This requirement also flags any prior flipping activity on the home in the previous 12 months to the lender for further consideration.

  2. In cases where the investor wants to sell within 180 days of purchase, and where the sale price exceeds the previous purchase price by more than 20%, the lender is required to take extra steps to ensure the sale is legitimate. This may include a second appraisal and/or a full FHA inspection where only one of the inspections can be paid for by the buyer. It may also include some due diligence on the part of the seller to prove the increase in value with records and receipts from work done on the property.
Some Words of Caution

While FHA allows for quick resales, some banks are still reluctant to lend on them. Some banks are still applying the more restrictive (old) FHA guidelines. While there are plenty of banks that will do FHA "flips", it's important to find one or two well in advance of obtaining the planned flip. Otherwise, be prepared to carry the property slightly longer while a conventional or cash buyer browses the market.

When planning to resell within 180 days, just expect that you will need to have two appraisals on the property and that you (the seller) will need to pay for at least one of them. Alternatively, the broker/lender could pay for it, but those costs are generally passed back to the buyer in some form or another. So, it's likely best if you (the seller) just plan to pay for it.

Keep detailed plans and receipts of your flips, taking plenty of photos of the before and after state of the property. The lender may call on you to provide renovation details, invoices, receipts, etc. to substantiate the work that was done on the property to increase it's value beyond 20%.

There are no specific guidelines on how much work must be done to prove the increase in value. It's mostly at the discretion and experience of the appraiser or underwriter. If either feels that there hasn't been enough improvement on the property to justify the new purchase price (or resale value regardless of the offer), the appraisal will likely come in low, regardless of comps. Because of the comp process, however, you should be prepared anyhow to justify the added value of the property, whether marketing to FHA or not. You may want to refinance and at that time too, the appraiser may need justification of the improvement.

Wholesalers (or investors buying from wholesalers with the intention of flipping the property) should be careful in how the deal is structured as well. Lenders will look for a “pattern of flipping”, or rather when there has been more than one title change (other than a foreclosure) in the past year. Note that in scenarios of double closing or simultaneous closes there would be two title transfers within a very short period of time. Should the lender choose to identify that as a "pattern", they may reject the loan forcing you to exercise on an alternate exit strategy... which could be to wait 6-12 months to resell to another FHA buyer. As such, be prepared to carry the property for that period of time.

It Can Be Done!

So, while there are some newer challenges "flippers" need to be ready for, it is still plenty possible to "flip" properties if that's your strategy.

Be on the lookout in an upcoming blog post for why I kept putting "flip" in quotes as an investment strategy.

Investing or Speculating? Your Call.

posted Oct 14, 2009, 11:11 PM by Joshua Durrin   [ updated Dec 10, 2014, 8:24 PM ]

A few days ago I finished a blog on overcoming some obstacles in flipping, a well-known and popular strategy in real estate investing.  At the end of it I promised to shed some light on why I kept the term flipping in quotes throughout the blog post.

There is much debate as to whether flipping is actually investing at all, but rather more like speculating. Novice real estate investors tend to overpay for their investment property banking on a continuation of an historical rising trend in the real estate market… or rather, speculating that the market will continue to rise. Well, in 2009 the nation as a whole, not just our local area, saw otherwise. You must have heard the old adage a million times, “what goes up must come down.” The real estate market did indeed plummet and those flippers that had overpaid for their properties assuming that the market would continue to rise were found “holding the bag.”  (I couldn’t resist.) 

This type of investing is common even in the stock market.  It has a name even… technical investing.  The fact is, however, there is nothing technical about it.  It’s speculating, or worse, gambling.  The technical investor banks on the same continuation of a similar rising market trend assuming that future returns will mimic those of the past with a given company.  Sometimes, just like in the hay-day of the early 21st century real estate market, the gambling pays off… the company does perform historically the same or better.  However, the investor is sometimes misguided by the winnings into thinking he/she made a good investment because they saw positive returns.  Sometimes they’ll even boast about being a good investor when in fact they only got lucky on their roll of the dice. 

The technical investor is not much in control of their investment at all.  What they often fail to realize is that their investment is at the mercy of the market often driven by other speculators up and down, often influenced by the seasons, often influenced by the political environment, and certainly influenced by the company management.  So, unless you’re a board member of the company with which you invest, perhaps have some political clout, have visibility into the adaptability of the business of which you invested with regard to market and seasonal changes, you are entrusting your money to someone else to manage it for you and banking that all those involved are going to continue to perform just as they did or better.

A stronger investor is the fundamental investor, one that does take the time to fully evaluate the fundamentals (not just the financials) of a given company.  This is the Warren Buffet type of investor.  That is, this type assesses the earnings against the assets and liabilities to find the real value in each share of a company versus the perceived value based on the emotion or seasonality of the market (and then often compares the two when finding the investment opportunity).  They may take an active role in the management of the company, perhaps by purchasing the majority share or otherwise participating in the governing board.  They also keep on top of the management of the company if they’re not directly involved and essentially review the resume of the new CEO upon any sort of changeover to understand the potential for the company to change directions entirely or review the capability of the new CEO to maintain the company’s performance. 

So, how does all this relate to flipping?  Flipping, if done haphazardly, can result in the same trouble as that often experienced by the technical investor… or the passive investor.  The best results come from being actively involved in your flips and really assessing and understanding the quality of the PURCHASE.  (Emphasis is obvious there, no?)  The savvy flippers quickly realized the difference between investing and speculating after the market crash of 2009.  Those that didn’t went back to work their day jobs. 

Flipping is still a reasonable exit strategy and often a good one when the investment is analyzed properly up front.  To do so, one has to stick to their business plan and work the numbers based on the current market value rather than the future market value.  Not that the future value or market trend shouldn’t be considered, but your business plan rather than your purchase price should be what’s revised if the market conditions shift.  Your purchase price and your business plan should be strong enough to withstand most short term market fluctuations (note, flipping is defined as reselling within 90 days per my prior blog), but certainly strong enough to capitalize on the long term gains. 

Our business plan involves purchasing properties at a wholesale price versus a retail price.  Additionally, we have a series of criteria used in determining our maximum purchase price for a given property.  As such, we often purchase at a discount… albeit properties that aren’t in retail condition.  However, it’s because of this that we’re afforded the opportunity to work with seller and execute a plan that enables us to be profitable within reasonable expectations. 

Setting reasonable expectations is vital to responsible investing and running a small community-oriented business.  I’ll go into more detail on this and other topics in future blog posts.  Thanks for reading.  

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