STEP-BY-STEP PROCESS TO SELECT
A PROPERTY FOR INVESTMENT

by Ernesto R. Martin

To find the right properties you already know that you should be working with a Realtor that will listen to your requirements and is familiar with investment properties, like a condo or a duplex (a self-standing building consisting of 2 apartments, each typically having 1 or 2 bedrooms with 1 bath). You're looking for condos in the $200,000 - $300,000 price range and duplexes in the $350,000 - $500,000 price range. These typically provide the best return without the headaches of cheaper properties. You're also looking for properties that are in good neighborhoods (for appreciation, and so it attracts good tenants and to reduce vacancy), and that seem to be in good shape (requiring minimal repairs now and in the future).

But once you find a unit which seems to fit those criteria, you need to do more, regardless of whether you're buying for cash principally for income or buying with a mortgage for growth. You need to determine if the unit, if bought for cash* has a net income which is at least 5% - 6% of the purchase price. That's what we do here. Take you by the hand and show you how -- we'll do it step by step, but it's so easy a 5th grader can do it. And we'll do a condo example and a duplex example. In brief, we'll annualize everything (like the monthly rent times 12), then we'll subtract expenses from the income, to get the annual net income, and then we'll divide that by the price of the unit.

Let's do a condo first.

  • You need to get from your Realtor the following: what the condo will cost you, monthly condo maintenace fee ("condo fee"), year it was built, estimated monthly rental, and yearly property taxes (these taxes are likely to be higher than the current taxes, so your Realtor needs to give you an updated estimate).

  • Your annual gross income is the estimated monthly rental multiplied by 12.

  • Now your annual expenses.

    1. Start with the monthly condo fee and multiply by 12.

    2. For an annual allowance to account for vacancy, take the estimated monthly rental and divide by 3 (this allowance assumes a month lost to vacancy every 3 years).

    3. For an estimate of annual repairs, take the age of the building, multiply by 20 and add 100 (we'll show you an example below).

    4. And for your final number get the updated estimate of annual property taxes.

    5. Finally, add these 4 numbers to get your total annual expenses.

  • Subtract your total annual expenses from your annual gross income (monthly rental times 12) to get net income.

  • Now divide this net income by the price of the unit, and that number multiplied by 100 gives you the target 5% - 6% we're looking for. We're done.

  • Here's an example. Price is $250,000. Estimated rent is $2,000 monthly. Condo fee is $300 monthly, the unit was built 30 years ago, and updated annual property taxes are $4,000.


    ItemAmount
    Cost of Condo$250,000
        
    Gross Annual Income (Rent X 12)$24,000
        
    Condo Maintenance Fee (Monthly fee X 12)($3,600)
    Property Taxes (Updated estimate)($4,000)
    Repairs ((30 yrs X 200) + 100)($700)
    Vacancy Allowance (1/3 of monthly rent)($667)
    TOTAL EXPENSES($8,967)
        
    ANNUAL NET INCOME ($24,000 - $8,967)$15,033
    ANNUAL RETURN FROM INCOME (15033/250000 x 100)      6%
        
    Estimated Property Appreciation (Miami saw 5.39% annually last 18 years)    ~ 5%
        
    TOTAL ANNUAL RETURN    ~ 11%

Let's now do a duplex (again, a self-standing building consisting of 2 apartments, each typically having 1 or 2 bedrooms with 1 bath).

  • You need to get from your Realtor the following: what the duplex will cost you, what the sellers are paying for insurance and recurring exterior expenses (e.g., yard) and what they are setting aside annually for non-recurring expenses like roof and painting, the year it was built, estimated monthly rental, and yearly property taxes (these taxes are likely to be higher than the current taxes, so your Realtor needs to give you an updated estimate).

  • Your annual gross income is the estimated monthly rental multiplied by 12.

  • Now your annual expenses.

    1. For an annual allowance to account for vacancy, take the estimated monthly rental and divide by 3 (this allowance assumes a month lost to vacancy every 3 years).

    2. For an estimate of annual repairs for EACH of the apartments, take the age of the building, multiply by 20 and add 100 (we'll show you an example below).

    3. Use the insurance being paid by sellers BUT adjusted upwards so it's for the price you're paying for the property.

    4. Use the recurring expenses (e.g., yard) being paid by sellers ONLY IF they seem conservative; otherwise use the estimates shown in the example below.

    5. Use the annual set-aside for non-recurring expenses like roof and painting you got from sellers ONLY IF they seem conservative; otherwise use the estimates shown in the example below.

    6. And for your final number get the updated estimate of annual property taxes.

    7. Finally, add these numbers to get your total annual expenses.

  • Subtract your total annual expenses from your annual gross income (monthly rental times 12) to get net income.

  • Now divide this net income by the price of the unit, and that number multiplied by 100 gives you the target 5% - 6% we're looking for. We're done.

  • Here's an example. Price is $400,000. Estimated rent for both apartments is $3,000 monthly. The unit was built 30 years ago, updated annual property taxes are $5,000, and you got from the sellers what they are paying for insurance and recurring exterior expenses (e.g., yard) and what they are setting aside annually for non-recurring expenses like roof and painting.


ItemAmount
Cost of Duplex$400,000
    
Gross Annual Income (Rent X 12)$36,000
    
Insurance (Coverage amount updated to cover your cost of duplex)($4,000)
Property Taxes (Updated estimate)($5,000)
Apartment 1 Repairs ((30 yrs X 200) + 100)($700)
Apartment 2 Repairs ((30 yrs X 200) + 100)($700)
Vacancy Allowance (1/3 of monthly rent)($1,000)
Yard maintenance (Use the higher of seller estimate or $1,000)($1,000)
Roof Allowance (Use the higher of seller estimate or $30,000@20yrs)($1,500)
Exterior Painting Allowance (Use the higher of seller estimate or $10,000@10yrs)($1,000)
Misc. exterior repairs (Covers broken window, gutter cleaning, etc.; use the higher of seller estimate or $1,000)($1,000)
TOTAL EXPENSES($15,900)
    
ANNUAL NET INCOME ($36,000 - $15,900)$20,100
ANNUAL RETURN FROM INCOME (20100/400000 x 100)      5%
    
Estimated Property Appreciation (Miami saw 5.39% annually last 18 years)    ~ 5%
    
TOTAL ANNUAL RETURN    ~ 10%

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* Even if you're buying it with a mortgage for growth, it's critical that the unit's income be as high as possible, in part so it pays for all your expenses, including the mortgage payments.