If you pay too much for a property, there is not a lot of cushion if the market declines.
Gary Wilson, Owner of A.R. Wilson Realtors in Springfield, Mo., receives a lot of calls from people who hear about his company. They usually will start the conversation by asking if he wants to buy their homes. After a few moments, the conversation ends with a disappointed caller.
“I tell them, ‘If I cannot buy your property for, at most, 75 cents on the dollar, I am not interested,” Wilson says.
Whenever Wilson educates would-be sellers, he illustrates one of the most important things any new small rental owner must learn—do not overpay for property. When doing so, the owner automatically is placed in a hole. Wilson saw that scenario play out during the Great Recession.
“We started buying so far before the recession that, when it hit, we were not highly leveraged,” he says. “But if we had bought a lot of property in early 2000s and we were highly leveraged when 2008 hit, we could have been in trouble just like a lot of people.”
Wilson is not alone in that sentiment. Mark Hurley, President of Highland Commercial Properties in San Antonio, says the biggest mistake he sees newcomers make is overpaying for properties.
“If they buy at the highest point in the market, any blip in vacancy they experience will be sure to kill them,” Hurley says.
Hurley has developed a formula for acquisitions. He typically goes in and spends approximately $30,000 for a property in his home state of Texas. With that purchase, he targets rents that bring a 15 percent return for the price of the house. If the price is $30,000, an annual gross income of $9,000 will net $4,500 profit after expenses.
While that plan works for Hurley, the problem for most people is that they often do not have the cash to make a 25 percent down payment.
“You have to have some money,” Wilson says. “You have to put yourself in a position to succeed.”
In addition to the down payment, owners need to set aside cash for reserves in case roof leaks, an appliance breaks or any other costly repairs are necessary.
“It does not take long to get an owner in trouble financially if they don’t have reserves,” Wilson says.
Hurley used the Great Recession as a time to purchase homes that cost between $10,000 and $19,000. Now, those properties are appraised at about $42,000 and fetching rents of about $750 to $800 a month.
“We are not planning to sell them because we are long-term holders,” Hurley says.
So, if you need to find a good deal to make a purchase, what does a small rental owner do during the market of the past couple of years when values have skyrocketed? For Hurley, that means it is time to sit things out.
“We are not buying when it is this hot,” Hurley says. “We are mostly using our extra funds to improve our properties. We are waiting to buy because today is not a good time.”
Les Shaver is Editor, Online Publications at NAA.