From: eder@hsvaic.boeing.com (Dani Eder)
Newsgroups: misc.invest.real-estate
Subject: Re: multi-family housing as investment
Date: 23 Dec 92 15:14:43 GMT
Distribution: na
Organization: Boeing AI Center, Huntsville, AL

wk01687@worldlink.com (Jamet) writes:

>I am looking for some information on investing in multi-family housing.

>This is probably real basic stuff and I apologize if this is in a FAQ.
>My questions are:

>     What is a reasonable amount to pay for a rental building?
>       (I have heard phrases such as 3.5 times rent roll...)
>        I imagine this is contingent on location and condintion of building...
>      
>     What kind of return is reasonable on this kind of investment?
>       (None of the no money down type hype please.)

>Recommendations for resource material on this subject would be greatly
>appreciated.  Post or e-mail is fine.

The rule of thumb for single or multi-family dwellings is the same,
only your expenses are different.  What you want to look for is the
return on the price of the building after all expenses except the
mortgage payment.  Expressed as a percentage, the rate should be
in the 7-8% range for a reasonable investment.  More than this
is good, less is not a very good deal.  This is a range based on
my experience.  It may vary regionally, so you need to determine
what the typical value is for your area.

Here are some things to calculate:

- Theoretical rent = sum of annual rents for all units if all are
rented.  

- Any incidental income, such as a vending machine or coin-operatd
washer & dryer.

- All expenses

 -- Vacancy & credit loss : assume that you will experience vacancies
    at the local average vacancy rate.  Add 1-2% of rent lost to bad
    checks, etc.
 -- Maintenance : The most exact way is to figure the service life of
    the roof, water heater, carpet, curtains, light bulbs, appliances,
    paint, etc., and allow an annual amount to cover replacement of these 
    items.  A rough guide is to allow 3% of the annual rent for
    maintenance.
 -- Operating Expenses: Landscape services (shrub trimming, mowing),
    Electric, Water, Sewer, Garbage Collection you pay for.
 -- Taxes & Insurance.

- Subtract expenses from maximum income, and you will have the net
operating income of the property.  This should be 7-8% of the price
per year.

- It is very important to independantly verify as much of the income
and expenses as possible.  The seller and RE agent are motivated to
show as much of an operating income as possible, to get a higher 
selling price.  You want to talk them down by showing what a real
budget would be.  Copies of the sellers tax return schedule for the
property are good, because there the seller is motivated to show all
expenses, so as to minimize taxes.  Copies of the current leases are
good to verify rent.  You can check property taxes by calling the
tax assessors office, and estimate insurance by calling an
insurance agent.

Your return on a real estate investment consists of 4 parts: equity
build-up, price increase, cash flow, and tax deductions.

Normally you buy a rental property partly with a bank mortgage.
Let us take an example case of a property costing $100,000,
with a $75,000 mortgage at 8%.  Net operating income is
$7,000 before mortgage payments.  Your monthly payment will be
$550.32, of which $500.00 is interest the first month.

Thus your equity build-up will be $50.32 per month, or $604 per
year, rising gradually as the mortgage is paid down.  Your operating
inccome exceeds your morgage payment by $396 per year.  This is
cash flow.  Since 1935, inflation has averaged 4.7% per year.
Assuming this, you get a $4,700 price increase the first year.
(You may alternatively insert the current inflation rate).  Finally,
you get a tax break for owning property.  Assume that the land
value is $25,000, and the structure is worth $75,000.  The 
government lets you deduct 1/29 of the structure value per year
from your income.  This comes to $2,586.  You will save your
tax rate times this amount in income taxes.  If you are in the
28% bracket, this is $724 in federal taxes.  You will someday
pay a capital gains tax if you sell, so you are deferring the
tax, not avoiding it.  I count half of the tax reduction as a
gain, since I can invest the saved taxes until the sale of
the property.  Summing up we have:

	Equity Build-Up			  604
	Cash Flow			  396
	Price Increase			4,700
	Tax deduction			  362

	Total return			6,062

This is overstating the return if you sell the property and use
a real-estate agent.  Assume you sell after 8 years.  The accumulated
returns are as follows:

(1) Your mortgage balance will have fallen to $68,263.  You
accumulated $6737 in equity this way.

(2) Assuming rents rose with inflation, your operating income
averages $8411 over the 8 years, which is a net of $14,463
over the 8 years.

(3) The value of the property increases to $144,402, which nets
$32,850 in profit after selling commission

(4) You deducted $20,690 over the years, but pay a capital gain
tax of $14,991 at the end.  

Your net profit is $39,059 over 8 years on an initial investment
of $25,000.  This represents an un-compounded return of 19.5%
per year.  The crude compound rate of return is 12.5%.

Dani Eder


-- 
Dani Eder/Meridian Investment Company/(205)464-2697(w)/232-7467(h)/
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