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Pricing of Two Family Homes

What is reasonable regarding the amount of rent that a two family home should generate relative to mortgage payments and expenses.I'm looking at a house that I am assuming will sell for $290,000. It has $14,921 in expenses (insurance, taxes, water, heat) and if I put 20% I will have annual mortgage payments of $14,520, so it will cost me $29,441 not including the cost of capital (or the investment return that the 20% down payment may generate if I invested it in another type of investment).

The home currently generates $24,441 in rent, so I would have a negative cash flow of nearly $5,000. My thinking is that I should be able to generate a positive cash flow. Is that correct and if so, what kind of cash flow as a percentage of a down payment do most investors seek?
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September 10 2013 - Union City
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Hi Peter....just to be clear....in the following portion of your response you say "Your ROI is normally considered to be calculated from taking net income (rents minus expenses) and dividing by the cash price as you did in your first response giving a little over 7% and that is reasonable."  Are you including the mortgage payments in the expenses when calculating the net income? In other words, does the 7% return ROI factor in mortgage payments.

By the way, I looked at a two family home recently in Union City with less than $3000 in total gross rental income. It was in terrible shape. The owner bought it a year ago for $210,000 and has it on the market for $320,000. Yesterday, an agent told me that it is already under contract!
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September 12 2013
Your ROI is normally considered to be calculated from taking net income (rents minus expenses) and dividing by the cash price as you did in your first response giving a little over 7% and that is reasonable. If your numbers are correct and you get a net income after financing costs then that is good too and taking that net income and dividing by your actual investment that's pretty good as well.
2 different calculations but both are valid. 
With a single investment I would prefer to build a reserve fund of say 3 months rents plus a certain amount for repairs. Build that up and then set aside a portion of the cash flow - say 10% each month. against possible draw downs on the reserve fund.
I do not think that maintenance cost would reach $5,000 assuming the house is in good shape - be prepared to change light bulbs yourself!
If PSEG supplies the utilities then get the "Worry Free" policy for each unit. Around $10 or $15 a month per unit and covers basic stuff for the furnace and water heater, This is great for Landlords.
Would think that Union City might have higher rates of return

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September 12 2013
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Hey guys...thanks for your response. I just want to make sure I understand everything, so I'm going to rephrase things. Peter mention earlier that a 6 to 7% return on investment is a good target (If I'm understanding him correctly). Are we calculating that based on remaining rental income after paying taxes, mortgage payments, water, sewer, maintenance, and any possible utilities (I do agree with Peter about the issue of heat. In my college days I shared a house with a guy and one winter day I came home and he had the heat set to 80 and was sitting in the living wearing nothing buy his jockey briefs. I was like, why don't we just throw cash out the window!)

Pardon the diversion, but after calculating the remaining rental income after the expenses I mentioned above, do we divide remaining rental income by down payment, closing costs and any initial repairs to calculate the return on investment?  I'm primarily looking at properties in Union City, North Bergen and West New York. Assuming I am calculating my return on investment, is the 6 to 7% return on investment a reasonable target?
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September 12 2013
yes your numbers begin to make sense Think I said 6% or 7% was a good target and you identify a cap rate of 7.7% and a positive cash flow if you finance. My concern is the property you are considering. I have learned from experience DO NOT buy a house where there are not separate furnaces so that the tenants pay heat in addition to other utilities. Trust me they abuse them.
I had a house where I had a partial problem with this and I put a lock box on the Thermostat but guess what - they managed to get it open.
You have not included reserves for occupancy or repairs which will eat into your cash flow but then you have the tax advantages of owning investment property.
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September 10 2013
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Hi everyone. Thanks so much for your responses....this is my first house purchase so I feel like I have a lot to learn.

Actually, I made a mistake with my math. The annual rent is currently $36,600. After paying the mortgage and expenses (heat, water, sewer, taxes and insurance), I would have an annual positive cash flow of $7,159. The house is listed for $298,000. If the seller accepts $280,000, then I would have to put $52,000 down. The $7,159 cash flow divided by the $52,000 comes out to 12% return on my investment.  (that doesn't factor in possible vacancy or maintenance however).With gross income of $36,600 and non mortgage expenses of $14,921 the house would have a net income of $21,679. That amount divided by the potential purchase price of $280,000 would be a cap rate (if I'm calculating that correctly) of 7.7%. I'm wondering if those numbers are attractive and of course, how much I should factor for maintenance. Does $5000 a year for maintenance seem reasonable? If so, then I would have only $2,159 of positive cash flow and if I have a vacancy for a month of two, then I'm in negative cash flow territory. 
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September 10 2013
First off you are going to be hard put to it to get a positive cash flow unless you pay cash or at least a substantial part of the purchase price in cash. We reckon that about 6% or 7% return on investment on a 2 family house assuming a cash investment with double figures easily obtainable in one of the inner cities 
The example you mention has an expense ratio that is far too high. Never ever buy an investment where the landlord pays any of the utilities except maybe water. 
Usually properties with more than 2 units are more profitable as long as you realise that they are controlled by the state and not the town and some towns( Jersey City is one that comes to mind) have rent control on them.
You mention rent income of $24,441. This equates to a little over $1,000 per unit per month. Either these are real small apartments or they are below market value. We usually set the bar at the rate they get for Section 8 and your typical rate for a 2 bedroom apartment is certainly more than that.
And don't waste your money on anything where the apartments have less than 2 bedrooms. 2 2 bedroom apartments is the very minimum
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September 10 2013
 Assuming you've included all a vacancy factor and reserve monies with your numbers.  These numbers wouldn't work on face value.  At least based on the details given.  Unless you can raise rents, reduce expenses, negotiate a better loan interest or in any otherway increase the spread between income to expense, this deal doesn't work.  I'm a big supporter in the premise "never buy negative cash flow unless you can turn it quickly to positive".

As you make assumptions on sales value, you need to get a realistic value and start deducting from the price until you get to the number that makes the most sense for an offer.  If the seller doesn't like it, go find a deal that fits your investment goals.
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September 10 2013
 
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