I get calls from investors almost daily asking me if it’s a good deal for them to purchase a house 20% under appraisal. Obviously, there’s no way I could know the answer! I generally ask them — What’s the price? They tell me $109,000. Next I ask — How much can you rent the place for? They say $750, they think. Then I ask — How much do comparable houses in the neighborhood rent for? They don ‘t know, but somewhere between $700 and $850, seems about right they say! Are there lots of $750 renters, I ask?
Don ‘t know’, they say!

It’s right about now when I tell them — You ain’t quite ready to do business just yet! You’ve got to get yourself prepared a little more before you stick you neck in a noose and can’t pull it back out. Mark Twain used to say it took him two weeks to prepare for an impromptu speech. I wouldn’t think buying houses and trying to make a profit would take anything less! Unprepared real estate investors are indeed like sheep marching toward the slaughterhouse. Perhaps a few will succeed on pure luck, but the odds are heavily stacked against them.

In the case of the $109.000 house, which supposedly is appraised for $136,000 or so, maybe it’s a good deal and maybe it’s not! Without more information and a little bit of homework, I don’t really know, for example — If all the other houses around it are selling for $100,000 or so, then what good is a 20% below appraisal price? That’s no bargain! If you live in a low income area like I do, where only 20% of the total renting population can pay $750 or more per month, you must ask yourself-– Will there be enough customers (renters) so the house will stay rented? You certainly don’t need a bunch of $750 rental houses without a matching supply of $750 renters. Buying at 20% under appraisal could still sink your ship if you “buy in” before you know a few answers!

Say they’re lucky enough to buy in with a 10% down payment for a non-owner occupied property, then there’s the matter of financing the other 90%! Fixed-rate mortgages for rental houses will always cost more than your personal residence when it comes to long-term financing. Many lenders have nothing to offer except variable interest rate mortgages for rental houses. But, let’s just assume we can find a fixed rate, 30-year mortgage at 7.5% for a rental property. Principal and interest will add up to a monthly payment of $685. That’s just the finance cost and as you might guess, we ain’t quite done with expenses yet.
No matter how tight you manage, and in this case you’re doing it for free, there’s still property taxes, insurance, maintenance like in painting and repairs when something breaks – plus the occasional “down time” when a tenant moves out. No matter how you slice it, or sometimes ignore it, the total expenses will still cost 30-35 cents out of every rent dollar that comes in! Right off the bat we have a glaring math problem here! The $685 mortgage payment gobbles up about 90% of the $750 income. Adding $90 to 30% should give you a pretty fair idea that something’s wacko! In this example, we would need another $160 every month just to break even while we’re managing the house for nothing!