Rentals in Boise: Do they pencil?

I‘ve been getting a lot of calls lately from potential buyers and investors asking that very question.  Have prices of easily rentable homes in Boise dropped to a level that makes them pencil out as cash flow positive?  The answer is yes…and no.

     As we are all aware, the mortgage crisis and the ensuing recession have all put downward pressure on housing prices both nationally and here in the Boise market.  The latest numbers for August 2009 indicate that single family home prices in Ada County have dropped 17.9% in just the last year and in many areas have dropped as much as 35-40% since the peak in 2006.  The current climate of near record low interest rates, readily available credit for well qualified borrowers, and relatively  low prices presents a unique opportunity for those with access to cash, whether they be seasoned investors, or those lucky enough to have saved up a nest egg.  Add to this that rents, while somewhat down, have held up much better than home prices and you can see why there is renewed interest in buying rental properties. 

    There are many, many ways to approach this question from in-depth analysis using several different measuring criteria such as Cap Rates, time value of money, GRM (Gross Rent Multiplier), etc. to the most basic.  Is there any money left each month after I make my payment and cover other expenses?   For the purposes of this discussion I will only be looking at single family residences, not apartments or multi-family houses.  If the answer is yes, then there is positive cash flow.  Obviously, this is the most desirable scenario.  However, especially in times when home values are rising, there are many investors who are willing to tolerate negative cash flow in order to build equity.  I believe it will be quite some time before home prices in this market begin to significantly appreciate so it makes much less sense to look at anything that isn’t cash flow positive or at least neutral, unless you have deep pockets and lots of patience.

     I spoke to Gary Stott, a loan officer with Waterstone Mortgage The Stonebrook Group here in Boise, to get a lender’s perspective.  A few basic things to consider before you decide that buying a rental makes sense now:

Almost all lenders will require at least a 25% down payment to provide competitive rates. 

You will also need closing costs of around 3% of the purchase price.

Rates are currently around 5.5% for this type of loan, but can change daily.

You must be well qualified. 

If you currently own a rental you must have a 2 year history as a landlord for the rental income to be eligible for qualifying you for the loan.  Banks will typically assume a 25% vacancy rate and deduct that from the allowable rental income.

Most lenders will limit you to a total of four financed properties (including your residence), although Fannie Mae is now allowing up to 10.  However the PITI reserves required by lenders increase dramatically for 5 or more properties.

Since the property will not be your principal residence you will not be eligible for the Idaho property tax homeowners exemption.  If the property you are buying currently has the exemption applied to it you will need to multiply the assessed value by the levy rate to determine what the approximate taxes will be.  This information is available from a qualified real estate agent or on line at www.adacountyassessor.org

There are other expenses which should be considered in your decision such as maintenance, repairs, vacancy, and management fees (optional).

So what are the magic numbers that you should look for to find properties that will pencil?  There is no simple magic formula because there are so many non-numerical variables, such as location, condition of the property, layout of the house, etc.  Most importantly in evaluating the property you need to try and determine, ‘How rentable is the property and how much will it realistically rent for?’  Rentability and rents vary by neighborhood, so thorough research is important.  You need to ask, ‘Who are the potential renters in this neighborhood?’ ‘What affect will things like proximity to large employers, the freeway, or schools have?’  You can also research what current rents are by talking to a qualified real estate agent, property manager, or by scanning such sites as www.CraigsList.org  and www.idahostatesman.com.  You can typically search these sites by neighborhood and type of house.

 But is there a simple litmus test the potential investor can use in today’s market here in Boise?  Depending on your investment and income goals there are some criteria that you can apply to “weed out” properties once you have determined the areas you want to focus on and what the expected rents will be.                                                                                                      1) Typically, the most “rentable” home is a 3 bedroom, 2 bath newer home with at least a 1 car garage.                                                                                                                                                     2) Rents will, of course, vary by neighborhood, but for our purposes, $800/month is a pretty reasonable number to use.                                                                                                                               

So one easy place to start would be 3 bedroom, 2 bath, homes with a garage where the PITI (Principal, Interest, Taxes, & Insurance) payment is going to be less than $800/month.  We assumed hazard insurance of $35/month ($420 annually) and taxes at $185/ month ($2,220 annually). 

       We figured $140,000 for a starting point. Of course these are only estimates and the actual numbers would be dependent on the specific property involved.   So I researched to see if there were specific properties available in the city of Boise that would meet our most basic criteria.  There were:

 

Listed Price (3bed, 2bathw/garage)	Number Listed as of 09-10-2009
$140,000 or less	181
$130,000 or less	91
$120,000 or less	38

I had Gary Stott at Waterstone Mortgage The Stonebrook Group run some sample good-faith estimates for me to see if we could hone in on a price point that works. 

Purchase Price	Loan Amount	Interest Rate	PITI Payment
$140,000	105,000	5.5	816
$140,000	105,000	6.0	849
$130,000	97,500	5.5	773
$130,000	97,500	6.0	805
$120,000	90,000	5.5	731
$120,000	90,000	6.0	759

                                                                                                                                                                                                                                                                                          Based on Gary’s samples it looks like at an interest rate of 5.5% or lower the purchase price cutoff is around $130,000 and if the interest rate jumps to 6% then it is closer $120,000.  Of course, this is not the whole picture as no allowance was made for other expenses such as vacancy, repairs, maintenance, or management.  Nor does this consider that you are tying up anywhere from $30,000-35,000 in cash as a down payment in a market where values are not expected to increase anytime soon. 

     My conclusion at this time would be that if you can find a well located, easily rentable, property under $120,000 there maybe some marginal positive cash flow and that if you are able to hold the property for at least 3-5 years you may see some increase in the property’s value.  Given the relatively large amount of up-front cash required and the relatively low (if any) cash flow in a declining market, this is probably not the investment strategy for most.  However, compared to from 2005-mid 2009, the numbers are really starting to improve.  For those who are comfortable doing more detailed financial analysis of rental properties there are several web sites that offer easy to use programs to quickly analyze investment properties.  www.erealinvestor.com, www.realdata.com  (I suggest the REIA Lite Edition), and www.planease.com  are three that I am aware of.  And of course you can always seek the advice of a qualified real estate professional.

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