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Automatic wealth The 6 steps to financial independence - Masreson M.

Masreson M. Automatic wealth The 6 steps to financial independence - Wiley & sons , 2005. - 291 p.
ISBN 0-471-71027
Download (direct link): automaticwealththesixstepsto2005.pdf
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Principal and interest $570
Property taxes $120
Insurance $35
Total hard costs
$725
212 AUTOMATIC WEALTH
Obviously, to cover your PITI costs, you’ll need to be able to rent the property for at least $725 a month. But the fact is, PITI won’t be your only costs.
Make an Allowance for Maintenance and Vacancy
PITI are your hard costs. You know you’ll have to pay them every month, quarter, or year. Other costs are not so hard, meaning you don’t know exactly what they’ll be. But you should make allowances for them. You’ll also have maintenance expenses, for example.
YOUR MAINTENANCE ALLOWANCE HAS NOTHING TO DO WITH MAJOR REPAIRS
Monthly maintenance figures will vary, depending on the condition of the property. The maintenance allowance I'm using here is not for renovation, rehab, or major repairs. It is an allowance for maintaining a property that is already in good shape to begin with.
If the property you're considering buying needs major repairs, you should account for that as part of your initial investment. So if you're buying a property for $50,000 and it needs $5,000 in repairs, consider the total price to you to be $55,000.
If you're paying for those repairs with cash, it increases your initial investment, but not your carrying costs. If you're financing the repairs, your initial investment doesn't increase, but your carrying costs do.
For example, let's say you take out a $5,000 loan to pay for those repairs. Terms are 30 years at 6 percent—so your monthly payments on it are $30. In this case, you would add that $30 to your monthly carrying costs. And that means the minimum monthly rents you'd need to cover all your carrying costs would increase by $30.
Once you've made those repairs and brought the property up to a condition that is safe, functional, and presentable, however, you should still expect ongoing minor repairs and maintenance. That is what your maintenance allowance is for. By putting it into your expected costs and using those costs to help determine your maximum offer, you're creating a cash-flow cushion for those contingencies.
Step 5: Get Richer While You Sleep 213
According to the Census Bureau’s American Housing Survey, maintenance averages about 1 percent of the property value per year. So let’s say you expect to have $1,020 a year in maintenance expenses (a little more than 1 percent of the property value). That works out to $85 a month.
You should also make an allowance for some vacancies. National statistics put this at around 10 percent a year. That means, whatever the rental value of the property, you can expect to receive, on the average, about 90 percent of that value.
To make an allowance for vacancies, take 10 percent off the monthly rental value. So if the monthly rental value is $900, expect to receive about $810 a month, on the average, over the course of the year (because $810 is 90 percent of $900).
Then, you’ll want to make sure that the $810 covers at least your PITI and maintenance. In this case, it does that, exactly. So you have, at the very least, a potential deal.
Even When You Initially Break Even on Cash Flow,
You Can Still Make Sizable Profits
In our example, you’ve put just $10,000 down on this $100,000 property. And let’s say you pay $2,000 in closing costs. If you’ve chosen a good neighborhood with strong appreciation potential, you have a property that should pay for itself1—and you get all the appreciation and amortization.
With average appreciation, the house would go up by about 13 percent—or $13,000—in two years, more than doubling your investment in that time while the property pays for itself.
Plus, you’d pick up about $2,000 in amortization (reducing the loan balance), for a gross profit of about $15,000 on $12,000 invested for two years.
And that’s in a market rising by historically average rates of appreciation. In a fast-rising market, you might make three or even four times your money in two or three years.
On top of all this, as rents rise, you should eventually collect positive net rents, too. Even though you originally bought at a price that was just enough to cover your carrying costs, over time that property could produce hundreds in net rents every month.
Your rents are paying all your carrying costs. And if your rental value covers your PITI plus allowances for maintenance and vacancy
214 AUTOMATIC WEALTH
and then some, all the better. You’ll have a positive cash flow from the get-go, one that should grow steadily in coming years with the rise in net rents.
Coming Up with a Handy Guideline Number
Wouldn’t it be nice to have a guideline number you can use with any property in your target investment area?
For instance, let’s say you see a property for $100,000 and you immediately know that if it has annual rental income of $10,000, it’s a possible deal. Or you see a property that has a rental value of $6,000 a year and you immediately know that it’s a potential deal if you can get it for $60,000 or less.
In this case, your magic number would be 10 percent. (I was alluding to a guideline like this at the beginning of the chapter.) You’re potentially interested in properties with a gross rental yield of 10 percent or more of the purchase price. I say “or more,” because any property you’d be interested in has to have that yield as a minimum. That’s your minimum gross rental yield.
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