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Chris is with us in Atlanta, Georgia. Hi Chris, welcome to The Dave Ramsey Show.
Hi Dave, how are you doing?
Better than I deserve. What's up?
Yeah, I had a question. My wife and I are out of debt and have always invested every month in mutual funds, similar to what you talked about, and we would like to get into real estate. I just want to know better how to get comfortable. I understand mutual funds and I'm comfortable with them, but putting $150,000 or $200,000 down on one house seems a little overwhelming to me.
Well, it is a lot of money, especially if it's a large percentage of your net worth. Going into that is nerve-racking, so it makes you slow down and be very wise about it. There are two kinds of fear. One is the fear that says, "I'm scared of driving a car because I've never driven one before," or "riding a bike because I've never ridden one." That kind of fear says the more knowledge I have, the less fear I'll have. The other kind of fear is "don't touch a hot stove" or "don't walk out in front of a bus," which keeps you alive. You're not going to get over that kind of fear, and you shouldn't, because it's keeping you from harm. Not understanding a mutual fund so you don't put money into it is a knowledge-based or lack-of-knowledge-based fear, and it's the same thing with real estate. The way to overcome it is to spend time studying, spend time looking at deals, don't be in a hurry, don't let anybody pressure you, and don't let anybody roll their eyes at you for not knowing what you're doing. You're the guy standing there with the money, so take your time.
Money in real estate investing, when you get ready to buy a house as your first rental or real estate investment, is made primarily at the buy.
Okay, so you want to work with an agent to teach you that, or did you do that on your own?
That would be fine, but I wouldn't rely exclusively on them. It won't hurt my feelings if you walk through 50 houses before you buy one. It might hurt the agent's feelings, and they might not want to mess with you, but it wouldn't hurt mine. Make sure you get it.
Yeah. What area of Atlanta are you in?
We're kind of in the north suburbs, the Alpharetta, Roswell area.
Okay, all right, cool. If you looked at 50 houses over the next three years, that's an exaggeration, but compare that to today. If you looked at the numbers, looked at the comparable sales, looked at the price per square foot, looked at what they're renting for, and looked at what types of rentals people are looking for in your area, one bedroom, two bedroom, three bedroom, five bedroom, then you are in a sense making a non-purchase decision on a whole bunch of properties. But you get very, very familiar with the numbers, and they start to leak out of your eyes and your ears at that point. Right now, part of the fear comes from simply not knowing the numbers. But if you can walk up to a house and think, "Houses in this area go for $75 a foot, this idiot is asking for $100, I'm wasting my time," and you've looked at 40 of them, you don't even have to look it up on the computer. You don't have to pull comps or do anything, because you've internalized the information through due diligence. So what you've got to do is look at a bunch of different things. I'm saying 50 and two years, and it doesn't take that many, but my point is that the more knowledge you have of that house over there, the more you can say, "I've looked at six just like it, they all rented for $1,200, and the only way this deal works is if it rents for $1,400, so this deal doesn't work." You can say that in your head because you have the base knowledge from having kicked the tires a bunch. Does that make sense?
Yeah, that does make sense. Is there a certain percentage of price to value that you want to build a rep for?
I try to buy houses on a residential basis, and I try to buy all our property this way. It's very difficult to market that. I don't go in and tell you upfront, and I haven't bought a property in a while because we're building a large office building, and that's a concrete hole taking all my money. But when we were buying property the last time, a few years back, our formula was to try to buy it for 70 percent of what we think the actual retail value is. That also means you're going to make a lot of people mad with low offers. It's a specialty of mine. I'm not trying to make you mad, I've got money, and I can close by Friday. But if you can buy a $200,000 house for $140,000, you can make this work.
Okay, that makes sense. When you have cash on hand and you're not in a rush, because you're trying to move into the house, exactly, and I don't care if it needs work. If it has heavy repairs, I might deduct repairs from that as well, but if I've got to run a coat of paint through it, put in some carpet, and tear the bushes out, that's okay. I've spent five or ten grand on it, whatever. But if you've got $150,000 invested, and when everything's done the property is worth $200,000, most properties, and it changes from market to market, you're generally going to find about 1% a month of value in rent. So a $200,000 house typically rents for about $2,000 a month. That's rough and dirty, and it will change from market to market, so you need to learn that for your market. Sometimes they'll run it a factor higher than that. But if you pay cash of $150,000 for something and you can roll $24,000 in top line, minus expenses, to get to your net profit on that property in cash-on-cash returns in a year, you will make good money. You'd be at an 8 to 10 percent rate of return on your money before we even get to appreciation. The fact that a $150,000 house is now worth $200,000 means you've already made $50,000 before you started, so appreciation starts to kick in to your overall rate of return. But I look at cash-on-cash rate of return after monthly and annual expenses, and I want to be in that 8 to 10 percent range. Under 80 percent of value, 70 percent is what I aim for on a residential or single-family property, and that will typically get me there. Is that logical?
Yeah, that makes sense. It's just about the knowledge, like you said. You're comfortable with it.
Yeah, it's just like, okay, you've driven six different kinds of sports cars that cost around $50,000, and you know the Lexus has this and the BMW has that, and you can start to make a comparison. But until you've gone and gotten in them, driven them, and looked at the horsepower, the chassis, the suspension, and the technology available on them, you don't know whether you're getting a good deal on the one you're looking at in comparison. Knowledge of the marketplace is what gives you that. I do that with anything I'm buying. I just become an expert on it, and I'll wear people out for a while until I get my knowledge base up.