These questions keep getting better and better all the time. And I appreciate the questions that you guys are sending in, I’m going to keep running through them. Today’s question comes from Chris, and he writes in and says, hi, Marco, I have been recently turned onto your podcast after gaining interest in real estate. I am 23 years old birthday in a few days, happy birthday, Chris, and want to get started in real estate to get time freedom for when I am older, I’m a mechanical engineer for a medical device company. And while I love what I do, I would like to have the ability, later on, to spend time with family, friends and work a job I have always wanted, to be a calculus teacher.
That’s interesting. I’ve never heard that one before, but I’m glad you got clarity on what you want to do Chris.
I have about $30,000 cash saved up through work and several other investment accounts with various amounts. I am most interested in low-cost houses with good cashflow. Since this will be my first investment, I would love to hear what you would do if you were in my shoes. I am very confident in Dayton, Ohio, and Memphis, Tennessee markets. However, I have seen a lot of houses that fit my agenda in Jackson, Mississippi, really looking forward to hearing your response, and thanks for all the information.
You’re welcome, Chris.
All right. First of all, your definition of what you call quote-unquote, low cost is different from what many other people might define it as. So let’s be clear on what the differences between low cost and cheap because those are often different things. So cheap is what you find in really distressed areas. These are often distressed properties, but they’re in, you know, rough neighborhoods, rough streets, they’re cheap for a reason and cheapest. Like we’re talking very cheap within the market. That’s the context because every market is different. What’s cheap and Southern California is going to be different than what’s cheap in, you know, even a very inexpensive market. Let’s say like in Dayton, Ohio, or Jackson, Mississippi, but low cost typically means for most people, the lower end of a particular market, the affordable housing, certainly under the median price of a market. So it’s not that it’s cheap property or cheap or bad neighborhoods. It’s just lower cost relatively speaking. But for your example, I’m going to assume that low-cost houses are what you would find in your C class neighborhoods. They’re often, well, at least within the markets that we operate in anything from 50 to a $100 So keep in mind that low cost is probably going to be in your lower-income neighborhoods. That’s the type of demographic you’re dealing with. They are certainly the cheaper properties on the price spectrum for a particular market. And there’s nothing wrong with that. Just to understand the demographic that you’re dealing with in those markets and what you might potentially be dealing with that type of tenant class. They may be a little more transient. They might skip from job to job more frequently. They’re not necessarily as rooted in the community and the area as others. They, anecdotally speaking might have more tenant payment issues like late payments, skipped payments. And that doesn’t necessarily mean that they get, you know, evicted often, but just understand that the possibility or probability of that happening might be a little more than dealing with a tenant class in a B, B plus neighborhood, or even, especially in A class neighborhood. So understand what you’re getting into when you are going after lower-cost property.
Now often, but not always the cash flows are not as good in low-cost housing or lower costs, neighborhoods, or C class neighborhoods compared to B’s and compared to A’s. And that’s just because the rents will go down as you go to C class neighborhoods and up towards A class neighborhoods, more expensive properties have higher rents. And so often, but not always that translates to higher cash flow in dollar terms, but there’s often an inverse relationship between your cash on cash return and the dollar net cash flow that you receive from the property. So as you go up into A class neighborhoods, you tend to often not always have a higher cashflow in dollar terms, but because your down payment was larger coming in, you’re going to have lower cash on cash return. It’s just math. You’re dividing your down payment into your annual cash flow. And if that cash flow is larger, you tend to have higher cash on cash return. If your cash flows are lower, you’re going to have a lower rate of return in percentages.
So when you’re saying you want good cash flow, I assume you’re talking about the net spendable cash, the dollars that you generate from the property. So if that’s the case, then you may want to look at the not most expensive, but the best. And sometimes that means spending a little more on the down payment, the investment that you make, that you can afford because if you can get the best you can buy odds are you’re going to have better cash flow. Let me give you some quick examples here. I just pulled four properties quickly off of our website and keep in mind on our website. We probably only post about 20% of the properties that are in the pipeline and available. It’s just humanly and physically impossible to keep up refreshing the inventory on our website in real-time, on a daily basis, we do our best, but just understand that we put a good sampling of the properties available on our website at noradarealestate.com.
Just talk to your investment counselor and we’ll have more information and probably lists of what we can share with you. That’s not on the site, but here are four that I picked. So this first one is in Birmingham, Alabama, it’s $110,000 property, and I’m just going to give you very high-level numbers here. I’m not going to go into a lot of detail, but I’m talking about cash flow in true net cash flow numbers. So this is after vacancy allowance and after maintenance and repairs. This is what you should expect in terms of your cash flows starting in year one. So this $110,000 property will generate about $2,100 per year in net cash flow, which is about an 8% cash on cash return. Let’s compare that to the second one here. This is a $188,000 single-family home, four-bedroom home in Fort Worth, Texas. So it’s considerably more, $188,000. So 20% down, plus your closing costs puts you, you know, somewhere around $43,000. Look at the cash flow on this. The net cash flow is about $2,300. It’s only about $250 more per year. So it’s not that much higher. And therefore your cash on cash return is lower. It’s about 5.2%. So this is a more stable area, more mature, possibly an area that will have more stability going forward as real estate cycle change, economic cycles change. It’s probably going to have stronger appreciation potential. And even if everything grows at the same rate, let’s just call it 4% could be higher, lower. Let’s just say it’s 4% per year. On average, over the long term, your equity growth in dollar terms will be higher on the $188,000 property. Then it will be on the $110,000 property. It’s just simple math. If you’re taking 4% of each of those, the 4% will be larger on the $188,000 property. That’s just simple math.
So let’s compare it to a third. The third property is another one in Birmingham. I took this one at 105,000 small down payment of 20, just under $21,000 plus closing costs. But this one, interestingly enough has even higher cash flow, $2,500 per year. Cashflow spendable, net cashflow cash on cash return is 10.2%, very attractive, very attractive, but again, it’s $105,000 property. And the last example, certainly not the least. This is $160,000 property in one of our other markets in Pennsylvania. And this one kicks off a whopping $5,600 of net cash flow per year, very high cash on cash return of 15.1%.
So see, you have to compare one property next to another property. Compare the cash flows as well as the other factors that we talked about before. So it’s not that everything in Memphis is going to be the same. It’ll differ from submarket and neighborhood within the same market, but then you can start taking properties in Memphis and start comparing them to properties in Pennsylvania or Kansas City, Missouri, or Birmingham, Alabama, or wherever it may be. And you will see differences because things change, insurance changes, property taxes certainly change. Sometimes they have small HOA fees. So keep all this stuff in mind. But if you’re confused by any of this, Chris, you know, just speak to your investment counselor here, or just educate yourself and learn as much as you can as you’re already doing. And that will certainly help you, but just be clear about, you know, what it is that you’re looking for in terms of cash flow and you can help navigate the water.
So again, I wanted to keep this one at a high level, 30,000 feet, but congratulations, Chris, you know, as a 20, some year old, getting your first investment and really thinking about this, says a lot about you and your character and your maturity, so good for you. And if there’s anything we can do to help you by all means, let us know. I appreciate the question. Thank you for submitting that. I wanted to keep this to 10 minutes and we’re right about the 10-minute mark. So thank you for the question.
For everybody else. That’s listening. If you have any questions about real estate investing or finance, let me know, just go to AskMarco.com. You can also go to passiverealestateinvesting.com and just let me know what your question is. And if you are new to the show like Chris was, I hope that you have subscribed. If you haven’t clicked that subscribe button and that way you get notified every day that we release an episode, help us share the show with your friends and family. I’m sure they’re like-minded like you, at least I hope they are. If they’re not, you can always educate them with this podcast. And of course, thank you for listening. I appreciate you all. And I will see you on our next episode.
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