Originally Published at The Motley Fool

I have been told that to buy rentals and make money you should not pay more than 5 times the annual rent for a property. In this case the house would be worth about 90,000 dollars as is.

I abhor the ‘rules of thumb’ as they are always formulated for generic situations, and that WILL (not “can”) cost you dearly when the rubber hits the road.

Time to fire up Excel (or other,) and figure actual numbers…

Low-reality comparable monthly rental revenues,
Times 11 for realistic annual gross revenues,
(You’ll lose an average of a month per year (or 2 per each other year) in vacancies,)
Subtract annual taxes,
Subtract annual insurance,
Subtract association dues (if any,)
Subtract 10% for maintenance (short & longterm,)
Subtract 5-10% for management (even if you intend to DIY,)
Subtract your carry costs of down payment*
(Longterm Market rate on your investable safe cash elsewhere… I use 8% for my figuring.)

What’s left? That’s what there is to cover amortization burdens & interest on your mortgage.

Take this final number, plug it as your payment into a mortgage calculator at 30 years, with your investor-level interest rate (again, I currently use 8% to be conservative.) Solve for loan amount.

THIS is your loan which is 80% of your purchase price. (Divide your result by 80% for your breakeven cashflow purchase price.)
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THEN… back to CraigsList (and local free access to MLS, perhaps,) and search out comps for sales. See if the purchase comps are in any similar universe to the fundamental cashflow value of owning.

Hope that helps!

Dave Donhoff
Leverage Planner