The Myth of Cashflow – and understanding how to reserve properly and model.

[David Lutz]

Let me start by saying I am all in on RE. I have an MBA, spent years learning about RE before I pulled the trigger. And when I did, I bought 5 houses worth over $1M in 18 months with only $100K of my own money. So I feel pretty good about saying I am financially literate, know how to model, and to find deals purchasing out of state.

I’m also embarrassed to admit I was so focused on getting going that I just assumed I could track if I was doing well by watching my bank balance. That was dumb. To be fair, in addition to buying all those houses over the last 3 years I also dealt with an eviction, $47.4K in capital expenses, insurance claims, building teams in my local markets, and all the other nonsense involved in this lovely industry.

Anyway, I finally got around to putting together a complete general ledger and had the horrible realization that over the last two years (bank and credit card record limitation make it harder to go back farther)…

….. between 2022 and 2023 I have been $17.5K cash flow negative on $171K expected rent !!!!!

How the **** did that happen? I budgeted 21.2% of the expected rent toward vacancy, maintenance, and CapX, and in reality I ran at around 27% in the last two years. Also,.. why am I telling you? I figure that I’ve gotten so much from everyone at Bigger Pockets, and there is so little information on the hard numbers of how non-professional investors do, that I should give something back. Because most of the tools you have access to are a figment of imagination pushed by self-aggrandizing gurus and the Real Estate industry … because they only make money when you’re buying.

Again, let me stress I've made a lot of money over the last 3 years. I think you should buy real estate, I just want you to be smart. One of the major dangers is caused by the bizarre reality distortion field people have regarding the term cashflow. It seems like a lot of people use the term cashflow to refer to how much net income they average per month with no (or minimal) reserving or debt servicing. And the per door numbers sound huge, which is great but also meaningless. Because, reality check, if you think you're clearing $500 per month over 3 years ($18K) but you end up with one $5K Cap Ex cost, $4K in vacancy, and $3K in random maintenance then you're really only averaging $166 per month ($6K). And if you borrowed money for your downpayment from a HELOC, personal loan, cash out refi, 401K etc., then your hidden debt servicing can take your cashflow negative in a heartbeat. Rosy assumptions about how much free cash your real estate investment is going to throw off make it really easy to be unrealistic about what it's going to take to make owning rentals actually work.

So, 3 years into my Real Estate journey (5 with planning) I have some learnings I want to share:

• The default assumptions in every calculator you look at are rosy at best and complete lies at worst. Unless you buy a brand new house there is probably deferred maintenance. Your costs are going to be higher than you expect in the first few years. Plus, you’re not a professional. There is a high likelihood that you’re going to end up paying slightly more than you should for repairs, and turning houses when tenants leave is going to take longer than it should.
  • -- I’m sorry. I know you think you’re awesome. You’re not. Bleeding money that a pro wouldn’t is just going to happen. It’s better to anticipate it.
  • -- My recommendation is 25% of rent to cover vacancy, maintenance, and Cap X for older homes (+20 year), 20% for middle age (5 to 20), and 15% for new homes (you’ll need it eventually). I’m running hotter than that, but I honestly believe that I’ve caught up on deferred maintenance and these numbers are good for the long run.

• Have a plan for dealing with getting it wrong. I started with a $20K reserve. In addition to a strong W2, I have a HELOC to lean on. I stopped fed tax withholdings because the penalty is cheaper than borrowing cash, which buys a year (I still pay my taxes in full). In a pinch I can borrow against my 401K. And if things ever went truly sideways I could sell a house.

• Leverage is awesome. I borrowed 90% of the money for the homes I purchased at an average of ~4% interest. But the higher your leverage, the more likely you’re going to be cashflow negative. You’re going to make more money with more leverage, but only if you can handle the debt service. Don’t overextend yourself.

• As insane as it sounds, going all in actually helped. The rent from 4 houses covered the mortgage for 5 over the last 18 months I’ve been dealing with an appealed eviction and the court collecting and holding the rent.

• Everything I bought rented for 1% to 0.65% of the initial purchase price (more now). And the 1% has been the biggest headache. So if you go for cashflow you better be on premises, because there are going to be issue to deal with. And if you go for appreciation/quality houses you need to have a plan for dealing with weak cashflow.

• For pity sake don’t turn on water service on a Friday. My buddy and I have both ended up with minorly flooded houses despite the property managers telling us that all the taps had been turned off.

• If you’re buying out of state, ask potential property managers if they have local staff on site or if they outsource their inspections to a vendor (common for larger PM companies).

• When I model returns, I assume appreciation on B-/C+ properties at 1% above inflation. I did a lot of research, long term that’s a safe assumption. Rent I assume tracks with inflation (which is still great because a lot of your costs are fixed). This is probably a bit conservative, but I think it’s generally accurate, and I only like good surprises.

• You have to be able to get +$1000 per door to use a property manager, less than that and the minimums they charge start screwing up your returns.

• Water heaters, etc. cost roughly the same everywhere - it’s closer to a fixed cost. Buy where taxes are low on rental properties, populations are growing, economies are growing, and there are at least two of the following: Gov spend, Major healthcare, transportation hubs, universities, sports teams, industry concentration, tourism, manufacturing. These drive jobs, the more there are where you buy the better and more stable your investment.
  • -- If you’re as nuts as I am read the local area development plans and research planned corporate and other investments. Building an amazon hub and a zoo to the east of the city along with a new planned transit rail line? Awesome.

• Offer what you have and ask for help (preferably in that order). I did some financial modeling for an RE Agent I wanted to build a relationship with, and a year later he gave me some great recommendations on local tradespeople. During a friendly conversation I asked one of my property managers for recommendations on areas with the most growth potential and ended up buying two homes there.

• LLC get expensive if you're thinking of opening one for every property, plus it's a lot of work to make sure they can't be pierced. Consider just getting an umbrella insurance policy.

• Interest only HELOC are only just interest until you hit the repayment period, so make sure you're ready for the increase when you start paying back principal. Also, some lenders have limits on how many mortgages you can have and qualify for a HELOC. So if you think you might want one, set it up early.

• Current taxes on the property you buy generally lag current market value, and in some cases taxes on rental properties are higher than owner occupied. That’s all going to get corrected when your purchase triggers a reappraisal. So put together some realistic tax estimates before you buy.
  • -- All the info you need is available online from the local assessor, and pay attention to what the local community has tacked on to the mill rate. Taxes for two houses twenty minutes apart can be wildly different.

Major costs over last 3 years on 5 homes:

• $10K in missed rent leading to and waiting for eviction
• $3K Eviction costs (lawyers, travel, writ, etc.)
• $2.5K additional lost rent due to 4 month instead of 2 month property turn
• $3.8K for a new furnace
• $7.4K for a new HVAC
• $700 for a bathroom re-pipe
• $12K turn on large home, included new high quality carpet and full repaint
• $5.5K in unnecessary plumbing issues caused by tenant in eviction (no way to recover costs)
• $1.5K in utility bills during vacancy or owner responsibilities
• $900 for a refrigerator
• $4.8K for concrete piers to shore up a foundation
• $5.6K for a roof (insurance claim)
• $5.2K for another roof
• $1.3K for new AC line set (punctured in second roof replacement)
• $1.6 for a water heater
• $1.3 for a water heater
• $2K for a water heater
• $1.7K for new water line from meter to house
• … this actually isn’t everything but I’m getting depressed.

That’s $70.8K which was money that never made it to me, I didn’t expect to spend, or thought I had more time. And this is separate from regular maintenance my property management companies took care of and deducted from the rental income.

So the moral here is that RE is great but you can’t depend on cashflow. If you buy class C or D properties you are going to have way more issues than you can ever anticipate on paper. And if you buy class A or B you’re banking on appreciation. Either way, buy and hold is a long term play and it’s not going to throw off lots of cash in the short term. I’m guessing my year 4 is going to be pretty good, but it’s taken that long to get everything stabilized.

And If I decide to pull equity out to buy more houses, it extends this issue. I would end up with cash to buy more houses, but my monthly debt load goes up and cashflow goes down. So dream of equity and forget about cashflow,... its just a myth.

* These are just my personal beliefs based on my experience. If you hadn’t guessed I am not a RE professional (you probably aren’t either), and that’s kind of my point. I think it’s way too easy to over estimate investment performance based on how well the pro’s do. So don’t take any of my opinions as anything more than that. Make sure you do your own due diligence on your own deals.

**and if you find this info useful vote the post up. I'd like for folks to be able to find this kind of detailed info more easily.

[Becca F.]

@David Lutz

For that Indy Class A house, I did do a $50,000 cash out refinance (to help pay for the Bay Area house renovations) in 2021 so my loan amount is bigger than the original loan amount resulting in the 0.57% rent to price ratio. I guess if I had just done a rate and term refinance then that ratio would be higher? It appreciated, I pulled out some equity which enabled me to add value to the Bay Area house to rent it out - it wasn't safe to rent out with code violations before the renovation. 

That's a great point about selling a house with tenants who have way below market rent or trying to pull money out of it and the debt to income ratios being off.  I'll start pulling rental comps 

[Jeff S.]

@David Lutz back of the napkin calculation would say $10k month rent with 5k for taxes, insurance, property taxes, maintenance and repairs plus cap ex and reserves which leaves 5k for principal and interest. That would be a break even anymore for PI would likely put you negative sometime in the futures because reserves aren't being built up. The beauty is if rents can keep up with expenses then PI remains constant and that is where the appreciation of increasing rents becomes a good thing.

Sure overall costs can come in below 50% then that is a safety net. If they are over for a long-term then under rented. I tracked a 20 year period with a few properties and came in at 48%. This included lots of terrible things happening along the way.

[Jeff S.]

@David Lutz total operating expenses at about 40% with cap ex at about 10%. Their PI better be less than 50% or they be borrowing to stay afloat. Rehab to improve rent another story.

[Devin Scott]

Quote from @Steve Smith:
NEVER ReFi anything! Every time you do that, you loose money. 

Strange take.  That's not how finance works, though.  By that logic, you should never use leverage in the first place.  There's no actual difference between a house you've owned for 20 years and just re-levered and a house you just bought with a new mortgage, all else being equal.

[Henry Lazerow]

Awesome post. I will add all my clients that self manage (even those from out of state) cashflow as well as myself so I wouldn’t say its a myth even in early years of ownership. But when using property managers its almost impossible. A lot of people read books and think they can cashflow out of state with managers its just not reality 99% of the time. You need good below market connections for repairs and cant be paying out fees to managers, etc. 

[Sam Yin]

@David Lutz

Very thorough post and thanks for the transparency. I'm here in SoCal. I invest in SoCal. I have had many, if not all, those issues, AND MUCH MORE. However, based on your capital costs, leverage, and cash flow, it does not make too much sense to me. At least from a sustainable investment standpoint. There have been a few responses that shed some light and provide different strategies, but I understand you will do what makes most sense to you based on your personal goals.

As I have slowly grown my portfolio, I ran into your capital expense issues. But my cash flow has always covered it. There may be something amiss in your underwriting. Did you account for vacancy, capex, management, maintenance, and reserves, before your cash flow projection? Outside of doing a whole new roof or whole AC system, you should always cash flow. Although I mainly focus on small multifamily, I did start with SFR and duplex/triplexes. They were in some nasty shape. They needed a lot of work. They received a lot of work. But they cash flowed.

Wealth is built on the equity. Thus if you lever too high, it will take you too long to make good use of the proper ratio of equity to grow. Your current operation/trajectory will likely take to the a cap/limit of growth very soon. Unless these were just a brief growing pain and you are now running a very profitable business in REI. For context, I'm not an RE professional. I'm just a guy that hustled to get out of W2 via RE and grow generational wealth along the way.

This is only an opinion based on what I have read so far. It may not be an accurate assessment if there is more information not yet produced. But the way I see it, if you have that many units and are looking to grow, you should be cash flowing roughly 15K/yr in your pocket, minimum. However, your 90% LTV may be your Achilles. If you have not already done so, take a moment and do a stress test on your portfolio. If it can sustain, you are OK to continue on your current strategy. If not, consider adjusting and reinforcing your current holding. Better yet, prune it. It has been suggested already, but it appears it not the right strategy, in your view. I recommend revisiting that concept of pruning your portfolio to increase the quality of your assets, regardless if you are investing in B, C, or D class.

[Jeremy H.]

I'm going to be honest here - there's some of good and some bad in this post... 

There is a theme of a lack of due diligence, reserve capital, budgeting in general, tenant screening, location, inspections, leverage, property managers and just a variety of general amateur mistakes/learnings... I also find it very odd to list your qualifications on financial literacy then follow it with very (in my opinion) poor real estate financial modeling. I think some of this is fairly normal for new investors and a lot of it will come out in the wash in 10-15 years anyway. RE is a LONG game. If you run conservative numbers you avoid a lot of this. The cashflow over the long term is by far a myth when you buy right and budget correctly. 

The $1000+ per door to use a PM is straight up nonsense. I use a PM on all my properties - just factor it into your returns - it's an additional expense just like vacancy or repairs. That's literally all it is.

I think the cool thing here is you were able to use a lot of OPM and you were honest about what your real estate REALLY looks like. It's not a passive job (regardless of what the IRS says).

Everyone honestly should be running and creating their own calculators - why people invest tens/hundreds of thousands of dollars and then rely on someone elses (or better yet - pay for someone elses) calculator blows my mind. these are simple calculations for 90% of landlords. And calculators are only as accurate as your inputs...

Did you inspect these places? I mean 3 hot water heaters in a couple of years? I mean if it's that old when you buy the place, just replace it. Same with HVAC/furnace - if this stuff is going out within a year of the purchase that means it is OLD and could go out any second. You can expect a maintenance call in the very near future. Same with the foundation. Same with the TWO roofs. This is just a budgeting/rehab and due diligence thing. 

As far as deducting all those losses (repairs and maintenance) - you may be about to learn something new here as well. If you're not a REP you're going to be limited to 25k. If you make over 100k it's going to get phased out. If you make over 150k, you're going to be passing those losses on...And if you're a single member LLC - that real estate revenue is a straight pass-through and will add to your W2 income.

You have to figure out what works for YOU. This is not a one size fits all game - everyone is different. People have different strategies, different amounts of money, different goals, locations etc and yes there are LOTS of fake "pros" and gurus out there. A lot of this game has turned into a social media/marketing business instead of RE investing. 

[Jay Hinrichs]

Quote from @Jeremy H.:

I'm going to be honest here - there's some of good and some bad in this post... 

There is a theme of a lack of due diligence, reserve capital, budgeting in general, tenant screening, location, inspections, leverage, property managers and just a variety of general amateur mistakes/learnings... I also find it very odd to list your qualifications on financial literacy then follow it with very (in my opinion) poor real estate financial modeling. I think some of this is fairly normal for new investors and a lot of it will come out in the wash in 10-15 years anyway. RE is a LONG game. If you run conservative numbers you avoid a lot of this. The cashflow over the long term is by far a myth when you buy right and budget correctly. 

The $1000+ per door to use a PM is straight up nonsense. I use a PM on all my properties - just factor it into your returns - it's an additional expense just like vacancy or repairs. That's literally all it is.

I think the cool thing here is you were able to use a lot of OPM and you were honest about what your real estate REALLY looks like. It's not a passive job (regardless of what the IRS says).

Everyone honestly should be running and creating their own calculators - why people invest tens/hundreds of thousands of dollars and then rely on someone elses (or better yet - pay for someone elses) calculator blows my mind. these are simple calculations for 90% of landlords. And calculators are only as accurate as your inputs...

Did you inspect these places? I mean 3 hot water heaters in a couple of years? I mean if it's that old when you buy the place, just replace it. Same with HVAC/furnace - if this stuff is going out within a year of the purchase that means it is OLD and could go out any second. You can expect a maintenance call in the very near future. Same with the foundation. Same with the TWO roofs. This is just a budgeting/rehab and due diligence thing. 

As far as deducting all those losses (repairs and maintenance) - you may be about to learn something new here as well. If you're not a REP you're going to be limited to 25k. If you make over 100k it's going to get phased out. If you make over 150k, you're going to be passing those losses on...And if you're a single member LLC - that real estate revenue is a straight pass-through and will add to your W2 income.

You have to figure out what works for YOU. This is not a one size fits all game - everyone is different. People have different strategies, different amounts of money, different goals, locations etc and yes there are LOTS of fake "pros" and gurus out there. A lot of this game has turned into a social media/marketing business instead of RE investing. 

rental property returns etc is nothing more than napkin math trying to dive deeper into it up front is just silly.. every property is different in its condition and build quality every tenant is a different experience etc.. this only works if your buying a building with all the same units and same construction. Tax's will vary insurance will vary..

For me the biggest issue I learned was that after owning rentals if you do want to exit and you want to say sell to a retail client ( owner occ) which generally will pay the most for a SFR asset if its in a decent school district. Is to be saleable and relevant the home generally needs massive upgrades to make it modern.. your not going to get top dollar for a home thats been a rental for 15 years and is as is.. ( with the exception of high priced coastal markets ) . I sold off 12 new builds I had in the best county of all of Mississippi ( which could be an oxymoron) these were best school districts etc . I had to remodel all of them to compete with new builds .. so that is something you dont model up front in your fancy calculator.. Appreciation paid for it but in the long run.. Was a poor investment compared to other niche's out there.. like lending money .  land in path of progress .. fix and flip
JV deals.. etc etc.. at least for me.

[Steve Smith]

Quote from @Devin Scott:

Quote from @Steve Smith:
NEVER ReFi anything! Every time you do that, you loose money. 

Strange take.  That's not how finance works, though.  By that logic, you should never use leverage in the first place.  There's no actual difference between a house you've owned for 20 years and just re-levered and a house you just bought with a new mortgage, all else being equal.

Devin,

There's a LOT of difference! The 20yr house should be cash flowing handsomely! Why kill that income stream with a refi? If you need cash, borrow against the equity if you have to. Don't kill a good note (assuming you had a good note when you bought).

There's on case where one might want to refi, and that's if you bought a property that had bad debt on it from the start...pay that off with a new note. And there's ways to do that without much risk using a joint venture with other investors. Give them a piece of the deal if they pay off the bad loan. That can work well for both of you. I have worked both sides of that deal and works well. 

[Allan C.]

@Steve Smith refi can surely make sense if one secures long term fixed rate debt. Borrowing against equity is effectively the same as a refi, but likely with inferior terms.

I’m not a big fan of 1031 for repositioning due to transaction inefficiencies, so I prefer to refi once my assets’ capital basis has been depreciated. You’ll achieve the same cash flow with new acquisition but have lower tax obligation with depreciation from the new asset shielding the income. The ultimate question is whether someone is in growth or sustain mode, so that will change the strategy.

[Allan C.]

@David Lutz it’s a great thread you started and I’m aligned with a lot of points you made. However, I want to correct a statement you made so you are looking at things correctly.

If you refi to strip your equity in the future, you will not be receiving tax shielded income when your tenants pay down the new mortgage. Depreciation is what shields the principal paydown, and you’ll likely not have any capital basis to depreciate down the line. I’m still aligned with your approach, but you’ll need to have enough depreciable assets, which means you’ll stay in buy till you die mode.

This is where I see the value of buying high cost properties as you near the end of your investing career. The large depreciation offsets high EBITDA, and you can avoid taxes altogether when you die and step up everything to your kids.

[Eric James]

A lot of people have the same experience you did after they buy only 1 or 2 rentals. For me, rental real estate wouldn't be worthwhile without having multiple advantages. Living in the area of my rentals, self managing, being onsite frequently, able to do repairs cheaply by doing them myself or having employees do them, owning in a relatively landlord friendly area, etc.

[Steve Smith]

Quote from @Eric James:

A lot of people have the same experience you did after they buy only 1 or 2 rentals. For me, rental real estate wouldn't be worthwhile without having multiple advantages. Living in the area of my rentals, self managing, being onsite frequently, able to do repairs cheaply by doing them myself or having employees do them, owning in a relatively landlord friendly area, etc.

Eric, You're spot on! Buy homes close to you, do your own management, and keep a close eye on them. However, there's and argument to let the tenant do almost all of the maintenance items. Work well if you train them. However, I do maintain the AC (if the tenant changes the filters on time, major structural issues and roofs. Rarely do I have any major issues... far and few between. Usually nothing between 15 to 20 year roof replacements. Maybe an AC unit, but not much. Love my houses, and my tenants!

[Jeremy H.]

Quote from @Jay Hinrichs: 
rental property returns etc is nothing more than napkin math trying to dive deeper into it up front is just silly.. every property is different in its condition and build quality every tenant is a different experience etc.. this only works if your buying a building with all the same units and same construction. Tax's will vary insurance will vary..

For me the biggest issue I learned was that after owning rentals if you do want to exit and you want to say sell to a retail client ( owner occ) which generally will pay the most for a SFR asset if its in a decent school district. Is to be saleable and relevant the home generally needs massive upgrades to make it modern.. your not going to get top dollar for a home thats been a rental for 15 years and is as is.. ( with the exception of high priced coastal markets ) . I sold off 12 new builds I had in the best county of all of Mississippi ( which could be an oxymoron) these were best school districts etc . I had to remodel all of them to compete with new builds .. so that is something you dont model up front in your fancy calculator.. Appreciation paid for it but in the long run.. Was a poor investment compared to other niche's out there.. like lending money .  land in path of progress .. fix and flip
JV deals.. etc etc.. at least for me.

Interesting point on selling rental properties - and how true! I mean how many rentals do you see listed for sale or rent that are completely dated and have a laundry list of deferred maintenance? I'd say 90% of them at least. 

This is a good point to ensure you buy in great locations, maintain and repair any issues (I think this can keep you from having big repair bills down the road) and make small updates throughout the years. I have a few houses in "nicer" areas - I'm planning to slightly improve these over the years - just to maintain the best rents/tenants and all that. 

I have a few "workhorses" as well - these I just maintain/repair and let them ride out. I think this is the majority of landlords. 

[Devin Scott]

Quote from @Steve Smith:

Quote from @Devin Scott:

Quote from @Steve Smith:
NEVER ReFi anything! Every time you do that, you loose money. 

Strange take.  That's not how finance works, though.  By that logic, you should never use leverage in the first place.  There's no actual difference between a house you've owned for 20 years and just re-levered and a house you just bought with a new mortgage, all else being equal.

Devin,

There's a LOT of difference! The 20yr house should be cash flowing handsomely! Why kill that income stream with a refi? If you need cash, borrow against the equity if you have to. Don't kill a good note (assuming you had a good note when you bought).

There's on case where one might want to refi, and that's if you bought a property that had bad debt on it from the start...pay that off with a new note. And there's ways to do that without much risk using a joint venture with other investors. Give them a piece of the deal if they pay off the bad loan. That can work well for both of you. I have worked both sides of that deal and works well.  

No. There is literally zero difference between a house you just refinanced at 80% LTV and the same house if you buy it today with 80% LTV. I'm talking post-refinance. "Why kill that income stream with a refi?" Well that applies to new acquisitions as well, if that's your thought process. A new deal is also theoretically cash flowing handsomely.... unless you use a mortgage to buy it, lol. Any mortgage of any type kills cash flow. So why do it? I don't think I need to explain that on this board.

Again, the fact that you've owned the house for a long time makes no difference.  There's nothing inherently different about re-leveraging a property versus a brand new mortgage.  In both cases you're keeping more of your own cash and paying a bank interest to do that.  But if you're making the assumption there's a low-interest mortgage in place, so why refi that out, then yea that's a little different.  But if you've held for 20 years that mortgage is going to be next to nothing anyway.

Whether you are buying a new place or evaluating your own portfolio, if you value current cash flow over leverage to allow you to buy more properties, then you shouldn't have any debt whatsoever.  No argument on that point.

[Dan Heuschele]

Quote from @David Lutz:

Let me start by saying I am all in on RE. I have an MBA, spent years learning about RE before I pulled the trigger. And when I did, I bought 5 houses worth over $1M in 18 months with only $100K of my own money. So I feel pretty good about saying I am financially literate, know how to model, and to find deals purchasing out of state.

I’m also embarrassed to admit I was so focused on getting going that I just assumed I could track if I was doing well by watching my bank balance. That was dumb. To be fair, in addition to buying all those houses over the last 3 years I also dealt with an eviction, $47.4K in capital expenses, insurance claims, building teams in my local markets, and all the other nonsense involved in this lovely industry.

Anyway, I finally got around to putting together a complete general ledger and had the horrible realization that over the last two years (bank and credit card record limitation make it harder to go back farther)…

….. between 2022 and 2023 I have been $17.5K cash flow negative on $171K expected rent !!!!!

How the **** did that happen? I budgeted 21.2% of the expected rent toward vacancy, maintenance, and CapX, and in reality I ran at around 27% in the last two years. Also,.. why am I telling you? I figure that I’ve gotten so much from everyone at Bigger Pockets, and there is so little information on the hard numbers of how non-professional investors do, that I should give something back. Because most of the tools you have access to are a figment of imagination pushed by self-aggrandizing gurus and the Real Estate industry … because they only make money when you’re buying.

Again, let me stress I've made a lot of money over the last 3 years. I think you should buy real estate, I just want you to be smart. One of the major dangers is caused by the bizarre reality distortion field people have regarding the term cashflow. It seems like a lot of people use the term cashflow to refer to how much net income they average per month with no (or minimal) reserving or debt servicing. And the per door numbers sound huge, which is great but also meaningless. Because, reality check, if you think you're clearing $500 per month over 3 years ($18K) but you end up with one $5K Cap Ex cost, $4K in vacancy, and $3K in random maintenance then you're really only averaging $166 per month ($6K). And if you borrowed money for your downpayment from a HELOC, personal loan, cash out refi, 401K etc., then your hidden debt servicing can take your cashflow negative in a heartbeat. Rosy assumptions about how much free cash your real estate investment is going to throw off make it really easy to be unrealistic about what it's going to take to make owning rentals actually work.

So, 3 years into my Real Estate journey (5 with planning) I have some learnings I want to share:

• The default assumptions in every calculator you look at are rosy at best and complete lies at worst. Unless you buy a brand new house there is probably deferred maintenance. Your costs are going to be higher than you expect in the first few years. Plus, you’re not a professional. There is a high likelihood that you’re going to end up paying slightly more than you should for repairs, and turning houses when tenants leave is going to take longer than it should.
  • -- I’m sorry. I know you think you’re awesome. You’re not. Bleeding money that a pro wouldn’t is just going to happen. It’s better to anticipate it.
  • -- My recommendation is 25% of rent to cover vacancy, maintenance, and Cap X for older homes (+20 year), 20% for middle age (5 to 20), and 15% for new homes (you’ll need it eventually). I’m running hotter than that, but I honestly believe that I’ve caught up on deferred maintenance and these numbers are good for the long run.

• Have a plan for dealing with getting it wrong. I started with a $20K reserve. In addition to a strong W2, I have a HELOC to lean on. I stopped fed tax withholdings because the penalty is cheaper than borrowing cash, which buys a year (I still pay my taxes in full). In a pinch I can borrow against my 401K. And if things ever went truly sideways I could sell a house.

• Leverage is awesome. I borrowed 90% of the money for the homes I purchased at an average of ~4% interest. But the higher your leverage, the more likely you’re going to be cashflow negative. You’re going to make more money with more leverage, but only if you can handle the debt service. Don’t overextend yourself.

• As insane as it sounds, going all in actually helped. The rent from 4 houses covered the mortgage for 5 over the last 18 months I’ve been dealing with an appealed eviction and the court collecting and holding the rent.

• Everything I bought rented for 1% to 0.65% of the initial purchase price (more now). And the 1% has been the biggest headache. So if you go for cashflow you better be on premises, because there are going to be issue to deal with. And if you go for appreciation/quality houses you need to have a plan for dealing with weak cashflow.

• For pity sake don’t turn on water service on a Friday. My buddy and I have both ended up with minorly flooded houses despite the property managers telling us that all the taps had been turned off.

• If you’re buying out of state, ask potential property managers if they have local staff on site or if they outsource their inspections to a vendor (common for larger PM companies).

• When I model returns, I assume appreciation on B-/C+ properties at 1% above inflation. I did a lot of research, long term that’s a safe assumption. Rent I assume tracks with inflation (which is still great because a lot of your costs are fixed). This is probably a bit conservative, but I think it’s generally accurate, and I only like good surprises.

• You have to be able to get +$1000 per door to use a property manager, less than that and the minimums they charge start screwing up your returns.

• Water heaters, etc. cost roughly the same everywhere - it’s closer to a fixed cost. Buy where taxes are low on rental properties, populations are growing, economies are growing, and there are at least two of the following: Gov spend, Major healthcare, transportation hubs, universities, sports teams, industry concentration, tourism, manufacturing. These drive jobs, the more there are where you buy the better and more stable your investment.
  • -- If you’re as nuts as I am read the local area development plans and research planned corporate and other investments. Building an amazon hub and a zoo to the east of the city along with a new planned transit rail line? Awesome.

• Offer what you have and ask for help (preferably in that order). I did some financial modeling for an RE Agent I wanted to build a relationship with, and a year later he gave me some great recommendations on local tradespeople. During a friendly conversation I asked one of my property managers for recommendations on areas with the most growth potential and ended up buying two homes there.

• LLC get expensive if you're thinking of opening one for every property, plus it's a lot of work to make sure they can't be pierced. Consider just getting an umbrella insurance policy.

• Interest only HELOC are only just interest until you hit the repayment period, so make sure you're ready for the increase when you start paying back principal. Also, some lenders have limits on how many mortgages you can have and qualify for a HELOC. So if you think you might want one, set it up early.

• Current taxes on the property you buy generally lag current market value, and in some cases taxes on rental properties are higher than owner occupied. That’s all going to get corrected when your purchase triggers a reappraisal. So put together some realistic tax estimates before you buy.
  • -- All the info you need is available online from the local assessor, and pay attention to what the local community has tacked on to the mill rate. Taxes for two houses twenty minutes apart can be wildly different.

Major costs over last 3 years on 5 homes:

• $10K in missed rent leading to and waiting for eviction
• $3K Eviction costs (lawyers, travel, writ, etc.)
• $2.5K additional lost rent due to 4 month instead of 2 month property turn
• $3.8K for a new furnace
• $7.4K for a new HVAC
• $700 for a bathroom re-pipe
• $12K turn on large home, included new high quality carpet and full repaint
• $5.5K in unnecessary plumbing issues caused by tenant in eviction (no way to recover costs)
• $1.5K in utility bills during vacancy or owner responsibilities
• $900 for a refrigerator
• $4.8K for concrete piers to shore up a foundation
• $5.6K for a roof (insurance claim)
• $5.2K for another roof
• $1.3K for new AC line set (punctured in second roof replacement)
• $1.6 for a water heater
• $1.3 for a water heater
• $2K for a water heater
• $1.7K for new water line from meter to house
• … this actually isn’t everything but I’m getting depressed.

That’s $70.8K which was money that never made it to me, I didn’t expect to spend, or thought I had more time. And this is separate from regular maintenance my property management companies took care of and deducted from the rental income.

So the moral here is that RE is great but you can’t depend on cashflow. If you buy class C or D properties you are going to have way more issues than you can ever anticipate on paper. And if you buy class A or B you’re banking on appreciation. Either way, buy and hold is a long term play and it’s not going to throw off lots of cash in the short term. I’m guessing my year 4 is going to be pretty good, but it’s taken that long to get everything stabilized.

And If I decide to pull equity out to buy more houses, it extends this issue. I would end up with cash to buy more houses, but my monthly debt load goes up and cashflow goes down. So dream of equity and forget about cashflow,... its just a myth.

* These are just my personal beliefs based on my experience. If you hadn’t guessed I am not a RE professional (you probably aren’t either), and that’s kind of my point. I think it’s way too easy to over estimate investment performance based on how well the pro’s do. So don’t take any of my opinions as anything more than that. Make sure you do your own due diligence on your own deals.

**and if you find this info useful vote the post up. I'd like for folks to be able to find this kind of detailed info more easily.

 I agree with so much of this post but wanted to point out something that bothers me every time I see it and I see it everywhere including in most rental calculators:

“My recommendation is 25% of rent to cover vacancy, maintenance, and Cap X for older homes (+20 year), 20% for middle age (5 to 20), and 15% for new homes (you’ll need it eventually). I’m running hotter than that, but I honestly believe that I’ve caught up on deferred maintenance and these numbers are good for the long run.’

Maintenance and cap ex is not a function of rent but the features of the property and the class of tenant.   Example I have a small 2 br, 1 Ba 600’ beach cottage that is class A value with market at $4400.   I have a 4/2, 1450’ class c+ unit that has market rent at $4200.  Rents are close.  Do you think maintenance and cap ex is close?  Class c tenants in general are harder on properties than class a tenants.  More bathrooms, square footage, yard, hardscape, fence has more costs than less.   Now let’s do a further extreme of a 4/2, 1500’ unit in the rough part (class d) of Detroit.   I really do not know what such a unit would rent for, but my guess is $1509/month.   How would its maintenance, cap ex, turn over costs compare to my San Diego beach cottage?   I suspect the Detroit hood unit would have far higher maintenance and cap ex than the little beach cottage. 

I used to do a maintenance/cap ex spreadsheet on each unit.  I took the replacement cost divided by expected life span to get a monthly cost.  For example in my market we have special water heaters that cost a little extra.  Using my licensed plumber that does water heater replacements at a good price for my market it costs $1600 for a Rheem installed.   12.5 year life span equates to just over $125/year or just over $10/month.  This is one measly water heater.  I recently did a roof of a 1120’ unit with 2 car garage (I estimate 1500’ including garage).  The roof with facia repairs, a small underpayment repair, and installation of 2 wind vents was ~$11700.  If I use a 25 year lifespan then the monthly cost on this roof is ~$40/month.  When you do all items, the numbers add up to a large monthly expense   

So what did my spreadsheets show me?  It showed that maintenance/cap ex is higher than all the calculators default percentage would reflect and higher than I would have expected.  2/2 Condos with just interior is ~$300/month.  Attached studios are slightly higher.  Detached 2/1 is near $400.   Note the labor in my market is higher than the Midwest or south east, but not astronomically higher. 

overall I think your post reflected a reality that is not typically conveyed   

Best wishes

[David Lutz]

Quote from @V.G Jason:

If your debt is 8%, and you are paying it down that's your guaranteed rate of return. Using the question of if you have $1million in cash with $1million in loans at 8%, if you hedge 20% of your loan volume and that guaranteed rate is subpar from the other $800k invested. That's a great problem, right? That's why you deleverage some, basic portfolio management. However, I'd argue truly yielding over 8% isn't as common as people think going forward. 

The argument of the benefits of a locked in leveraged return is fine, but it is only as material as you are able to capture the appreciation-- sell or refinance-- so with that said, the better quality houses will likely prevail in a high(er) rate environment than in years past. And assuming everyone has a budget, the quality houses will likely dip into the quantity of houses you can pursue.  I would argue the route to increase portfolio value in 2024 is quality houses + buying asset-backed debt versus scaling in property count.  An example, I'd buy 7 higher quality houses at varying downpayments 25-40%, with 2 downpayments worth in debt funds versus 16-18 lower quality, 20% downpayment houses. In 2014, I'd argue the inverse, I'd take the latter. 

@V.G Jason I’ve been rereading some of the comments people have made, and yours was one of the more strategic. What makes you think better quality houses will likely prevail in a high(er) rate environment? I could see an argument that reduced affordability would cause the inverse.

I really like your idea of buying asset backed debt. Anywhere you’d recommend to go to learn more?

Your comments about down payment size in a hard vs soft market make complete sense. I view it as overall portfolio leverage instead of individual house, but it’s the same concept. When rates are high taking out more leverage starts to create a lot more operational risk.

There’s been a good discussion of house quality in the thread, but it has largely related to portfolio management over time, not the type of economic market. If you were going to put 25% down on one $600K home or on four $150K homes, why would you be more interested in low quality houses in a low interest rate environment? (removing the down payment variance since you could apply that change in approach to either option as rates go up)

Best,
David

[David Lutz]

@Jeremy H.

The title of the post was to grab eyeballs, a more accurate title would have been “myth of cashflow in the early years for OOS investors who are not handymen doing their own repairs on lower class properties” but that’s not nearly as catchy. You’re clearly right that long term you can cashflow huge amounts if you deleverage.

Why do you think $1000 per door as a minimum to use a PM is nonsense? Many PM have a minimum per door which you can hit if the rents are too low. And if you’re paying a $100 minimum on $800 rent, property management is suddenly costing 12.5%. There may be plenty of specific scenarios where rents hiring property managers for rents under $1000 per door works, but as a general guide I think it gets a lot harder to make the numbers work below that because repairs etc. become proportionally larger too.

In line with that, what part of my RE financial modeling did you think was poor? If there’s something I’ve missed I’d appreciate the heads up so I can fix it. 

All of the homes I bought were inspected, and I had a good sense that many of the issues I've had were coming. I just didn't know exactly when. That's part of why I was reserving 10% of the rent for repairs and another 10% for CapX. Unfortunately, I don't think everyone is as detailed and going so far as to request a photo of the water heater serial number so they can check the units age, and have unrealistic assumptions about their coming costs. That's the whole reason I created this post. The foundation issue got me a $17K credit on the purchase price of the house and was immediately addressed. One roof was storm damage and covered by insurance. The other roof had a partial roof repair 7 years prior my purchase, I knew was going to need attention within 5 years of buying, it just hit sooner than I expected. Fundamentally the point I was trying to get across in my original post wasn't about my due diligence, its that the cost of known and unknown repairs when you first acquire a REI is way higher than people seem to anticipate.

The way my tax person explained it is the 25K limit you’re talking about is the limit to losses you can claim per property per year, I haven’t hit that for any property individually so it works out. Also that aggregate losses can exceed 25K over multiple years and carry forward indefinitely to protect future “passive” income. If any RE CPA see this and that’s wrong please let me know. She did tell me I need to get licensed this year for some of the other benefits it would create.

Best,

David

[V.G Jason]

Quote from @David Lutz:

Quote from @V.G Jason:

If your debt is 8%, and you are paying it down that's your guaranteed rate of return. Using the question of if you have $1million in cash with $1million in loans at 8%, if you hedge 20% of your loan volume and that guaranteed rate is subpar from the other $800k invested. That's a great problem, right? That's why you deleverage some, basic portfolio management. However, I'd argue truly yielding over 8% isn't as common as people think going forward. 

The argument of the benefits of a locked in leveraged return is fine, but it is only as material as you are able to capture the appreciation-- sell or refinance-- so with that said, the better quality houses will likely prevail in a high(er) rate environment than in years past. And assuming everyone has a budget, the quality houses will likely dip into the quantity of houses you can pursue.  I would argue the route to increase portfolio value in 2024 is quality houses + buying asset-backed debt versus scaling in property count.  An example, I'd buy 7 higher quality houses at varying downpayments 25-40%, with 2 downpayments worth in debt funds versus 16-18 lower quality, 20% downpayment houses. In 2014, I'd argue the inverse, I'd take the latter. 

@V.G Jason I’ve been rereading some of the comments people have made, and yours was one of the more strategic. What makes you think better quality houses will likely prevail in a high(er) rate environment? I could see an argument that reduced affordability would cause the inverse.

I really like your idea of buying asset backed debt. Anywhere you’d recommend to go to learn more?

Your comments about down payment size in a hard vs soft market make complete sense. I view it as overall portfolio leverage instead of individual house, but it’s the same concept. When rates are high taking out more leverage starts to create a lot more operational risk.

There’s been a good discussion of house quality in the thread, but it has largely related to portfolio management over time, not the type of economic market. If you were going to put 25% down on one $600K home or on four $150K homes, why would you be more interested in low quality houses in a low interest rate environment? (removing the down payment variance since you could apply that change in approach to either option as rates go up)

Best,
David

 I appreciate the comments. Rather than toot my own horn, I'd tell you this forum can offer you some tremendous advice and guidance for free. No bootcamp, or paid guru, or what not can even provide. There's people on this forum if you knew their background, they'd be heavily pressured to do a Q&A or get on one of those podcasts with that thumb-looking guy I forget his name. Or even that other guy that's crashed his train syndication into the yesteryears of "investment" methods.

The reason I say better quality houses will prevail in a high(er) rate environment is for many reasons. For one, they'll attract better quality tenants, which makes vacancies, tenant turns, servicing your debt a lot more likely and less variance to when you go to lower or middle class tenants. That debt servicing rate is a lot more of a problem when the rate is higher, so you have to fully realize who you are renting to.  

Two, when I say better quality and less quantity you're going to now have to look at capex as something that is going to be devastating than times when money was cheap and people would heloc a house to cover capex, or take finance from the repair company. Devastating enough to where if you have quite a bit of capex to cover over a few houses, you may actually have to sell some houses rather than take 8-10% debt to finance the fixes. From a portfolio management perspective, that's terrible. 

Affordability is a fair point, but the underlying reason why it's not affordable is the same reason why you'll get rented. They can't afford to buy it, but you're one of the few available rentals. You're basically providing liquidity in a demanding market.  

You can buy asset-backed debt by being a private lender, or buying notes really. That's how I do it, the former I am a rookie on but got my hands a little dirty. 

As for the cheaper house during cheaper debt times, at some point when that debt is realized as cheap the asset is now the debt not the house. So I'm totally for maximizing the quantity of that. It'd be a completely different view of REI, but nonetheless a way to manage a portfolio.

[Sam Yin]

@V.G Jason Very nice. That was a great explanation. I think the insight into higher quality/prices assets is not discussed often enough. I see a lot of investors drawn to OOS investing for the potential higher cash flow. Some even argue they are able to buy in a Class A neighborhood in OOS. But that's still short sighted.

I totally agree on the way you described the higher quality assets as the one that people could not afford to buy, but you will have the inventory to rent. That would allow the better quality tenant to live in the area they correspond with and will likely give you much better stability based on their qualifications. Great post!

I would like to add that even in tertiary markets, there are locations/assets that meet this. However, it would be difficult to properly identify it from OOS.

[Basit Siddiqi]

Cash flow is not a myth.

If you properly budget for your expenses, including capital expenditures(Roof, HVAC, furnace, etc), then you can rely on the cash-flow.

People who say cash-flow is a myth are normally people who say things such as 'we had to pay for an unexpected roof'

[Dan Heuschele]

Quote from @David Lutz:

@Jeremy H.

The title of the post was to grab eyeballs, a more accurate title would have been “myth of cashflow in the early years for OOS investors who are not handymen doing their own repairs on lower class properties” but that’s not nearly as catchy. You’re clearly right that long term you can cashflow huge amounts if you deleverage.

Why do you think $1000 per door as a minimum to use a PM is nonsense? Many PM have a minimum per door which you can hit if the rents are too low. And if you’re paying a $100 minimum on $800 rent, property management is suddenly costing 12.5%. There may be plenty of specific scenarios where rents hiring property managers for rents under $1000 per door works, but as a general guide I think it gets a lot harder to make the numbers work below that because repairs etc. become proportionally larger too.

In line with that, what part of my RE financial modeling did you think was poor? If there’s something I’ve missed I’d appreciate the heads up so I can fix it. 

All of the homes I bought were inspected, and I had a good sense that many of the issues I've had were coming. I just didn't know exactly when. That's part of why I was reserving 10% of the rent for repairs and another 10% for CapX. Unfortunately, I don't think everyone is as detailed and going so far as to request a photo of the water heater serial number so they can check the units age, and have unrealistic assumptions about their coming costs. That's the whole reason I created this post. The foundation issue got me a $17K credit on the purchase price of the house and was immediately addressed. One roof was storm damage and covered by insurance. The other roof had a partial roof repair 7 years prior my purchase, I knew was going to need attention within 5 years of buying, it just hit sooner than I expected. Fundamentally the point I was trying to get across in my original post wasn't about my due diligence, its that the cost of known and unknown repairs when you first acquire a REI is way higher than people seem to anticipate.

The way my tax person explained it is the 25K limit you’re talking about is the limit to losses you can claim per property per year, I haven’t hit that for any property individually so it works out. Also that aggregate losses can exceed 25K over multiple years and carry forward indefinitely to protect future “passive” income. If any RE CPA see this and that’s wrong please let me know. She did tell me I need to get licensed this year for some of the other benefits it would create.

Best,

David

 >Why do you think $1000 per door as a minimum to use a PM is nonsense? Many PM have a minimum per door which you can hit if the rents are too low. And if you’re paying a $100 minimum on $800 rent, property management is suddenly costing 12.5%. There may be plenty of specific scenarios where rents hiring property managers for rents under $1000 per door works, but as a general guide I think it gets a lot harder to make the numbers work below that because repairs etc. become proportionally larger too.

If the rent is so low that PM minimums apply then in general 1) this is exactly the type of unit that requires PM specializing in those units.   Low demand, often lower class areas with lower class tenants.  Dealing with these units takes experience and is not easy.   The PM fees are justified 2) I question if such units make sense as an investment.  They clearly have poor historical rent growth so cash flow will be lucky to keep pace with inflation. They take more effort/expertise than a higher rent point units.  This is either your time and gain the experience the difficult way or you pay a PM a substantial part of the rent.  The maintenance/cap ex, not being a function of the rent but a function of the unit and tenant, will consume a significant portion of rent.  Owning residential RE is not passive even with the use of a PM. The profit must justify the work associated with being an asset manager of the residential unit.  I question if such a unit can meet most investor’s expectation for return.   How many of these units would be required to be life impacting in a positive way?

IMO if you are starting to invest in a unit that the rent is so low that it results in minimum PM fees being applied 1) it better be local 2) you should have experience in that class of property; at a minimum grew up in a similar area 3) better be hands on.  This implies that you investigate each maintenance report and evaluate if you can do the repair or need to call in a professional. 

You likely will need more than 30 such units for it to have a decent chance to be a benefit to your lifestyle. I recognize there are people on this forum Who have successfully accomplished this scale on these cheap rental Units. My view is there are easier ways to make life improving money.  

Best wishes

[Ganesh Krishnan]

Wanted to pop up in and thank everyone for such a great discussion. Special thanks to @David Lutz for taking the time to write such a thoughtful original post. Really appreciate it.

As a beginner, it helps me clarify my goals for real estate investing. In particular, I had similar thoughts to the OP about S&P stock market returns vs real estate and realized that it was the leverage in RE that makes all the difference. Will probably re-read this thread which has so many nuggets of wisdom as I formulate my plan.

[Diane Chapman]

Quote from @David Lutz:

Let me start by saying I am all in on RE. I have an MBA, spent years learning about RE before I pulled the trigger. And when I did, I bought 5 houses worth over $1M in 18 months with only $100K of my own money. So I feel pretty good about saying I am financially literate, know how to model, and to find deals purchasing out of state.

I’m also embarrassed to admit I was so focused on getting going that I just assumed I could track if I was doing well by watching my bank balance. That was dumb. To be fair, in addition to buying all those houses over the last 3 years I also dealt with an eviction, $47.4K in capital expenses, insurance claims, building teams in my local markets, and all the other nonsense involved in this lovely industry.

Anyway, I finally got around to putting together a complete general ledger and had the horrible realization that over the last two years (bank and credit card record limitation make it harder to go back farther)…

….. between 2022 and 2023 I have been $17.5K cash flow negative on $171K expected rent !!!!!

How the **** did that happen? I budgeted 21.2% of the expected rent toward vacancy, maintenance, and CapX, and in reality I ran at around 27% in the last two years. Also,.. why am I telling you? I figure that I’ve gotten so much from everyone at Bigger Pockets, and there is so little information on the hard numbers of how non-professional investors do, that I should give something back. Because most of the tools you have access to are a figment of imagination pushed by self-aggrandizing gurus and the Real Estate industry … because they only make money when you’re buying.

Again, let me stress I've made a lot of money over the last 3 years. I think you should buy real estate, I just want you to be smart. One of the major dangers is caused by the bizarre reality distortion field people have regarding the term cashflow. It seems like a lot of people use the term cashflow to refer to how much net income they average per month with no (or minimal) reserving or debt servicing. And the per door numbers sound huge, which is great but also meaningless. Because, reality check, if you think you're clearing $500 per month over 3 years ($18K) but you end up with one $5K Cap Ex cost, $4K in vacancy, and $3K in random maintenance then you're really only averaging $166 per month ($6K). And if you borrowed money for your downpayment from a HELOC, personal loan, cash out refi, 401K etc., then your hidden debt servicing can take your cashflow negative in a heartbeat. Rosy assumptions about how much free cash your real estate investment is going to throw off make it really easy to be unrealistic about what it's going to take to make owning rentals actually work.

So, 3 years into my Real Estate journey (5 with planning) I have some learnings I want to share:

• The default assumptions in every calculator you look at are rosy at best and complete lies at worst. Unless you buy a brand new house there is probably deferred maintenance. Your costs are going to be higher than you expect in the first few years. Plus, you’re not a professional. There is a high likelihood that you’re going to end up paying slightly more than you should for repairs, and turning houses when tenants leave is going to take longer than it should.
  • -- I’m sorry. I know you think you’re awesome. You’re not. Bleeding money that a pro wouldn’t is just going to happen. It’s better to anticipate it.
  • -- My recommendation is 25% of rent to cover vacancy, maintenance, and Cap X for older homes (+20 year), 20% for middle age (5 to 20), and 15% for new homes (you’ll need it eventually). I’m running hotter than that, but I honestly believe that I’ve caught up on deferred maintenance and these numbers are good for the long run.

• Have a plan for dealing with getting it wrong. I started with a $20K reserve. In addition to a strong W2, I have a HELOC to lean on. I stopped fed tax withholdings because the penalty is cheaper than borrowing cash, which buys a year (I still pay my taxes in full). In a pinch I can borrow against my 401K. And if things ever went truly sideways I could sell a house.

• Leverage is awesome. I borrowed 90% of the money for the homes I purchased at an average of ~4% interest. But the higher your leverage, the more likely you’re going to be cashflow negative. You’re going to make more money with more leverage, but only if you can handle the debt service. Don’t overextend yourself.

• As insane as it sounds, going all in actually helped. The rent from 4 houses covered the mortgage for 5 over the last 18 months I’ve been dealing with an appealed eviction and the court collecting and holding the rent.

• Everything I bought rented for 1% to 0.65% of the initial purchase price (more now). And the 1% has been the biggest headache. So if you go for cashflow you better be on premises, because there are going to be issue to deal with. And if you go for appreciation/quality houses you need to have a plan for dealing with weak cashflow.

• For pity sake don’t turn on water service on a Friday. My buddy and I have both ended up with minorly flooded houses despite the property managers telling us that all the taps had been turned off.

• If you’re buying out of state, ask potential property managers if they have local staff on site or if they outsource their inspections to a vendor (common for larger PM companies).

• When I model returns, I assume appreciation on B-/C+ properties at 1% above inflation. I did a lot of research, long term that’s a safe assumption. Rent I assume tracks with inflation (which is still great because a lot of your costs are fixed). This is probably a bit conservative, but I think it’s generally accurate, and I only like good surprises.

• You have to be able to get +$1000 per door to use a property manager, less than that and the minimums they charge start screwing up your returns.

• Water heaters, etc. cost roughly the same everywhere - it’s closer to a fixed cost. Buy where taxes are low on rental properties, populations are growing, economies are growing, and there are at least two of the following: Gov spend, Major healthcare, transportation hubs, universities, sports teams, industry concentration, tourism, manufacturing. These drive jobs, the more there are where you buy the better and more stable your investment.
  • -- If you’re as nuts as I am read the local area development plans and research planned corporate and other investments. Building an amazon hub and a zoo to the east of the city along with a new planned transit rail line? Awesome.

• Offer what you have and ask for help (preferably in that order). I did some financial modeling for an RE Agent I wanted to build a relationship with, and a year later he gave me some great recommendations on local tradespeople. During a friendly conversation I asked one of my property managers for recommendations on areas with the most growth potential and ended up buying two homes there.

• LLC get expensive if you're thinking of opening one for every property, plus it's a lot of work to make sure they can't be pierced. Consider just getting an umbrella insurance policy.

• Interest only HELOC are only just interest until you hit the repayment period, so make sure you're ready for the increase when you start paying back principal. Also, some lenders have limits on how many mortgages you can have and qualify for a HELOC. So if you think you might want one, set it up early.

• Current taxes on the property you buy generally lag current market value, and in some cases taxes on rental properties are higher than owner occupied. That’s all going to get corrected when your purchase triggers a reappraisal. So put together some realistic tax estimates before you buy.
  • -- All the info you need is available online from the local assessor, and pay attention to what the local community has tacked on to the mill rate. Taxes for two houses twenty minutes apart can be wildly different.

Major costs over last 3 years on 5 homes:

• $10K in missed rent leading to and waiting for eviction
• $3K Eviction costs (lawyers, travel, writ, etc.)
• $2.5K additional lost rent due to 4 month instead of 2 month property turn
• $3.8K for a new furnace
• $7.4K for a new HVAC
• $700 for a bathroom re-pipe
• $12K turn on large home, included new high quality carpet and full repaint
• $5.5K in unnecessary plumbing issues caused by tenant in eviction (no way to recover costs)
• $1.5K in utility bills during vacancy or owner responsibilities
• $900 for a refrigerator
• $4.8K for concrete piers to shore up a foundation
• $5.6K for a roof (insurance claim)
• $5.2K for another roof
• $1.3K for new AC line set (punctured in second roof replacement)
• $1.6 for a water heater
• $1.3 for a water heater
• $2K for a water heater
• $1.7K for new water line from meter to house
• … this actually isn’t everything but I’m getting depressed.

That’s $70.8K which was money that never made it to me, I didn’t expect to spend, or thought I had more time. And this is separate from regular maintenance my property management companies took care of and deducted from the rental income.

So the moral here is that RE is great but you can’t depend on cashflow. If you buy class C or D properties you are going to have way more issues than you can ever anticipate on paper. And if you buy class A or B you’re banking on appreciation. Either way, buy and hold is a long term play and it’s not going to throw off lots of cash in the short term. I’m guessing my year 4 is going to be pretty good, but it’s taken that long to get everything stabilized.

And If I decide to pull equity out to buy more houses, it extends this issue. I would end up with cash to buy more houses, but my monthly debt load goes up and cashflow goes down. So dream of equity and forget about cashflow,... its just a myth.

* These are just my personal beliefs based on my experience. If you hadn’t guessed I am not a RE professional (you probably aren’t either), and that’s kind of my point. I think it’s way too easy to over estimate investment performance based on how well the pro’s do. So don’t take any of my opinions as anything more than that. Make sure you do your own due diligence on your own deals.

**and if you find this info useful vote the post up. I'd like for folks to be able to find this kind of detailed info more easily.

[Diane Chapman]

WoW! What an education you just gave me\us! Thanks for sharing!