WHO has a crystal ball?

Question

Hello BP!

Where to go from here? (Does anyone have a crystal ball?) haha

I've been reading and reading, I'm just not sure where to go from here. Any input would be GREATLY appreciated

I currently rent two of my properties out and live in another. I have two mortgages and one paid off (which I have a line out on). The home with a line out (has a small balance on), I was going to do a cash out refinance to put some money back in my pocket and move to the next.

Both rentals have a positive cash flow of $1k average per month. Where I live will soon be rented out also for a positive cash flow of $850/ month.

I was going to rent a house for cheap and build up more capital. I've been thinking like this because I've only been a landlord for about a year now. I'm not sure if I can purchase another home and continue to grow.  Has anyone had this issue, or am I over thinking this too much?

Thanks for any input!

Jon Holdman · Answer

I don't try to slice this onion too thin.  If you break out each item its really, really easy to say "that's too much, I'll trim that" and then you're down to 30% of rents.

Even brand new roofs and furnaces need replacement someday.   If you're in this for the long haul, you have to budget for that.

I've had $300 service bills on a furnace that was only a few years old.

Its impossible to predict when your tenant will bug out and leave you with a bunch of damage.  Or even worse, doesn't bug out and drags you through a lengthy and expensive eviction.

When doing an evaluation I simply look at the 50% number and use that.  I know that some years might be better, though its impossible to avoid taxes and insurance.  And I know some years, like last year on this one rental, will be really bad.  That sewer line alone was over 50% of the gross rents for that property last year.

My goal is six months rent for reserves.  Perhaps that's high given the high rent places you have.

Do realize the 50% number include property management.  That's usually at least 10% of rents, maybe more if the PM charges to fill vacancies.  If you do that job yourself, you can earn the PM's cut.

Jon Holdman · Answer

I call that "phony cash flow".  It IS NOT your true cash flow.  Banks would estimate your net rental income at $2600 * 75% less the payment.  That's $350 a month.  I even think that's on the optimistic side and I believe it assumes you're self managing.  A better rule of thumb is that 50% of gross rents will go to expenses, capital and vacancy.  That's $1300 in the example. Then you subtract your P&I payment (taxes and insurance are in the 50%).  I'm not sure how much that is in your examples.

The $1000 from this rental is your absolute best case.  Some months you'll get that.  Other months you'll have a vacancy or some big expense (like my $6200 sewer line last summer.)  If you want to scale up your business, you have to budget for these on an ongoing basis.  If you have 20 rentals and roofs last 20 years in your area, you'll be replacing a roof every year, for example.

In your case I'd consider "adequate reserves" to be about $40,000.  The bare minimum banks are going to want to see ask you scale up would be about $20,000 plus six months PITI on a new loan.  I'm assuming you're very quickly looking for loans 5-10 if you're doing conventional.  You have three mortgaged properties currently, so reserves four number 4 will be less, but number 5 will be six months PITI on all properties.

Julian G. · Answer

@Jon Holdman

I appreciate the kick in the as*, this made me realize I should factor a larger portion of my proceeds to the "UN-expected".

I have to agree, some years you do have it great and some you dish out a TON of money. I was lucky this year, on that property I dished out $384.xx in repairs!

Kevin Pfeiffer · Answer

@Jon Holdman you are one of my favorites on here !  Way to make sure there is no "frosting" on it !!  LMAO !

@Julian G. Not picking on you just loved Jon's reply !  Keep going, don't stop !

Julian G. · Answer

@Jon Holdman

I've read over and over this:

http://www.biggerpockets.com/renewsblog/2010/06/30/introduction-to-real-estate-analysis-investing/

It shows my cash flow to be $10,150/ yr.

Albeit that I only used $1,000/yr for maintenance, I do have a new roof (3 years old) And a new furnace (2 years old). Maybe I went too low on my estimate?

I should increase this maintenance number? Is there a better formula to use also?

Thanks for taking time to respond to a newbie. ( I should have put the "Newbie" part in the title, haha)

Julian G. · Answer

@Jon Holdman

Great info, then using that 50% rule of thumb. My cash flow would be $338 a month.

I think I am still naive to a point as to what exactly is my cash flow and not my phony cash flow (I like that one!). I have many spreadsheets spelled out with my EXACTS on everything..

I do have the reserves you speak of thankfully. Good thing I have been gun-shy on getting a new place!

@Jon Holdman now I feel that I am in a different position then before..hmm

Julian G. · Answer

@Travis Sperr thanks for the reply.

I do have reserves set aside. I like to make sure I can cover all of them for at least a year. (overkill I know). It makes me feel better. I will be dipping into it soon to some much needed work soon.

Travis Sperr · Answer

I tend to agree with @Jon Holdman but in any case, I was in a similar position just a few years ago. The fist thing I would recommend is to build up and set aside ample reserves to handle any challenges with the current properties and really focus on what your monthly net cash flows are for planning and analyzing.

From there, assuming it makes sense in your area, keep buying great deals to increase monthly cashflows of your portfolio.

Julian G. · Answer

Thanks for the reply!

Rent is $2600 on one and payment is $1600.

Rent $2000 on one and payment is $550.

Rent is $2500 and payment is $1556.

Jon Holdman · Answer

Postivie cash flow of $1000 per month for a rental is truly incredible.  As in, I seriously think you're underestimating your expenses.  What's the rent and what's the P&I payment on these properties.

I ask because a long term plan for growing a portfolio must account for realistic expense.  One year with two properties is unlikely to be a good sample.

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