Do I have my math right?

Question

Hey guys. I am kind of an Excel nerd and spent some time putting together a cash flow model for passive (with a property manager) rental properties. Can you guys please review my math and let me know if there are any "blatantly wrong" assumptions or missing big-ticket line items? The numbers below assume a cash purchase. I know a lot of my assumptions are conservative. Thanks!

Vik

Scott Snider · Answer

Regarding the expense assumption, I would consider an ideal passive management model to include a landlord insurance or maintenance insurance policy which would significantly reduce your exposure to risk.  Maintenance is a fluctuating variable, but there are indeed favorable hedges offered at reasonable rates well below 50% of net.

Michael Evans · Answer

@Jon Holdman: I understand the 50% rule doesn't include debt, that's why I don't subscribe to it.  I  would never own a buy and hold property where non-debt costs were 50% of gross rents.  But I guess that's why we don't "rent", we use long term leases.  A buy and hold property we would buy with an ARV of $100K "leases" for about $1,300 per month.  Our non-debt costs are as follows:

• Insurance: $42/month
• Property Taxes: $125/month
• Property Management Fee: $150/monthIncludes renter insurance for tenant, home warranty for appliances, weekly external visual inspection, quarterly internal inspection with tenant, annual maintenance of property's systems (HVAC, flooring, etc.) and some for CAPEX
• Includes renter insurance for tenant, home warranty for appliances, weekly external visual inspection, quarterly internal inspection with tenant, annual maintenance of property's systems (HVAC, flooring, etc.) and some for CAPEX

• Includes renter insurance for tenant, home warranty for appliances, weekly external visual inspection, quarterly internal inspection with tenant, annual maintenance of property's systems (HVAC, flooring, etc.) and some for CAPEX

Total monthly non-debt costs = $317 which is 24% of the gross monthly rent.  Through our long term lease-purchase program, we don't have to worry about vacancy rates because the tenant puts down a large non-refundable deposit towards the purchase of the property.  If they terminate the lease, the purchase option also terminates.

We believe in managing and shifting risk in order to properly use leverage to produce above-average Return on Investments.  We are going to change the way people buy houses in America.

Jon Holdman · Answer

@Vik C. the 50% rule of thumb already includes vacancy, so you're double deducting that.

@Michael Evans wrote:

The 50% rule doesn't include debt service.  It applies regardless of whether the property is financed or a cash purchase.

@William Hochstedler wrote:

I agree, with a caveat.  You do what to identify anything that's going to make your property WORSE than 50%.  If you start slicing and dicing its really tempting to make each slice a little thinner.  If you end up with total expenses at 30% with all the slicing, you've sliced too thin or left something out.

The 50% rule is simply a number that's supported by long term data for large numbers of rentals.  Any particular property in any particular year can vary a lot.  It can be somewhat better if you keep it filled and have only taxes and insurance.  OTOH, if you have some major incident, your actuals for a property could be well over 100%.

A big chunk of the 50% is property management.  Around here PM's typically charge 10% of collected rents plus half a month to fill a vacancy.  With one vacancy per year that's a total of 14% of your gross rents.  If you self manage you can earn that cut for yourself.

William Hochstedler · Answer

The 50% rule is a quick and dirty method to see if the property is even worth analyzing (and includes vacancies).

If you're breaking out Excel, you probably want to be more granular.  Try the FilePlace (http://www.biggerpockets.com/files) for some templates with more detail.

Also, as @Jerry W. mentioned, tax benefits are not included in cap rate calculations as the cap rate is a way to compare apples to apples.  Essentially it describes how much income a property produces assuming an all-cash purchase.  Cost basis, depreciation cycle, etc depends on the buyer--not the property--so is not included in that calculation which is better described as after-tax cash flow.

Also, check with an accountant familiar with your target area regarding % of improvements to value for depreciation.

Cheers,

Wm

Elizabeth Colegrove · Answer

@Vik C.

Looks like you are a financial analyst at heart like myself. I know you want to be "hands" off but I wasn't able to find anyone when I tried that 3 years ago. If you have been around this site at all you would have seen the "negative" reviews. Therefore I recommend you find a good pm.

Personally I have gone a different route. I also like the passive income and work full time but I don't mind limited contact. therefore I buy high end houses in my area and self manage. Yes it is some work but honestly I have great control, no middle man (which is work) and the areas tend to be appreciating since they are higher end. Plus I get more towards the 12% returns based on leverage.

Just food for thought.

Jerry W. · Answer

@Vik C.  welcome to Bigger pockets.  I have never heard of taking out your taxes before figuring income.  I would also expect your rent to be higher for a $100K property, but the nicer area usually the better appreciation is and the lower rent is.  A huge amount also depends on the area, some areas have high rent some have low, etc.  You might try looking mat an area and look up sales prices and rents just to get an idea of an actual application.

Arlan Potter · Answer

it depends on the area but, on my cheap properties I have the land at a nominal value. Very little, in fact empty lots virtually have no real value.

Vik C. · Answer

Thanks Michael, I appreciate the feedback. I am pretty sure that both the rental income and expense assumptions are conservative, but I prefer to err on the conservative side. Seems a lot of people assume they can make 15-20% a year on passive real estate, but I would be happy with 5-8% given I am looking at a turnkey or property-managed approach. Want to make this as passive as possible and am more than willing to pay a premium for that.

Michael Evans · Answer

Your math looks right but I think that your assumptions are slightly off.  That's a pretty low monthly rental amount for $100,000 property (0.8% of the purchase price).  I also don't subscribe to the 50% rule for expenses if you're paying all cash, which I would never pay all cash for property anyway. Those are just some of my thoughts.

God Bless You!