45% expenses ??

[Seth Mosley]

Hey all. Writing about the john reed article that was posted on here a bit ago, talking about how most investor's deals they say are good are actually not at all, because according to him, every property over time averages around 45% of the gross income on operating expenses - then you have the principle and interest. If I go off of his point, I might only have 4 out of my 7 rental properties cash flowing, and I probably wouldn't buy much of anything that came my way. Just curious, does anyone else out there base their investments off this rule? And if so, I should probably sell my 3 properties that don't meet this rule?

[Shane Pearlman]

hey @Seth Mosley - that is a super solid question, and I just went through that thought process myself recently!

On Metric Guidelines

Your rental properties / business is a vehicle for the life you are trying to create. The property type, location, deal structure, debt and management style all come together to create a specific set of outcomes. So let me ask you, why do you own these properties, and what are you hoping this will accomplish for you and your family? How involved do you want to be? Do you need cash today, or is this asset building for 3 decades in the future? Has your game plan changed since you bought them?

I see all these rules floating around on BP. They are helpful in some cases, and not in others. I find the more experience I get, the less I pay attention to broad stroke rules and the more I focus on analyzing deals carefully and structuring them to fit my personal goals and lifestyle requirements.

Why I Sold / Traded Up

We 1031 exchanged two properties in the last 14 months.

The first one was a pain in the *** to manage. It was my most profitable property at that point, but in a C neighborhood and the headache involved just wasn't worth it. I had to deal with my house being turned into a marijuana farm, people loosing jobs and going through a lot of apps to find tenants I was happy with. I was sick of it. I had enough equity in the property to reposition it into a 4-plex in a b+ class neighborhood with enough cashflow to pay for a PM and still give me the same monthly income. While on paper, the 4 plex didn't look as attractive as I had to put more capital in, lifestyle wise, I now have a newer, better asset in a higher appreciating area with no need for my day to day involvement. The neighborhood was also clearly in the path of progress and I have seen a year of ridiculous rent growth (1k / month increase since purchasing it).

The second property we traded a few months back when my tenants approached me with an offer to buy. I hadn't really planned to sell, but they made a solid offer. We had forced as much equity as I think we could into the home with the remodel, and repositioning the cash into a larger deal with more upside was appealing. I knew the property was due for a new roof, and this would let me use that equity in a new property rather than in the current one. I did the market analysis and saw a handful of apartments I would be happy to own in Seattle (my second market). My partners were interested in participating, so that gave us the opportunity to reach the next rung. The 1031 timelines can be tough, and as such I ended up having to get creative and bought a brand new 4-plex. It wasn't the apartment I was looking for, but time disappeared and it was the best deal I was able to lock in place. The new 4-plex is a good step up from the SFR I sold, but I'm still looking to do my first apartment.

Sometimes you reposition for profits, sometimes for equity, sometimes for lifestyle. Consider the 1031 carefully, as it is an epic vehicle and if the right deal is there you can really score, and if it isn't you settle or worst case, loose out. The key is to be strategic and have a clear set of goals for both your real estate business and your personal lifestyle.

On Cashflow & CapEx

You have owned these properties for a while. You know what your actual cash flow is. The only mystery is future capex, and you can do a reserve study to get a sense. If you have never done one it is pretty easy. List all your large expense items (roof, siding, HVAC, kitchen appliances....), when they were installed, what their reasonable working life is, what it costs to replace them and then do the math. It will give you an averaged annual number. Add that to your regular maintenance costs and you will have a better sense of your long term cashflow.

On Cashflow Vs Equity

Some of the largest growth in my net worth comes from forcing equity (fixer upper) & appreciation. While I would never tolerate negative cashflow, if you have bought in a market like the SF bay area that has strong appreciation cycles, your perception on minimum necessary cashflow profits might differ. I don't need 20%CoC like some of the midwestern folks. I need 2-5% minimum as that still beats what I get in my savings account, and then I get to build equity with the application of careful timing.

Good Luck and let us know what you decide.