am i missing something?

Question

ok im about to make an offer on a duplex. My cost i going to be $93,000. My mortgage is going to be $758 a month, and my two units are occupied at $450 on each side. This is below the little cul-de-sac. So we got positive cash flow of $150 a month. I'm going to fix the carpet or get an allowance in the deal for new carpet ( actually want laminate, 50 year warranty and don't have to replace every other tenant) and raise the rents to about $500-550 a month.

You guys keep talking about some type of formulas your using. Please tell me what I'm missing. I am new to rental type stuff please excuse my ignorance.

I hope I have a good deal going to work out. i submit my offer tomorrow. If any can get to me in time by monday before I make my offer, what am I supposed to get from the seller.

Michael Rossi · Answer

buyandtry, Unfortunately, that math only works in guru fantasyland! In the real world, operating expenses run 45% to 50% of gross rents. Then, with what's left, you subtract the mortgage payment to find the cash flow. In this case, you would be LOSING about $308 per month. OUCH! I would strongly suggest that you don't make an offer on anything until you understand the business. The truth is that the vast majority of newbies fail in a short period of time because they don't understand cash flow issues and they don't understand how to properly deal with tenants. Good Luck, Mike

Account Closed · Answer

I think Flipper now gets the point about true expenses. I also think there was some misunderstanding above. The way I read it is his father purchased and received $450/m when he started. Later, after 10 years of rent increases, the units were producing $1,100 a month. Hence the property was no way near 2% at the start while the property did finish at over 2% after 10 years. Likely some serious negative cash flow for the early years with some tax benefits if the person has a day job. Later the properties were producing income. Having lived and worked in the area I will speculate that these were likely rented to higher quality students (graduates and others) as there is a big demand in the area. It might have been good screening or great luck that kept down the maintenance and damage. John Corey

MATT WARDEN · Answer

Did you read MikeOH's post? He made a pretty good argument. The 50% is intended to be the conservative end of an interval within which the true average operating expense lies. If you go with this value and it's wrong, the worst that will happen is that you will have greater than expected cash flow. I'm okay with that problem. REI is an investment strategy where each investment has a potentially high opportunity cost. That is, you can only make so many investments in a given amount of time. If you execute on a deal, that means the number of deals you can execute on in the near future goes down by one. Given that you can execute on so few deals, why would you want to be anything but extremely conservative? You do not really run the risk of "missing deals", because as a newbie rental property investor you can probably only execute on 1-3 per year anyway. And with each one of your deals, the financing likely becomes and more expensive*. Why would you want to be anything but extremely patient, extremely discriminatory, and extremely conservative? Yes, action is great, but not if it's action on a mediocre deal that will keep you from executing on the real deal. *Of course, there are always exceptions, like if you have a good relationship with a smaller bank and can show a strong business plan with high, steady cash flow (which won't happen if you underestimate OE!).

Nick Rubino · Answer

wow my thread got jacked pretty good here. Still trying to figure out how these numbers are supposed to work. How do I come to this computation of 40 to 50%?

MATT WARDEN · Answer

Your post suggests that your rental property will cash flow even when the numbers say it won't, because: [x] You think cash flow is anything left over after the mortgage payment [ ] Your market is different [x] You expect costs to be lower than established estimates from experienced investors [ ] Your seller/realtor/wholesaler/mother/dentist said it was a good deal [ ] You are banking on appreciation/tax benefits/accidental rent overpayment/lottery [ ] You are planning on making a large down payment [ ] You are willing to take a loss now for tenant-subsidized mortgage paydown [ ] You learned a new technique and it only cost you $2k to learn from guru #593557 You are wrong. This property will not cash flow and you will lose a lot of your hard-earned money. Here is why you are wrong. (One or more of the following reasons may apply to your particular "deal", and it may have many other flaws not covered here.) [ ] Your market doesn't change the numbers [ ] You are ignoring or underestimating initial repair and maintenance costs [x] You are ignoring or underestimating eviction costs [x] You are ignoring or underestimating vacancy costs [x] You are ignoring or underestimating office supply and advertising costs [x] You are ignoring or underestimating asset protection costs [x] You are ignoring or underestimating ongoing legal counsel and lawsuit defense costs [ ] You are not factoring in the opportunity cost of your downpayment Also, the following issues may also apply: [ ] You don't like dealing with tenants [ ] You are investing in property out of state [ ] You believe you can use rents to reduce holding costs of a flip property without consequence I suggest the following: [x] Buy more realistic books on rental properties [x] Walk away from this deal [ ] Do more homework on this property before proceeding [ ] Sell all your current properties [ ] Quit investing in real estate

Michael Rossi · Answer

Flipper, I don't think your father is senile or lying to you. However, like a lot of small landlords, I don't think he understands what the expenses are or has a lot of expenses that he is just paying out of his pocket. Management typically runs 10% and maintenance is often another 10%. There's your 20%. Now, what about taxes, insurance, advertising, captial expenses, vacancies, damage done by the tenants, evictions, lawsuits, office supplies, etc, etc, etc. Are you somehow exempt from all these additional expenses. If so, let me know where you live and I'LL MOVE THERE TOMORROW!!! It's not a mute point, that is the point. Your father did it right and he was successful. Buy your rentals with gross rents at 2% of the purchase price as he did and you should be successful also! Good Luck, Mike

Nick Rubino · Answer

thanks for all the good replies, could you please further explain the 308 a month in expnses? Im at 757 or so with taxes and insurance. I'm not understanding that 40-50% number. Right now i would figure it's pretty turn key and I have had solid tenants for 3 years now and don't seem like they're going anywhere. I'm in a military town so someone will always be renting, I mean we're getting 38k people in the next 2 years. I've pulled the comps in the neighborhood and it seems like this one is the nicest and cheaper than others. The current owner as far as I can tell is out of state so they just want to get rid of it for some reason. I work with a trusted agent who is a friend of mine and he is working as the buyer/sellers agent on this one and he said that they haven't mentioned any reason why they are getting rid of it. He also said he gets called on it every other day. all that means nothing though if the numbers don't crunch correctly. I will also ask about the roof. seriously though, i really thank you all for looking and replying. I'm 21 and don't want to screw my self this early on in life. all cash-happy anniversary. thats a lot of experience you have.

Michael Rossi · Answer

Flipper01, If your father bought the properties for an average of $50K each and was getting $1,000 per month for rent, then he was getting 2% of the purchase price in rent. THAT IS THE REASON HE MADE MONEY. You clearly need to do some more study on operating expenses. Operating expenses do NOT only run 20% of the gross rents. That is ridiculous and can not be backed up with the facts. Even if you do all the management and maintenance yourself, operating expenses run more than 20%. Yes, and that tells me he had a very small portfolio. Is it possible to be lucky with very few rentals over a relatively short period of time? Yes. Is that the norm? No. He could have just as easily been unlucky and lost his shirt - EXCEPT FOR THE FACT THAT HE BOUGHT RIGHT. If you can find properties like your father for $50K and get $1,000 per month in rent, you should do fine also. He was smart and did it right!!! Buyandtry, The $308 was not expenses, the $308 was the monthly LOSS that you can expect on the property. Operating expenses include taxes, insurance, management, maintenance, vacancy allowance, entity maintenance, legal fees, evictions, court costs, advertising expenses, lawsuits, office supplies, damage done by the tenants (above the deposit) and capital expenses (which are included in the 45% to 50% number but are not technically operating expenses) etc, etc, etc (all the things that happen in the real world). Mike

Frank Adams · Answer

buyandtry; Do NOT do this deal! You sound like a lot of newer people who have been looking and finally find something that "looks OK". This is a sure-fire loser. Ask yourself the following; 1. If the units would support $500-$550, why wouldn't the CURRENT owner have already raised rent? Investment property sales price is based on RENT MULTIPLE, at least when bought and sold by KNOWLEDGEABLE PROS. By raising the rent, the seller would automatically raised his sales price, to a knowledgeable buyer. Instead he kept it at $450 hoping to find a newbie who thought $150/month was "good cash flow". 2. $900-$758 = $142, not $150. But $150 sounds better to someone trying to rationalize how good this deal is. 3. I'm guessing that number covers PITI. How much allowance do you have for; vacancy (which you will have as soon as you announce a 10-20% rent increase), major repairs-you don't mention the age of the roof, HVAC, any appliances, trust me, flooring is a small ticket item comparatively. 4. NOTHING lasts 50 years! I don't care what their ad says. Besides, laminate floors make "most" units look more "down market" than carpet, except in kitchens and baths where I always use ceramic tile. Please spend some time reading the archives here, pay particular attention to all the posts from people who thought a "skinny" deal was OK because it was a way to "get their feet wet", get started, get in the game etc. BTW, I pay CASH for all my deals, do my own repairs, except A/C (I can trouble shoot and repair that except for the "sealed-freon" bits) and I wouldn't bother to answer an ad on a deal like this. I've been doing this 29 years this month! all cash