Strategies and Philosophies: Multi-part question
Real Estate Investor · Covington, LA · Member since 2010 · 43 posts · 14 votes
Strategies and Philosophies: Multi-part question
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Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
15y1) The 50% taken for "expenses" is really operating expenses (as defined by the IRS), vacancy (actual or economic), and capital (big expenses like roof or furnaces that must be depreciated on your tax return.) Economic vacancy refers to discounts and incentives you give to tenants. The 50% that's left is your NOI - net operating income. From that you have to pay the note (just the P&I part, not taxes and insurance) and collect your cash flow.
2) IRS Form E would be a good starting point.
3) You just have to find a good deal. Simply said, hard to do. Nearly impossible in many areas. Very difficult in the Denver area. Fairly simple in some areas. Search around in the lower priced areas near you and you may find an area that works. Prices vary much more than rents, so having established the rents for your area, you need to find cheap enough properties to work with that rent.
4) Don't forget your down payment. In the analysis I write, I consider this two different ways. One is to assume 100% financing, even if you can't get it. The cash flow with 100% financing is, to my way of thinking, the cash flow from the property. If you then put in a down payment, and the cash flow is higher, that's the cash flow from your down payment. A second method is to compute cash on cash. Put in the down payment and compute cash flow. Divide by the total cash invested. If that's 2%, its not interesting. If its 25%, its very interesting. You have to compare that cash flow to other opportunities for your money. For example, if you have a wad of cash you could be making hard money loans, either by yourself or with a group. That will produce something like 10-14% returns. If rentals produce 8%, you're giving up some of your returns, presumably for the chance for appreciation.
5) You can reduce the actual cash expenses by doing some of the work yourself. In particular, property management and maintenance. A lot of maintenance is minor stuff and is caused by the tenants. Most of the time management doesn't involve anything more than chasing the rent. For those two items you can earn about 15% of the gross rents back for yourself. You will be earning that money, and if you have 50 units, it will keep you hopping. But it is a way to increase your cash flow.
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- Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes15y
1) The 50% taken for "expenses" is really operating expenses (as defined by the IRS), vacancy (actual or economic), and capital (big expenses like roof or furnaces that must be depreciated on your tax return.) Economic vacancy refers to discounts and incentives you give to tenants. The 50% that's left is your NOI - net operating income. From that you have to pay the note (just the P&I part, not taxes and insurance) and collect your cash flow.
2) IRS Form E would be a good starting point.
3) You just have to find a good deal. Simply said, hard to do. Nearly impossible in many areas. Very difficult in the Denver area. Fairly simple in some areas. Search around in the lower priced areas near you and you may find an area that works. Prices vary much more than rents, so having established the rents for your area, you need to find cheap enough properties to work with that rent.
4) Don't forget your down payment. In the analysis I write, I consider this two different ways. One is to assume 100% financing, even if you can't get it. The cash flow with 100% financing is, to my way of thinking, the cash flow from the property. If you then put in a down payment, and the cash flow is higher, that's the cash flow from your down payment. A second method is to compute cash on cash. Put in the down payment and compute cash flow. Divide by the total cash invested. If that's 2%, its not interesting. If its 25%, its very interesting. You have to compare that cash flow to other opportunities for your money. For example, if you have a wad of cash you could be making hard money loans, either by yourself or with a group. That will produce something like 10-14% returns. If rentals produce 8%, you're giving up some of your returns, presumably for the chance for appreciation.
5) You can reduce the actual cash expenses by doing some of the work yourself. In particular, property management and maintenance. A lot of maintenance is minor stuff and is caused by the tenants. Most of the time management doesn't involve anything more than chasing the rent. For those two items you can earn about 15% of the gross rents back for yourself. You will be earning that money, and if you have 50 units, it will keep you hopping. But it is a way to increase your cash flow.
- Real Estate Investor · Covington, LA · Member since 2010 · 43 posts · 14 votes15y
Originally posted by Jon Holdman:
1) The 50% taken for "expenses" is really operating expenses (as defined by the IRS), vacancy (actual or economic), and capital (big expenses like roof or furnaces that must be depreciated on your tax return.) Economic vacancy refers to discounts and incentives you give to tenants. The 50% that's left is your NOI - net operating income. From that you have to pay the note (just the P&I part, not taxes and insurance) and collect your cash flow.4) Don't forget your down payment. In the analysis I write, I consider this two different ways. One is to assume 100% financing, even if you can't get it. The cash flow with 100% financing is, to my way of thinking, the cash flow from the property. If you then put in a down payment, and the cash flow is higher, that's the cash flow from your down payment. A second method is to compute cash on cash. Put in the down payment and compute cash flow. Divide by the total cash invested. If that's 2%, its not interesting. If its 25%, its very interesting. You have to compare that cash flow to other opportunities for your money. For example, if you have a wad of cash you could be making hard money loans, either by yourself or with a group. That will produce something like 10-14% returns. If rentals produce 8%, you're giving up some of your returns, presumably for the chance for appreciation.
Thanks, Jon. I always enjoy your responses.
Your 2, 3, and 5 responses I understand; however, 1 and 4 I do not fully understand. I think I need to see some examples laid out. We'll use this hypothetically as a learning tool.
The last FSBO I looked at, he was asking $45,000. Retail rates for the home are about $48,000(ARV). He easily came down to $41,000 on the phone. Let's assume we paid an even $40,000 for the simple 2/1, 680 sqft home in the heart of town.
He currently has it rented out for $625. Assuming a bank loan at 5% interest for 15 years, the virtual calculator I used spit out $358 which approximated tax and insurance.
Make up the numbers where needed, but anyone who can give me an analytical break down would be great. I enjoy reading the different approaches as well.
Have at it!
- Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes15y
OK, here my analysis of your example:
Price: $40,000
Down: 20%, $8,000
Costs: $1,600
Rehab: $0
Cash invested: $9,600
Loan: $32,000
Payment: $235.05 (P&I only)Rent: $625
Expenses, vacancy, capital: $312.50 (50% rule)
NOI: $312.50
Cash flow: $59.45 ($312.50 - $245.05)
Annual cash flow: $713.35
Cash on cash return: 7.4% ($713.35 / $9,600)Forget using a "virtual calculator". Use Excel. (Open Office is free if you don't have Excel, http://www.openoffice.org/, yes, related to my day job). Payments should be calculated with just the payment function, PMT in Excel or OpenOffice. Or, at least use a financial calculator.
Yes, there are all sorts of spreadsheets around the break down that 50% number into vacancy, property management, maintenance, taxes, insurance, legal, cpa, eviction costs, make ready, etc., etc., etc. That gives you a lot of numbers to guess rather than just the one 50% number. Don't do it. You'll tweak those numbers to the point where you make a crummy deal look good.
If you're really willing to manage it and fix it yourself and work for free, you could make that 50% number something more like 35%. Property management is expensive, and a lot of repairs are quite minor. I've spent a couple of hours, for example, swapping out a sink faucet. Cost, other than time? Zero. Home Depot gave me a new faucet under its lifetime warranty. A plumber would have charged me for a faucet and labor and this could have easily been $200. So instead of watching "Swamp Loggers", I spent two hours.
If you were to do that, and used 35% for your ratio, your NOI goes up to $406 and annual cash flow is $1,838. Cash on cash return is 19.1%.
- Real Estate Investor · Covington, LA · Member since 2010 · 43 posts · 14 votes15y
Thanks again, Jon. I've been sneaking this in at work so can't comment. Will reply tonight when I have more time.
Exactly what I was after!!!
- Real Estate Investor · Covington, LA · Member since 2010 · 43 posts · 14 votes15y
Jon, I wrote out 2 very lengthy replies and was timed out both time. LOL! In short, I think I have a good grasp of this.
Checking out the property tomorrow or Friday. Confident he'll come down to $35k or less. Also, good chance it will be a USDA loan with nothing down. I'm going to rework the numbers. Please check for me, make sure I understand correctly. This is helping me a lot!
Price: $35,000
Down: $0
Costs: $1,600
Rehab: $0
Cash invested: $1,600
Loan: $35,000
Payment: $276.78 (P&I only)Rent: $625
Expenses, vacancy, capital: $312.50 (50% rule)
NOI: $312.50
Cash flow: $35.72 ($312.50 - $276.78)
Annual cash flow: $428.64
Cash on cash return: 26.8% ($428.64 / $1,600)Rent/2 (50% rule)- P&I = cashflow
Does it look right to you?
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes15y
Finding a fully performing property especially at the 50% suggestion with multifamily is a non starter.
A trophy property the owners will demand a premium.The typical buyer is a doctor,lawyer,etc. who wants a newer property in turn key condition to us as a tax shelter.
They don't really need the income all that much.
What I see most investors going after including myself is value add deals.Where you have a burnt out landlord or a property with deferred maintenance or both.Some people have more money than sense and do not make good managers.
The value add deal is where you can create equity and cash flow the quickest.Many investors love apartment foreclosures from banks.There is no emotion like from a regular seller but also there isn't usually as many ways to structure a deal.So each avenue has it's pluses and minuses.
If you talk to banks they are hoping the market gets better.If you talk to buyers many say we are still in a recession and will not pay the banks prices based on over inflated appraisals.So what you have is a stand still in the bid-ask gap pricing.
Some product is moving but not the kind of volume to turn the market around yet.
If you want start out with one house and build from there.
I agree with everyone on the fees.The contractors will suck you dry.You have to know what work you want to do and not to do.I tell contractors I want investor pricing and that I am very cheap and want a deal.If they are looking for a retail deal don't even waste my time.
Between plumbing,electrical,pest control,lawn maintenance,and on and on your cash flow can go out the window real fast.
On my apartment building I have a cheap handyman mow the grass and do minor repairs.Grass company wanted a one year contract and 210 a month!
Bug guy wanted 100 a month.A/C guy wanted 110 just to do a service call.I got another service guy who charges a 1/4th of that and you just buy the parts needed.You have to stay away from the big companies and find someone local who will cut a deal but is still well qualified.Just by doing things ourselves with the handyman we are saving about 6,000 in annual maintenance costs alone on our buildings.
I have a live in manager on one of the units and he does all the PM stuff day to day.
You really have to know how to squeeze every penny out.
A quick way to look at this is to take monthly rent of $625 times 12 months times 50% and divide it by the purchase price. 625x12=7500x50%=3750/35,000=10.7%. This is the BP way of calculating cap rate,or cash on cash before debt service. The 10.7 will more than pay your interest of 5% so the rest is profit to be used for principal and cash flow.
Use the $3750 to pay your PI pymts. Try 30 yrs instead of 15 for cash flow.
- Real Estate Investor · Covington, LA · Member since 2010 · 43 posts · 14 votes15y
@Joel -
I see your point on maintaining the property and watching your pennies. But with the realistic numbers provided thus far, it seems one would have to own a lot of properties to cashflow a decent annual income. I'm ignorant to the cashflow of an apartment complex or other multi-family properties.@Jeff -
This is great! Thanks, it gives me something to research.So, do most long term investors go for more cashflow now instead of paying the loan off faster, giving even more cashflow once the mortgage or loan is paid off? I wondered what the popular mentality is for cashflow. Also, Is private funds the best to acquire rentals? I can see where funding is the issue once personal credit is consumed or better, to avoid using one's credit.
Todd,
Most investors use longer term financing for the very reason you mention. It is hard to get much income from properties and having a cash crunch can be a disaster if credit runs dry and unanticipated problems come up.
You are younger so 30 yrs can go by pretty quickly. If you have large cash reserves and have all the properties you want then you can consider paying stuff off.
I am 58 and many my age have cash and income and would just as soon take the benefit of lower interest and short pay-offs to build equity. But, other older investors I know have kept loans long and downs small and own many properties so each to their own.
If you can start with bank funds, then private funds, then when you have a business going find a portfolio lender(bank holds loans in-house). This is what people on here are doing like J Scott and the like.
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