Help! Are My Assumptions Reasonable?

Question

Hi All-  Newbie investor here, searching for my first rental property.  This has been a goal of mine for many years and I'm finally in a place to pull the trigger.

I live in So. Cal and (though sparse) I'm able to find a number of deals right on the MLS that cash flow reasonably well based on my model- to the tune of 9% - 17% cash on cash (levered up from 5% - 8% cap).  I've heard over and over again that getting those kinds of returns in CA (absent appreciation) is pretty uncommon.

SO... What am I missing?  Are those returns realistic? I feel like I must be missing something.  I'm using the below to arrive at my monthly net cash flow number:

• +Rental Income
• (-) Vacancy Assumption = 8% of rent
• (-) Mgmt Fees = 10% of rent
• (-) Mortgage Interest Expense = 4% rate
• (-) HOAs = Actual
• (-) Insurance = 6.8% of annual rent
• (-) Property Tax = Actual per MLS
• (-) Repair/Maint = 10% of rent
• (-) Gardner = $50/mo
• = Net Rental Income
• (-) Mortgage Principal Paydown
• =Net Monthly Cash Flow

Any input is very much appreciated.  Thanks!

Some Geography Context:  I'm looking in San Bernadino, Apple Valley, San Jacinto, Hemet, Adelanto, Riverside, LA, and other low-price areas.  I am also interested in out of state investing, but I'll leave those questions/comments for another post.

Aaron Mazzrillo · Answer

San Bernadino - Anything here cash flowing is probably south of Baseline. I wouldn't want to own that junk.

Apple Valley - I haven't done much up in the high desert, but I hear from my friends who own houses up there that the tenant base is pretty bottom of the barrel.

San  Jacinto - Not a bad area. Not a great area.

Hemet - This is where felons go when they get out of prison early.

Adelanto -  This is where people who are going to end up in prison live now.

Riverside - I can't imagine you're seeing any real cash flowing deals on the MLS in Riverside. Houses are quite expensive at this point in the market. Rents are strong. If you bought here 4 years ago you'd be killing it.

LA - Can't provide any details. Most of my deals here have been wholesaled

Account Closed · Answer

I don't know southern CA at all.  Isn't it funny that we can live in the same state and not have a clue about one half of it.  But, our state is enormous!  I've always lived in northern CA.

I see a couple things that bug me.  One is the  management fee.  Can you manage it yourself?  Management fees are never just the monthly amount.  They, unfortunately, will also often bump up your maintenance costs by rushing to spend your money with their maintenance guys doing the work (and charging you for it), and charging you a fee to supervise the maintenance guys.  They charge a fee to find a tenant, a fee to kick a tenant out, then fees to start all over.  They even charge you a fee to fire them!

Get a copy of their contract and look it over with a fine tooth comb.  And don't let them tell you that the contract is "standard," or you don't have to worry about all the fees mentioned in it.  Because my personal experience, and that of my daughter, and countless others you'll talk to - were all royally ripped off with all those fees.

Then, there is the clause where they don't have to call you if something is an "emergency" and they will often abuse that.  Then, they finally call you because there are no more reserves left in your account, because they spent it all on "emergencies" that they didn't need to call you about because they were emergencies or all under $250 or whatever.

And, you will have to manage the manager anyway, if you are smart.

So, 1) manage it yourself.  And I strongly discourage you from investing out of state, because then you will have absolutely no control and no way to go see for yourself what is going on.  And you will be trusting your investment to a stranger far away.  I had a bad experience doing this, and I think it's a crazy thing to do.  Just my two cents on that.

2) If you can avoid a HOA, that would be best.  That's another unknown expense.  You never know when they will vote to raise the dues or have a special assessment.  And they can change the rules.  It's another person with their fingers in your investment.  And they also have some control over it, in that they may not be financially responsible with the dues and then not be able to fix the pool or paint the buildings or put new roofs on, or pave the driveways.  They may change the rules as far as how many units can have renters in them.  And, if you get behind on your dues, they can foreclose on your property.  HOAs are scary, in my opinion.  I had a condo in Davis and couldn't wait to get rid of it.

Also, if it's a condo, they're harder to finance, which also means they're harder to sell, should you ever want to.

3) If you would be buying the house for a higher price than the current taxes are based on, your taxes may be higher.  Your taxes will be based on the purchase price you pay for it.  So, you may be wrong on your budget for taxes.

4) I don't know how some people here figure vacancy rates for these types of calculations.  I would figure on one month's rent per year at least, that would be lost due to vacancies.  I'm not sure if that would equal your 8%/month or not.  And hopefully, you wouldn't have turnover even as often as once per year, but that's the number I'd use, just to be safe.

5) Can you really get a gardner for only $50?  If so, that's a good deal.

6) I'd add in a monthly pest control service contract.  They're usually pretty cheap if you sign up for a monthly plan.  And then, if there's an infestation of ants all of a sudden, etc., they usually will treat them for no extra charge, as they include them if you get a monthly service plan.

7) Utilities paid by you?

Get this book on being a landlord in CA.  Easy to read and has all the contracts and forms you need.  It was my bible.  Love their contracts, too, because they're easy to understand by everyone and you can edit them to put in special parking rules, etc.

http://www.nolo.com/products/the-california-landlo...

I wish you the very best of luck.  I hope you can find an investment property that is not a condo, does not have HOA fees, that you manage yourself.  I think that would be your best bet as far as a good investment with less unknowns and keeping control over your investment.

Account Closed · Answer

Including the 10% maintenance might be enough.  It wouldn't have touched what happened to me or my daughter.  I am not someone who will ever agree with hiring some stranger/property manager to manage a property for you that is far away, in a market you don't know.  So, you'll have to get sympathy somewhere else if you decide you absolutely must invest in RE no matter where it is, or who else has control over that investment.  I think doing it is foolish.  So, I'm not the one to ask for advice there.  My advice is to absolutely not do it.

I think having the tenant pay the utilities is perfectly acceptable.  If you have a vacancy, though, you'll have those bills during that time.

Aaron Mazzrillo · Answer

I always have something in escrow. If I don't, I start to get a bit edgy. I mainly focus on the IE, but sometimes will venture over to OC. I rarely even look at L.A. I've done a few deals out there, but it really isn't a market I know very well... at all.

I think prices are quite high. There is one camp that thinks they have considerable room to keep climbing IF interest rates stay low. That is one BIG 'if.' We are in an election year and it's any one's guess what is going to happen and if it will have any affect on the real estate market.

I was keeping a house about once every 2 months, but that really started to wind down 2-3 years ago. I've sold many off over the last year 2 years. Am I selling at the top? I don't know. I know that the profits are 'good enough.' You never see the guy on the news bitching that he got out of the market a bit too early and still made a healthy profit.

Personally, I wouldn't buy a rental in SoCal unless I got really favorable terms, was in light cash or I was able to get one of those absurd <4% bank loans. The only properties I've considered keeping this year are subject to or big equity spread deals. I've only kept one thus far.

I do own property out of state. I am in a total of 5 states. I have tossed around the idea of finding some small city where I could just hammer it with marketing and buy a lot of rentals, but to what end? I'd prefer one California rental over any 5 houses in any other state. Unless it were a state I'd like to go to often, but I haven't put much more thought into it.

Michael Lee · Answer

Hello and welcome to BP!  I am not saying you are wrong, but I would look at oyhrt "rules" besides cash on cash return.  It could be that most others are just guessing about what is happening.  If a property still looks good after doing the typical math analysis go ahead and buy a property if it meets your goals.  Just make sure the buyer line on the contract it states your name and "and/or Asigns".  That way you can make a wholesale or transfer to your company name.

Hire/Find a good Team to help you get to where you are going.  Just make sure your Team members are experienced and will return your phone calls promptly.  Do not try to do everything yourself.  Do not cut any corners to make something look better.  The primary Team members are Attornies, real estate Agents, CPA's (or accountants), Inspectors, General Contractors, and Handymen.

Right after you close on an improved property, get an insurance policy that will be protector if there is a loss.  As soon as you comfortably can, change the exterior door locks.  If the locks are still in good shape just use them at the next address.  Know the market you select and it's best locations very well.  Do what is average in that particular neighberhood.

I also went to college, not that is mandatory, I got a business degree that emphasized real estate.  Since I was in Texas and planned on staying there I found out that I was qualified to take a test and become a real estate broker so I took the test and became a licensed broker but I never did that full time.  Regardless of what I had, I felt more comfortably being in the construction business.

I have been in the construction-related business since I was 17 including those college years, from 1975 to 1980.  I did close a few deals for other people.  My father has been in real estate buying and selling business for about 40 years and he has taught me a little bit.  If you think I could help you in any way please contact me through BP at any time. Good luck to you!

Ricardo R. · Answer

Sean it all looks pretty good to me. Just a few points: 1) are you factoring in closing costs? ; 2) are there any renovations that need to take place before renting and if so are you factoring those as well? 3) I don't know if you have homestead taxes in Cal. in MI we do, so you have to convert those to non-homestead (if you're not house hacking) if homestead applies to Cal. Also, remember that taxes on the MLS maybe due to an old assessment and they may go up once your sale goes through for you since it is I'm assuming a higher price than previously; 4) The last thing is your educated assumption of expected rent, have you done your due diligence to verify you can get the rent you think you can (make sure you have some wiggle room)? --- Lastly, I think you're insurance looks good but again you're in a different state, call in for a quote on insurance make sure they know you'll be renting it out - if you haven't done so yet - to narrow that variable down. If this all checks out then just make sure the 'Net Monthly Cash Flow' and ROI is worth it for you. Personally, I have a set Monthly Cash Flow and ROI which I want to meet for it to be worth it for me.

I hope this helps.

Alex

Sean Autry · Answer

Alright Account Closed, I'm taking your comments from 2 months ago to heart.  I open escrow on my first rental tomorrow here in So Cal and will be managing it myself.  Wish me luck; it's 68miles away.  Regardless, I'm sure I'm going to learn the most by self-managing.

Sean Autry · Answer

Alex R., Thanks for your response!

(1) Good point, I didn't mention how I'm arriving at the denominator, which is (Down payment + Closing Costs + Initial repairs).  I've set closing costs and initial repair low @~$2,500 a piece.  I know $2,500 repair is low, but I'm looking for something won't need much more than carpet/paint.  Still tool low?

(2) See (1) above.

(3) I'm not familiar w/ homestead taxes so I'll have to look them up.  I own a primary in CA, so any additional taxes for a rental property would be foreign to me.  This is a GREAT point.  I'll ask my realtor and factor that in.  For prop tax I derive the tax rate from the most recent year's tax liability and total assessed value- then multiply that rate times the assumed purchase price.

(4) 100% agree.  I'd have to do my due diligence per deal.  Right now I am looking at income properties on the MLS that have existing tenants and a published current rent.  Of course I'd have to validate that it is accurate and being paid timely.

The insurance assumption is the one I worry most about.  I don't have any data on that, so it's my least reliable assumption.  I've put it together based on word of mouth.  Reaching out to an agent for a quote is a good suggestion (and obvious- actually a little embarrassed it didn't' occur to me to do that).

Thanks again for your input, Alex.

Kiersten Vance · Answer

Hi @Sean Autry

Yes some of my expenses would be different from normal rentals but I have them broken down and you could exclude all electric, gas, internet, TV, and furnishing costs and they would come out pretty much the same. Property tax is calculated the same way, insurance isn't much different, water/sewer/trash would be comparable and so would gardening and maintenance costs. PM or text me and we could set up a time to chat either in person or over the phone.

Sean Autry · Answer

Hi @Kiersten Vance

I'm sorry I'm just now responding.  I'm always trying to improve those assumptions.  One question, though.  I took a look at your profile and saw that you are into rather niche markets.  Do you think the data on your rentals would be comparable?  I just wonder if the costs on your rentals would be different given the property-use.

In either case, I'd be interested in connecting and learning more about how you came across such focused markets.  I have never considered taking such a focused approach (at this point I'm just trying to get started), but now I'm intrigued by it.

And I might also add that I'm impressed at how far along you've come at such a young age.  I'm not much older, but I am older and have nowhere near the experience you appear to have.  Good for you!

Help! Are My Assumptions Reasonable?

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