All Forum Posts by: Ben Wilkins

Good morning @Alexander Griffin

A few questions:

You say "Owner pays $650 a month for expenses" - what expenses would this include? I'm assuming trash, sewer, and water. There might be a owner's electrical panel? Since you mentioned taxes separately, are those on top of the $650 per month expenses? Or is that included? What about insurance?

You never mentioned what I call "percentage expenses", which include Maintenance (10%), Capital Expenses (CapEx) (10%), Vacancies (your choice for your market - anywhere from 2% to 10%), and Property Management (again, based on the market - say 8%).

Broken down:

Maintenance - expect an average of 10% of your income to be spent on general maintenance. This could include utility repairs (fridge, stove, etc), contractor work (electrical, small repairs, door repairs, new locks, etc), and other wear and tear maintenance.

CapEx - set aside 10% per month for when the "big ticket" items come due. Water heaters, stoves, furnaces, roof... the big repairs. When you need to replace these, you'll appreciate that 10% CapEx that you've been saving up.

Vacancies - set aside a certain percentage as an "Expense". When you do have a vacancy, you consume those savings rather than taking an immediate hit on your income. This is playing the numbers. Say you have a vacancy for two months, which means you are losing out on $900 per month for a total of $1800. Since you've been "saving up" or "expensing" vacancy each month, you consume that as an expense instead which means you are still "making" the same income. Another way of looking at this is that your Vacancy expense is a bucket that saves money for the day when you have a vacancy. A final way of looking at it is that if you can afford to set aside X% vacancy (based on your market's average vacancy rate), then you can afford to take the vacancies that will most likely hit you one day (at your market's average rate).

Property Management - Two ways of looking at this. First way: one day, you might not want to manage the property. Can you afford to pay a PM and still make a profit? Second way: you're managing the property, and your time should be worth something. Pay yourself.

Summing these up and adding to your already-listed expenses:

Maintenance - $270
CapEx - $270
Vacancies (5%) - $135
PM (8%) - $216
Expenses you listed: $650

Total percentage expenses per month - $891
Total Expenses per Month: $1,541

So your Income minus Expenses:
$2700 - $1541 = $1159 income per month

The last thing to be added in as expenses, and is dependent on your area: Inspections and Licensing. Usually there's an engineering firm or city firm that will provide this service. This usually comes out to $75 per unit for a license, and $75 per unit for inspection (once a year). This would come out to $450 annual. This might not seem like a lot, but when you scale it starts to add up. This is especially the case if the license or inspection aren't current, and you need to pay this year and also save up for next year.

Anyway, on to whether it's worth it or not.

If those numbers that you listed are real, and if the inspection (that I hope you have done) turns out looking good... yeah, that doesn't look bad. There are several ways of looking at this (go figure):

The 1% or 2% rule (depending on who you ask). Is the gross rent more than 1%/2% of the purchase price? That's the fastest (and least-accurate) method of seeing whether a property is a deal or not. It requires a really, really small amount of math and is super fast to do. So $2700 / $150,000 = 1.8%. You're in the ballpark of that number, so it's worth digging into. If you don't pass this quick test, it's usually not worth looking any further. Usually. Exceptions would be if you have a strong strategy planned for how to increase your income or decrease your expenses. If you pass this quick test, you would pull all of the expenses (utilities, taxes, insurance) plus the Percentage Expenses. 

The ROI (Return on Investment) rule: this is really up to you. What returns are you looking for? Right now you could be making $1159 per month, or $13,908 per year with this deal. Let's assume you pay 20% down payment and 5% purchase fees = $30,000 + $7500 = $37,500 out of pocket. Your annual return is Annual Income divided by Purchase, or $13908 / $37500 = 37%. You set the goal that you want for this. Stock market average is anywhere from 10% to %16% depending on where you look up your data. Real estate is more work... how much is it worth for you? 20% ROI? 30% ROI? That's a goal for your to set up.

Ok... key take aways:

Never, ever skip the Percentage Expenses. Yeah, it makes your income look a heck of a lot better. But when you have repairs or CapEx or vacancies, you won't be liking it. These expenses will happen at some point, so count them as expenses from the beginning

Determine what your ROI goals are, and stick to that goal. Re-evaluate each year to see if your goals should change with the market / your situation.

Is this deal worth it? Yeah... I would go for it. The numbers are solid. That said, it really comes down to the inspection. Is the building in good repair? How much work will be needed for the vacant unit? If it's a weekend of work that you and some friends can do, I'd schedule an inspection now and start putting together how much money will be needed for the repairs of the vacant unit. Add those into your Purchase number and re-calculate your ROI. It shouldn't drop by more than 10% if it's only some ceiling work and counter tops, which will still put you at 27% ROI.

Some questions for your to ask: What's the ceiling damage? Water damage? What caused it? Is it fixed? How much will it cost to repair?

If you have questions, feel free to ask!

 "If he understands that appreciation in his market is not speculative" 

I don't know that appreciation is ever anything other than speculative. Sure, an "overall history" of housing prices shows that they go up - but this could just be based on inflation rather than the value of the property. Saying that appreciation isn't speculative is claiming something close to being a crystal ball - there's no guarantee that a property will appreciate, regardless of which market it is in. There is a lot of data showing that it will most likely appreciate, but there is zero "proof" that it will 100% definitely appreciate.

A mathematical comparison is Brocard's Conjecture, which has been tested out to "2 * 10^9" but is still only accepted as a conjecture. My point being: that's a massive number that shows a fantastic trend... but it's still only speculation or conjecture.

Buying into a non-cashflow market based on appreciation is always speculative, regardless of what market you go to. There are definitely markets that have 99.9% better odds of appreciating, and some show fantastic trends... but appreciation will always be conjecture.

Add in your assumption of 100% occupancy - that might be a great goal, but also is really tough to have 100% all of the time. Did you include maintenance savings? CapEx? If you're waiting out appreciation, then you'll most likely be holding on to the property and will have stuff to fix down the line. With those expenses, your "zero cash flow at best" quickly becomes negative.

Are you crazy? No. Is this a good investment strategy? It can be if you minimize your risks. Is appreciation ever "not speculative"? Heck no. Personally, I'm in the real estate investing business for the cash flow - but that's what fits my goals. I acknowledge the strengths and weaknesses of my investing strategy, and I build my business around that.

My suggestion to you? Keep some of your cash-flowing properties to help cover your costs / expenses. Why give up cash flow now for a chance at appreciation in ten or fifteen years? Why trade everything for "zero cash flow at best" when you can hold two properties that are flowing for every X number of non-cash flow properties?

@Immanuel Sibero - I agree more with @Rob Dahlager on this one. The question that I have for you: why should I limit myself to the Cap Rate of everyone else in the area in order to make my offer? What if the seller is desperate and would have sold for less? What if I don't want an "average" deal and want a great deal?

If I use your model, I will always get just an average deal by the definition of using the average cap rate for the area.

In my opinion, almost every property can be a great deal for me. What I mean:

If I have my own goals: say a certain cash flow per month per door, or a certain cap rate, or whatever my goal may be - I can potentially make any property fit that goal. So in the calculation, I have income and expenses:

• Income
  • Rents
  • Charge for storage / parking
  • Other
• Expenses
  • Utility Bills
  • Mortgage
  • Insurance
  • Savings percentages (CapEx savings, Maintenance savings, Vacancy savings, PM savings)

Out of these, I have control over a limited number of options: I can raise / lower rent to increase income, or I can reduce my mortgage payment. The Bills can be split or improved, but that's more of a Value-Add opportunity.

So if my goal is cash flow, my model will be (assuming all numbers as monthly):

Cash Flow = Income - (Expenses)

Cash Flow = (Rent + Other) - (Bills + Mortgage + Insurance + Savings)

So back to my statement: Every Property can be a great deal for me. I have control over the Income and the Mortgage as the easiest variables during a deal. In theory, I can lower the mortgage payment to A Number that will provide the cash flow that I need for this to be a great deal for me. Whether the seller will agree to that number? I don't know, but why should I make an offer based on someone else's goal (market Cap) when I can make an offer based on what the property is worth to me. The key is that I'm making the offer on the property, so I will never offer more than what it's worth to me in my portfolio.

With that in mind, my offer is an algebraic formula (from above)

Cash Flow = (Rent + Other) - (Bills + Mortgage + Insurance + Savings)

Cash Flow + Mortgage = (Rent + Other) - (Bills + Insurance + Savings)

Mortgage = (Rent + Other) - (Bills + Insurance + Savings) - Cash Flow

If Mortgage Payment = L[c(1 + c)n]/[(1 + c)n - 1], L = Loan Amount, c = Monthly Interest Rate (divide interest rate by 12), n = Length of Loan (months)

My offer amount would be:

Offer = [(Rent + Other) - (Bills + Insurance + Savings) - Cash Flow] / [c(1 + c)n]/[(1 + c)n - 1]

Is it pretty? Not really. I could have simplified the equation to make it easier to read, but my math teachers always told me to show my work. Why only "almost every"? There's always exceptions: a piece of land is harder to value because of future income potential. You could take a building and change its function (school into apartments). This rule doesn't fit everything, but it fits almost everything that a new purchaser will be looking at.

"Can't I just decrease my expenses?" Sure, if you want to cheat yourself. I will always be an advocate of setting aside the percentage expenses (CapEx, Maintenance, PM, Vacancy). If you don't save for Capital Expenses or Maintenance, you will end up paying out-of-pocket at some point. If you manage yourself, isn't your time worthy of being paid? What happens if you pass management on at some point - you may as well calculate it as an expense initially. Vacancy is based on market average or personal experience - buy you'll always have some month where you experience a vacancy - add that expense into your calculations.

A lot of my deals will get rejected, and I'm alright with that. I'll always offer what the property is worth to me, and sometimes I win sometimes I lose. Either way, I'll go through this exercise and determine what I think the property is worth - I don't base my offer on the market average.

TL;DR - This was a long read. The underlying point: make an offer based on what the property is worth to you. Don't make an offer based on the average market Cap Rate.

@Mark S. - I didn't say you couldn't use commercial lending for SFR's... but someone before me said that the OP had to use commercial because it was an investment property. The OP also went to a bank that quoted him fairly high interest for a commercial loan...

My post was stating that if a bank tells you that you have to use a commercial loan for a small rental (sub five units), leave the bank and go find another one that knows how lending works for investment properties.

Maybe the bank he went to knew what they were saying and wanted to mitigate their risk by giving a higher interest rate commercial loan to a new investor? Maybe they didn't know what they were saying and thought it had to be commercial? I don't know which is true, but either way I would walk out and find a bank that is more investor-friendly.

For a first property, under five units, where you have enough for 20% down and haven't maxed your number of traditional loans (10), I see absolutely zero reasons to go commercial lending. Higher interest rate, often times variable with a five year period... why go through that if you can get a lower interest rate that is fixed? 

My advice: use as many traditional loans as you possibly can. Max out the number, and take advantage of the perks that go with traditional. The only reason I used commercial when I didn't need to was because I took a different approach on my third property by using someone else's money and therefore didn't qualify for a traditional loan with seasoned money.

A security deposit helps invest the tenant in the property - if they have money "on the line" so to speak, they're more likely to take a little better care of the place. The mention of "security deposit" and "application fee" also helps weed out the tenants I don't want to deal with - a lot of them flee like cockroaches before the sunlight at those terms

@Alan Zee - In answer to your question about rivers drying up: LoopNet is not a river. You need to network with living people who will become your potential sources of deals. Go to the local meetups, send out yellow pages, knock on doors, make phone calls, talk with your uncle who is a landlord and will probably sell at some point, talk with the realtor who gave you your last deal.

I have nothing against LoopNet and other MLS sites - they are definitely still a source of deals but those deals are looked at by every Tom, Dick, and Jane out there. Another local investor in my area has a portfolio that he sometimes sells from in order to buy his kids / nieces / self something... and any time I talk with him, he mentions two or three properties that he'd be willing to sell. With my current network, I'm actually up against my own finances rather than a lack of deals... but I wouldn't have had that without meeting this guy at the local meetup.

This is just one example and isn't my only source of deals in the past, but I think that the real metaphor should be a "canal" rather than "river" - your canal is only as big as you make it, and if it starts drying up... well, start digging and make it bigger! MLS / LoopNet is a river metaphor: it's as big as it's going to get, and it can dry up as more people siphon off deals.

Get out of the river, and build yourself a canal

@Tom Kaz - for the first two properties, I used Stessa to track expenses and income. The free product does a pretty good job of linking to accounts, splitting expenses and income, and tracking property performance. As you scale, you might want to consider going to something that has more options and can handle multiple aspects of the business. At this point, Stessa doesn't handle tenant payments, fees, background checks, etc. As you get larger, it becomes more cumbersome to use Cozy for one part of the business and Stessa for another, when you could use Buildium or Rentec to handle both parts of the business (as an example)

By all means, Stessa worked well for me to start - just start planning how you will scale your business as you grow.

Commercial loan for an investment property? Find another bank. I have two multifamily buildings (a duplex and a four) that are both on personal loans. Commercial is either 5+ units, or if you don't have the cash for 20% down and need to borrow the money for the down payment. 

For the two standard loans, I just needed the 20% down and had to follow the standard requirements (proof it was my money, W2, etc). In both cases, the bank knew it was an investment property (even used two different banks)

I also have a three unit on a commercial loan where someone else fronted the 30% down payment. 

@Wen Wang - a few thoughts:

• You have Maintenance and CapEx at 10% (which I am a total advocate of), but you also have a HOA fee. Depending on what the HOA covers for maintenance (exterior - siding, roof, etc?), you might be able to decrease the other costs.
• Interest rate of 4% might be a little low, depending on who you get to lend to you.
• $250 taxes seems low - is that accurate?
• $150 cash flow is low for something that costs $100k... not a lot of margin for error. What's your goal with this property?

@John Paul Whaley - what did you end up missing? Savings percentages?