All Forum Posts by: Neal Bawa

Jose, yes, a certain level of turnover is inevitable and necessary. Average stays of 24-30 months are considered above average, and would help to raise NOI.

Yes, schools are important, but much less so than they are for single family. Also, depends on unit mix. Schools are more important for a property with a unit mix of 25% one bed, 60% 2 bed and 15% 3 bed property than a property that is mostly studios and one beds.

NeighborhoodScout is pretty awesome. 

I see a lot of beginners on BiggerPockets using the 1% rule to buy small multifamily products such as duplexes or quadplexes. I own and manage over 1,600 units, and I started out in the multifamily world by buying duplexes, triplexes and quad plexes in Chicago and in California. While I found the 1% rule to be a good general guide, It's insufficient by itself. So today's discussion is about something known as churn. This word churn is not used often enough, and from what I've seen in my experience of over 1,600 units in eight different states, churn is the true killer of profit.

So what is churn? what does it really mean and how does it affect your profits? Churn refers to costs associated with turnover of tenants, and also loss of profit associated with such turnover. There are so many areas in the United States that not only abide by the 1% rule, but even qualify for the 1.5% rule. Areas frequently mentioned on BiggerPockets include Kansas City, Indianapolis, Memphis, South Chicago, Detroit etc. Many of The Class c properties in such metros go beyond even 1.5%. investors use the BiggerPockets calculator and the 1% rule, apply them to these properties and go ahead and buy, and subsequently suffer for years because they didn't focus on turnover cost.

Let me start off by giving you an example of how churn can truly destroy profit. You have a property that is a quadplex, and it is in St Louis Missouri. The rents are $800 a door and all units in the properties fully occupied. So at $3,200 in monthly rent, if you buy this property for $225,000, you're making a killing, right? You've already checked to make sure that capital expenditure is not a problem, roof are okay boilers and plumbing is fine. You're excited, because what could go wrong?

A lot could go wrong. In late 2018, a lot of the properties that are available for sale on BiggerPockets or loopnet or equivalent sites are properties with extraordinarily high Churn. In this example of ours in St Louis, the property keeps its tenants for only about 11 months on average. Nearly 20% of the tenants leave after a long and brutal eviction process, or they leave several months into an eviction process when they realize that they will get an eviction on their name. Most property managers don't even bother trying to recover past rent from such tenants. The owner is just so relieved that when people leave, that he starts to focus on renting the unit again. The repair and maintenance budget is completely out of whack because of such a high level of turnover. The consequence is that there is no profit to be made.

The money to be made in rental real estate tends to be mostly in the second and third year, not in the first year. You're mostly just breaking even in the first year because you had to pay for that cost of turnover. Sometimes you may be paying a leasing cost to your property manager so that is an additional factor to keep in mind.

So how do you figure out if the building that you're looking at today is a building similar to our example? It's not easy. There's no super simple rule of thumb. I have talk a method that takes about 60 minutes the thousands of investors in the San Francisco Bay Area as a demo. For the purposes of this post, however, here is a mini version. You should be using a website name City-data.com and plugging in the zip code of the subject property. Then look at the median household income indicator. A good rule of thumb to apply is that the median household income should be above 38 K in the Midwest, and at least 40K everywhere else in the US. If it's expensive States like California or New York, go up to 45 k. I have found through experience and data science experiments that median household income appears to be the greatest indicator of churn, so it's a good place to get started. You should also look at poverty levels on the same website. Try to buy properties in areas where the poverty level is 10% or below. That's not going to be easy. If you're not finding any properties below 10%, where the other rules work, try to go up to 15% in terms of poverty level, but no further.

another useful indicator is ethnicity mix. For a particular zip code, look for a healthy mix of ethnicity. An area where only a single ethnicity lives can be harder to rent out, because you can only target one type of audience from an advertising perspective. They're always going to be some tenants that want to live in a diverse community, so keep ethnicity mixes in mind as well.

Lastly, if you're looking at an occupied building that is crushing the 1% rule. Focus very strongly on the rent rules to understand how often the tenants move. Use basic Excel calculators to figure out if the tenants are staying for at least 20 months or longer. If they're only staying for 12 to 14 months, then understand that the 1% rule was never designed for a building like this. It simply won't work.

Questions? Rebuttals?

I have over 1,600 multi-family units that I own and manage, so I feel that I can contribute to this discussion. Here are my two cents.

Looks like you've already gotten really good advice on the capex. The 1% rule was also mentioned. So let me skip those and go to a different viewpoint. While the 1% rule is a great General guideline, what really applies in an area such as St Louis, which is predominantly a Class C or worse area for cash flowing rentals it's something known as churn. Churn is the frequency with which you lose tenants, either because they want to leave, or because you're forcing them to leave through an eviction process churn is the real killer of profit and is not covered as often by BiggerPockets or other forms as it should be, in an area such as st. Louis or Detroit or South Chicago or Kansas City Kansas. You should be looking at the quality of the area to determine what the churn in that area is going to be. I have taught many multifamily classes on this, and one of the simplest ways to determine churn is to go to City- data.com, and plug in the zip code that your property is in. Now scroll down to see what the median household income level is in this ZIP code. If the income level in the zip code is very low, you will have a large amount of churn. The general rule of thumb that I provide is that you want the median household income level to be above 38 K in the Midwest and above 40K in the rest of the u.s. numbers below this, cause tremendous churn, which will spike your repairs and maintenance cost and kill your profits. This is why, you commonly see buildings not only crushing the 1% rule in St Louis, but even crushing the 1.5% rule. if it was this easy to make money in St Louis, everyone in the world would be buying in St Louis. But the locals know about the churn issue, and so the 1% rule should not apply to most of the c neighborhoods in areas like st. Louis. Another metric to look at in city data is poverty level in that particular zip code. You want the poverty level to be at 10% or below to prevent eviction and delinquency related churn. In certain cases numbers between 10% and 20% could be acceptable. But poverty levels higher than 20% cause excessive churn and delinquency and eviction related costs. So keep those in mind.

San Francisco based investor owns eight duplexes/triplexes in Chicago, and is selling one of them. This property is in a decent neighborhood, has a good property management company managing it, and is a 2-unit. Each unit is 5 Bed 1.5 bath. Both units are rented at the time this brochure was made. The Rents provided on Page 3 for both units are ACTUALS. Both tenants have been in the units for over 6 months, so are mature tenants with a solid history of paying rents. After financing, the potential returns (estimates) are over 22% cash-on-cash returns, not counting either principal pay down or appreciation. Owner is selling because he is now investing in much larger Multifamily projects and moving out of smaller properties.

This property is located very close to Bronzeville, one of the hottest new construction areas in Chicago. Refer to the Map on page 2, and you will see that this property can appreciate a great deal in coming years.

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