Amount of money to put aside for expenses in tri-plex

Rehabbing, Fix and Flip, Rental Properties
1

OK…this is my first time in here. I’m hoping that someone with some insight can provide me with some sound advice.

I am looking at buying a tri-plex to rent out to college students. It is a shell of a house that has been completely gutted, and will be rebuilt from “soup to nuts.” It is going for 350K. I have received 100% financing and a 3% sellers assist. Basically I am going to sit down at settlement with maybe 1-2K to buy this thing.

My mortgage WITH insurance, taxes, and PMI will come to around $3150/month (interest rates on investment property suck…even with great credit). My gross rent per month with be $4500. The students will pay on top of their rent all utilities.

My question is, after my $3150 payment, how much extra will I need to save (being conservative) to cover expenses (i.e. vacancy, minor and major repairs, etc.) Remember…this is a new property, and I will be the one managing it…so no management fees right now.

Any help would be appreciated.

Thanks,

Matthew

2

Few questions:

How old is the building? Were any of the HVAC systems replaced?

You said its gutted and will be rebuilt, by whom, you? So is that added expenses for you ontol the $350k?

Have you researched the rental market in that area? If so you should know market rent and how quickly the typical unit gets rented?

3

Hi…thanks for the reply.

This house will be brand new except for the exterior brick walls. The 350K is the final cost of the new house. All of the systems will be new.

The builder is a realtor/investor. My cousin who has been in the business for 20 years, and can tell within a few minutes whether the construction is worth it’s salt will walk through it with me when it is done. With that, let’s make the assumption that the construction is solid (not top of the line…but solid for students).

The rental market is great at the moment, and actually as part of the deal, all of the units will be rented by students with their parent’s as co-signers at time of settlement.

Any thoughts? My rates are really high, but I still make positive cash flow before other expenses…I just need to get a realistic idea of how much it will cost to keep this thing up and going.

thanks in advance for your help.

4

mhr, do you have a substantial amount of cash reserves? You might need that. Even though students will have co-signed leases, weird stuff can happen. Just make sure you can survive if 2 units go vacant/delinquent at the same time and it takes you a couple months to remedy the situation.

Even though everything will be “new”, things can still break. Your cousin will be a big help but tenants can be hard on property. I’d suggest a home warranty to cover appliances, HVAC, etc. $600 a year more than pays for itself. A maintenance plan and/or agreement to keep things in tip top shape wouldn’t hurt either.

It would be best to have a good plumber, handyman, landscaper, house cleaner, and pest control guy. Start up a good relationship with these people so you’ll have a good idea of the costs when you need repairs/maintenance.

Again, tenants are hard on property, they’ll break/stain/ruin things and call YOU to fix it. I really hope you have strong cash reserves/income aside from the property income.

Do you have an exit strategy? What will you do if things don’t work out? Can you sell it without ruining your credit/finances? Develop one BEFORE you buy the property. Hope this helps, I’m not being doom and gloom, just want you to be aware of all that’s involved.

5

where do you get a home warranty at?
new systems usually have warrantys but can you buy one for your appliances etc as well?

6

Yeah, for new stuff you should be ok, but after that expires…

Here is googles list:

http://www.google.com/search?q=home+warranty&rls=com.microsoft:en-us&ie=UTF-8&oe=UTF-8&startIndex=&startPage=1

7

MHR108,

This does not look cash flow positive to me. With a purchase price of $350,000 and a fully amortizing loan, the mortgage payment, (P & I) would be about $2,330. With operating expenses running about 50% of gross rents, you would have a NOI of about $2,250 per month, leaving a negative cash flow of about $80 per month.

In addition, just because everything is new does not mean that you won’t have maintenance. Students are VERY HARD on rentals - VERY HARD! Remember when you were in college? In any rental, a lot of the maintenance that is required is caused by the tenants. I just received a call from one of my college rentals today and one of the students moved out. That’s the reality of student rentals (or all rentals for that matter).

Mike

8

Property Manager,

With 50% of gross rent per month going towards expenses, it would be (4500*.5=2250/month). At 2250/month * 12 months, that would be $27000/year in expenses. Isn’t that a bit high? I mean, even if just about every major applicance in the house goes awry, replacing them wouldn’t even be this much. Or, even if I had to replace all of the windows or even the roof if god forbid it collapsed, it wouldn’t cost that much. Please tell me how you came up with the 50%, I really need this information before I make this decision.

The way I was figuring out what to put aside for expenses (above and beyong mortgage, interest, insurance, and PMI), was to figure in 15% of the gross rent towards expenses. The non-variable expenses would be the following:
-Water: $120/month = $1440/year
-Landlord license = $35 per unit per year in PHilly = $105/year
-1 month complete vacancy = $2782 (That is my mortgage payment)
-Those 3 things would come to $4327/year
-That would leave around $3773 left during the year for repairs.

Let me know what you think…thanks.

9

mhr108,

Throughout the United States, operating expenses run 45% to 50% of gross rents. That is the rental business. You haven’t even scratched the surface with the expenses you listed. Operating expenses include taxes, insurance, management, maintenance, advertising, office supplies, entity maintenance, legal fees, evictions, court costs, utilities paid by the owner (yes there will be utilities even if the tenant pays them), damage done by tenants (above the security deposit), tax preparation, lawsuits, etc, etc, etc (I could go on and on). Are the expenses really that high - you bet they are!

Mike

10

Property manager,

Thanks for the info, but I don’t think some of the things that you mentioned are applicable to me, and/or I already factored them into my equation prior to listing the additional expenses.

Basically, there will be no maintenance fee. I am managing this property myself. As for advertising, Craigslist is King in Philadelphia. After researching with many other investors, Craigslist is all that it takes these days in the Temple area. As far as utilities, I factored in water, which I will pay for, but the tenants will pay for gas/electric. What other things were you thinking? I also factored in a vacancy factor that you probably saw.

Legal fees, eviction cost, etc. are things that I didn’t factor…so that is good feedback. However, how much per year should I put away for those instances.

I’m not trying to deny your 50% rule, I just think that some of the things that I include in my base cost, are things that others, maybe yourself include in expenses. For me, my mortgage payment includes pricipal, interest, PMI, home owner’s insurance, and taxes. It’s above and beyond that, for which I need to estimate.

Believe me…I’m not trying to give you a hard time. I definitely value the conversation and feedback, and hope that you come back to me with some additional comments. I don’t want to make a mistake on my first property.

thanks,

Matthew

11

mhr,

It is not my “50% Rule”. In fact, there is no 50% rule. The fact is that throughout the United States, operating expenses run 45% to 50% of the gross rents. You can’t bargain with me to reduce those numbers - I have absolutely no control over your expenses and I can’t grant operating expense waivers (that probably takes the blessing of a guru). If you don’t believe that the 45% to 50% number is correct, you can use any number you want. I can’t tell you how many newbies that I’ve heard say that those expenses “don’t apply to me.” Yet, the vast majority of newbies consistently fail in this business.

I also can’t tell you what number to assign to specific expenses in your area. In fact, I don’t even know what numbers to assign to specific expenses in my area. How many evictions will a given property have this year? Will the tenant in a specific rental sue me this year? Will the tenant in a particular rental do $5,000 in damage this year? How many months will a given rental be vacant this year? How could you ever know that? I think it’s a waste of time to even try.

If you have low income rentals in rough neighborhoods, your tenant-related expenses will probably be high. In the leftist states, your taxes will probably be higher as will the cost associated with evicting tenants (tenant friendly states). If you live in Florida or other hurricane-prone areas, your insurance costs will probably be through the roof. So, the answer is that I don’t know (can’t know) what numbers to assign to many of the specific expenses. What I do know is that the throughout the United States, operating expenses run 45% to 50% of gross rents.

Finally, the fact that you will manage your rental has no bearing on the cash flow. When you manage the property yourself, all you are doing is earning the management fee instead of paying someone else. Yes, you will have more money at the end of the month, but you will be earning it!

Hope this helps!

Mike

12

OK Mike…one last go round, and I promise I will stop asking your advice about this specific property. I ran my numbers one last time, and although you said it is impossible to predict expenses by line item (and I agree), I would definitely appreciate your feedback.

Here goes:
House Cost $359,000.00
Interest Rate 8.00%

                                       Monthy Income	 Anuual Income

Rent $4500 $54,000.00
Expenses
Monthly Annual
Mortgage (P&I) $2,371.55 $28,458.65
Home Insurance $125.00 $1,500.00
PMI $269.25 $3,231.00
Taxes $166.67 $2,000.00
Landlord License $3.00 $105.00 ($35 per unit/year)
Unit Cleaning Upon Exit $175.00 $2,100.00 ($700/year/unit: pain/clean/repair)Vacancy $466.77 $5,600.00 (2 months entirely vacant)
Pest Control $37.50 $450.00
Water $120.00 $1,440.00 ($40/month per unit)
Legal/Eviction Reserve $83.33 $1,000.00
Repairs During Year $125.00 $1,500.00 ($500 per unit/year)
Water Heater $12.50 $150.00 (3/unit over 30 yrs @ $500 each)
Roof $34.72 $416.67 (2 new roof over 30 yrs @ $5k each)
Total Expenses $3,990.19 $47,951.31

Net Income $509.81 $6,048.69

So, $509/month in net, although I would probably add another 10% expense for contingency. I think that I have figured it out, that $359K is not a good price. Right now I am trying to get to the right price. Ultimately, I would like to get to at least 800/month in NOI.

What are your thoughts on the above, and any thoughts on what “price is right?” I tried to take your advice and 50:50 rule (I know it’s not yours) into consideration when I was putting this together.

Thanks in advance. Going to buy your book this weekend.

Matthew

13

Matthew,

First, I think that you’re a little confused on the terminology.

NOI (Net Operating Income) is found by subtracting the Operating Expenses from the Gross Rents. Operating Expenses do not include the Mortgage (P & I).

Therefore, you’re NOI is going to be well above the $800 per month that you mention in your post. In fact, if you use the 50% rule, the NOI would be half of the gross rents or $2,250 in your example.

Cash flow is what’s left after the operating expenses and the debt are paid.

In your example, you’ve omitted management, damage done by tenants (in excess of the deposit), lawsuits, advertising, utilities paid by the landlord (for example when vacant, during rehabs, office supplies, phone expenses, tax preparation, entity maintenance, etc, etc, etc).

Some of your other expenses seem high to me. For example, the “cleaning upon exit” should be zero. If the tenant gives me an apartment back and it is not spotless, I take the cleaning expense out of their deposit. Pest control also seems high. Even with dozens of rentals, I don’t spend $37.50 per month. I occassionally buy mouse traps, roach traps, or roach bombs, but that’s about it.

Again, I think it’s a pointless exercise to try to assign specific numbers to specific expenses. It’s just impossible to know all the expenses that will occur for a given rental in a given year. Knowing that the operating expenses will be about 50% of the gross rents is more accurate than trying to predict the unknowable.

Mike

14

ahh…

so finally I get it…now that I look back at one of you first emails to me.

At 4500/month in rent, I would be left with 2250/month in NOI. With a 2370/month P&I, that would leave me with -120/month cash flow…not good.

Thanks for the insight Mike. I need to negotiate on the price to get the P&I down significantly.

I will let you know how it turns out. I will put together the offer this weekend.

15

Let us know how it turns out. In many parts of the country, while it’s nice to be able to meet those numbers Mike talks about, it’s just not possible to find properties that have that kind of cash flow. Many investors have turned into speculators and have taken on higher risks in order to take a shot at some kind of reward in the future.

Keep in mind that rents rise over time, if you’re in a 30 year, the mortgage stays the same over that time period. You also get to deduct your expenses and also get to take depreciation on your taxes so investment property can also be a good tax shelter if you’re in a high income bracket.

16
Keep in mind that rents rise over time,

Also keep in mind that operating expenses rise over time.

Mike

17

Mike,

I feel like I’m your little puppy following you around this forum hanging on your every word…LOL

Thanks for sharing your experiences and knowledge. It’s means so much too many of us here, I’m sure.