Hello,
I’m beginning to do research in purchasing my first rental property. I was wondering what software you would recommend to offer projection analysis on a property. I’ve seen “Cash Flow Analyzer” from rentalsoftware.com, which looks like it would do the job, but am wondering if anyone would recommend a different one.
Thanks!
paging PropertyManager Mike
I wouldn’t use those softwares.
Just write out the income and expenses.
What kind of rental properties are you looking to buy? How many units?
There are plenty of free spreadsheets floating around the web. No need purchasing one. However, by far the best “analyzer” I’ve seen is Mike’s (propertymanager) 50% rule. Hard to go wrong with it.
GeXus,
As the others said, do a search (at the top of the page) of the 50% rule.
Here is how I determine cash flow.
Divide the gross rents by 2. That is your NOI (Net Operating Income).
Subtract your mortgage payment (P & I only) from the NOI. What’s left is the cash flow you can expect. NO SOFTWARE NEEDED!
Good Luck,
Mike
The “50% rule” is a rule of thumb. It is not an absolute number for every property. In the absence of actual operating expense numbers for a property you might consider adding to your rental holdings, you start with 50% of gross rents to estimate your operating costs. If the other 50% of gross rents leaves enough left over to pay your debt service and leave you enough cash flow, then you may want to take a closer look at this property.
When you take the closer look, you will do a detailed cash flow analysis. Get actual amounts for all the operating costs you are likely to have for that property. This means you will have to do some homework.
Get quotes from the insurance company for a rental dwelling policy. Look up the property tax record and see what the current property taxes are. Ask the tax assessor’s office if the property is scheduled for a reassessment anytime soon, especially if transfer of title triggers a reassessment.
Talk to property management companies about management costs and market rents for that property. Ask about their experience with the vacancy rate and eviction rate for similar properties the company manages in the same neighborhood. Is there an HOA and what is the monthly assessment?
What is the age of the property? Are major systems (such as roof, HVAC) and appliances at or near the end of their life cycle? What is the age and condition of carpet and vinyl? What is the replacement cost for each of these things? How much will you need to contribute to a replacement reserve each month to handle the replacement costs when they come up.
Once you get real numbers or accurate estimates for your operating expenses, then you can make an informed purchase decision.
The two critical numbers you need to know from your detailed cash flow analysis is the debt coverage ratio and the cash on cash return. These numbers will tell you if the cash flow is sufficient to support the property and whether the return on your investment competes favorably with what you might get from another investment vehicle.
There is a spreadsheet you can download from this very site. Click on Cash Flow Analysis to download the spreadsheet. It assumes that the property is sold after eight years and doesn’t do any inflation adjustment, but you may get some useful feedback from just experimenting with this tool.
Thanks a lot for your feedback. Checked out the 50% rule, looks like based on that if you’re able to get positive you’ve found a clear winner. Also, Dave - Used your spreadsheet, it seems that the property taxes, insurance, hoa (basically column B), don’t subtract from the annual cash flow at all… maybe I’m missing something.
Just wanted to add, is there a way to do this in reverse. So here’s an example.
There’s one specific town that’s really hot right now near where I live. Rents for townhouses that are 3BR, 2+ BA, go for about $2000-$2200/m., most of the townhouses are pretty much the same. Property taxes are about $6,000 a year, HOA is $85/month. The homes are 6 years old, generally in good condition. Based on these numbers, how could I figure out what a good purchase price could be? Also, the most I can do for a down payment would be about $200,000.
The avg. ASKING price for these right now, is between $500,000 - $600,000.
All I can do is direct you to the instructions at the “Read Me First” tab.
Column B is your initial cash outlay before you even put the property into service as a rental. Column B is your downpayment, closing costs, and rehab/maintenance expense. All of these items are entered as negative numbers. The items you mention are entered into Year 1 (column C) and then propagated through Year 8. I looked at the spreadsheet and it appears to be doing the arithmetic correctly. Did you change any of the formulas?
Starting with the 50% rule, you need all your costs of rental operation and property ownership paid by half of the rental income. You already know that property taxes and HOA fees will be $585 per month.
How much is the hazard insurance going to run? If the hazard insurance is $2400 per year, then add another $200 to your monthly operating expenses.
Now, what about replacement? Things breakdown and need replacement. Kitchen appliances are at least six years old and no longer under warranty. If they have a useful life of about ten years, how much do you have to set aside each month to pay for the replacements. Let’s say $240 per year, or $20 per month if everything is brand new. Since everything is already six years old you may need to set aside more each month. Roof will probably need replacement in 25 years, HVAC system is usually good for 12 to 15 years. If the roof replacement will cost $12K and a new HVAC will cost $6300 then you will need to add another $75 a month to your replacement reserve account (more if everything is not brand new).
Annual or semi-annual HVAC preventive maintenance inspections cost around $150 per year. For most of my properties, I have an annual fire safety inspection to check and recharge the fire extinguisher and replace batteries in the smoke detectors at a cost of about $50 per year. If you do these and then add in another $17 to your monthly operating expenses.
How about advertising and leasing expenses? Are your lease forms prepared by an attorney and reviewed annually to ensure they are current with your landlord-tenant law? Will you pay a referral fee if a real estate agent brings you a tenant? Let’s just add another $600 per year to your operating expenses to cover these items.
Are you managing the property yourself or outsourcing management to a professional management company. Regardless, expect to spend around 10% of your collected rents on your management costs. Even if you do it yourself, it still costs you money to show the property to applicants, visit the property for routine inspections or to supervise repairs, and again for the moveout inspection. You will have office equipment and supplies to purchase. Even mailing your tenants is not free. If your collected rents are just $2000 per month, then allocate $200 to your management overhead.
Adding up all the costs you have so far, your operating overhead comes to $1147 per month. provided you have 100% occupancy. For a property in the price range you are looking at, you need to consider a vacancy allowance of three month’s rent which will add another $500 per month to your overhead based on a $2000 monthly rent.
Just from our preliminary calculations, your operating expenses are running $1647 per month. This leaves you $353 per month to pay your mortgage loan.
Assuming that you want around $100 per month cash flow, you can only afford $253 per month for your loan payment. A 30 year fixed rate loan for $42166 at 6% interest will cost you about $253 per month. If you are using 80% financing, then the most you can pay for this property and still cash flow is $52708.
This would be a great purchase price for a $500K property, but not very realistic. If you use 80% financing at 6% fixed for 30 years, then if you purchase this propertty at $500K, your rents will need to be at least $4500 per month to just get a $100 monthly cash flow.
Even if you could get those numbers, you still need to ask if this property is an efficient use of your money. Let’s ignore closing costs, and just look at the $100K downpayment. Your annual cash flow is $1200 for a 1.2% return on your invested capital.
If this is the best you can do, then you would be better off putting your money in 5 year bank CDs at 5%.
The lesson here is that the property that produces a positive cash flow may still not be a good investment. The property in this example is certainly not a “clear winner” just from a rental cash flow point of view. Now, buy that property for $50K and flip it for $450K and you have a clear winner.
Just for the record, I disagree with Dave T. The 50% rule is not a screening tool, it is the average operating expense experienced by hundreds of thousands of rental units across the United States. It is not a worst case scenario, it is the scenario you should expect with a number of rental units over a period of time.
In theory, I would agree with Dave T that you should do whatever homework is needed to use the specific numbers for your area. Unfortunately, that is virtually impossible for all but the largest apartment complexes. How many evictions will a given property have in a given year? Impossible to know. Will a tenant do more damage to your property than the security deposit this year? Impossible to know. Will a tenant sue you? Impossible to know. Will you need to replace the stove this year, even the stove is 2 years old (because the tenant destroyed it)? Impossible to know. So, while I agree with Dave T in theory, that is normally impossible in reality, which is why I use the 50% rule. I haven’t seen anything more accurate - if I did, I would certainly use it.
My properties are divided into several companies (LLCs). I just got my taxes back from the accountant on Friday (they were on extension). After thoroughly reviewing them, I figured the operating expenses for each of them. The operating expenses for these companies ranged from 38% of gross rents to 68% of gross rents, with the median coincidentally being 50%. The average for all the companies was 48%. When you look at those numbers, that’s quite a range: 38% to 68%.
Why were the operating expenses so low in one company and so high in another? The answer is found in the randomness of numbers (luck). All of these companies are in the same city. All of these properties are managed in exactly the same manner by me. All of these properties are maintained to the same standard. In fact, the really ironic thing is that the company with the expense number of 38% was a company with very low income tenants! They just happened to be well behaved this year. Should I count on similar numbers with that company next year? I wouldn’t take that bet!
Mike
Mike,
We don’t disagree. We both agree that 50% is not an absolute number for the operating overhead for a specific property at a specific point in time. The actual numbers could be higher or lower. Yes, we both agree that over time, the operating overhead for a specific property will tend to average 50% of scheduled rents. And, we also agree that for a portfolio of properties, the group will tend to have an aggregate operating overhead that approximates 50% of scheduled rents.
I am saying that the application of the rule is not quite as simple as you stated earlier in this thread. Let me repeat what you said earlier.
[b]Here is how I determine cash flow.
Divide the gross rents by 2. That is your NOI (Net Operating Income).
Subtract your mortgage payment (P & I only) from the NOI. What’s left is the cash flow you can expect.[/b]
If GeXus naively applied your formula to his $500K property that has a market rent of $2000 per month, then he would say that his operating overhead will be $1000 per month. This leaves $1000 per month left over for debt service and cash flow. If GeXus simply reserves $100 for his monthly cash flow, he will conclude that he can afford a $900 monthly loan payment or he can finance $150K on a 30-year fixed at 6%. For his $500K property, he would have to put $350K down and pay closing costs out of pocket. In actuality, his operating overhead is closer to 100% of his market rent as I demonstrated.
I know you did not intend for the casual reader to apply the 50% rule in this manner. I suspect you really want GeXus to only consider properties for which the operating overhead can be paid with 50% of the rent (or less).
If this is the way you apply the 50% rule, then the rule really is a screening tool to identify potential purchase candidates from the pool of available properties. You might feel comfortable stopping at this step. I don’t. I am suggesting that a more detailed cash flow analysis is still needed to confirm that a specific candidate property is a better investment than some other investment vehicle.
Or, better yet, given a choice of candidate properties that pass the 50% rule, which is the best investment. The property with the highest cash flow is not always the property that produces the highest return on your invested capital. I still need a more detailed cash flow analysis to make that determination.
We don't disagree. We both agree that 50% is not an absolute number for the operating overhead for a specific property at a specific point in time. The actual numbers could be higher or lower. Yes, we both agree that over time, the operating overhead for a specific property will tend to average 50% of scheduled rents. And, we also agree that for a portfolio of properties, the group will tend to have an aggregate operating overhead that approximates 50% of scheduled rents.
Sorry, I misinterpreted what you were saying. This was my main point and I see that we do agree.
For his $500K property, he would have to put $350K down and pay closing costs out of pocket.
I agree. I always assume that 100% of the acquisition cost will be financed when I determine whether a property is acceptable or not (whether I’m putting any of my own cash into the deal or not). Furthermore, I also agree with you that if you’re putting your own cash into the deal, that you should consider whether this is indeed the most productive use of your money.
Mike
Mike,
Your approach is to only consider purchasing properties that will generate a monthly rent that is at least 2% of your purchase price. This confines your pool of candidate properties to only those that cash flow under your 50% rule and. additionally, limits the maximum purchase price for your properties.
In this model, the ratio of monthly market rent to purchase price is really your screening criteria. I am assuming that you already have sufficient experience with properties that pass the 2% test to know that the operating overhead will not generally exceed 50% of the market rent.
Since you use 100% financing, you don’t need to worry about cash on cash return. I can see that you just use the 50% rule to make sure you will still cash flow given your available financing. In your approach, the 2% rule is your screening tool.
In my market, I am investing in higher cost and higher income neighborhoods where the 2% rule will not work. I am buying more expensive properties that fail the 2% rule. So, I tend to use the 50% rule (as a screening tool) to determine how much I can afford to pay for a particular property using 80% financing. If a property passes this quick and dirty affordability test, then I do the detailed cash flow analysis to see if the property has sufficient cash flow to support the property and whether my cash on cash return is acceptable.
If GeXus just asks if he can make the debt service and still cash flow on half of the market rent, then this use of the 50% rule as a screening tool will eliminate this $500K property from his radar screen.
If GeXus just asks if he can make the debt service and still cash flow on half of the market rent, then his use of the 50% rule as a screening tool will eliminate this $500K property from his radar screen.
As is should!!! Paying $500,000 - $600,000 for a property that has gross rents of $2,000 - $2,200 per month is INSANITY!
Mike
I can’t even bring myself to pay close to the $550K asking price for the multi-unit complex we’ve looked at that generates $6675/mo income. I know based on real world available financing, maint. issues, etc. this owner is way high on his price. Sad thing is someone will probably pay for it, but I can’t bring myself to do it.
There’s no way I would consider paying that much for the deal GeXus posted.