Hey Danny thats a great post and I totally agree. Although at the monet I have to churn the equity to the utmost that will still allow me to have a cash flow because that is my ultimate goal. A large monthly passive cash flow from the properties. Once I have built up enough to buy a property for cash you can be sure I will do that because hard money costs. Then I will refi to pull cash out just as you stated. This is my plan all along but until I get to that point I need to pull the max cash that will allow me to be positive each month on top. Thanks
Where can I get a few of those? I’ll take a dozen please!!
Try Florida.
Hey spaceace you like KISS?? My favorite band! Anyway I find them all the time. Although I have not been able to capitalize on them because I am doing it starting with nothing and just using money from refiing the properties as I get them. I wish I had a nice credit line of 30-50k, that would make things much faster and easier. Good luck
Back to losing faith in the formulas… although it’s preached over and over, I can’t agree on the 50% expense ratio.
If that’s the case here, EVERYONE is losing money and EVERYONE is still buying properties because I doubt their all being sold at 60% discounts.
I’m guessing in a market like the one I’m in, the expenses are less in relation to the rental rates since the rental rates are probably higher per unit than in other areas of the world.
If you have a unit renting at $500 per month ($6000 per year) I could assume that total expenses will equal about $3000 per year.
However, if you have a similiar building, (a 4 plex) bringing in $3500 a month, $42,000 a year, you need to spend a lot on appliances to burn up $21,000 ($5,250 per unit) a year to get expenses to equal 50%.
Although I haven’t purchased anything yet, I don’t understand how a higher demand rental area with an additional bedroom per unit increases the cost when each unit has the same number of generic appliances, similiar sized parking spots, and similar sized roofs.
The expenses also include taxes insurance, gas for your car if you drive it management fees you dont do it for free right? Computer,paper,pens, printers,faxes whatever overhead you have to operate the property plus any repairs.
Right. I agree.
But here’s the thing. If you have a duplex earning you $800 in a low demand area versus a different market where you collect $4000 per month rents on a 4 plex, all other expenses don’t relate to the rental price.
Low demand area, $800 per month expenses might equal 50% of the $9600 GOI.
So $4800 of expenses. Say $1150 for taxes and $600 insurance. The remaining $3050 is for everything else. (Pens, gas, ads, repairs, garbage, new appliances etc).
If you have a 4-plex yielding $48,000 a year. Since rents are 5X the rent of the other property, let’s make the taxes 5x as well. $5750. Insurance is not 5x, but more likely around $1500-$2000.
So gross income minus insurance and taxes, you have $16,250 for the remaining expenses. That’s an extra $13,200 of “expense money to spend” on the high demand 4-plex to use up to equal a 50% expense ratio over the low demand duplex.
I understand with the 4-plex, the roof is slightly larger and there are two additional parking spots and an extra 6 appliances. But what is it in the higher market 4 plex that will take more consumption than the lower demand duplex?
dd,
I agree with you to a point. Higher demand rentals (higher rents) wouldn’t automatically increase operating expenses at the exact same proportion. There might be a little more sq. footage which costs more to build, maintain, clean, heat, power, plumb, etc. but just because you can get $100/month more for your unit, doesn’t automatically mean operating expenses increase $50/month. Allocating 50% of the gross rent towards operating expenses is a conservative estimate. I’m sure you’d agree that it’s better to overestimate rather than underestimate expenses. In reality your annual operating expenses will never be a nice round number of 50% of the EGI.
The conservative estimate of 50% is not a number taken out of thin air either. It’s based on real life tangible expenses from the United States accounting for EVERY cost.
Spending $5,250/ unit/ year on expenses is not unreasonable or unimaginable for units renting at $875/month.
Maybe we can fill in the gaps for your expense estimates… try to think up a list of every expense of a rental property and the percentage you think it would take up of the projected (scheduled, contracted, whatever) gross income. Let’s assume the property has 8 units.
dd,
The 50% “formula” comes from the factual information provided for hundreds of thousands of rental units throughout the United States. In reality, the expense number is actually a range of 45% to 50% of gross rents.
It is very common for new investors to think that THEIR operating expenses are lower than this range. That’s because they haven’t experienced the reality of being a landlord. Moreover, the popular gurus will never tell you the truth about expenses because it cuts into their sales of expensive courses and mentoring.
So, if you aren’t going to use 45% to 50% for your expense number, what number are YOU going to use? Many newbies think that Gross Rent less the mortgage payment = cash flow. Would you use this formula? Many gurus say that Gross rent minus mortgage payment, management, maintenance, vacancy allowance, taxes, and insurance = cash flow. Would you use this formula?
Even if you realize that the expenses are more than management, maintenance, vacancy allowance, taxes and insurance, what number do you put on these additional expenses? What data do you have to support this number?
It’s easy to pretend that the expenses are somehow lower for YOU. The vast majority of new investors believe this. However, the vast majority of newbies also don’t last long in the rental business.
Good Luck,
Mike
I’m not disagreeing with the 45-50% as a conservative measurement. But few if any properties cashflow at 50% expense when financed at 100%.
I’m in a competitve area with smart and dumb investors alike, and deals are not easy to find that cash flow with 100% financing using 50% for expense. I have a spreadsheet of over 100 properties, and 80 of them would have to be purchased at less than half price to make it work. With an overabundance of investors, a new guy won’t get too many properties purchased (let along a first one) offering 60% off asking price.
Even in the areas of the city that I don’t care to get shot at, the discounts need to be greater than 30%.
My strategy is to buy and hold.
Properies will be purchased on 30 year loans which pay down the mortgage (not interest only).
I will not buy unless it cashflows after mortgage and ALL expesnes are accounted for.
I’ll use the 50% for rule of thumb to sort out possible good properties but I won’t let it prevent me from buying my first property which will be my best education.
To protect myself, I’ll have sufficent cash funds on hand. I’ll make sure the property cash flows at 100% financing, but I’ll pay down 20% to help provide extra cash flow while still mainaining a better than 10% return on my investment.
I’ve been reading on the forum for 2 weeks straight. Every brain fuse is blown. I haven’t eaten in days. And I just wet myself.
DD564
You had me knodding my head agreeing with you until I read that part about education.
I’m the first to admit that life is the best school, so I’m not even disagreeing with you there. Just don’t fall into that “if I don’t do this one, I’ll never do it” trap.
Keep in mind its easier to avoid a mistake than it is to fix one, also remember no matter how careful you are, you will probably make some.
(sorry about the zen)
Good luck in your REI
dd,
No one (who knows the truth about rental properties) ever said it was easy. The majority of properties in your area won’t cash flow? That’s absolutely normal. If you thought that you could easily find good rental properties, you were wrong. You might hear that crap from some of the gurus, but it is simply NONSENSE.
Nothing about operating rentals is easy. It is not easy to find properties that will cash flow. It is not easy to find financing. It is not easy to find good tenants. It is not easy to deal with tenants. If it were easy, everyone would be rich, yet only about 2% of Americans are millionaires.
The good thing about rental properties is that you don’t have to be buying several properties each month. In fact, once you get the number of properties you need to generate the cash flow you want, you never need to buy another one! This is very different than birddogging, wholesaling, rehabbing, retailing, etc, where you have to be constantly buying to be eating. However, the other side of this equation is that it is critically important that every property generate a profit. Otherwise, some of your properties are paying for others and part of your business is sucking the life out of another part.
My advice is to do the work to find a property that has proper cashflow. If that takes a month, fine. If it takes 6 months or a year, that’s also fine. It’s MUCH better to wish you had a property, than to have a property that you wish you didn’t have!
Good Luck,
Mike
propertymanager,
I agree with almost everything you say. I agree with your philosophy of buying and holding becuase I don’t want to have to buy 300 properties in order to reach the net worth I desire. I’d sooner buy 12 or 13 properties with 4 units each that cash flow $200 per unit per month. (TRUE CASH FLOW). That’s easier to do in my book than flipping 300 properties, but what do I know, I’m not even started yet.
On a seperate note, to help defend my argument on what % expenses we have in my area, I emailed another investor in my area to ask him what % of rents his expenses are. He said that he didn’t quite understand my question because he doesn’t watch his expenses that well, but he said on his 15 properties he barely cashflows each month so he’d assume about 90%.
Not real reliable information from a guy who doesn’t watch his expenses. So anyway, that’s the kind of investor I’ll be in a bidding war with on some of the properties I pursue, at least until he goes broke.
dd,
That guy and all the other newbies who haven’t done their homework will become your best friends. Join your local REIA. Many of them will be hanging out there. The reason that they will be your best friends is that they will provide you with a constant source of deals. Every single day, newbies go belly up and they become absolutely DESPERATE to sell. Most will not be deals because they owe too much, but a few will even bring cash to the closing to stop the pain! I have bought many properties from these folks and I appreciate their ignorance and lack of planning. Let him know that when he’s ready to throw in the towel, you’re buying - at 60 cents on the dollar! You think I’m kidding…
Mike
dd,
I hope your not turning your nose up at the notion that operating expenses run about 50% of the gross income because few properties in your area could cash flow like that. In which case, most people would be losing money on there rentals. This infact is the case! Most people do lose money on there rentals. This is the major reason there are a 1000 times more beginners than seasoned vets. They might appear to be making a profit for a while until a tenant sues them and they weren’t accounting for legal fees. It might also be when a large capital expenditure is required to put on a new roof and they weren’t setting money aside for a reserves for replacement. Business is not a game that you can go with the flow and do what the popular kids are doing to be successful. The overwhelming majority will fail eventually. Your only chance at success is to do something different from the norm. In your market it seems that buying properties at 60% would be what’s required from you to be successful in your business.
The dumb investor you emailed is probably confusing a mortgage payment with an operating expense. Just for the record, debt service is not included as an operating expense! This guys awful bookkeeping is the reason why you never trust a pro forma and verify all income and expenses in your due dilligence.
Hang in there. Stay with REI.
The key to having properties cashflowing is to either buy at a steep discount and/or put more money into the property (i.e., more money down). Kellar (author of “The Millionaire Real Estate Investor” and co-founder of Keller-Williams) recommends buying at (or below) 80% FMV and putting 20% down, so you will have a minimum of 40% in the property from the get-go. This is accomplished in a myriad of ways, one of which is to buy properties for purely cash reasons (i.e., flips). For example, buy a property that nets you $20,000 profit. Find a $100,000 property for $80,000 (or less) and put down $20,000. I wouldn’t use those exact percentages for every property as each has it’s own individual characteristics, but that’s one way to get properties cash flowing positive.
NMD,
Just finished reading the Millionaire Investor. Very good approach for wealth builiding. With a $20k down on a $100k property you purchased for $80k, your ROI would be 12% if your cash flow is $200 a month. or 18% @ $300/mo.
If you put money down then you are not making money till you have made the money down back a few years down the road depending on the numbers. True or am I missing something. All money costs, fees, holding and what ever must be included to get the true profit numbers.
It is like the flipping houses tv show. A lot are saying the made x amount and not saying or including all the numbers. Very missleading for the ones who do not know the investing world of re.