Cash flow case study

[JSB]

Hi everyone,

I hope this is okay - I`ve outlined below a property I`m very interested in. Based on the numbers shown it`s negative cash flow, but I`m looking for advice on what to change. Some things that I know I should change are both interest rates and the mortgage term.

When it comes to rent, am I better off being safe with a lower but acheivable rent, or should I budget for what I think I might be able to get? Simply changing to financing options and increasing the total rent to $42,00 takes it from -$409 to +$771.

The property is located in the GTA with good access to transit, schools, parks. Property has ample parking.

Any input is greatly appreciated! Sorry for the formatting - it was all lined up nicelybefore I posted it...


Total Purchase Price $597,875 incl. Closing

Total Revenue $3,720

Expenses
Finance - Mortgage $2,823
Finance - DP - LOC $479
Operating $827
Total Expenses $4,129

Net Cash Flow: -$409



Purchase Costs
Purchase Price $575,000
Downpayment 20% $115,000
Balance $460,000

Closing Costs
Legal $2,000
Title Ins. $500
Inspection $1,000
Land Transfer $14,375 Estimate at 2.5%
Renovation $5,000
Total Closing $22,875

Finance Costs
Mortgage
Balance $482,875
Rate 5%
Term (years) 25
Payment $2,823

Downpayment
Amount $115,000
Interest rate 5%
Annual Interest $5,750 Interest only
Monthly Interest $479

Revenue
Monthly Annual
Basement Rental - 3 BR $1,120 $13,440
Main Floor Rental - 3 BR $1,300 $15,600
Second Floor Rental - 3 BR $1,300 $15,600
Total Revenue $3,720 $44,640

Non-financing (Operating) Expenses
Monthly Annual
Heat (gas) $183 $2,200 Current
Electricity $50 $600 Cmmon areas only
Water $33 $400
Taxes $385 $4,625 assume increase from current
Insurance $92 $1,100 Current
Summer maint. $42 $500 Estimate
Winter maint. $42 $500 Estimate
Reserve
Total Expenses $827 $9,925

 

[FayWong]

QUOTE (JSB @ Jul 29 2008, 07:30 AM) Hi everyone,

I hope this is okay - I`ve outlined below a property I`m very interested in. Based on the numbers shown it`s negative cash flow, but I`m looking for advice on what to change. Some things that I know I should change are both interest rates and the mortgage term.

When it comes to rent, am I better off being safe with a lower but acheivable rent, or should I budget for what I think I might be able to get? Simply changing to financing options and increasing the total rent to $42,00 takes it from -$409 to +$771.
What does your broker/banker say about the term and rate? Go for the lowest monthly cost you can based on your financial situation. What do you qualify for?
What are you basing your maintenance figures on? They look a little low to me, but if everything (hot water tank, furnace, roof) is new it might be reasonable.
When it comes to rent you are better off not guessing. Do your research what are similar units in the area renting for? How nice a place is yours compared to the competition? I usually charge a little bit more than other places in the neighbourhood, but make sure they are noticably nicer, fresh paint, no repairs, curb appeal. You can`t just plug in the figures you would like to have, find out the real figures.

 

[Thomas Beyer]

QUOTE (JSB @ Jul 29 2008, 07:30 AM) Hi everyone,

I hope this is okay - I`ve outlined below a property I`m very interested in. Based on the numbers shown it`s negative cash flow, but I`m looking for advice on what to change. Some things that I know I should change are both interest rates and the mortgage term.

When it comes to rent, am I better off being safe with a lower but acheivable rent, or should I budget for what I think I might be able to get? Simply changing to financing options and increasing the total rent to $42,00 takes it from -$409 to +$771.

The property is located in the GTA with good access to transit, schools, parks. Property has ample parking.

Any input is greatly appreciated! Sorry for the formatting - it was all lined up nicelybefore I posted it...


Total Purchase Price $597,875 incl. Closing

Total Revenue $3,720
What type of property is this ? a legal tri-plex .. or a single family house with 2 add`l illegal suites ?

I`d say the rent to price ratio is out of line .. so high risk .. and too tight / too negative a cash flow ..

Expenses missing are: R&M and management fees .. how is managing three tenants and the occasional vacancy ? Who is fixing the leaky taps, worn carpet or doorknob ?

 

[JSB]

QUOTE (FayWong @ Jul 29 2008, 10:04 AM) What does your broker/banker say about the term and rate? Go for the lowest monthly cost you can based on your financial situation. What do you qualify for?
What are you basing your maintenance figures on? They look a little low to me, but if everything (hot water tank, furnace, roof) is new it might be reasonable.
When it comes to rent you are better off not guessing. Do your research what are similar units in the area renting for? How nice a place is yours compared to the competition? I usually charge a little bit more than other places in the neighbourhood, but make sure they are noticably nicer, fresh paint, no repairs, curb appeal. You can`t just plug in the figures you would like to have, find out the real figures.

Thanks for the reply.

In terms of rentals in the area, they can be all over the place. I`ve seen one bedroom apartments renting for $1700, and basements renting for $1300 (both include utilities). given that each unit has 3 bedrooms, mu assumption is that they will be able to garner higher rent. I`m thinking that as long as I undertsand the impact of not getting higher rent (neg cash flow), then I should plan to get what I hope.

Most of the maintenance figures are based on what the current owner is saying are actual. I`ve estimated basic seasonal maintenance - furnace, roof and windows are all new (windows are oldest at 2001).

Another question is the reserve - how much should it be (6 months expenses?) and how long should it take to build it?

 

[JSB]

QUOTE (thomasbeyer2000 @ Jul 29 2008, 10:37 AM) What type of property is this ? a legal tri-plex .. or a single family house with 2 add`l illegal suites ?
I`d say the rent to price ratio is out of line .. so high risk .. and too tight / too negative a cash flow ..

I have to confirm that it`s a legal tri-plex, but it certainly seems to be. It was construced as a multi-residence building, not as a single family house. As well, the property has a large footprint (larger than adjacent similar properties), so providing ample parking/outdoor storage is possible as well.

I agree with your comment re: the rent/price ratio, but I believe the rent is likely too low. And as I said, the example I gave is not aggressivle financed. Just changing the interest rate to 4.5% and the amoritzation to 40 years takes it to +$239 without increasing the rent figures.

I appreciate the feedback - it helps just to talk about it!

 

[invst4profit]

Basing on the industry accepted expenses (50% long term) your actual negative cash flow according to my calculations will be closer to -1462/month on this property. The expenses given to you by the present owner do not come close to reality.
This is not a property I would advise someone to buy and if owned I would recommend selling sooner rather than later.

 

[JSB]

QUOTE (invst4profit @ Jul 29 2008, 11:03 AM) Basing on the industry accepted expenses (50% long term) your actual negative cash flow according to my calculations will be closer to -1462/month on this property. The expenses given to you by the present owner do not come close to reality.
This is not a property I would advise someone to buy and if owned I would recommend selling sooner rather than later.

Where does the 50% rule come from? I`ve seen that mentioned in other threads, and it seems really high. Is there an expense component that I`m completely missing? I can appreciate that expenses might be understated by 25% or even 50%, but by over 100%?

 

[HeatherBrandt]

I didn`t see an estimate for vacancy. I would use a minimum of 8 % (ie-one month lost rent/year/suite) even if the rate for your area is extremely low.

I would say the 50 % for expenses is a good rule of thumb. If you are fortunate, you will have a good year to build reserves and prepare for the time when you get whacked by vacancies, evictions, or large repairs (generally happening all at the same time!). Even a very small handyman type job will cost about $200 and having any type of tradesman look at a repair will run about $50.

 

[Thomas Beyer]

QUOTE (JSB @ Jul 29 2008, 08:44 AM) I have to confirm that it`s a legal tri-plex, but it certainly seems to be. It was construced as a multi-residence building, not as a single family house. As well, the property has a large footprint (larger than adjacent similar properties), so providing ample parking/outdoor storage is possible as well.

I agree with your comment re: the rent/price ratio, but I believe the rent is likely too low. And as I said, the example I gave is not aggressivle financed. Just changing the interest rate to 4.5% and the amoritzation to 40 years takes it to +$239 without increasing the rent figures.

I appreciate the feedback - it helps just to talk about it!
40 year amortization is going away .. so do not use it ..

use an appropriate vacancy, repair & maintenance and property management figure to arrive at true cost to hold for a number of years .. plus potential major upgrades to roofs, windows, boilers, carpets ..

Also: who is paying utilities ? can you convert such that you do not pay hydro nor heating cost, but the tenant ? utilities go UP UP UP in the years to come ..

if rents are too low then yes, this MAY be a worthwhile project .. with the caution that in ON you have rent control and as such rental increases in earnest happen only on turnover !

 

[invst4profit]

The 50% rule is a general guide that takes into account all types of rentals and is compiled from hundreds of thousands of units over decades of time throughout the U.S.
It is more a starting point than anything else when evaluation a property but historically has been proven reliable over the long hall.
Different types of units do vary and a range of 40-60% is not impossible.
As many have noted your expense estimates are low and will likely come back to bite you.
Ask the present owner if you can see expenses back 3-5 years. The money he has spent on upgrades, other than in the case of slumlords, will be required in other areas and you will very likely be hit with expensive vacancies, legal, evictions, advertising etc. etc. as time goes on. He is also most likely hiding other expenses that are normal to the building that would probably turn away potential buyers. Or it is a mom and pop operation and they have no idea of there normal operating expenses.

 

[JSB]

QUOTE (HeatherBrandt @ Jul 29 2008, 12:38 PM) I didn`t see an estimate for vacancy. I would use a minimum of 8 % (ie-one month lost rent/year/suite) even if the rate for your area is extremely low.
Thanks - I`ll add that in. I actually just made my `Reserve` expense 8% of rent.

QUOTE (HeatherBrandt @ Jul 29 2008, 12:38 PM) I would say the 50 % for expenses is a good rule of thumb. If you are fortunate, you will have a good year to build reserves and prepare for the time when you get whacked by vacancies, evictions, or large repairs (generally happening all at the same time!). Even a very small handyman type job will cost about $200 and having any type of tradesman look at a repair will run about $50.
I`m assuming 50% means 50% of rental revenue? If so, is that assuming that the landlord pays all utilities? I`m still not sure how to get my expenses to 50% aside from jacking up every line item just to get there.

 

[JSB]

QUOTE (invst4profit @ Jul 29 2008, 01:08 PM) Ask the present owner if you can see expenses back 3-5 years. The money he has spent on upgrades, other than in the case of slumlords, will be required in other areas and you will very likely be hit with expensive vacancies, legal, evictions, advertising etc. etc. as time goes on. He is also most likely hiding other expenses that are normal to the building that would probably turn away potential buyers. Or it is a mom and pop operation and they have no idea of there normal operating expenses.
One of my conditions is verfication of expenses (utilities, taxes, insurance).

What kind of `other` expenses could he be hiding? Provided the building is in good shape (inspection should verify), and provided that the recent reno`s are confirmed (windows 2001, furnace 2003, roof 2004),I`m not sure what sort of hidden expenses there could be - anything more you can do to point me towards them would be appreciated.

 

[JSB]

QUOTE (thomasbeyer2000 @ Jul 29 2008, 12:57 PM) 40 year amortization is going away .. so do not use it ..
I just heard the same from my banker - and apparently 35 may be going away too.

QUOTE (thomasbeyer2000 @ Jul 29 2008, 12:57 PM) use an appropriate vacancy, repair & maintenance and property management figure to arrive at true cost to hold for a number of years .. plus potential major upgrades to roofs, windows, boilers, carpets ..
This is the kind of stuff I want to make sure I`m not missing. I don`t know what `appropriate` is. If I`ve budgeted a reserve into my monthly expenses (8% of revenue) as well as budgeting for seasonal maintenance, what else do I need?

QUOTE (thomasbeyer2000 @ Jul 29 2008, 12:57 PM) Also: who is paying utilities ? can you convert such that you do not pay hydro nor heating cost, but the tenant ? utilities go UP UP UP in the years to come ..
Tenants pay electricity - each unit is separately metered.
Gas and water are not separate, but the idea of a shared utilities agreement between tenants is something I`d look into, if only for gas. Cost to separately meter gas is (supposedly) around $7,000.

QUOTE (thomasbeyer2000 @ Jul 29 2008, 12:57 PM) if rents are too low then yes, this MAY be a worthwhile project .. with the caution that in ON you have rent control and as such rental increases in earnest happen only on turnover !
That`s my biggest problem right now. I`m trying to get information on truly comparable rents; there are three similar building adjacent to this one, and I`m hopefully going to find out what the tenants pay there, but in many cases tenants have been there for many years, so rent values will be artificially low due to rent control.

 

[invst4profit]

Go to BiggerPockets.com forum and search "50% rule". It`s on page 2.

This forum discussion pretty well covers the topic.

 

[JSB]

QUOTE (invst4profit @ Jul 29 2008, 03:21 PM) http://forums.biggerpocket.com/about19967...;highlight=rule
This forum discussion pretty well covers the topic.

The first time I clicked the link I got the forum, but now all I get is a generic search screen.

Anyway, the reading that I did do was informative, but it still didn`t answer the question of what the 50% includes. I understand that as a general rule of thumb it`s useful, but I`m trying to reconcile 50% with the 35% I`ve got that still seems overly conservative. I can`t imagine where another 15% of expenses would come from. That`s why I feel like I`m missing something pretty major.

 

[invst4profit]

Assuming you read the first response to the question on that link you now do know where all the expenses come from.
The problem you are facing is you do not accept the fact that expenses will be in that range. Many before you have had the same response and usually find out the hard way that reality bites.
I can not tell you where your expenses will be but you will have them and they will be as predicted assuming you hold the property long term. It boils down to the law of averages.

 

[Thomas Beyer]

QUOTE (JSB @ Jul 29 2008, 11:24 AM) Tenants pay electricity - each unit is separately metered.
Gas and water are not separate, but the idea of a shared utilities agreement between tenants is something I`d look into, if only for gas. Cost to separately meter gas is (supposedly) around $7,000.


That`s my biggest problem right now. I`m trying to get information on truly comparable rents; there are three similar building adjacent to this one, and I`m hopefully going to find out what the tenants pay there, but in many cases tenants have been there for many years, so rent values will be artificially low due to rent control.

Utilities can only be shared with a new tenant as you canNOT force utilities onto existing tenants !

Welcome to ON .. a land tilting more and more to the left and into economic abyss .. so why move as a tenant if rents are 30-50% below market .. only way to make money here as a landlord is to keep expenses extremely tight .. and then renovate a suite when a tenant leaves and adjust rents to market !

 

[vandriani]

QUOTE Basing on the industry accepted expenses (50% long term) your actual negative cash flow according to my calculations will be closer to -1462/month on this property.

Could you please elaborate more on this. Expenses are 50% of what?
Thanks in advance

 

[invst4profit]

It is 50% of your total monthly rental income.
Assuming you have a unit rented out for $1000/month your expenses to maintain that property over the long term will be approximately $500/month. The remaining $500 has to cover your dept payment (plus lost income on cash invested) and provide you with your positive cash flow.
This is a ball park figure used to evaluate a property but is usually fairly accurate give or take 5%.

 

[vandriani]

QUOTE (invst4profit @ Jul 30 2008, 01:06 PM) It is 50% of your total monthly rental income.
Assuming you have a unit rented out for $1000/month your expenses to maintain that property over the long term will be approximately $500/month. The remaining $500 has to cover your dept payment (plus lost income on cash invested) and provide you with your positive cash flow.
This is a ball park figure used to evaluate a property but is usually fairly accurate give or take 5%.


Thanks invst4profit. I would think it`s even more.