Cash flow case study

[JSB]

QUOTE (invst4profit @ Jul 30 2008, 09:13 AM) 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.

Actually, the problem I`m having is getting a proper answer.

I understand the law of averages and using rules of thumb. However, the law of averages is called that because it is about AVERAGES.

I`m trying to get some understanding about this process, so to have somebody tell me that expenses will be 50% no matter what isn`t very helpful. I`ve taken an example and jacked up what I had as actuals by a substantial margin and added a generous vacancy/reserve portion, and I`m a little under 40% right now.

So for me to simply accept that there will be another 10% of unknown expenses is really now how I`m built. It`s got nothing to do with accepting that expenses may be in the range, but before I budget accordingly I`d like to know why I`m doing so.

As an example, for me to get to 50% based on my revised numbers, I`d have to increase my vacancy/reserve from 1 month/year to 2.5 months/year, or by $465/month. A MONTH.

I`m really not trying to be argumentative, but if the only answer to my question is "that`s what the average is", then that`s really not helpful.

 

[JSB]

QUOTE (thomasbeyer2000 @ Jul 30 2008, 12:03 PM) 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 !
That`s one of the bright spots about this property - two of the units are owner occupied, so the rent will be whatever the market will bear. The existing tenants in the basement apt. have indicated they will be leaving end of August. Good news if I find renters, bad news if I can`t.

I went to see this property again last night and I`m having some more doubts. I think that it might pose a cash flow challenge (or be a cash sinkhole if expenses peak at 50%+), but I`m still a big believer in the neighborhood. I`m going to revisit it with a greatly reduced offer price and see if there any interest.

Thanks Tom for your advice!

 

[housingrental]

Include in your expense % :
1) Management fees - 5%-10%
2) Tenant leaves, bashes place, you can`t collect from them damages - wholes in walls, all floors need replacement, etc..$$$$
3) Tenant cause major problem, damages place, see above, causes other tenants to leave before being eveicted - factor in $0 income for X months
4) Periodic major repairs - Windows/roof/furnace/appliances all newer? - Factor in 1/15 of total cost of replacement for all each year
5) Preventive maintenance - Eavestrough cleaning, Furnacing servicing, Grading, S/F/E + Siding + Chimney + Flashing Repairs - $XX
6) Random major repairs - toilet leaks into other unit and you need to replace ceiling and floors, etc.. windstorm takes shingles off and leaks in from there - sewage back up? flood? foundation cracks?
7) Exterior maintenance - Snow and ice clearing, grass cutting, tree and shrub cutting, landscapping.
8) Periodic aesthetic upgrades - Equiviliant of repaiting property every 10 years - Flooring? Kitchens? Etc..
9) Periodic minor fixes - Drywall repair? Changing locks? Appliances repair? Hot water heater? Plumber?
needed?
10) Advertising

 

[JSB]

QUOTE (housingrental @ Jul 30 2008, 07:27 PM) Include in your expense % :
Thanks - this at least gives me some idea where the 50% comes from.

In looking at the items you`ve listed, the ones of major concern are big ones that for the most part can be either prevented/minimized by thorough inspection/tenant screening, or will just happen (act-of-God type stuff). I appreciate that to be COMPLETELY certain you need to budget for the extreme in each of these cases, but I`m of the mind that if I`m fairly comfortable that the building is in good shape then budgeting for these things immediately is not a requirement. I understand this is a risk, but I`m thinking that if I wait until I find a property that absolutely fits the 50% rule, I could be waiting a long time. I`m thinking that by doing proper investigation and being diligent that it CAN (not WILL) keep expenses down. In order to be completely safe, I shoudl view the 50% rule as a rule and not a guideline; I`m happy to use it as a guideline.

One thing that I`m wondering - you mentioned `management fees` at 5-10%. What do those fees represent?

 

[Nir]

Dear JSB {=Just Started Buying?} joking, I also started recently

Greg and Thomas are 100% correct!

I wouldn`t buy it even for $400K!

To compensate for separate meters let`s add 5% to the 50% income estimate --->
CAP =~ 55% * 12 * $3,720 / $597,875 = 4.1% that`s bad, really bad!

How about looking for a CAP double that % say around 8% elsewhere, outside the GTA.

Good luck,
Neil

 

[invst4profit]

This property is destined to bleed money. Toronto property value to rental income is way out of whack.
In my area top asking price would be about $370,000 but I would be closer to the $300.000 (max) range to hope for any positive cash flow.

 

[JSB]

QUOTE (investmart @ Jul 31 2008, 12:15 AM) To compensate for separate meters let`s add 5% to the 50% income estimate --->
CAP =~ 55% * 12 * $3,720 / $597,875 = 4.1% that`s bad, really bad!

How about looking for a CAP double that % say around 8% elsewhere, outside the GTA.

Good luck,
Neil


Based on your calculation, you`re using the net income to determine the capitilization rate?

So, if I`m looking for an 8% NET Cap rate, then I`d be looking for something in the 12-16% GROSS Cap rate?

For this property, that would mean charging rents of between $6,000 and $8,000. Alternatively, the property should be reasonably priced at about $300,000?

Basically, this requirement means that for every $100,000 spent, the GROSS rent needs to be $12-16,000?

Somebody please tell me if these properties really exist. I have a feeling that we may be talking apples and bicycles with our numbers...

 

[housingrental]

Hope this helps, let me know if you have anymore questions.

1) You can`t prevent the big ones. They`ll happen. Budget for them. Furnace new? It`ll be dead soon enough - budget the 1/X years replacement cost each year for it. What are you going to do break even each year without maintenance cost and then a) Come up with $10 000 out of pocket 10 years from now for a reno and b) Have vacancy/lower rents/lower sale or refinance price because your not constantly beautifying property?

What happens if item a) comes up when you lose your job, have no access to savings or credit? Etc..

2) Management fees of 5%-10% are to co-ordinate everything happening - If you think you`re doing this yourself and you don`t need to budget anything for this it skews the desireability of the investment. Your time isn`t free. Is a company bond at 7% the same as rental property that has a 7% return if you have to work mornings and nights 7 days a week if self managing? Rental properties are a business that requires someone doing work to make it run - either you or another manager - but it has to be done. This includes things like:


Acting as a rental agent for the property including preparing and posting advertisings, responding to emails and phone calls from potential enters, scheduling viewings, preparing leases, and following up with potential renters who express interest. Contacting current tenants to obtain N9`s.


Coordinating moves in and moves outs of tenants including condition

reports.



Preparing the property for new tenants.



Deposit, issuing cheques, and record keeping of monthly rental deposits and expenses



Periodic exterior inspections of property



Periodic interior inspections of property



Scheduling periodic maintenance workers to the property (i.e. eaves trough cleaning, yard cleanup, furnace servicing, landscaping)



Responding to phone calls, emails, and letters from tenants, guarantors, workers, or anyone else in regards to the property.



Providing notices to the tenants including reminders on expected standards of cleanliness, interior and exterior upkeep, and move-out procedures.



Responding to maintenance requests from tenants, arranging for workers when needed, providing access to the property for workers as needed.



Making small interior and exterior repairs.



Procuring quotes from workers for capital improvements to be done to the property.


Serving and preparing legal notice and providing representation.






QUOTE (JSB @ Jul 30 2008, 08:51 PM) Thanks - this at least gives me some idea where the 50% comes from.

In looking at the items you`ve listed, the ones of major concern are big ones that for the most part can be either prevented/minimized by thorough inspection/tenant screening, or will just happen (act-of-God type stuff). I appreciate that to be COMPLETELY certain you need to budget for the extreme in each of these cases, but I`m of the mind that if I`m fairly comfortable that the building is in good shape then budgeting for these things immediately is not a requirement. I understand this is a risk, but I`m thinking that if I wait until I find a property that absolutely fits the 50% rule, I could be waiting a long time. I`m thinking that by doing proper investigation and being diligent that it CAN (not WILL) keep expenses down. In order to be completely safe, I shoudl view the 50% rule as a rule and not a guideline; I`m happy to use it as a guideline.

One thing that I`m wondering - you mentioned `management fees` at 5-10%. What do those fees represent?

 

[housingrental]

I`m not certain what you meant re gross rent but I think your idea is rent/price ? If so i`d look for at minimum (if value can`t be added) 9.5% of gross rent to purchase price yearly (assuming no/minimal (exterior lights, etc..) utility costs included in rent)
Yes these properties can be found. 12%-16% of gross rent with tenants paying utilities will be hard to find unless a) There`s a major deffered maintenance issues or b) It`s a dying town



QUOTE (JSB @ Jul 31 2008, 12:38 PM) Based on your calculation, you`re using the net income to determine the capitilization rate?

So, if I`m looking for an 8% NET Cap rate, then I`d be looking for something in the 12-16% GROSS Cap rate?

For this property, that would mean charging rents of between $6,000 and $8,000. Alternatively, the property should be reasonably priced at about $300,000?

Basically, this requirement means that for every $100,000 spent, the GROSS rent needs to be $12-16,000?

Somebody please tell me if these properties really exist. I have a feeling that we may be talking apples and bicycles with our numbers...

 

[invst4profit]

JSB

I believe REIN members use the 1% rule. Monthly rent equals 1% of purchase price of unit.
As you have stated for every $1000/month rent you can pay $100.000 to purchase.
It is possible to find units in that range and as a investor it is far wiser to wait for the right property than rush into buying a bad property through fear of losing time.
Although some bank on appreciation at sale making up the loses I believe the hay days of wild appreciation growth will be dropping back to the norm of somewhere around the inflation rate.
All of this info so far stated has been proven valid time and time again by many investors on this site and others.
REIN works but you must adhere to the underlying principals.

 

[JSB]

QUOTE (housingrental @ Jul 31 2008, 01:00 PM) I`m not certain what you meant re gross rent but I think your idea is rent/price ? If so i`d look for at minimum (if value can`t be added) 9.5% of gross rent to purchase price yearly (assuming no/minimal (exterior lights, etc..) utility costs included in rent)
Yes these properties can be found. 12%-16% of gross rent with tenants paying utilities will be hard to find unless a) There`s a major deffered maintenance issues or b) It`s a dying town

That`s pretty much where I am too. Even the 1% rule seems a little generous; 12% a year is basically double a mortgage payment, so I`m thinking that anybody with that much to spend in rent would (or should) be looking to buy.

In terms of management fees, I think that may be where the disconnect is occurring. I`m looking at cash flow as containing money for me as well. I haven`t taken the step (but should) of paying myself, because, as you state, I`ll be doing the work. And, in the beginning, it would be me. One of the benefits of the properties I`m looking at is that most of them are within about 1-2km of my house. No, I`m not that lazy, I just think this is a great area with both great rental potential and great mid-to-long-term appreciation potential.

Thanks again to everybody for the help. This property certainly has become much less appealing to me. I don`t necessarily think it`s completely terrible, but I`m not prepared to take the risk and find out.

I have a couple others I`m looking at, so maybe once I get a little further in I`ll do another case study!

 

[Thomas Beyer]

QUOTE (JSB @ Jul 31 2008, 01:14 PM) ...

Thanks again to everybody for the help. This property certainly has become much less appealing to me. I don`t necessarily think it`s completely terrible, but I`m not prepared to take the risk and find out.
...

or write a lower offer, or better 2, one all cash to seller and one with a VTB, and see where it goes !!

 

[b18bgone]

I agree with Thomas,

Write another offer, or ask for the owner to carry back a note @ zero % for 5years, or a note with no payments
for 3 years. Some times owners are just hell bent on their number, and if thats the case move on.

 

[JSB]

QUOTE (b18bgone @ Aug 1 2008, 12:44 AM)
I agree with Thomas,



Write another offer, or ask for the owner to carry back a note @ zero % for 5years, or a note with no payments

for 3 years. Some times owners are just hell bent on their number, and if thats the case move on.


Thanks - I'm actually going to be away for a week, so I'm goign to think about it. If I come back and the property is still available, then I'll go in with a much lower offer.



I know the seller is agreeable to a lower number already, so the question is how low!

 

[Thomas Beyer]

QUOTE (JSB @ Aug 1 2008, 07:43 AM) I know the seller is agreeable to a lower number already, so the question is how low!

The only way to finds out is to WRITE an offer .. unless you can see him (or her) face-to-face.

or ask him this VERY QUESTION:

If I paid all cash and closed quickly, what is the least you would accept.

He might say XXX $s.

So, you ask a 2nd question: So, if I offered you XXX $s - 1 you would not sell it to me ?

 

[aleksei]

Hi my name is Alex. I am a 22 year old university student graduating next year and hoping to start investing in Real Estate as soon as I do. Mean while I am educating myself as much I can in the different aspects of real estate and reading about the different issues that existing real estate investors have encountered in this forum. Basically just reading through all the topics.

Just a quick question here about the "50% expense rule of thumb" for long term property holding. If you purchase a condo, a lot of your major expenses such as re-roofing, window replacement, heater replacement, landscaping etc will not be something that you would have to worry about. Though it`s understandable that the condo maintenance fee that is to be paid regularly is something that is added to expenses.

If I`m not missing something, would this mean that we could assume a lower percentage of the monthly rental income for expenses (for example 40%) when holding a condo long-term and therefore allow us to calculate a higher monthly cash flow? (Assuming this is a break-even or positive cash flow property already when you take the 50% rule into account) Does this make sense?

It works mathematically but it it what actually happens in reality?

Thanks
Alex

 

[holymoly]

QUOTE (JSB @ Jul 29 2008, 08:20 PM) The first time I clicked the link I got the forum, but now all I get is a generic search screen.

In case you`re looking again.... there was an S missing in your link -- it went to "biggerpockets" when it should`ve gone to "biggerpockets."

 

[Nir]

Alex,

On one hand you do not worry about roof etc. as you mentioned on the other hand with condo you pay maintenance which is higher than average maintenance & repair costs for a non condo. so bottom line about the same. but one of the experts here like Mr. Thomas Beyer or Greg can provide a better estimate as I do not purchase Condos myself, just my logic/common sense.

Good luck,
Neil

 

[aleksei]

QUOTE (investmart @ Aug 12 2008, 01:00 AM) Alex,

On one hand you do not worry about roof etc. as you mentioned on the other hand with condo you pay maintenance which is higher than average maintenance & repair costs for a non condo. so bottom line about the same. but one of the experts here like Mr. Thomas Beyer or Greg can provide a better estimate as I do not purchase Condos myself, just my logic/common sense.

Good luck,
Neil


Thank you Neil for the insight.

 

[JSB]

Hi everyone - I thought I`d pop back in here and share an update.

I ended up walking away from this property; it stayed on the market for almost a year, and after it finally sold, at least one of the unts stayed vacant for almost another whole year. I think that at least one is still vacant, and one of them is apparently using newspaper as a window covering.

In any event, the sobering discussion here helped me avoid making what would have likely been a TERRIBLE investment. So thanks!