Definition of Cash Flow

[nepoez]

Not sure I see where you`re coming from.

QUOTE (invst4profit @ May 5 2008, 07:38 AM) Actually Nepoez with expences eating up 50% of your rental income you will be hard pressed getting positive cash flow from $1300 rent on a $165000 purchase.

 

[MonteDobson]

QUOTE (invst4profit @ May 5 2008, 08:38 AM) Actually Nepoez with expences eating up 50% of your rental income you will be hard pressed getting positive cash flow from $1300 rent on a $165000 purchase.

When you say expenses at 50% of rental income, does that include debt service, or just your basic taxes, insurance, property mgt and reserve vacany allowance?

 

[Thomas Beyer]

QUOTE (C2Ventures @ May 5 2008, 07:54 PM) When you say expenses at 50% of rental income, does that include debt service, or just your basic taxes, insurance, property mgt and reserve vacany allowance?

allow 50% of rent for expenses BEFORE debt service .. or about $3000 to $3500/year/unit .. more if heavy upgrades are involved which is the case usually in year one !

then, 50% (more or less) for debt servicing, depending on leverage !

so, 0 cash-flow .. at least in year 1 .. better in year 2 and beyond. The trick is TO HANG ON FOR A WHILE !!! i.e. break even is all you need .. more is better, of course .. but not required ..

Why is real estate a great investment EVEN IN A FLAT MARKET WITH $0 POSITIVE CASH-FLOW SO POWERFUL ?

If you buy an asset with a 20% down-payment, and 0 cash-low for 10 years, with

a ) No appreciation (equity upside), you have DOUBLED your money as the mortgage has been paid down 20% !

b ) 20% price increase (less than 4% annually compounded, below Canada`s long term average !!), you would have TRIPLED your money.

c ) 30% price increase (less than 6% annually compounded, about Canada`s long term average as house prices in Canada have doubled every 15 years in a normal economy !!) you would have made 250% on your money.

d ) 40% price increase (slightly higher than Canada`s long term average as house prices in Canada have doubled every 15 years in a normal economy, and AB or BC have a better economy than the rest of Canada !!), you would have made 300% on your money, i.e. quadrupled it!

 

[invst4profit]

Well put Thomas.

Expences include, taxes, insurance, management(self or hired), legal, evictions, vacancies, advertising,
routine maintance(paint, etc.), repairs etc.
Basicly every cent of costs to run the business and service the tenants before debt service.

 

[nepoez]

So are you guys saying that if a property is rented for $1000/m in order to cash flow, my mortgage, insurance, vacancy allowance, tax, etc, etc, all have to total to under $500 dollars/m because the other $500(50% of rent) is for upgrades?

In other words in the debit section of my analysis form there will be a row called Reserve Fund and it is the Rental Income X 50%?

Or do you mean.. if income is $1000 then morgage payment can be $500, and expense can be $500. The 50% allowance of expense includes anything such as taxes, insurance, management(self or hired), legal, evictions, vacancies, advertising, routine maintance(paint, etc.), repairs etc.

So using 50% of the income as a guide line? That isn`t making sense to me. I must be misunderstanding.



QUOTE (invst4profit @ May 6 2008, 05:51 AM) Well put Thomas.

Expences include, taxes, insurance, management(self or hired), legal, evictions, vacancies, advertising,
routine maintance(paint, etc.), repairs etc.
Basicly every cent of costs to run the business and service the tenants before debt service.

 

[MonteDobson]

QUOTE (nepoez @ May 6 2008, 08:55 AM) So are you guys saying that if a property is rented for $1000/m in order to cash flow, my mortgage, insurance, vacancy allowance, tax, etc, etc, all have to total to under $500 dollars/m because the other $500(50% of rent) is for upgrades?

In other words in the debit section of my analysis form there will be a row called Reserve Fund and it is the Rental Income X 50%?

What they are saying is factor in 50% for expenses and 50% for debt service. Obviously if you find a property that rents out for more, or expenses/debt service are less than this, you will have greater cashflow.

Thanks,

 

[nepoez]

So if a property`s debt service is more than 50% of the rental income, you will assume that it won`t work? Say the mortgage+Heloc interest is $1000/m and the rent is $1700/m, then you have $700 left for expenses. You are saying that $700/m isn`t enough because 50% of 1700 is 850 and you need 850 for expense?

QUOTE (C2Ventures @ May 6 2008, 07:05 AM) What they are saying is factor in 50% for expenses and 50% for debt service. Obviously if you find a property that rents out for more, or expenses/debt service are less than this, you will have greater cashflow.

Thanks,

 

[MonteDobson]

QUOTE (nepoez @ May 6 2008, 09:16 AM) So if a property`s debt service is more than 50% of the rental income, you will assume that it won`t work? Say the mortgage+Heloc interest is $1000/m and the rent is $1700/m, then you have $700 left for expenses. You are saying that $700/m isn`t enough because 50% of 1700 is 850 and you need 850 for expense?

I would suggest it is more of a guideline. Positive cashflow is postive cashflow: Simply put, if income (rent) is greater than ALL expenses and mortgage payments, then you have postive cashflow. It is up to you whether you include your LOC interest only payments in the analysis as well.

Bring out a calulator and pencil, or a spreadsheet and start working with the numbers.

Here is a link to a great Mortgage Calculator to easily figure out your mortgage payments: http://www.c2ventures.ca/mortgage_calculator.html

 

[ChrisDavies]

Monte`s very correct. I`ve seen buildings with what is normally strong cash flow have months where everything goes in the crapper because of a big bill and a couple vacancies. Like when you find dead people.

Cash flow is an idea, and a goal. There will always be hiccups. Often they`re rather large.

 

[Thomas Beyer]

QUOTE (nepoez @ May 6 2008, 08:16 AM) So if a property`s debt service is more than 50% of the rental income, you will assume that it won`t work? Say the mortgage+Heloc interest is $1000/m and the rent is $1700/m, then you have $700 left for expenses. You are saying that $700/m isn`t enough because 50% of 1700 is 850 and you need 850 for expense?


50% is a guideline, of course .. depending on state of property or depending on who pays utilities ..

likely $1700 is high rent .. and will have more than 5 or even 10% vacancy over a 24-48 month period .. so that is "an expense" ..


50% is used for smaller units (bachelors, 1BR or 2BR) in an apartment building .. in a single family house it may be lower, especially if nicely upgraded (i.e. low R&M) and if tenants pay utilities .. but then you also need more reserves for future upgrades (say a new bathroom or a new carpet ...)

 

[nepoez]

Thanks again for explaining such rudimentary things to me. It`s all making sense now. I`m just trying to make sure my analysis sheet as realistic and all these feed back have been excellent for my adjustments. Although it`s starting to make me feel that the goal is getting farther out of reach. So easy to lower the bar based on emotion when this happens.

QUOTE (thomasbeyer2000 @ May 6 2008, 08:46 AM) 50% is a guideline, of course .. depending on state of property or depending on who pays utilities ..

likely $1700 is high rent .. and will have more than 5 or even 10% vacancy over a 24-48 month period .. so that is "an expense" ..


50% is used for smaller units (bachelors, 1BR or 2BR) in an apartment building .. in a single family house it may be lower, especially if nicely upgraded (i.e. low R&M) and if tenants pay utilities .. but then you also need more reserves for future upgrades (say a new bathroom or a new carpet ...)

 

[vbasic]

Nepoez - this thread has been very insightful to me as well. thx for starting it and seeing it thru!

Monte - nice mortgage calculator. thx for the link.

Cheers
from another newb

 

[brad]

Hi all,

I totally agree that your L.O.C. should be included in your expenses, HOWEVER, I am going to play devil`s advocate.

If I am going to use my HELOC to buy shares of TD, BNS, Citi, Visa, etc etc. it is on me to cover the interest payment on the L.O.C. That interest is deductible, but by no means do the dividends cover on going interest expenses. Why should real estate be calculated differently?

Just throwing that out there.

Brad Hamilton

 

[Smitty]

QUOTE (brad @ May 8 2008, 02:50 PM) Hi all, I totally agree that your L.O.C. should be included in your expenses, HOWEVER, I am going to play devil`s advocate.If I am going to use my HELOC to buy shares of TD, BNS, Citi, Visa, etc etc. it is on me to cover the interest payment on the L.O.C. That interest is deductible, but by no means do the dividends cover on going interest expenses. Why should real estate be calculated differently?Just throwing that out there.Brad Hamilton

Brad:

I am inclined to agree wholeheartedly with your POV.

Nepoev:

In Quickstarts I have attended, Russell clearly demonstrates compelling reasons why a JV partner using a HELOC is getting an incredible deal. It`s all about the principle of O.P.M. - Other People`s Money.

Wealth is created by managing risk - not eliminating it - and using leverage. The ultimate leverage in real estate is to have a bank lend you money via a mortgage for 75% of the deal, and then the 25% downpayment comes from the bank again via HELOC. Leverage + leverage! That means I am controlling an asset for the price of servicing the HELOC debt. What an incredible deal!!! For a top 10 town like Edmonton, when the right deal comes up, and the numbers crunch beautifully (without considering the debt servicing in the HELOC) I`ll buy property all day long and twice on Sunday!

Using the simple numbers example (for easy math) that REIN uses - a property whose purchase price is $100,000 - then if I use the HELOC for 25% and the mortgage is for 75% I have totally used OPM. Now, you say, what about the interest only payments? For $100,000 my payments are going to be, what...right now, say, $6000 per year? $500 a month for the sake of simplicity.

So I get to control an asset in a top 10 town for $6000 per $100,000 of purchase price? Yep, I am all over that. See Thomas`s comments about why real estate is such a great deal in flat markets with no cash flow. So instead of using up $25,000 for a downpayment, I am only using $6000. Wonderful.

But ok, so the bottom line is someone, some way, some how, must come up with the $500 every month. If it comes from another JV partner, then hopefully I am good at marketing, math, and selling the deal because it`s a terrific deal for them.

But if you are your own JV partner, then yes, that $500 has to come from somewhere. It`s going to impact your monthly income from your day-paying job, or it hopefully will come from cash flow, right? It`s gotta be paid, every month. You could try capitalizing the interest payments - not for the faint of heart, and you`d better know what your doing, that means borrowing enough money for the downpayment and, say as an example, enough to cover interest payments for 2 years - another $12,000 per $100,000 of borrowing until rents are raised high enough to service the debt. More advanced, mor leverage = more risk, more potential reward.

I don`t want to go forever with creative financial strategies, nor am I advising you to take on more risk or employ financing techniques you wouldn`t be comfortable with.

My point here is that, unless I am grossly mistaken, the REIN funnel of analyzing numbers and filtering out good deals/prices/properties from bad deals/prices/properties, HELOC payments are not part of initial analysis.

I know I wouldn`t do it that way. Its enough to try and find break even properties in Edmonton that cover mortgage payments plus ,monthly expenses, plus have enough in the reserve fund. I know REIN members that are syaing they have "positive" cash flow in Edmonton, but they cheat themselves a little, they`re not allowing enough for property management, vacancy, repairs, advertising, etc. Used fully and completely (I`m talking about the Property Analyzer Form) with REIN`s suggested numbers, its still tough to find truly positive cash flow properties, at least for single family dwellings. So, at the end of the day, if you have an additional $500 in cash to cover the HELOC payment, you truly have a break even property - BUY IT! (ok, you can ignore me, but I would but it).

That`s just my approach. Figuring out how to service the HELOC payment is one of the secondary, last things I do. I am not saying to ignore the HELOC - it is your investment, the interest is an expense, but I don`t necessarily kill deals because I don`t have enough cash flow to service the interest payment.

I sincerely hope that didn`t confuse you, but I just thought I`d support Brad`s perspective on this.

Mike `Smitty` Smith

 

[Smitty]

Nepoez:As a former math teacher I should know better. Sheesh!
There`s some bad math in my post that may confuse you. If the debt servicing for a $100,000 HELOC comes out to $6000 a year or $500 a month, well that`s all well and good, but I completely missed something.

Of course, you won`t need $100,000 for the downpayment! You only need 1/4 of that or $25,000. Therefore if you are only borrowing $25,000 from the HELOC, then servicing that will also only be a 1/4. Silly rabbit, tricks are for kids...

Anyways, so this might or might not in your view make my point even stronger because to service the $25,000 HELOC loan is only 1/4 x $500 = $125 per month. Thats better! Knew there was something faulty with my math!...

Actually, what you could say, based in my original post, is that for $500 of HELOC debt servicing a month, you could buy four(!) $100,000 assets! Woo-hoo!

($25,000 downpayment x 4 properties)

Sorry about that!

Smitty
(Of course, in this lovely hometown city of mine - Edmonchuk - you could easily spend the entire $100 of HELOC as a downpayment for one single property...)

 

[invst4profit]

When it comes to numbers and math everyone knows they can be turned around many different ways to reflect any desired bottom line.The real question is are you a business person making an investment or are you a speculator.Yes many can afford to have no cash flow or even negative cash flow but what smart business person enters into a new business expecting no positive return to operate the business on.
That person may be a speculator, one that sees the market increasing and expects it to continue to grow allowing a profit at resale or refinance.
There is nothing wrong with that. What is wrong is for those starting out in real estate investment (rental) to base a business plan on hypothetical profits.
We have all heard that the majority of startup businesses fail in the first 5 years. Real estate is no different. Although the REIN system gives people a leg up it is by no means a garantee of success as there is always the human factor. Ignoring some or any expences in order to make the numbers work is poor business practice for the novice. Include every possible expense on a property plus some.
I can afford to have negative cash flow on one or more properties because others can carry the loss but a new investor starting out does not have that option and will likley have great difficulty in surviving let alone growing if operating on negative cash flow.
When I started my Business I felt it was the number one priority to make money, daily, weekly, monthly, yearly. I had no desire to work or run a business with a pay out at the end or having ongoing negative flow with periodic infusion from a property sale.
My intent was to operate a rental business not a Real estate investment company and I believe that is the major differance in how individules see cash flow.

You can`t put food on the table today with money you earn 5 years from now.

 

[Thomas Beyer]

QUOTE (Smitty @ May 8 2008, 09:00 PM) ..Of course, you won`t need $100,000 for the downpayment! You only need 1/4 of that or $25,000. Therefore if you are only borrowing $25,000 from the HELOC, then servicing that will also only be a 1/4. Silly rabbit, tricks are for kids ......

what can you buy for $100,000 in Edmonton, though ???

Maybe 120K for an entry level condo .. likely much more ..

 

[invst4profit]

$100,000 down may be closer to reality after all.

 

[Smitty]

Invest for Profit:
Well said (you`re previous post about cash flow and food on the table now).

However, I would like to point out a small difference; an aggressive real estate buyer using creative and leveraged buying/financing strategies does not automatically imply that they are a speculator, they may just have a different risk tolerance and goals for their real estate investing. If they do all the due diligence and they buy based on economic fundamentals, they`re still investing, not speculating just because they have (or not) a tolerance for negative cash flow.

And of course, I did acknowledge that given the conditions in Edmonton, 100,000 may get you 1 to 3 (at most!) properties. But there`s always more doors, extra suites, detached garages etc to boost rental income. I was merely using $100k as an easy math number - the same which is used at Quickstart to explain the principle, knowing full well that the number is not necessarily grounded in 2008 reality.

Nepoev:

So as you can see, their are many factors to consider here. Many people starting out want positive cash flow, enough to cover all expenses including HELOC debt servicing, no matter what, as their number one or top criteria when selecting a purchase. There`s nothing wrong with that, it is a very sound, solid approach to buying property. It`s relatively hassle and headache free, when you have leftover cash after every expense is taken into consideration.

But you will miss some deals based on considering the HELOC debt servicing - and that`s ok too!

But that`s why finding a JV money is so powerful. If you can`t afford to swallow the interest payments, finding someone who can will broaden your opportunities and provide flexibility.


Well I don`t know if I opened a Pandora`s box or a can of worms, but its just a different perspective.

Smitty

 

[nepoez]

Hi I think everyone here has made real good points and I`ve taken them all into consideration. As a new investor I will attempt to find completely self servicing properties at first. Since I only have enough to purchase 2-3 this year my team has time on their side in terms of searching. If it`s going to be just 2-3 the next 12 months I may as well get the best I can. If after 6-7 month and we still cannot find such properties, then maybe I`ll consider lowering the bar, or looking else where. If I can make it through the first year with properties that self service then I will probably continue doing so. Imagine telling your JV that they don`t need to put in HELOC interest every month.
Thanks again. I will let everyone know how things go. In the mean time we`re still searching...

QUOTE (Smitty @ May 9 2008, 11:41 AM) Invest for Profit:

Well said (you`re previous post about cash flow and food on the table now).

However, I would like to point out a small difference; an aggressive real estate buyer using creative and leveraged buying/financing strategies does not automatically imply that they are a speculator, they may just have a different risk tolerance and goals for their real estate investing. If they do all the due diligence and they buy based on economic fundamentals, they`re still investing, not speculating just because they have (or not) a tolerance for negative cash flow.

And of course, I did acknowledge that given the conditions in Edmonton, 100,000 may get you 1 to 3 (at most!) properties. But there`s always more doors, extra suites, detached garages etc to boost rental income. I was merely using $100k as an easy math number - the same which is used at Quickstart to explain the principle, knowing full well that the number is not necessarily grounded in 2008 reality.

Nepoev:

So as you can see, their are many factors to consider here. Many people starting out want positive cash flow, enough to cover all expenses including HELOC debt servicing, no matter what, as their number one or top criteria when selecting a purchase. There`s nothing wrong with that, it is a very sound, solid approach to buying property. It`s relatively hassle and headache free, when you have leftover cash after every expense is taken into consideration.

But you will miss some deals based on considering the HELOC debt servicing - and that`s ok too!

But that`s why finding a JV money is so powerful. If you can`t afford to swallow the interest payments, finding someone who can will broaden your opportunities and provide flexibility.


Well I don`t know if I opened a Pandora`s box or a can of worms, but its just a different perspective.

Smitty