Calculating Cashflow
So I'm ready to buy my first SFH rental, but I'm struggling with a few things. I want to know what expenses I MUST account for when calculating rental income minus expenses. (Tax, Insurance, etc.) Also, how do I know what some of those numbers will be? I have a property I've been looking at and I know that tax on it was 2,000$ last year.. what else do I need?
I'm excited to here back from you all at BP, keep in mind I've done a lot of reading and homework, but I'm kind of freezing when it is starting to become real. I want to keep my drive going, which is why I decided to ask for help!
The more conservative the better. Figure out PITI. Then 10% for property management even if you self manage (pay yourself), 10% for maintenace, 10% for vacancy, 10% for CAPEX, HOA if there is one, and I want $100 per door after all those expenses. But, most importantly check with investors in your area to see what else you need to incorporate. I'm in Virginia and not Canada so you might have different rules.
Hey Ryan, good question! It all depends if your numbers are correct. A lot of people make the mistake of saying their property can get $1200 in rent a month when in reality it probably will get $800. So i suggest rentometer.com or zillow or ask neighbors who are renting, and what they are paying. Alot of people run numbers and make a plan in their head, and its all good until they find out that their numbers were wrong. Ok so rent, insurance, hoa fees, if its sfh, you dont pay for water or sewer, the tenant pays that. so you don't have to worry about that. Also when i run numbers, I always run "worst case senario" numbers. meaning that if all my research suggest 1000 in rent, ill just write in 800 to be safe. if insurance is 80 bucks a month, ill just put in 120 bucks just to be safe. This way, if your off on the numbers, you can still save yourself. Also and most importantly is the mortgage and the cash flow you will create. just add them all up and subtract from rent and thats your cashflow. You asked how do you get the numbers, well rent you have to reasearch of the sites i addressed earlier, and insurance is pretty basic, you can call insurance companies and get quotes. Hoa fees you can just ask who is listing the property if there are any. Alot of people underestimamte hoa fees.
hope this helps. any other questions. lemme know.
There are a few things that you will pay every year for sure like taxes and insurance. Just about everything else is an estimate because there could be some years when you don't pay it at all and other years when you do. Those are things like a month or two with no tenant, having to pay utilities between tenants, maintenance such as sending a plumber or electrician to fix something, paying someone to mow the lawn between tenants, and general "sprucing-up" between tenants such as painting walls and replacing carpet. Then there are capital expenses that may not occur every year but will occur every five to ten years. Things like replacing a heat pump or HVAC system, putting on a new roof, having to paint the entire exterior (not technically a capital item but a big ticket item), etc. You need to plan on setting aside money for those big ticket items every year (preferably every month) so that you have the funds to cover. If you don't literally set aside the money then you need to at least account for that in your calculations of cash flow and ROI. Otherwise you can wind up with a SFH that you think is doing OK but you just wind up breaking even over the long haul.
@Bryan N. @Account Closed Thank you guys all so much from the input, you have no idea how much I appreciate it! I started working numbers with what's been said and I can tell it's going to be hard to find a good cash flowing single family home..
Slightly off-topic but I have noticed that many of the shows on HGTV are based in Canada and I'm always surprised at how high the prices are. Does everyone make a ton of money there? I'm used to hearing about super high prices in parts of California and New York but the houses on Income Property, etc are routinely $500k to $700k. I know that Canada didn't get hit as hard in the downturn so I think that's part of why so many of the HGTV shows are based there. In any case .. keep reading BP and make sure you have a proper definition of what "good" cash flow is for your area. We are always reminded not to count on appreciation to cover a poor investment, but if that is working in your favor it's at least something to be thankful for.
Rentometer and Zillow are U.S.A. centric. While Rentometer does include data on some Canadian locations, in our experience it is dangerously inaccurate. Have a look on Kijiji for comparable units in your neighbourhood and determine what the range of rents are in your area. Once you have that range, I would budget/forecast using the low-end, but set your rent slightly below the median rent for your neighbourhood.
When it comes to revenue and operating expenses, treat your rental(s) as you would any other business.
Your effective gross revenue would be your scheduled rent (what you would receive if the property were 100% occupied all the time) minus an allowance for vacancy/bad debt/evictions. Some folks include secondary revenue streams such as coin-op laundry and parking in their gross revenue. While this is technically true, we never include laundry revenue, and, rarely any other secondary revenue stream when analysing a property. Here on BP, you will often see folks treating vacancy as an expense, but it is really a missed/lost opportunity.
Operating expenses: - any expense incurred in the operation of the property: property taxes, insurance, utilities, repairs and maintenance (but not capital improvements), property management, groundskeeping (lawn care & snow removal), advertising, accounting & administration, etc. The interest you pay on your debt could be included here, but it is often deducted later to keep the NOI number the same as it would be if the property were not financed.
Net Operating Income (NOI) is your effective gross revenue minus your operating expenses.
Debt service: If your property / business is financed, the current portion of your long-term debt (all mortgages, LoCs, etc). If the carrying costs were included in your operating expenses, then just the principal portion will be included here.
Capital reserve/expenditures: any set aside you make for capital improvement to the property (new roof, new HVAC, and addition, etc)
Cash-flow-before-Taxes (CFBT) - This is the amount of "free cash flow" you have available before you pay the taxman. It is your NOI minus any debt payments and capital reserves. {Note that the taxman will require you add some of those deductions back to your bottom line in determining the amount of taxes due}.
Originally posted by @Shera Gregory:
Slightly off-topic but I have noticed that many of the shows on HGTV are based in Canada and I'm always surprised at how high the prices are. Does everyone make a ton of money there? I'm used to hearing about super high prices in parts of California and New York but the houses on Income Property, etc are routinely $500k to $700k. I know that Canada didn't get hit as hard in the downturn so I think that's part of why so many of the HGTV shows are based there. In any case .. keep reading BP and make sure you have a proper definition of what "good" cash flow is for your area. We are always reminded not to count on appreciation to cover a poor investment, but if that is working in your favor it's at least something to be thankful for.
Shera:
No, everyone in Canada does not make a tonne of money. Real Estate is more expensive here - ridiculously so in some areas. There is also the documented "Canada effect" on consumer goods - when the Canadian dollar was weak (i.e. 0.70 USD), Canadians became accustomed to paying more for consumer goods (cars, televisions, etc). When our dollar strengthened (> then the USD in 2013, about 0.90 USD now), companies continued to charge higher prices to Canadians, because they were already doing it and Canadians were use to paying a premium.
As for HGTV, the channel is originally from Canada, which is why so many of the shows are based here.
Mortgage
Property Taxes
Property Insurance
Allow for Vacancies
$100 per month allowance for house repairs (at least)
Allow for non payment of rents
You should show at least a $100 profit per rental unit.
I also recommend investors purchasing at least 3 houses right off the bat to allow for vacancies and non payment of rent. You need other houses to offset the houses that are not making you money during that month!
Nancy Neville
This may sound like a stupid question but is there a standard set of parameters used to calculate mortgage for the use of calculating cash flow? Your principal payment will differ greatly based on the amount you put down (3.5% v. 20% v. 100% lol).
Thanks!
@Roy N. -- that makes a lot more sense (re: HGTV and Canada). Interesting about the Income Property show -- that one always has me scratching my head. And with even shorter terms on the mortgages in Canada it's hard to see how those "basement apartments" that seem to be all the rage will cover as much of the mortgage as the show claims. Still fun to watch though.
Originally posted by @Shera Gregory:
@Roy N. -- that makes a lot more sense (re: HGTV and Canada). Interesting about the Income Property show -- that one always has me scratching my head. And with even shorter terms on the mortgages in Canada it's hard to see how those "basement apartments" that seem to be all the rage will cover as much of the mortgage as the show claims. Still fun to watch though.
Shera,
Funny, I scratch my head about 15 and 30-year mortgage terms in the U.S.A. ;-) While we have shorter terms, we also have lower interest rates (we just renewed a 5-year variable residential mortgage at 2.4%)
I speculate that the tenancy towards accessory apartments by Income Property is because the show is aimed at homeowners, not investors/land lords. Given the price of homes in Toronto, there is an appeal for accessory apartments as mortgage helpers.
Your welcome and keep asking questions. This is the best place for everyone to learn from others. The school of hard knocks is much better then an actual diloma.
@Bryan N. Thanks Bryan, much appreciated!
Kind of off-topic but I want to throw another question out there! I have about 6k in student debt, I've already payed off 2/3's of it, 6k is remaining. (I'm only 20) I was wondering if I should pay that off or continue pursuing a house with my down payment? The interest on the loan isn't a lot so I'm not too concerned about it. Just wanted to get other input
I'm not sure how student loans work in Canada but I can say they are and will be the financial killers of most professionals in the states. Even if you file bankruptcy, student loans aren't forgiven. They literally bleed Americans for decades and the cost is not worth the employment they achieve. Not in all cases, but in a majority. Pay off the student debt. It is holding you back. Get that out of your life forever and especially while your young. Real estate will be there waiting for you when the student loan is gone.
Originally posted by @Ryan Dukelow:@Bryan N. Thanks Bryan, much appreciated!
Kind of off-topic but I want to throw another question out there! I have about 6k in student debt, I've already payed off 2/3's of it, 6k is remaining. (I'm only 20) I was wondering if I should pay that off or continue pursuing a house with my down payment? The interest on the loan isn't a lot so I'm not too concerned about it. Just wanted to get other input
Ryan:
The answer to this one is in the numbers.
Remember that your student loan debt is paid back with after tax dollars. If your student loan is at 6%, your opportunity cost could be as high as 9% depending on your nominal income tax rate.
If investing your money into a rental property is going to produce a return greater than your opportunity costs, then invest. If the return will not exceed your opportunity cost, then pay down the loan.
Bryan N.
University tuition in Canada - though significantly greater than when I was a student - is considerably more manageable than south of the 49th. Back in the 80s, I was accepted into a graduate programme at MIT on "tuition remission" - I pay for the first year and, pending my performance, MIT would cover the second year. I could not come-up with the $35K required for the first year and had to withdraw ... on the bright side, funding for a graduate degree here in Canada was half that amount for the entire programme.
Roy N makes a good point, but trust me pay off that debt. You can make payments to a student loan or a property that pays you back. Focus all extra money you have on getting rid of that student loan. You don't want that following you...
@Roy N. @Bryan N.
Yeah I agree with that as well. I've been on the fence about it.. To go with what Roy said, I don't think my first investment property will do well enough to make up to holding on the the student loan.. I hate passing up on opportunities, I've built myself a history of regretting on taking action, but I know in this case many of other opportunities will come around again, possibly bigger and better
There will be other oppurtunities. Pay off the student loan. You will thank yourself for the rest of your life....
I wrote an article that breaks down the numbers if you want to check it out...
http://www.biggerpockets.com/renewsblog/2013/01/19...
If you are looking at MFRs, you'll need to add in utilities to some degree in there, but otherwise the formula is the same.
@Ali Boone Thanks so much! I was looking for a "this is what I do" example! Now I can relate my properties and numbers to that article! Much appreciated!
You bet @Ryan Dukelow! Glad it helped.