Cash Flow: Real vs. Realtor
I recently met a real estate agent at a networking meeting. He was a likeable guy but nothing really stood out about him. When he learned that I had a number of rental properties and had been investing in real estate for many years he suddenly “specialized” in working with investors. I had the feeling that if I had stated that I was in the market for a Himalayan mountain property to start a vacation retreat for Yetis he would have specialized in that too. After exchanging business cards we both moved along.
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The Phone Call
A few days later the agent called me. Was he being smart and suggesting that we meet for coffee or lunch in order to establish a networking relationship? Not a chance. He was excited because he "suddenly" came across a property that he knew was perfect for me and I should jump on it right away. Though tempted to quickly dismiss him, I didn't because he was a nice guy just trying to make a living.
To be clear, in our brief conversation a few nights earlier he never asked what kind of property I invested in. He didn’t ask what areas I invested in or if I was in the market for more properties. All he heard was that I was a real estate investor. It was obvious that his only aim was to make a sale.
As I politely listened, he made the following statement:
“Everyone knows that if the rent equals 1% of the purchase price, it’s a good deal. This is even better!”
With that, what little credibility he had flew out the window. He went through the details of this “cash cow” and it was evident that he knew absolutely nothing about rental properties. It’s not totally his fault. Real estate agents are almost universally taught that rent – PITI = cash flow. If that were true, his deal worked. Unfortunately that doesn’t pass muster in the real world.
I’m certain that after meeting me a few nights earlier he set out to find a deal. I could picture him scouring the MLS in search of something he could sell me. Novice investors frequently fall for the 1% myth or the rent – PITI fallacy. Unfortunately many real estate agents truly believe it as well. That would change in a hurry of they ever owned a rental.
When the agent finished his pitch I told him that it was a dog with fleas that was certain to lose money. I asked if he had ever heard of the 50% rule and he admitted he hadn’t. When I explained that the rule simply stated that you could expect the property expenses to be about 50% of the gross rent (40% if you self-manage) he was flabbergasted. He insisted that the rule didn’t apply here; if it did you would never find a rental property.
I took him through his “deal” and asked him about the things he forgot. Based on rent – PITI it was positive a few hundred dollars a month.
My questions and his answers:
What about vacancies? “You’ll always be able to rent it quickly.”
What about maintenance? “The property is in great shape.”
Evictions and tenant damage? “That’s what the security deposit is for.”
What about utilities paid by the landlord? Business taxes and fees? Tax returns? On and on it went.
By the time we were done he realized how little he really knew. I suggested that if he wants to become an expert in investment properties, he should own one.
Education is a progressive discovery of our own ignorance. – Will Durant (Historian)
Photo Credit: Jim Epler