Don’t Fall For the Hype: How to REALLY Discern a Good Deal

Don’t Fall For the Hype: How to REALLY Discern a Good Deal

2 min read
Kevin Perk

Kevin Perk is a full-time buy and hold and fix and flip real estate investor with over 15 years of experience. He and his wife Terron operate Kevron Properties, LLC, a boutique real estate investing company in Memphis, Tenn.

Experience
Kevin was a past president and is a current board member of the Memphis Investors Group. He’s also a blogger and writer who has authored hundreds of real estate investing articles on BiggerPockets and his own blog, SmarterLandlording.com, some of which have been featured on The Motley Fool and MONEY: Personal Finance News & Advice.

Kevin is also host of the SmarterLandlording podcast.

Originally from the Washington D.C. area, Kevin moved to Memphis to attend graduate school at The University of Memphis. After receiving his master’s degree in City and Regional Planning, Kevin climbed the planning career ladder to eventually become planning director of a county in the Memphis metro area. He “retired” from planning in 2003 to pursue real estate investing full-time.

Since “retiring,” Kevin’s main real estate investment strategy has been to buy and hold, otherwise known as landlording. Generally working in historic Midtown Memphis, Kevin is also known to fix and flip grand, historic homes when the right opportunity presents itself. He and his wife Terron (who is the principal broker at Perk Realty) have participated in dozens of real estate transactions in the Memphis metro area.

Kevin has the heart of a teacher and believes in helping others through education. An instructor of college-level geography for over 25 years, Kevin also regularly participates in seminars and panel discussions at such forums as the Memphis Investor’s Group and the Single-Family Rental Summit.

In addition, Kevin has been interviewed in publications such as the Memphis Commercial Appeal, the Memphis Daily News, and the Foreclosure News Report.

Education
Kevin earned a master’s in City and Regional Planning from The University of Memphis.

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When something is important, I like to repeat it. So here goes, cash flow is king.  And because cash flow is king, many like to hype up their properties as excellent cash flow producers to attract interest.  However, as with anything else, buyers should beware of the hype.

I have seen many people here on the BP forums, at my local reia club, on the MLS, on Craigslist and anywhere else properties are advertised hype their properties as generating excellent positive cash flow.   Here is an example of what might be said:

123 Main Street – Red Hot Cash Flow!

Monthly Cash Flow
Rental Income $1,000
Principal and Interest $350
Insurance $50
Taxes $150
Total Cash Flow $450 per Month

 

At first glance, this appears to be an awesome property.  $450 positive cash flow per month!  Who can pass on that?  But those of us with more experience know there are a few pieces of this puzzle that are missing.  Here is what those pieces are.

Vacancy Factor

The property is not going to stay rented 100% of the time.  There will be some periods of time where you are in between tenants and there will be some costs associated with moving tenants in and out.  You should budget for at least 10% of your gross rents going towards a vacancy factor.   Thus, in the above example, if rental income is $1,000 per month, add another $100 to the expense side of the equation.

Repair Expenses

Things break.  You as the landlord are going to have to fix it.  You can expect to pay about 10% of your gross rents in repair expenses.  So again, like in the example above, add another $100 to the expense side of the equation.  Do you actually spend $100 every month?  No.  But over the course of a year or two, it is amazing how repairs end up totaling about 10% of gross rents.

Capital Reserves

Roofs do not last forever, nor do air conditioners or hot water heaters.  When these things break down, you are going to have to come up with the funds to replace them.  These items are not cheap.  They can run several thousands of dollars.  So again you should be putting aside about 10% of gross rents for future reserves.  Add another $100 to the expense side of the equation.

Property Management

Are you going to manage the property yourself?  Will you be screening the tenants, doing the showings fielding the complaints?  If not, you are likely going to hire a management company or buy a property from one of those turnkey operations.  They are also going to take a cut.  On average this cut is about 10% of gross rents, so add another $100 to the expense side of the equation.

Now, let’s look at that cash flow for our example at 123 Main Street again.

123 Main Street

Monthly Cash Flow
Rental Income $1,000
Principal and Interest $350
Insurance $50
Taxes $150
Vacancy Factor $100
Repair Expense $100
Capital Reserves $100
Property Management $100
Total Cash Flow $50 per Month

 

Quite a difference when you plug in all of the expected expenses.  Still, $100 per month is not bad and could make this property a potential good deal.  Is it “Red Hot” though, perhaps not.

One last thing.  Be sure you verify your principal and interest payments as well as the insurance amounts quoted in the ad.  How were the principal and interest payments calculated?  Can you get the same terms?  Is insurance really that cheap?  Would you want and can you get such a cheap policy?

Remember sellers are going to hype up their properties the best they can.  It is up to us buyers to know and understand what we are doing and how to calculate actual cash flows and returns based on all probable expenses.  As with anything else in life, educate yourself before you buy, get trusted advice and most of all, don’t fall for the hype.

Photo Credit: Lorenia