{"id":48799,"date":"2013-10-07T05:33:36","date_gmt":"2013-10-07T11:33:36","guid":{"rendered":"https:\/\/www.biggerpockets.com\/renewsblog\/?p=48799"},"modified":"2024-06-09T14:20:48","modified_gmt":"2024-06-09T20:20:48","slug":"2013-10-07-dont-fall-hype","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/2013-10-07-dont-fall-hype","title":{"rendered":"Don\u2019t Fall For the Hype: How to REALLY Discern a Good Deal"},"content":{"rendered":"

When something is important, I like to repeat it.<\/a> So here goes, cash flow is king.<\/strong>\u00a0 And because cash flow is king, many like to hype up their properties as excellent cash flow producers to attract interest.\u00a0 However, as with anything else, buyers should beware of the hype<\/em>.<\/p>\n

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.\u00a0\u00a0 Here is an example of what might be said:<\/p>\n

123 Main Street \u2013 Red Hot Cash Flow!<\/h2>\n\n\n\n\n\n\n\n\n
Monthly Cash Flow<\/th>\n<\/tr>\n
Rental Income<\/td>\n$1,000<\/td>\n<\/tr>\n
Principal and Interest<\/td>\n$350<\/td>\n<\/tr>\n
Insurance<\/td>\n$50<\/td>\n<\/tr>\n
Taxes<\/td>\n$150<\/td>\n<\/tr>\n
Total Cash Flow<\/em><\/td>\n$450 per Month<\/em><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

 <\/p>\n

At first glance, this appears to be an awesome property.\u00a0 $450 positive cash flow per month!\u00a0 Who can pass on that?\u00a0 But those of us with more experience know there are a few pieces of this puzzle that are missing.\u00a0 Here is what those pieces are.<\/p>\n

Vacancy Factor<\/h3>\n

The property is not going to stay rented 100% of the time.\u00a0 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.\u00a0 You should budget for at least 10% of your gross rents going towards a vacancy factor.\u00a0\u00a0 Thus, in the above example, if rental income is $1,000 per month, add another $100 to the expense side of the equation.<\/p>\n

Repair Expenses<\/h3>\n

Things break.\u00a0 You as the landlord are going to have to fix it.\u00a0 You can expect to pay about 10% of your gross rents in repair expenses.\u00a0 So again, like in the example above, add another $100 to the expense side of the equation.\u00a0 Do you actually spend $100 every month?\u00a0 No.\u00a0 But over the course of a year or two, it is amazing how repairs end up totaling about 10% of gross rents.<\/p>\n

Capital Reserves<\/h3>\n

Roofs do not last forever, nor do air conditioners or hot water heaters.\u00a0 When these things break down, you are going to have to come up with the funds to replace them.\u00a0 These items are not cheap.\u00a0 They can run several thousands of dollars.\u00a0 So again you should be putting aside about 10% of gross rents for future reserves.\u00a0 Add another $100 to the expense side of the equation.<\/p>\n

Property Management<\/h3>\n

Are you going to manage the property yourself?\u00a0 Will you be screening the tenants, doing the showings fielding the complaints?\u00a0 If not, you are likely going to hire a management company or buy a property from one of those turnkey operations.\u00a0 They are also going to take a cut.\u00a0 On average this cut is about 10% of gross rents, so add another $100 to the expense side of the equation.<\/p>\n

Now, let\u2019s look at that cash flow for our example at 123 Main Street again.<\/p>\n

123 Main Street<\/h2>\n\n\n\n\n\n\n\n\n\n\n\n\n
Monthly Cash Flow<\/th>\n<\/tr>\n
Rental Income<\/td>\n$1,000<\/td>\n<\/tr>\n
Principal and Interest<\/td>\n$350<\/td>\n<\/tr>\n
Insurance<\/td>\n$50<\/td>\n<\/tr>\n
Taxes<\/td>\n$150<\/td>\n<\/tr>\n
Vacancy Factor<\/td>\n$100<\/td>\n<\/tr>\n
Repair Expense<\/td>\n$100<\/td>\n<\/tr>\n
Capital Reserves<\/td>\n$100<\/td>\n<\/tr>\n
Property Management<\/td>\n$100<\/td>\n<\/tr>\n
Total Cash Flow<\/em><\/td>\n$50 per Month<\/em><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

 <\/p>\n

Quite a difference when you plug in all<\/b> of the expected expenses.\u00a0 Still, $100 per month is not bad and could make this property a potential good deal.\u00a0 Is it \u201cRed Hot\u201d though, perhaps not.<\/p>\n

One last thing.\u00a0 Be sure you verify your principal and interest payments as well as the insurance amounts quoted in the ad.\u00a0 How were the principal and interest payments calculated?\u00a0 Can you get the same terms?\u00a0 Is insurance really that cheap?\u00a0 Would you want and can you get such a cheap policy?<\/p>\n

Remember sellers are going to hype up their properties the best they can.\u00a0 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.\u00a0 As with anything else in life, educate yourself before you buy, get trusted advice and most of all, don\u2019t fall for the hype.<\/p>\n

Photo Credit: Lorenia<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

When something is important, I like to repeat it. So here goes, cash flow is king.\u00a0 And because cash flow is king, many like to hype up their properties as […]<\/p>\n","protected":false},"author":726,"featured_media":169952,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[5528],"tags":[925,128,3115,3199,4894,59],"class_list":["post-48799","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-real-estate-news","tag-buying-property","tag-cash-flow","tag-deal-analysis","tag-deal-analyze","tag-hype","tag-real-estate-investing"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/48799","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/726"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=48799"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/48799\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/169952"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=48799"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=48799"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=48799"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}