Real Estate Investor · Jersey City, NJ · Member since 2008 · 203 posts · 1 vote
I'm not sure I understand how to do this and I think it's an important idea for us rooks to understand, as property taxes differ significantly from place to place (especially where I am).
The area I've been studying has high property taxes and I'm confused as to how I should adjust the additional property tax expense, using the 50% rule. Is it true that taxes typically run 10% of gross rents? Is so, I can calculate the additional property taxes and subtract that by 10% of the rents, but I'm not sure if that's even accurate. Is there another, perhaps more accurate way of adjusting the 50% rule to reflect higher property taxes?
First you must remember that the 50% rule is only a screening tool/guide to do a "quick peak" analysis of a property's performance. The rule is said that operating expenses will "average" 50% of gross rents all across the country. By definition of average, that means some will have 40% OE, some will have 60% OE, etc.
If your property is located in a higher prop tax state (as mine are in Texas), does not mean you need to adjust the rule as other expenses in that particular state may average lower or rents may average higher to compensate.
When evaluating any property, once you feel the investment has passed the 50% screening rule, dig deep into the numbers to come up with an accurate NOI (net operating income). Also keep in mind that not all expenses will be available to you and many sellers hide/lie/etc. about the real numbers. To see through that, you must use some averages in your calculations.
"Magic" formula's should only be used in the initial processing stages. I personally use a monthly Gross Rent Multiplier to quickly dig through the 100's of bogus deals. I take the monthly rent and multiply it by 50 for most properties to get my target purchase price, but when I find a possible winner I run a full income/expense statement on it. I want to know EXACTLY what I am looking at.
I agree. That is exactly what I was saying as well. Rules, formulas, magic recipes are for an initial screening only, not the sole authority on the investment performance.
Always make sure to dig deep into the numbers once the property has passed your screening tool. The GRM Ryan mentioned for his screening is the same as the 2% rule of MikeOh's. They look for gross income to be 2% of the purchase price.
In theory, I completely agree with this. Unfortunately, this is almost never possible in the real world for SFHs and small multi-unit buildings and apartment complexes. The reason is that it is IMPOSSIBLE to predict exactly which expenses will occur for a given property in a given year. In addition, most owners of residential rentals don't understand operating expenses themselves and don't keep accurate records. On a more malicious note, many (most) sellers and agents intentionally slant the data to make the property look better than it actually is. Finally, the distressed properties that we often buy for HUGE discounts have been neglected for many years and haven't incurred the normal operating expenses - especially maintenance which is often deferred.
What this all adds up to is that it is usually impossible to get accurate numbers for a given property. That is why I use 50% of the gross rents as the operating expenses. What we're really need when we calculate the expenses (and cash flow) is the average expenses over time (assuming that we're planning to be in business in the long term).
I don't think anyone ever helped Fred with his question. Mike, what do taxes run in your neck of the woods? Fred, you should be able to find out what the taxes are in your area. Adjust appropriately vs. Mike's number. Or google some counties in OH and see what their taxes run.
Jon,
If you read my first post, you will see I did answer the original question in detail. As I stated, there is no need to make adjustments as the 50% rule is an average and over time, as Mike says, you will end up with that figure. That is, of course, if you agree with the 50% rule. Perhaps others choose to use a 55% rule or a 45% rule or you who choose to use the 40% rule. Mike will argue that using anything less than the 50% will be asking for trouble, as it is his opinion.
Yes, I did see that. I guess its a reasonable point that other factors will offset it. However, I know from having lived in TX that property taxes are much higher there than other places. The fact there is no state income tax offsets it if you live there, but I'm not sure it offsets it for rental expenses. I've also seen other posters say taxes are very high in some of the NE states. I didn't bother to take the time to try to look up the rates in OH and NJ to get a feel for the difference.
As you point out, though, trying to come up with real numbers is difficult at best. Whether a property is brand new, newly rehabbed, or falling down, it is impossible, I contend, to accurately estimate maintenance expenses for any particular year. Nor it is possible to estimate how much you'll spend doing a lengthly eviction. So, trying to come up with several estimates (i.e., guesses) about several different components is unlikely to be more accurate than just using one overall number.
It is true taxes are higher in Texas. A vast majority of my investments are there. What I have found is that the undervalued property and the ability to get higher rents more than makes up for the higher taxes. That, amoungst many other things, is why I invest there and will continue to do so.
I also agree that pegging an exact figure on repairs or vacancy for a given year is near impossible. I simply use a % of the rents and factor that in to my expense ratio. The % for vacancy is based on averages for the specific type of property in that given area. The repairs % can also vary depending on the investment. Each investor should use a figure which is appropriate for their investment and their situation.
I would say that taxes average about 10% of the gross rents in my area. However, taxes here seem to vary wildly with no rhyme or reason. For example, I have a couple of $60,000 (market value) houses with annual taxes of only $350 (good deal) and I have other $60,000 houses with annual taxes of $800 (ouch!). It may be that the city hasn't updated the taxes in decades or that their valuations are off. I simply don't know. At any rate, I couldn't tell you that property taxes are exactly X% of the market value or x% of the gross rents.
I think Texas is a great example of the idea that some higher expenses being offset by some lower expenses. In addition to your point about the income taxes, many people on this forum have commented on the speed at which you can evict deadbeats in Texas. Here in my little corner of Ohio, it takes 5 weeks to get the deadbeats out. That essentially means that I've lost 2 months rent per eviction. If you can evict them in 2 weeks in Texas, that means you've only lost 1 month of rent per eviction. That's a significant difference.
Very good points Mike. As far as evictions in Texas, it is not 2 weeks (unless you get lucky and they leave during the process on their own) but I have got it down in 4 weeks.
As we both mentioned, some expenses in some states are higher than others, such as taxes, and others are lower. By the end of the day, they usually wash out and therfore whatever rule the investor chooses to use to calculate OE, they can use the same one always without need to adjust for higher property taxes, etc.
Mike is able to find properties at huge discounts and able to get good enough rents so that his rent to purchase ratio is around 2%. That is excellent. I have been concentrating on new construction multifamily units in TX which have no where near that ratio, but in my experience, have had much lower OE than the 50%. I do have higher than average taces, but I also have higher than average rent and lower than average vacancies, etc, etc.
Off topic, Mike, are you finding apartment buildings of over 18 units, in decent areas where they meet your 2% rule? (In your neck of the woods)
Thanks for the responses guys...The area I've focused on has taxes that run appx. 15%-20% of gross rents (NY state -yikes!).
I'm not sure, however, how these higher taxes are offset by other variables, as rents are not proportionally higher. I guess the question this leads to is: in an area like this, is the primary way to offset higher property taxes simply paying less for a property? Can this be used as a negotiation tactic on my part (a lower price offered, partially resulting from higher property taxes)?
In reference to evictions in Texas, you have to give a 3 day notice of eviction before you can file the eviction, unless a 1 day is stipulated in the lease. 10 days normally for the court date. 5 days to get out unless the tenant puts up the entire back rent owed as deposit to protest the eviction (I have never seen or even heard of anyone doing this), and then 1 day for the sheriff to come out if required.
3+10+5+1= 19 days on the realistic long side and 1+10+5= 16 days on the realistic short side if you use a Texas Apartment Association Lease or another lease that stipulates 1 day eviction notices.
That's fantastic. I wish we could do it that quickly here in Ohio! I've got three evictions going this month (2 are inherited tenants). One bought a motorcycle and therefore didn't have the money for the rent. One bought crack and therefore didn't have the money for the rent. The third is just a deadbeat.
Mike,
Perhaps the third guy sold the 1st guy the bike, as well as the 2nd guy the crack, so he could have a down payment on the RE investment down the st. and stiff you on the rent to increase his cash flow! :goofy:
This is one of the reasons why I wonder/question how profitable it is to buy the units you have. The aspirin bill alone must be killing your cash flow.
Time for a drink! :beer:
Thanks for the responses guys...The area I've focused on has taxes that run appx. 15%-20% of gross rents (NY state -yikes!).
I'm not sure, however, how these higher taxes are offset by other variables, as rents are not proportionally higher. I guess the question this leads is: in an area like this, is the primary way to offset higher property taxes simply paying less for a property? Can this be used as a negotiation tactic on my part (a lower price offered, partially resulting from higher property taxes)?
Those tax figures compiled with the rents not being higher = no cash flow. I would not invest in an area like that. Negotiating a lower purchase price can only help, but you must ask yourself, can you do better in another market?
You clearly still don't understand cash flow issues associated with rental property. There is no aspirin bill because of evictions or any other aspect of the business (except maybe dealing with city officials). The profitability of my business is not affected by evictions because the eviction expense is already accounted for. Evictions, vacancies, maintenance, management, capital expenses, etc, etc, etc are all part of the rental business. We are in two completely businesses. I don't buy rentals at near retail and sell them to newbies. Your business appears to be the flipping business, not the rental business, which is why you don't understand how this works.
The vast majority of renters in this country are low income and lower-middle income people. That is why I rent to them, because they are the majority of the market and that's where the money is in the rental business. Paying near retail and then selling the properties to newbies is a completely different business. Good for you and not so good for the newbie if they're bleeding cash. You don't worry about the negative cash flow because you are not experiencing it. Your website lists rentals at nearly 90% of market value as having a $150 cash flow. That is just not reality. I see you've taken the numbers off your website for each property, but I could pull up some of the numbers from your earlier posts if you like. Post the numbers. I'd like to see how a $150,000 house bought near retail price has a $150 positive cash flow each month! Only in fantasyland.
Again Mike you misquote and take what I said out of context. The aspirin bill was a joke, obviously that went over your head, and I merely stated that an area of such high taxes and lower rental rates is not condusive for cash flow. If you disagree with that, then why are you not investing there rather than OH?
You also choose to go completely off topic. We are not talking about what business I do or do not run, nor were we talking about your business. We were talking about if an investor should make an adjustment to the 50% rule or any other rule they are comfortable using when the area they invest in has notoriously higher taxes or other expenses.
If you insist on knowing, there are many aspects to my business. No I do not rely solely on cash flow to put food in my family's mouth. My business is not one dimensional as yours is. I did not change any number details on my property lists so I am afraid I do not know what you are talking about.
As far as the duplex for $155k, it has a proforma cash flow of $380 per month which includes expenses of ONLY: mortahhe, taxes, insurance, & management. It is up to the investor to calculate the vacancy factor, repairs, etc. etc. etc. etc. etc. These units are brand new and are for an investor looking for income other than just cash flow. That is all that needs to be said as this remains off topic.