Feedback on First RE Investment

28 Replies

Requesting feedback or constructive criticism on my first RE investment. I bought two properties in OKC last year. I have a property manager that charges 8%.

The first was $110,000 3/2/2. Rents for $995 with $787 mortg. I put $5,000 tile, carpet and paint & paid the first 3 mortg payments. It’s been rented out since Sept 05.

The second was $94,000 3/2/2. Rents for $850 with $663 mortg. I put $11,000 tile, carpet, paint & appliances and paid the fist 4 mortg payments. It’s been rented out since Oct 05.

I learned a lot and feel I could have negotiated lower prices but they are renting for a positive. The $94,000 could probably rent for $950 but I lowered it because it took a while to rent. Also, I didn’t have to spend so much on tile and carpet, but I wanted to tile most of the houses to avoid further problems.

I’m trying to talk my business partner/wife into repeating the process. Any constructive criticism is welcome and appreciated.

I've got a few Excel spreadsheets I can email to you to evaluate IRR and cash flows. I'm no accountant but I've developed these over the past few years through integrating the different ones I've come across. You might also find these helpful when evaluating the income potential / cash flow impact of new prospective deals.

One recommendation--build up 3-6 months of expenses in a savings account (money market or whatever) for each property. It's a lot of money, but that will help you cover vacancies when you have them, and you will have them, as well as any other unforseen boogiemen.

If you'd like the spreadsheets, just drop me an email at: jeff <dot> takle <at> jtnoel <dot> com

I'd recommend getting Jeff's spreadsheets and listing ALL your one time expenses and all your recurring expenses. You don't say if what you call "mortgage" includes taxes and insurance or if it's just P and I. Also you don't mention any down payment or closing costs (but I'm sure you had BOTH), knowing that would help us give you a better reading.

I can tell you that a property manager is a HUGE (and often wasted) expense. At 8% I'm sure it exceeds your taxes or insurance. Consider dropping that and doing it yourself. You also don't mention if you paid a Realtor to find your tenants.

My rule of thumb is that MONTHLY rent needs to be AT LEAST 1% of value of the house, but then I'm looking for a higher return. Just looking at yours you're a bit below on each of them.

Let's take a look at the numbers you did provide. On number 1 your NET rent is $915.40, and your NET POSITIVE CASH FLOW is $128.40. Even assuming that you had ZERO out of pocket acquisition expenses, you still put another $7985 into it before you received ANY rent. That means you'll be SIXTY TWO MONTHS into this deal before you BREAK EVEN.

On the second one your NET monthly rent is $782, and your positive cash flow is $119. Again assuming that you had ZERO out of pocket acquisition costs (?) you still put $13652 into this deal before you pulled a nickel out of it. At $119/month it'll take you 114 months to break even. You say that you could get $950 for this place, but in my experience you won't be able to raise your current tenant to that, not in fewer than two renewals, so assume you're 3 years away from that number.

In both cases you will have extraordinary expenses (carpet, a heater or A/C bill or two) on these units before you break even on your initial investment. Not only that, you're going to have a couple of tenant turnovers before you hit that point. Turnovers entail vacancies, painting, maybe carpet or other flooring, etc.

I didn't mean to rain on your parade but if you take a hard look at these numbers it doesn't look as good as saying "well, I have a positive cash flow".

You may well get bailed out by price appreciation. But OK isn't CA or NY or FL. With the numbers you're showing I'd be looking to get out of them as soon as I could. And I sure wouldn't buy any more.

Sorry to bear bad news, but I'm sure there are plenty of others to tell you you're doing great and to go get more like this.

all cash

All Cash, that was detailed and honest analysis, but it looks like you overlooked one important point. His current tenants are building equity for him even if he does not have great cash flow right now. For the first property, after 62 months (your break even point), he would have built $56,754 in equity and on the second property using a similar reasoning he would have built $89,148 in equity. After paying interest and expenses he should still be ahead by at least $100,000 over a 10 year period.

Most people who start off as real estate investors probably get rich through the equity they build over time and cash flow only makes a difference in the later years. This is coming from a novice so feel free to correct me if I am wrong.

This is the beauty of the real estate game. A good deal to one person is a bad deal to another. In my opinion, both all cash and TheEdge are correct in their analysis. all cash is looking at cash-on-cash return while Asif is looking at long-term equity.

My personal preference is to purchase so that I get good cash flow and any cash that I put into the deal is returned to me within 6 months.

For the first property, after 62 months (your break even point), he would have built $56,754 in equity and on the second property using a similar reasoning he would have built $89,148 in equity. After paying interest and expenses he should still be ahead by at least $100,000 over a 10 year period.
I am glad to see someone else writing that down... because that was a concept I was trying to explain to my business partners just last week! While I tend to agree with your analysis I think you have missed out on one very important detail:

A (traditional) mortgage is a forced savings plan.

Yes it is true that he is earning profit / building equity each month (so long as rents exceed actual expenses). However, the investor still has to plow cash into the mortgage, insurance, etc. regardless of how much paper profit he's making. So yes he will earn a profit, but if you don't have cash then you have to increase your capital base in the property (either through another loan, or by adding equity/cash to the equation).

All of that being said... I tend to agree with all cash's assessment of the situation. A simple philosophy: if it puts cash into my pocket every month then it's an asset, if it takes cash out of my pocket every month then it's a liability. It's all about the Benjamins baby.

OK edge, I've read your post several times, and I'm not the brightest guy that ever walked, so I can't figure out where the heck you got your "equity build-up" numbers.

Edge wrote

For the first property, after 62 months (your break even point), he would have built $56,754

$56754 divided by 62 = 915/month!
While that much may flow through his hands, his equty build-up through paying down the mortgage is only about $7K, he'll have paid about $40K in interest and the rest of the payment will have gone to ppty tax and insurance.

Edge wrote;

on the second property using a similar reasoning he would have built $89,148 in equity
.

$89148 divided by 114 months = $782. Again that much flows through his hands, but ALMOST ALL of it is going to interest, taxes and insurance.

Prohabber wrote;

In my opinion, both all cash and TheEdge are correct in their analysis. all cash is looking at cash-on-cash return while Asif is looking at long-term equity
.

While there are different ways of analyzing deals, unless you're Enron, counting EXPENSES as INCOME doesn't work too well. Equity build-up through loan payments is a very slow process, and is ALMOST ALWAYS counterproductive, ie; INTEREST PAID more than offsets build up.

If I've missed something please let me know. I've only been doing this for 29 years and my GPA in grad school was only 3.8 so it's possible I'm wrong.

all cash

Originally posted by "Detchu":
Requesting feedback or constructive criticism on my first RE investment. I bought two properties in OKC last year. I have a property manager that charges 8%.

The first was $110,000 3/2/2. Rents for $995 with $787 mortg. I put $5,000 tile, carpet and paint & paid the first 3 mortg payments. It’s been rented out since Sept 05.

The second was $94,000 3/2/2. Rents for $850 with $663 mortg. I put $11,000 tile, carpet, paint & appliances and paid the fist 4 mortg payments. It’s been rented out since Oct 05.

I learned a lot and feel I could have negotiated lower prices but they are renting for a positive. The $94,000 could probably rent for $950 but I lowered it because it took a while to rent. Also, I didn’t have to spend so much on tile and carpet, but I wanted to tile most of the houses to avoid further problems.

I’m trying to talk my business partner/wife into repeating the process. Any constructive criticism is welcome and appreciated.

Wow, awsome feedback. Just to add a few things I forgot to post. I bought the 1st property about $15,000 below average comps in the area. The 2nd was a REO that I got for almost $18,000 below average comps. Another thing no PMI and taxes and insurance are figured in the numbers I submitted.

Detchu

Hey detchu, good update. What about your "out of pocket" expenses for getting these places, down payment, closing costs, appraisals etc. Obviously that affects your payback period.

Again, not to rain on you too much, but the $18K discount on the second one is kind of offset by the $11K you had to put into it to make it rentable.

BTW, I'm sure lots of folks will take issue with my somewhat sarcastic attitude in my response to "edge" and "prohabber". I do that for a very good reason, if my resonse doesn't have any edge to it most people will just read the post and think, "oh, another opinion, I'm sure they're all correct", or something similar. Let's face it many (most) people misinterpret a lot of what they read.

By doing it the way I do, it ensures that many readers will go back and re-read all of the previous posts to see what the fuss is all about. This is particularly true if (as is often the case) we get a "heated" exchange going on. I have a thick skin and I assume others do as well, let's face it one of the "benefits" of posting questions on line is that you know you may get a bit "flamed" for your posts.

Again, I could just tell everyone "wow, you're a genius, you'll be a millionaire in no time" like the gurus do. But I don't believe in snowing people. They post here because they legitimately want the opinion of the "gray hairs" on the site. If we don't give them honesty (no matter how brutal) we do both them and EVERYONE ELSE who will read the post in the future a grave disservice.

Just my opinion, on which I am the world's greatest authority!

all cash

All Cash,

The down was 10% on both. The other numbers on the post are all my expenses. Closing, flight from CA. gas, food lodging everything. It's all fresh and ready for the Tax Man. Sorry my first post was incomplete, I'm new to this. Rates are 6.2% 30 years.

Detchu

yeah I get what you mean all cash... I read your response and realized that I hadn't done any of the calculations myself and I was totally going off of someone else's calculations. Woops.

Unfortunately since you have PITI all wrapped up together it's tough for me to estimate what your actual equity is going to be in 10 years. Assumptions:

- Taxes and Insurance make up 30% of each monthly payment, so the implied interest rate is 4.25%
- You have a 30 year note

After 10 years you'll have paid off about 20% of the Principal for the mortgage, so you would owe around 80% on each mortgage. Then you would need to know what the appreciation rate is in your area for the next 10 years... appreciate your purchase price by that amount (remember to compound that interest) and presto, you have the future equity in your home in 10 years.

But you still want to be cash flow positive on the road to get there. :violin:

I pulled them out of thin air All Cash. Just kidding.

I should have worded my post a little differently. The amounts I posted (as you corrected) are income. However over a ten year period, after interest and expenses he ought to be able to build equity unless certain exotic means of financing were used. Not considering the recent runup in prices, housing generally keeps pace with inflation and building $100,000 in equity after 10 years does not sound far fetched to me.

But like I stated before I am a novice and feedback such as yours is appreciated.

Well detchu, unfortunately that amount downstroke makes it WORSE. More out of pocket and you have the added expense of paying PMI on two loans since you didn't put 20% down.

Hey edge, I agree that housing generally keeps up with inflation, unfortunately the ppties are in OK so it'll probably be at the lower end, whereas detchu lives in CA where it's at the higher end.

Again, I stick by my original assessment. I'd get out of them NOW.

all cash

Originally posted by "ProHabber":
This is the beauty of the real estate game. A good deal to one person is a bad deal to another. In my opinion, both all cash and TheEdge are correct in their analysis. all cash is looking at cash-on-cash return while Asif is looking at long-term equity.

My personal preference is to purchase so that I get good cash flow and any cash that I put into the deal is returned to me within 6 months.

all cash,
Please be more careful about pulling quotes out of context. I didn't take the time to run all of the numbers and maybe I should have but it has no bearing on my point that different investors have different goals. You are correct that the numbers Edge used were wrong for this type of analysis, but his concept was towards equity build-up and that concept has made people millions.

If I've missed something please let me know. I've only been doing this for 29 years and my GPA in grad school was only 3.8 so it's possible I'm wrong.

Your resume is not required, this board is a great resource for beginners and your 29 years of experience would be better used to help than to intimidate.

Prohabber;

I agree with your points, up to a point.

You wrote;

but it has no bearing on my point that different investors have different goals

True, but having the right numbers to start with is only part of it. Interpreting those numbers correctly is the difference between making a profit and losing everything because you thought you had a "good cash flow".

You wrote;

the numbers Edge used were wrong for this type of analysis, but his concept was towards equity build-up and that concept has made people millions
.

See answer above.

Like I said in my earlier post, I often take a more "sarcastic" attitude, but it's not meant in a mean spirited way. I feel I've done a good job if when I look in a couple of weeks and see that there have lots lots of "views" on this thread.

My last post for awhile. Going to Utah tomorrow for skiing.

BTW, didn't I see an earlier post of yours about ppty on the Covgington side of the river. My MIL owns a place right around the corner from the old Robke Chevrolet dealership in CVG.

all cash

I can say that All Cash means no disrespect and harm. He's been around for a while and has been very helpful. He has his own brand of sarcasm that no one should take personally.

I'm extremly pleased with the dialog that has been taking place here. It is important to hear differing opinions, and I'm glad we've provided a safe forum for that to take place.

That said, continue the discussion, and Cash - I'm truly jealous of you and your ski trip! Have a great time and check back in soon.

First, this is a great back and forth--I am amazed at how many people I speak with tell me their mortgage is "X" and their rent is "X+$100" so they have positive cash flow. There is, as evidenced above, a lot more to it. A few other thoughts, if you want to get down to the nitty gritty about the bottom line, though some of these stats are relevant whether you sell or keep the prop:

-expected appreciation over life of investment
-equity bought through mortgage payments
-benefit of the interest home mortgage interest deduction in terms of saved (or shielded) current annual income
-a 10% misc operating expenses bill tacked on
-a 4%-12% vacancy rate average depending on local norms
-25% recapture of depreciation
-cost of improvements that will likely become necessary if you keep the house for 10 years+ like new roof, new water heater, new carpet/floors, etc...minus the depreciation you can claim for each over time
-whether you've held the property for at least a year, which will impact the classification of short-term cap gains taxed at personal income rate, or long-term cap gains currently taxed at 15%.
-etc. etc. In short, it's a bit more complex to get the clearest picture on the numbers, IMHO, than a lot of folks portray. Some things impact current cash flows, some impact future cash flows, some impact current taxes, some impact future taxes...

Is this a good buy or not and should you keep it: Can you afford the cash outflows required to sustain the property? What is your projected IRR and how does that compare with other options like stocks or bonds?

7 months? That's awesome. I've met too many people who have none, or maybe one month's expenses and tell me not to worry because they "haven't had any problems getting tenants in their properties." That system works great as long as life doesn't throw any unexpected curves. At all. Ever.

All Cash stated, "Again, I stick by my original assessment. I'd get out of them NOW".

Okay. Lets say I took All Cash's advice and sold the properties "NOW". What is the tax situation if I sold for a loss?

Detchu

Looking at the numbers more closely, all cash is correct that these are probably not going to be very good deals for you to hang onto. A very quick rule of thumb is that your monthly gross income times 100 should be more than the purchase price of the home. That is VERY oversimplified, but you can use it as a super quick calculation to see if the asking price is anywhere near where it needs to be.

As an example, a duplex that generates $1300 gross per month in rent should be purchased for less than $130,000 if it is in perfect shape. This is just another way to say the same thing that all cash said when he said that he wants his monthly rent to be more than 1% of his purchase price.

If you do sell, you should of course try to get the most you can. You may be able to find someone that can cash you out at nearly a wash. In the event that you have a loss you will most likely classify it as a loss in a passive investment. You can then bounce the loss against other passive gains that you may have (e.g. interest, stocks, etc.). You should check with an accountant for the best answer to your question. Also, I am sure there are plenty of real estate accounting books that can help you.

UPDATE: Just finished with my accountant regarding 2005 taxes. My wife I and made around $155,000 gross last year. We paid nearly $18,000 in Fed and State taxes. After everything, we have $12,000 coming back to us from the govt. The two afformentioned rental properties really helped us to keep some of our money. Just wanted to update things to see if it changes any opinions.

Detchu