Rental Calc question

3 Replies

#AskBP

So I have an opportunity on a mutli and playing around with the rental properties calc here on BP (unlimited usage is why I upgraded to Pro - worth it). 

All my #s stay the same but altering the income /expense yields different results. I want to reiterate all my inputs stay the same except for what's detailed below. Let me explain...

Option A: 

-- Monthly Income: $2,500

-- Monthly Expenses: $700

Yields a cash flow of $422.21 with a 12.84 return. 

In option B below, I net out the monthly income & expenses and get a different result. Here ya go:

Option B:

-- Monthly Income: $1,800

-- Monthly Expenses: $0.00( zero) 

This yields a better cash flow @ $541.21 with 16.46 return. 

In both options, the net monthly income is $1,800. My question is this, why is there a difference? What am I not understanding about this powerful tool?

  

Could it be because your vacancy rate is calculated from the income? So, if the income is lower, the vacancy cost will be lower. Try putting $10,000 for income and $8200 for expenses and see what you get.

Truth is one method is planning and what will be your actual may in fact differ. The point being is that you want the numbers to make sense (if and when). You are accounting for contingencies with planning and so you are prepared but will still profit an acceptable amount per year  while holding the property. You want to be sure the property generates enough to cover costs, taxes, insurance, maintenance, vacancies etc. If under normal operations the property cash flows then it will cash flow better and be higher yielding in the case things should optimize in your favor.

The consequence of not accounting for contingencies in your numbers and evaluations is that you may end up not generating enough money to pay for ongoing operating expenses then fall behind the 8 ball with a property, bad ending to it all and definitely buyers regret along with possible financial ruin. 

You want to be sure you are not paying too much for a property and have a realistic expectation of how the property will perform financially and you want to assure yourself of generating a profit (if and when) also. You are taking steps to protect yourself. Why do you buy car insurance. Some people drive their entire life time without ever having a single accident but if they have insurance (if and when) they are prepared to deal with that expense and loss. So when you evaluate cost, value, cash flow etc. you are in essence creating an insurance for yourself. Let us say you allow $150,000.00 to pay for replacing the roof in the next 10 years on your apartment building but to your surprise the roof last 40 years without the need of replacement or major repairs. When you made sure you would have the $150,000.00 you are insuring you were prepared to deal with that and of course you would try to assure the property itself earned that money and not represent an addition cost out of pocket from you. This process is a part of risk management. 

What I am finding sad to see is allot of people posting on here especially newbees is that they do not spend enough time doing a proper evaluation of what they are getting themselves into. I read about inexperienced people having problems with tenants, over leveraging themselves, over extending themselves, running into cost overruns etc. 

So many tell you hurry get into real estate now, take action, get started no matter what but there should be room to allow for the exercise of wisdom and not taking on more than you can chew. 

I agree that a certain amount of motivation is necessary and healthy but there are allot of pitfalls in real estate and once you fall into a trap you will find it very hard and painful to get out of it if you can at all. Many end their real estate investing careers even before they have a real chance to get started on a solid footing. If you try different numbers in a formula and see different results ask yourself if you understand how and why the results are different, In other words do you really understand what you are doing by using a certain formula, spreadsheet or whatever tool you are using?

Originally posted by @Scott Weaner :

Could it be because your vacancy rate is calculated from the income? So, if the income is lower, the vacancy cost will be lower. Try putting $10,000 for income and $8200 for expenses and see what you get.

 Great point Scott. So simple, I should have thought of that.  Thanks for the response. 

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