I think I found a winner!!

21 Replies

We found a 2 family property asking 115K. We will offer 85K and keep out fingers crossed he accepts. We have spoken to a contractor, for rehab. His estimate is 70K, that includes turning it into a 3 family and adding a coin op laundry room. ARV will be 220K per realtor. FMR are $650-700 X 3 units. Annual taxes are apx $2500, unable to obtain water/sewer at this time. After all is said and done we will have a brand new 3 family home in a decent neighborhood for 155K. This will be our 1st deal, what do you guys think???? I think if we go over 10K we will still be OK.

Let's say $2,000 for the rent.

Gross rents: $2,000
Operating Expenses: $1,000
NOI: $1,000

Mortgage Payment ($155K, 30 yr, 7%): $1,031

Monthly Cash Flow: $31 LOSS

This is NOT a good deal.

Mike

Ok, partially because I personally know how much MA SUCKS on cashflow, I'd like to help you out here. Found two 2-unit properties on realtor.com you should take a look at in Lowell.

http://www.realtor.com/search/listingdetail.aspx?pg=1&cmid=1076765%2c1076768%2c1076769%2c1076770%2c1012335%2c1076773%2c1076775%2c1012346%2c1012351%2c1076784%2c1076785%2c1076787%2c1012368%2c1076793%2c1012385%2c1012387%2c1076802%2c1012400%2c1076813%2c1012430%2c1012433%2c1076822%2c1076828%2c1076829%2c1076830%2c1076831%2c1076834%2c1076837%2c1012463%2c1076839%2c1076841%2c1012483%2c1012494%2c1076848%2c1012514%2c1076865%2c1012543%2c1076876%2c1076877%2c1076881%2c1012558%2c1012560%2c1012566%2c1076887%2c1012570%2c1076889%2c1076891%2c1076895%2c1012582%2c1012594%2c1076899%2c1076902%2c1076903%2c1012608%2c1100887%2c1012506&typ=4&sid=68087010bf724995bba86379d0586c36&lid=1092612088&lsn=1&srcnt=1088#Detail

http://www.realtor.com/search/listingdetail.aspx?pg=1&cmid=1076765%2c1076768%2c1076769%2c1076770%2c1012335%2c1076773%2c1076775%2c1012346%2c1012351%2c1076784%2c1076785%2c1076787%2c1012368%2c1076793%2c1012385%2c1012387%2c1076802%2c1012400%2c1076813%2c1012430%2c1012433%2c1076822%2c1076828%2c1076829%2c1076830%2c1076831%2c1076834%2c1076837%2c1012463%2c1076839%2c1076841%2c1012483%2c1012494%2c1076848%2c1012514%2c1076865%2c1012543%2c1076876%2c1076877%2c1076881%2c1012558%2c1012560%2c1012566%2c1076887%2c1012570%2c1076889%2c1076891%2c1076895%2c1012582%2c1012594%2c1076899%2c1076902%2c1076903%2c1012608%2c1100887%2c1012506&typ=4&sid=68087010bf724995bba86379d0586c36&lid=1097768463&lsn=2&srcnt=1088#Detail

Now I know nothing on Lowell rent prices. Get a list of repairs necessary to make the spaces livable, find the rents and see where these take you.

And here's one more in a place called Montague. This is already a 3 and from the photos looks like very light repairs. 99k sale price. 2k in rents on 99k purchase price and from my computer perspective under 20k in repairs. You're getting closer.

http://www.realtor.com/search/listingdetail.aspx?pg=1&cmid=1012329%2c1012344%2c1012360%2c1012366%2c1012375%2c1012377%2c1076796%2c1012395%2c1012405%2c1076812%2c1012424%2c1012425%2c1012445%2c1012447%2c1086225%2c1012480%2c1012486%2c1076852%2c1076854%2c1012531%2c1012542%2c1012546%2c1012561%2c1076894%2c1012585%2c1012600%2c1086219%2c1100885&typ=4&sid=26f1dac3c37843bba4ba32d73d315689&lid=1098412839&lsn=3&srcnt=62#Photo

Thanks Tim, We looked at the house in Montague...Needs ALOT or work, more than 100K, all units need a complete overhall. As far as Lowell, I think it might be too far for our 1st renal property. It's at least an hour and a half away. Do you recommend starting close to home for your first couple of deals? MA does suck as far as cash flow, perhaps we should start looking in southern VT and NH. Do you know anything about those 2 states?

Mike, thanks again for your reply. I read to take 40% as far as NOE go, looks like you suggest %50? My question is, considering we will have a brand newhome at this point would %40 NOE be more realistic? We "should" have no huges expenses for a long time, ie roof, electric ect. What do you think?

Thanks again guys!

Oh yeah, if it's 100k then forget it. I found that an hour and a half was the distance I needed to make cashflow work. Don't know about NH/VT but it certainly is worth a look. Red states tend to cash flow better than blue states - don't ask me why they just do.

Mike, thanks again for your reply. I read to take 40% as far as NOE go, looks like you suggest %50? My question is, considering we will have a brand newhome at this point would %40 NOE be more realistic? We "should" have no huges expenses for a long time, ie roof, electric ect. What do you think?

Throughout the United States, operating expenses run 45% to 50% of gross rents. Therefore, I use 50% to be conservative.

That 40% figure you saw probably did not account for vacancies or capital expenses, which is why it's 10% lower than the 50% figure I use.

Even though you may not have large capital expenses for a long time, you still need capital expenses in your equation or you won't have any reserve for theses expenses when you incur them in the future. In addition, you will CERTAINLY have maintenance even if things are all new in the beginning.

That 50% figure doesn't only include the expenses that come out every month, it also includes the expenses that only occur occassionally. For example, significant damage done by tenants in excess of the security deposit (often thousands of dollars), is an expense that may only occur once in a many years. However, when it does occur, it can wipe out literally many years of cash flow if you haven't accounted for it. That is an error that is fatal for many businesses. I see it all the time and have bought numerous properties from failed landlords that have made this mistake.

Good Luck,

Mike

I THINK. That it doesn't sound like a bad deal at all. As far as the 50% rule. It doesn't always work out that way. If your saying that you have a new roof, appliances?, etc...you should be fine. However, when renting any type of units - being that its your first - I suggest taking the cash flow every month and just banking it. Save up a kitty of money to use when something goes wrong. Don't think of it as extra income.

I'm here in WESTFIELD MA, not far away and your right, that price isn't bad at all!

We would CERTAINLY bank the $$$. We have no intention of using this property for something other than long term equity. Mike, I hear what you are saying about the expenses many landlords overlook. I much perfer to be conservative rather than gamble. As far as the blue/red states, I'll have to look into that theory a bit more!

Thanks for all of your advice!

PS: CChilds, Do you attend any local REIA meetings? Haven't been able to find any closer than Worcester. We have met somebody who plans on launching a meeting in Springfield area this August. If you're interested PM me and I can let you know when it starts up.

I've been reading a bunch of the discussions where the 50% rule has been brought up. I have to say, I had may doubts that it was anywhere close to that high. So, I finally decided to go back and check the history on both my duplexes and compare. Here's the results:

Duplex 1
I've owned for 10 months. It's a 30 year old property that had been neglected. It needed minor cosmetic rehab work when I purchased it, and it was empty. So, after replacing some carpet, painting the whole place, and some other minor improvents, here's where I'm at.

Expenses $9600 (including everything but mortgage)
Income $17300
Expenses=55% of gross rents

Duplex 2
I've owned for 8 years, and it was 3 years old at the time of purchase and needed nothing but a little touch up painting at the time.

Expenses $31200 (including everything but mortgage)
Income $104200
Expenses=30% of gross rents

Total expenses between the two = 34% I do expect this number to go up a as the property that is now 11 years old starts to need more repairs. However, the property that I purchased last year will not need as much work over the next year or two since I have taken care of most of it. So, I would think that 40% is a decent long term average between these two properties.

In any case, I think the amount of your expenses will be dependant on the quality of tenants that your property attracts, the age of your property, and the number of units (the duplexes probably require a little less maintenance than say an 8 unit).

What Mike is saying about 50% costs is probably a good rule of thumb for conservative cashflow estimates. It'll pretty much garauntee that you cashflow if you use that number when you are looking at purchasing a property.

Deuce, Thanks for those numbers. Always good to see actuals.

Did you have any vacancies? Those aren't "expenses", but when applying the "50% rule", the rent used in the calculation is scheduled rent, not collected rent. So, for that calculation, you have to use scheduled rent, and include any vacancies as an expense.

Originally posted by "Wheatie":
Deuce, Thanks for those numbers. Always good to see actuals.

Did you have any vacancies? Those aren't "expenses", but when applying the "50% rule", the rent used in the calculation is scheduled rent, not collected rent. So, for that calculation, you have to use scheduled rent, and include any vacancies as an expense.

I have averaged around 5% vacancy, just from tenants moving in and out. My numbers are actual income, not scheduled. So, my numbers would include the lack of income for those months when the properties are vacant.

Also, those numbers include one eviction with a tenant who did about $2500 in damage, and one tenant who broke the lease, and moved out early.

Deuce442,

It is good that you are looking at your expenses. Unfortunately, owning two duplexes is not enough of a sample to be meaningful. If I looked at my own portfolio, I have some properties where I literally haven't done anything over the past (almost) 5 years. One 3 bedroom house comes to mind where I haven't had a vacancy, no maintenance, nada! Only taxes and insurance. So, I could claim that the operating expenses over the past 5 years were about 18% (if I didn't include anything for my own management).

However, that wouldn't really be accurate. Will this house ever need a new roof? New furnace? New Air Conditioner? Painting? Will a future tenant do excessive damage? Will the tenant fall down the stairs and sue me? If I pretend that none of that will ever occur, I can claim an extremely low expense ratio today, but it won't reflect reality over time.

On the other extreme, the big apartment building (the pink elephant) that I purchased in January has one apartment that has been vacant for a couple of years. Some tenant did a bunch of damage and the previous owner was discouraged and never repaired it. I haven't even started the repair on that unit and probably will not for several months. My intention is to completely renovate the exterior before I rehab the apartment. So, this apartment has 100% vacancy. In addition, taxes and insurance never stop and there will be at least several hundreds of dollars of repairs when I do rehab it. What am I to conclude about operating expenses from this unit - that expenses are more than 120% of the gross scheduled rent? You see, that isn't the reality either over the long term.

The 50% rule is nothing more than a rule of thumb to say that throughout the United States, operating expenses run 45% to 50% of the gross rents. This is an average of hundreds of thousands of rental units over time. It certainly does not tell you what the expenses will be on one or two rentals in a short period of time.

Mike

I have averaged around 5% vacancy, just from tenants moving in and out. My numbers are actual income, not scheduled. So, my numbers would include the lack of income for those months when the properties are vacant.

That means that your expenses are about 35% and 60% of the (scheduled) gross rents on your units? What are you including in those figures for management? And what reserve are you including each month for capital expenses?

Mike

I'm not making any claims that my numbers would apply to all properties or all areas. I was simply trying to give an example and compare my actual numbers to this rule of thumb. I agree that with a larger portfolio of properties the expenses are probably higher (especially if some are appartments). However the person that started this topic was looking at a two family property. So, I think my examples are good info for them.

Originally posted by "MikeOH":

That means that your expenses are about 35% and 60% of the (scheduled) gross rents on your units?

No, my numbers included vacancy. My income that I listed was actual income, not scheduled income. Therefore, if I had a vacancy, there was no income for that time frame. So, the 30% and 55% numbers include vacancy.

Originally posted by "MikeOH":
And what reserve are you including each month for capital expenses?

I 100% agree that everybody needs to have reserves. However, in my opinon, reserves are not expenses until there is an expense that uses the reserves.

I keep 6 months worth of typical expenses (including mortgage payments) in a cash management fund. However, I do not buget any dollar value each month to be added to this fund.

Expenses $9600 (including everything but mortgage)
Income $17300
Expenses=55% of gross rents

"My income that I listed was actual income, not scheduled income. Therefore, if I had a vacancy, there was no income for that time frame. So, the 30% and 55% numbers include vacancy."

Unfortunately, the math doesn't work like that. The 50% rule is based on Scheduled Gross Rents and includes the vacancy as an expense. If you have about 5% vacancies, that means that your Scheduled Gross Rents would be about $18,200. Your expenses with the vacancies would be $10,500 ($9,600 + $900). Therefore, your expense ratio is $58%. Now, add in the allowance for Capital Expenses, about 5%, and you're up to 63%. You didn't mention management. If you're not including management expenses, then that's another 10% (or you're working for free).

Assuming that you ommitted these expenses on your other property, that 30% will become about 50% when you include the management, vacancies, and capital expenses.

My only point is going through all of this is that all of these expenses do occur in the real world. When you have a small portfolio, these expenses don't happen often and it's easy to ignore them. Unfortunately, as your portfolio grows (or even with a small portfolio over the long term), these expenses catch up with you and must be accounted for (because you have to spend real money to pay them). In your examples, your 30% expenses became about 50% when you include all the expenses and your 55% expenses became about 73%. Obviously, your 73% included the startup expenses, so over time this should come down to the normal range of 45% to 50% or something close to that.

Good Luck,

Mike

I understand what you are saying about management. I don't consider any costs for that. I manage my own properties like you do, but I don't figure that I am paying myself. My gain is based on the investments. The only money of my own I have into these properties is 10% down on the first property. So, I put down about $18,000, I have been cashflowing, and I now have $130,000 in equity between the two. I think the $112,000 in equity profit and the positive cashflow is more than enough to pay me for the little time I've spent managing these.

I think we also have to keep in mind that the reason for the ratio in the first place is to be able to compare deals. It is to be able to quickly tell whether a deal is good or not.

One question I have though. Why are we not including expected appreciation and the tax deductability of the mortgage in our calcs?

Why are we not including expected appreciation and the tax deductability of the mortgage in our calcs?

Obviously, you can include anything you like in your calculations. I don't include any appreciation in my calculations because I can't eat appreciation. Cash flow is KING in the rental business and having even millions of dollars in appreciation won't buy you so much as a diet coke. What's more, appreciation today can rapidly become depreciation tomorrow as millions of "investors" have been finding out.

I don't include tax deductability in my calculations because full time landlords don't usually pay income tax. I don't have a job or earned income to offset.

What really matters with rentals is the cash flow. With adequate cash flow you can survive to enjoy the appreciation later, which is just icing on the cake. Without cash flow, you'll never survive to enjoy the appreciation, unless you only have a few rentals.

Good Luck,

Mike