Are my assumptions reasonable?

Question

Hi BP,

We are out of state investors looking to buy our first property in Indianapolis or Columbus. Been having trouble finding properties that cash flow, so I’m wondering if our assumptions are part of the issue.

I use 10% of rents for vacancy, 10% for capex, and 10% for property management. Are these too conservative? If we are analyzing a turnkey property, is it reasonable to decrease the repairs and capex to like 5% each?

Any feedback is appreciated!

Thomas

Drew Sygit · Answer

@Thomas Loyola you haven't addressed the Class of property you intend to buy, so your assumptions could be too low or too high.

Your biggest challenge is you are assuming you have to pay asking prices!

Who told you that?

An investor should actually work backwards from their Target ROI, to  determine what to offer on a rental property:

• Determine reasonable market rent, NOT the highest!
• Deduct NEW property taxes after you buy
• Deduct home insurance costs
• Deduct maintenance percentage, typically 10%
• Deduct vacancy+tenant nonperformance percentage
(we recommend 5% for Class A, 10% Class B, 20% Class C, good luck with Class D)
• Deduct whatever dollar/percentage of cashflow you want

Now, what you have left over is the amount for debt service.

Enter it into a mortgage calculator, with current interest rate for an investment property, to determine your maximum mortgage amount.

Divide the mortgage amount by either 75% or 80%, depending on the required down payment percentage - this is your tentative price to offer.

If the property needs repairs, you'll want to deduct 110%-120% of the estimated repairs from this amount.

Be sure to also research the ARV and make sure it's 10-20% higher than your tentative purchase price.

As long as the ARV checks out, this is the purchase price to offer.

It is probably significantly below the asking price. Who cares? If you pay more, you won't meet your metrics and will probably have negative cashflow and/or equity.

You may have to make 10, 20 or even 100 offers to get one accepted at the price that meets your numbers.

Remington Lyman · Answer

I believe those are reasonable assumptions. I've seen investors allocate 5-10% for capital expenditures (capex) and vacancy, but you won't have a clear understanding until you've owned the property for a few years and established a track record. It's important not to get too caught up in the details; use the analyzer to compare one property to another. Feel free to adjust the numbers based on your expectations for capex or vacancy rates. If you purchase a newer property that has been recently and properly renovated, you may consider using a lower percentage.

The biggest impact on your cash flow will come from the property’s location. If you buy in a popular market, particularly in a Grade A neighborhood, you might experience negative cash flow. Conversely, if you invest on the east side of Cleveland, your numbers could show impressive cash flow.

Kerry Noble Jr · Answer

Id like to see the properties that you are analyzing around here in central IN

Nathan Gesner · Answer

It's hard to find cash-flowing properties because the prices are so high. You can't expect to get the same results investors were getting in 2018.

You can play with the numbers a little, but be careful. For example, you may reduce the maintenance and capex to 5% and then discover turnover occurs more often than you had planned.

Alecia Loveless · Answer

@Thomas Loyola My stuff is probably B- class  if you take into consideration the actual criteria for classes.

I generally plan for 5% each Vacancy, CapEx, and Maintenance.

My area generally has fairly long term renters. I’m currently averaging about 3.8 years per unit. My only real turnover has come from needing to raise rents to market value.  Also my area has a low volume of available units which generally means it’s easy to get vacant units rented quickly.

Usually I don’t buy anything that I suspect is going to have lots of long term maintenance issues. I know you can’t predict this but I try to get quality purchases which helps.

Once you’ve been doing this for a while you will be able to tell the difference between well maintained properties and neglected properties. Sometimes it’s obvious sometimes less so.

Starting out I was using 7-8% but have moved to less over time. I think 10% would be more than enough. Certainly if you go turn key you could consider less for maintenance and CapEx. Once you’ve have a feel for your target market you can adjust the vacancy rate accordingly.

Are my assumptions reasonable?

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