How do YOU do break-even for buy-and-holds?

21 Replies

Hey all the way from Norway! 

I've spent the past two weeks finalizing the business plan for my buy-and-hold real estate company and have ran into a wall.

The break-even-analysis looks very scewed and I can't figure out why, or whether it's supposed to look that way. Basically my first rental will be a small two bedroom which will cash flow positively from year 1. 

Financial assumptions:

Fixed expenses: HOA (includes sewer), Mortgage, Interest on mortgage. (Set to a rate of 4% at a 25 year amortization in a regular bank), electricity (in Norway and tenants are billed their electricity bill directly from the power company. Landlords only pay a monthly fee of nettleie which is like $20 for an apartment).

I've factored outcap ex, vacancy and evictions for the break-even as I have saved up a cash reserve to cover these. The cash reserve should cover a $ 6000 Cap ex, a max of 3 months vacancy the first year (24 %) AND a hypothetical 6 month eviction. The two bedroom unit I will buy will also be purchased brand new (most likely finished in 2017) to hedge against the need of any major repairs. 

Taxes are not worth mentioning at this point, as they are very different from the US to Norway.

The numbers:

Rent per month: $ 1600

Total fixed cost per month: $1446

Variable expenses: repairs and maintenance

Total variable cost per month: $160

Results:

A break even point during the first year due to downpayment of mortgage. 

Or am I doing something wrong? I would greatly appreciate it if you have any input or some better tools for break even analysis.

I think the simple answer, is that the numbers may simply not work. If you are struggling to break even on a property after accounting for debt service, fixed and variable costs, etc, then the numbers (for you as an investor) do not justify the deal if your goal is cash flow on a buy and hold. If other investors are making it work in terms of cash flow on a buy and hold, it is because they are working in different markets with different financing, cash reserves, etc. If you know of an investor in your market who has what you are looking for, speak with them and try and get a feel for what they are doing, but by and large, one market investment vehicle may not transpose itself well onto another market. 

For me, I break down the four primary ways that I (generally speaking) see to make money in real estate without getting too in depth:

-Loan paydown

-Equity buildup

-Net cash flow

-Tax benefits

Some buy and hold investors may buy and hold a property that merely breaks even, because of one or more of the other factors. Maybe they break even on the property in terms of cash in/cash out, but they know that if they hold the property for a few years, it will substantially increase in value due to the appreciative  nature of the market they invest in. 

That has a speculative nature to it, but if done correctly, it is a calculated risk, and investment is about the balance of risk/reward anyway. 

In terms of your specific market in Norway, it may not be a cash-flow market. Here in Los Angeles, CA, that is very much the case. The rents that an investor can demand, largely do not keep pace with the mortgages required to purchase homes here. Obviously the specifics change with unit size, but generally speaking, it is hard to rent a SFR for cash flow in my market. This appears to also be the case for you, as you have accounted for vacancies, evictions, capex, etc. You may have to choose another investment avenue (real estate or otherwise) if you are looking for cash flow, or a different market in Norway for buy and hold investment.

Also, with numbers that close to a break-even point, you have little to no cushion if something does happen to go wrong, and maybe your fixed costs or variable costs changed for some reason. 

Whatever the case, you can't force the numbers to work, if they don't work. Play around with a different market, perhaps a different source of financing, a different property, etc. The excitement for me in real estate is the infinite creativity that can be exacted on my investment to provide a return -- I wish you the best of luck in making it work!

Alex. 

We bought a small shack on the water we turned into a cottage and eventually rented.  Purchase price was probably 10K more than it should have been, fix up was exorbitant because the original idea was to have it as a getaway, cash flow was negligible.  But after 16 years the equity financed the purchase of 3 more rentals.  I still have it.  Cash flow still isn't good, but I have a tenant going on 4 years who was in her previous place for 10 years and only changed to come to my cottage (it is cute and it is on the water) and she is currently covering my mortgage expenses.  Because it is small, expenses are small.  We remade it from the walls in when we bought it.  Is it the best investment/business plan?  No.  Has it worked well for us?  Yes.

Based on what you've written are you including both mortgage payment and mortgage interest? The Interest would be included in the payment so you might be counting this twice (if I'm reading what you wrote correctly)

To me it looks like there is one key point you have forgotten. 

As said many times in Rich Dad Poor Dad: "you make your money when you buy the property". You say you want to buy a new property to avoid major renovations but this might be your mistake.

You win the cashflow game when you aquire a property cheaply and the rent is rather high in comparison. Last time I checked new properties all charge you a premium, which you do not want in the cashflow game. 

Even tho norway is a capgain marke rather than cashflow, you can still win big if you are creative. 

Perhaps it would be better for you to look for one bedroom flats that are older that you could convert into a two bedroom. this way you pay much less for a two bedroom. building a wall is not very expensive in norway.

I could be reading into this wrongly, but it sounds like you are scared of big renovations, and that you have fear that these things could break you. This fear could possibly be preventing you from making the optimal choices. You will likely buy in Tromsø, where its easy to sell. selling is a great exit strategy if a property becomes problematic. But thats only plan B or C. Banks have always been willing to give loans to fix issues. And the market in norway give you alot of repair value, so you get alot of eqiuty from your loan.

happy to discuss this further with you if you are interested :)

-M

No company avatar mediumMorgan Nilsen, NorthEast Holdings,LLC

There are always ways to make your numbers work abit better. As an example, I would definitly get a 30 year plan for your mortgage instead of 25. I would shop around to get the best interest rates too. Most banks in Norway that I know of give you better interest rates for mortgages over 2 million kroner, so I would try to place myself in that category if possible.

Another thing to concider is that there is a law here that let you take up to 15% of your rental income and make it tax free if you rent out your flat with furniture. Could benefit you greatly.

I personaly focus much more on the Net Operating Income rather than ROI and cash flow. Mortgage downpayment is increasing equity, and thats as good as cashflow in my mind.

-M

No company avatar mediumMorgan Nilsen, NorthEast Holdings,LLC

Also, just because you have saved up a sufficient cash reserve does NOT mean you should exclude cap ex or vacancy.

The aim of an investment is to increase your net worth.  You have to analyze the investment independent of your other assets.  If it is only profitable by relying on more of your assets, then it isn't really profitable at all.

Also, note the difference between the analysis and the execution in this case.  You can choose not to set aside funds for cap ex and vacancy if you so choose, because you have sufficient reserves already.  But, even so, you should include those variables in your analysis to determine whether or not to make the investment (and then later on, to determine how well the investment is performing).

@Alexander Bigwood Thank you for the input regarding cash flow and how you do break-even analysis! I will examine my own equity build up a little more closely.

I think I have have been somewhat unclear in my first post which I apologize for. To say it in a different and more clear way: The problem with the break even is not that the numbers are bad. It is that the numbers are too good. 

Everyone says make money going into the deal. This is exactly what I will achieve within the first year, and thus my question is: If the cash flow is positive from year one, is it right that the break even point is also met year one? Mathematically speaking it sounds right to me. 

Originally posted by @Tammy Vitale :

We bought a small shack on the water we turned into a cottage and eventually rented.  Purchase price was probably 10K more than it should have been, fix up was exorbitant because the original idea was to have it as a getaway, cash flow was negligible.  But after 16 years the equity financed the purchase of 3 more rentals.  I still have it.  Cash flow still isn't good, but I have a tenant going on 4 years who was in her previous place for 10 years and only changed to come to my cottage (it is cute and it is on the water) and she is currently covering my mortgage expenses.  Because it is small, expenses are small.  We remade it from the walls in when we bought it.  Is it the best investment/business plan?  No.  Has it worked well for us?  Yes.

@Tammy Vitale   Thank you for sharing. And you will still have a lot og equity in that cottage after so mnay years.

Originally posted by @Ellie Hanson :
Based on what you've written are you including both mortgage payment and mortgage interest? The Interest would be included in the payment so you might be counting this twice (if I'm reading what you wrote correctly)

 Just checked. Mortage is only counted once. Thank you for the input! 

Originally posted by @Robert G. :

Also, just because you have saved up a sufficient cash reserve does NOT mean you should exclude cap ex or vacancy.

The aim of an investment is to increase your net worth.  You have to analyze the investment independent of your other assets.  If it is only profitable by relying on more of your assets, then it isn't really profitable at all.

Also, note the difference between the analysis and the execution in this case.  You can choose not to set aside funds for cap ex and vacancy if you so choose, because you have sufficient reserves already.  But, even so, you should include those variables in your analysis to determine whether or not to make the investment (and then later on, to determine how well the investment is performing).

 @Robert G.  Thanks! Good point with Including vacancy, eviction and cap ex to review later.

Originally posted by @Morgan Nilsen :

To me it looks like there is one key point you have forgotten. 

As said many times in Rich Dad Poor Dad: "you make your money when you buy the property". You say you want to buy a new property to avoid major renovations but this might be your mistake.

You win the cashflow game when you aquire a property cheaply and the rent is rather high in comparison. Last time I checked new properties all charge you a premium, which you do not want in the cashflow game. 

Even tho norway is a capgain marke rather than cashflow, you can still win big if you are creative. 

Perhaps it would be better for you to look for one bedroom flats that are older that you could convert into a two bedroom. this way you pay much less for a two bedroom. building a wall is not very expensive in norway.

I could be reading into this wrongly, but it sounds like you are scared of big renovations, and that you have fear that these things could break you. This fear could possibly be preventing you from making the optimal choices. You will likely buy in Tromsø, where its easy to sell. selling is a great exit strategy if a property becomes problematic. But thats only plan B or C. Banks have always been willing to give loans to fix issues. And the market in norway give you alot of repair value, so you get alot of eqiuty from your loan.

happy to discuss this further with you if you are interested :)

-M

 Aloha Morgan, and thanks again for your insight which is always very useful :) 

I am indeed afraid of renovations, as I am not a handy person myself. I am also unskilled as negotiating with contractors and I don't have any friends who are into construction and could help me.

Buying a brand new house in my hometown is the most inexpensive way to purchase property here. The reason is that you avoid the insane bidding wars on houses. You can easily waste another $ 100 000 (dollars) if you start bidding on a 'used' house. For those in the US I can mention that if you bid on a property here in Norway you cannot withdraw your offer. You bid - you buy it! And what is even worse is that the highest bidder wins, just like at an auction. So there are quite a few bidding wars going on over here, except for brand new homes which have a set price. The latter is also sold first-come-first-serve.

Originally posted by @Morgan Nilsen :

There are always ways to make your numbers work abit better. As an example, I would definitly get a 30 year plan for your mortgage instead of 25. I would shop around to get the best interest rates too. Most banks in Norway that I know of give you better interest rates for mortgages over 2 million kroner, so I would try to place myself in that category if possible.

Another thing to concider is that there is a law here that let you take up to 15% of your rental income and make it tax free if you rent out your flat with furniture. Could benefit you greatly.

I personaly focus much more on the Net Operating Income rather than ROI and cash flow. Mortgage downpayment is increasing equity, and thats as good as cashflow in my mind.

-M

 Thank you again Morgan. I will consider doing a 2 million NOK loan. Do you know if the interest is bumped up later on when your loan amount has been paid down to an amount below 2 mill? Or does it stay that way as long as you had 2 MNOK going into the deal?

Agreed. Paying down the mortgage is ROE which is almost as good as cash flow :)

Glad to help! Here are a few more tips for you.

1. The mortgage interest will not change after you pay down below 2 mill. The interest gets set when you take the loan. Every bank should have an interest spreadsheet that you can google. Here is one of the two banks I use: Sparebank1 Nøtterøy-Tønsberg

2. Its important to calculate the taxbreak you get in Norway by having a loan. This will factor in to your math by a great deal. I hope you already do this, if you dont, let me break it down for you so you know how to do it:

 a mortgage of 2 mill with 4% interest, has an annual interest cost of 80.000kr. This sum you pay down monthly to the bank. But the tax system rewards you a tax break for having a loan. which is 28% of the interest total. 28% of your 80.000kr equates to 22.400kr that you get as a tax break, which is money in your pocket when your taxes are due. This is calculated automatically by the tax office automatically btw, so you dont have to do a thing. Just know that the 22.400kr is coming your way.

3. If you dont know about negotiations this is something you MUST learn to master, and learn it now. There are many tecniques to learn and many sources to learn from. This is a book I can recommend you to start off with, but keep reading after you have read this Trump Style Negotiation

4. You say you are afraid of renovations because of the lack of knowledge and experience you currently hold. This is a strong indicator that you should learn more about it, but learn as you go. In the bigger pockets podcast, they sometimes give a fog metaphore regarding this. The road will be made visible as you move down it. In USA contractors are often horrible, but this is not the case in Norway. Most contractors are excellent here, as they have a highly specialized education, and a sallary to match. 

5. I seriously think you should move away from thinking that new house is the better option. And educate yourself on the topics you currently fear. You are paying a very high cost avoiding your fear. And if I may be so bold as to remind you that you plan on being a buy and hold investor, you will run into every possible problem down the line anyways.

6. Befrend contractors now. Build your network! You may not know anyone now, but if you let your friends know u are looking to network with carpenters, electricians and plumbers etc surely some of them will know someone for you to be put in touch with.

Hope this helps :) 

-M

No company avatar mediumMorgan Nilsen, NorthEast Holdings,LLC

Hi again Morgan,

Great advice.

I am familiar with the tax benefits, but did not know it came automatically. Thanks for the tip!

It's funny. You're the third person in two days I've heard mentioning the Trump Style Negotiation. I bought it a while back and began to read, but didn't finish. I will start reading it as soon as I'm done with my current book on Getting Things Done by David Allen (a great action oriented read if you follow hsi instructions). What was the one thing you extracted from the Trump Style Negotiation book, and how has it helped you in your RE investing? 

And it's like you say: Going into real estate investing I should expect to meet every potential challange out there. Perhaps I can attend a contractor course myself where I may meet a few contractors? And I will let everyone know I am looking for skilled and honest contractors/electricians/plumbers.

The way you break even is to wait until you find a deal that makes money, right away.

Not all properties are deals at the sellers price.  You want to make money for you, not the seller.

Why would you have a 3 month vacancy the first year when you know two years ahead of time when the property will be ready for rent? If you are on the ball you will have renters moving in the weekend after you close, correct?

Originally posted by @Jeremiah Hilliard:

Why would you have a 3 month vacancy the first year when you know two years ahead of time when the property will be ready for rent? If you are on the ball you will have renters moving in the weekend after you close, correct?

 @ Jeremiah Hillard 

Good question and sorry bout the late reply. It's basically just the most conservative estimate I could come up with. I will be quick about marketing the place to new tenants should I lose the first ones. Additionally the vacancy cash reserve is more like a bank account for a rainy day. It might nor happen in the first year, but it's good to have a backup in case I hit a bump in the road some years later. 

Originally posted by @Eric D. :

The way you break even is to wait until you find a deal that makes money, right away.

Not all properties are deals at the sellers price.  You want to make money for you, not the seller.

 Ok thanks! That's what I was thinking, but didn't know how to phrase correctly. :)

Hello Ingrid. 

If you want to, send me a PM with link to property, price, "Fellesutgifter", "kommunale avgifter", and the rent you will get and i can take a look at the numbers and give you a quick feedback. 

Enjoy your summer up north:)
-Roger

Originally posted by @Roger Hjelmstadstuen :

Hello Ingrid. 

If you want to, send me a PM with link to property, price, "Fellesutgifter", "kommunale avgifter", and the rent you will get and i can take a look at the numbers and give you a quick feedback. 

Enjoy your summer up north:)
-Roger

 Aloha Roger, and thank you! 

Will do. You'll hear from me this weekend.

Best of wishes,

Ingrif.

i am really interested to know how this has gone for you Ingrid :)

Would you be willing to share what you have found out? :)