What are your default Expenses used when Analyzing Properties?

Question

I have been analyzing properties for the last 8 months without making a just yet-- We've been busy doing many other things. However, we're finally at the point where we'd like to start making offers.

At the moment, I first calculate using the typical BP rules-- 50% rule, 2% rule (I allow them to go down towards 1.25%), 70% rule with flipping estimates, $100/month/door, etc... But then I go to the next level to attempt to be a little more accurate. Some properties tend to look like they need lots of work. Others, not so much. Plus, taxes seem to range a bit.

I've heard @Brandon Turner talk about including property management with your analysis from the start, so you can easily start using a property management company and not impact your original pro forma estimates. However, given the current market (at least my amateur understanding of it) it seems that some MLS listings are difficult to make my numbers work unless I adjust my numbers slightly towards maybe 5% property management costs, with the assumption that I would be managing the property.

So I'm curious what metrics other investors are using when analyzing a property. Additionally, when talking "Cash on Cash" and Cap Rates with other investors, is it typically assumed that a Cash analysis on Cash includes the types of expenses I list below? Also, with Cap Rates, is it assumed to be calculated based on Purchase Price or Fair Market Value?

Here are the ones I default to and adjust slightly, depending on the property class and area (jobs, distance, etc..):

• Expense, Income, and Appreciation Rates = 1% (I prefer to not bet on any of these. So I feel 1% allows me to account for a little adjustment)
• Vacancy Rate = 11%
• Closing Costs = 2%
• Selling Costs = 6%
• Cleaning and Maintenance 0.8%
• Property Management = 11%
• Repairs = 8%
• CapEx = 12%
• Taxes = 1.2% (I tend to adjust this one frequently, but this is my default)
• Insurance = 0.5%
• Other Expenses = 0.1% (my flex money as a "just in case")
• Initial Renovation Costs = $500

Account Closed · Answer

Cap rates are always calculated based on purchase price. If you are an out of town owner then having a management company working for you is a must. I work with one here in Orlando FL that only charges 7%. They also has the rehab and maintenance crews available if needed.

Jeff G. · Answer

Heuristics are great for quickly weeding out terrible investments, but they should only be the first step when considering the merits of any individual property.

Imagine 2 identical homes built at the same time across town from each other. The one in the nice neighborhood rents for $2000, while the one in the slum grosses $1000. Do you think maintenance for the home in the nice neighborhood is going to be twice what it costs that same structure in a slum?

Another example: Around here, it is common to find two comparable neighborhoods separated by some imaginary district line. One neighborhood will have Mello-Roos that effectively doubles property taxes, while the other does not. Since it makes no difference to the renter on which side of the line he lives, rents are equal. Since most home buyers pay little attention to property taxes, home prices are equal. On which side of the line would you rather invest?

It really helps to know your area -- the less you know, the larger the margin of safety you need to factor into your purchase price.

And stay patient. Clearly you've been frustrated so far by the valuations in your market, but you're not alone. Depressed interest rates have left investors across the globe searching outside their circles of competence for better yields. Don't try to justify high prices with rosy assumptions, you'll find deals if you stick to your guns and keep turning over stones. In time, you may find your best deals come from properties where previous investors paid way too much and failed.

PS: It's a personal crusade of mine, but don't feel like you have to pay percentage-based fees for work that bears zero correlation with asset value. This goes for hedge fund fees, realtor commissions, property management fees, etc. It just doesn't take twice as much work to list a $400,000 home as a $200,000 home, so shop around for competent professionals charging fees commensurate with the work.

Joseph Hoot · Answer

@Bob Bowling - I love the response! Thanks for being candid. My analysis is just a bunch of numbers tossed into a spreadsheet (based off of many others I've found), so there isn't any extra work on my end. It was more of a curiosity, since I already have the numbers flashing in front of me when analyzing the other numbers. But duly noted.

Account Closed · Answer

You do NOT calculate a cap rate on a property that has NOT closed. You get the cap rate from closed sales of similar properties. So if they all sold for about an 8% cap rate then your $20,000 NOI is worth about $250,000.

You are wasting your time trying to figure what the seller will sell to you for and then figuring a cap rate based on that guess. So let's say you are a novice and think incorrectly that you should waste your time on what ifs. If the seller in this case is asking $300,000 for this $20,000 NOI you calculate a 6.67% cap rate. THAT TELLS YOU NOTHING! You are wasting time. Stop it!

What are your default Expenses used when Analyzing Properties?

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