Investor · Phoenixville, PA · Member since 2008 · 257 posts · 18 votes
When I find a promising multi-unit rental property, I usually assume that 50% of the gross rents is what I'll have after operating expenses to pay my mortgage. The listing sheets have a breakdown of the operating expenses; should I go by what they have or assume it's 50%? I don't want to overestimate the expenses too much.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
16y
Originally posted by Mark Beekman:
When I find a promising multi-unit rental property, I usually assume that 50% of the gross rents is what I'll have after operating expenses to pay my mortgage. The listing sheets have a breakdown of the operating expenses; should I go by what they have or assume it's 50%? I don't want to overestimate the expenses too much.
50% is a perfect screen test and is easy to do in your head. It is generally closer to 45% if you include management, capex set-asides, maintenance, economic vacancy, etc. Most of the broker submissions are coked up fantasy-world assumptions. Take their submission with you to the bathroom in case you run out of toilet paper.
It always baffles me to see someone with CCIM or some other high-brow designation after their name passing off some crapola underwriting example for a complex. These people should be immediately stripped of their designation IMO. I am all for them working on the behalf of their clients and trying to get top dollar for the asset, but outright bsing on the financials is borderline fraudulent in my book.
Real Estate Investor · Las Vegas, NV · Member since 2008 · 1k+ posts · 447 votes
19y
Definitely go with the 50%. You should certainly look at theirs but understand that they will try to make it look like less than it really is. You can use it and compare their figure to the 50% assumption.
Investor · Phoenixville, PA · Member since 2008 · 257 posts · 18 votes
19y
Thanks, Rehab. Does that 50% estimate include property management? I haven't been including it in my number-running. I've been subtracting 15% of the gross income to allow for a property management company.
Real Estate Lender · Member since 2008 · 642 posts · 13 votes
19y
This might be obvious to most but its worthy of repeating...
Using the 50% average approach is fine when trying to qualify deals that you potentially want to participate in, but it is not meant to replace due diligence.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
16y
Originally posted by Mark Beekman:
When I find a promising multi-unit rental property, I usually assume that 50% of the gross rents is what I'll have after operating expenses to pay my mortgage. The listing sheets have a breakdown of the operating expenses; should I go by what they have or assume it's 50%? I don't want to overestimate the expenses too much.
50% is a perfect screen test and is easy to do in your head. It is generally closer to 45% if you include management, capex set-asides, maintenance, economic vacancy, etc. Most of the broker submissions are coked up fantasy-world assumptions. Take their submission with you to the bathroom in case you run out of toilet paper.
It always baffles me to see someone with CCIM or some other high-brow designation after their name passing off some crapola underwriting example for a complex. These people should be immediately stripped of their designation IMO. I am all for them working on the behalf of their clients and trying to get top dollar for the asset, but outright bsing on the financials is borderline fraudulent in my book.
Real Estate Investor · scranton, PA · Member since 2010 · 174 posts · 14 votes
16y
In my market, one of the few I've found you can get cash out each month, here's my basic formula:
Total rents
-30% for Maintenance and Vacancy
-10% for management (even if I'm doing it, it has value)
-$100/month profit PER UNIT
- all hard costs (except mortgage)
The remaining number is how much I can spend on a mortgage...and therefore gives me the value of the property
Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
16y
Originally posted by Bryan Hancock:
Most of the broker submissions are coked up fantasy-world assumptions. Take their submission with you to the bathroom in case you run out of toilet paper.
Absolutely! I like to ask to see the owner's previous two years tax returns, which invariably will indicate operating expenses much higher than the pro-forma they give you.
In which case, it's fun to ask, "Are you lying to me on the pro-forma or are you cheating on your tax returns?"
Real Estate Investor · Los Angeles, CA · Member since 2010 · 3 posts · 0 votes
16y
Always try and get at least three years of operating statements on the property if they are available. Most brokers will have that ready to go since they are hungry to do a deal. Use an artificial cap of 7-8% and a 1.25 DSCR and take the lower of the two on a 65-75% lever.
Mobile Home Investor · Spanaway, WA · Member since 2008 · 1k+ posts · 578 votes
16y
Going in you want to expect the worst and use this to negotiate a lower price. After taking over - increase your income and reduce the expenses and turn it into the proverbial "cash cow".
Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
16y
Originally posted by Anthony Larson:
can you Identify what DSCR is and get in \to the the details as much as you can.
I did look into as best I could and found that
DSCR is a lenders number and determines the credentials of the property
DSCR is the debt service ratio which is equal to
annual net income divided by annual debt service cost
This is important to know the higher that number is the greater the cushion that is built in the property. Most commercial lenders require at least 1.25. Personally 1.25 is tighter than I want to be on a commercial deal.
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
16y
Not true. It is in the range of 45% to 50% - NOT generally closer to 45%. Furthermore, cities and states are broke all over the USA and are seeking to correct this problem with new taxes and fees. For example, there is a new 3.8% Medicare tax on unearned income - from the new Obamacare (healthcare) law. This is just ONE of a myriad of new taxes and fees that may/will affect rental property owners. In my opinion, the 50% Rule could certainly become the 55% Rule in the near future as the government attempts to cover our massive debt.
In my market, one of the few I've found you can get cash out each month, here's my basic formula:
Total rents
-30% for Maintenance and Vacancy
-10% for management (even if I'm doing it, it has value)
-$100/month profit PER UNIT
If your maintenance and vacancy expenses are 30% - YOU'VE GOT A PROBLEM!
More importantly, you've only accounted for THREE of the expenses (maintenance, vacancy, and management). What about taxes, insurance, legal fees, utilities (if only during vacancies), entity maintenance, evictions, lawsuits, capital expenses, etc, etc, etc???
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
16y
@Mike
Do you intentionally try to pick fights with everyone? It is nice to get a lecture once in a while, but I have been underwriting HUNDREDS of real estate transactions for a very long time buddy....as have my mentors with 35+ years of experience. Just because you buy broken down dilapidated buildings in Sticksville doesn't make your underwriting "THE way to do it." I see you on here castigating people for a divergent viewpoint.
45% plus or minus 2% is THE number verified by THE INSTITUTE OF REAL ESTATE MANAGEMENT AND (!!!!) THE NATIONAL APARTMENT ASSOCIATION. Are you claiming to have better data than those guys buddy?! I can provide links if you need them.
Please leave the political diatribe to the politicians too. Property taxes are used to confiscate wealth to pay for items where there are laws that MANDATE balanced budgets. If you want to throw stones throw them at the Feds who have a wreckless agenda.
Whatever you do please do more listening (watching) and less preaching. There are other smart people in the world too that don't share all of your OPINIONS masquerading as FACTS.
Mobile Home Investor · Spanaway, WA · Member since 2008 · 1k+ posts · 578 votes
16y
Charles:
I have to agree with you on the Debt Service Coverage Ratio being too high on commercial properties. It has come about due to some people who end up walking away from properties after they have mismanaged it or hired a mismanagement company to do it for them. This hurts those of us who really want the investments. It used to be only 20% was required for a down payment on a new purchase. Now banks want to see 35-50% down. This really eats away at your buying power!
Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes
16y
I was evaluating some apartment complexes (200+ units) last year in Texas and Florida and found that their expenses were around 55% to 60%. I am not sure if they were particularly poorly managed as I did not end up buying them. The ones in Texas may also have had higher expenses due to the higher property taxes there.
In any event, I think assuming 45% (or 50%) without doing your due diligence on the specific property can be dangerous.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
16y
50% is a good screen test. You obviously need to evaluate each investment to see whether or not the data still makes sense given the actual expenses. If rents are too low and there is a waiting list that could skew the data significantly. If rents are too high and there are vacancies a "50% rule" could also be very inaccurate.
I can understand being conservative and being frustrated that newbies underestimate expenses, but Mike has taken this to a whole new level. Blind belief in some magic ratio takes on a religious fervor! THIS IS NOT A RULE!!! It is a great guideline and a very useful starting point, but it doesn't apply in all cases.
All you need to have is ONE counterexample to disprove a RULE. That is exceedingly easy in this case.
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
16y
No, Brian, I'm not trying to pick a fight with you and I haven't underwritten a single loan. I'm not a loan officer - I am in the rental property business.
I don't buy "dilapidated" buildings, but not because it would be an insult to do so, as you seem to be insinuating. I don't buy dilapidated buildings because I don't like to do major rehabs. As for living in Sticksville - guilty! Ohio is indeed Sticksville, but then again, so is Texas!
WRONG AGAIN! If you use the NAA data to calculate the expenses the same way I do the 50% Rule, you'll find the expenses are in the 45% to 50% range - not 45% plus or minus 2%. I suggest you read one of the sticky threads on the 50% Rule.
You're right, I have made it my mission to try to educate newbies on the REALITY of expenses. There are dozens of gurus out there claiming that the expenses are lower for their own selfish purposes. In addition, there are thousands of other pretenders out there that are also claiming lower expenses. I stand by my 50% Rule numbers. They have been proven accurate over and over. Taz's study of 30,000+ rentals proved it accurate. In addition, every single person that has claimed otherwise on BP that has had data has been proven wrong.
That is often caused by terrible management. In my experience, these complexes are VERY inefficient and often are big money losers!
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
16y
I'm in the rental property business too buddy. I'll find a link for you on 45% plus or minus 2%.
Regardless of what the "rule" says there are myriad exceptions. Many of these exceptions I have already pointed out, but you conveniently avoided addressing them. If you buy a distressed sale where the rents are mispriced the X% "rule" WILL BE WRONG. My point is that adhering to some arbitrary rule without studying how the business ACTUALLY operates is stupid.
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
16y
I agree Brian. If you buy a rental where the rents are mispriced, the expenses will be off. Then, if you buy the property and correct the rents, the expenses will once again fit the 50% Rule (over a number or units and/or a long period of time). The same is true of buying a property that is mismanaged. Once you fix the management, your expenses should once again fall within the 50% Rule.
I also agree with you that you should do due diligence for every purchase and study how the property operates.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
16y
Fine...we agree then...just not on 50%. It DOES depend on what and where you buy property too. Buying something in Killeen, TX and Austin, TX yields different results. Buying something 50 years old and something brand new ALSO yields different results.
A 45% ratio overall for everything does not mean that it is accurate for EVERY property type in every locale. It is completely ridiculous to claim that this is the case.
The whole problem I have with this "rule" is that people use it to underwrite transactions blindly without doing the proper due diligence. A real-world cash flow model should be built using actual data to make things ACCURATE. Something with a brand new roof that needs to be replaced in 15 years and something with a worn out roof that needs to be replaced immediately are two very different animals when you plug them into a real world model. Present dollars are worth more than future dollars, especially when your money is worth 18%+ as a real estate investor. Your "50% rule" calculation as a universal underwriting mechanism values these two buildings THE SAME in this instance.
The "rule" also screws up anything non-stabilized as has been agreed upon. My whole beef with you on this is that you keep treating everyone that points this out as an idiot loan underwriter with no experience in the industry. Take some time, cool off, and read some divergent viewpoints from time to time.
A RULE IS NOT A RULE IF THERE IS ONE (!!!) EXCEPTION TO IT. It is a guideline that should be USED FOR SCREENING. That is what I originally said if you descend from your high horse and go back and read what I wrote earlier in the thread.
Real Estate Investor · Milwaukee, WI · Member since 2008 · 1k+ posts · 671 votes
16y
Bryan,
The roof that needs to be replaced asap fits into the 50% rule because we subtract profit and repairs before coming up with a purchase price. I buy 1oo+ year old properties and do total gut rehabs and pretty much only use the 50% rule and my experience to look at the deal and have not lost yet. I will let you know when expenses go down or up. In an apartment building with shared heat you can use 55-60% rule.