All Forum Posts by: Kirk B

Thanks for the advice. I think the reserve theory helps to sort between the properties that meet the 50% rule.

I am wary of the over analysis thing too! But at the same time i feel its vital to constantly re-evaluate and retool to find what works the best.

Here is a similar one:
"Without a plan you are planning to fail"

It looks great!

I doubt too many people will notice this, but next time, on the 30" height wall cabinets install the knobs on the bottom corner, not the middle.

I am told the V makes it weak. When the treee is young it is best to prune it to avoid this growth.

I like your second house! Do you have any updated photos?

That is a nice large tree in the backyard. But due to the way it grew, it is prone to failure. It appears it has been pruned in recent years. If you know a good certified arborist let them look at it. They may be able to cable it to keep it strong.

I learned this sort of thing the hard way. I had to take out two huuuuuuuuge trees that died and it was expensive. $2,800!!! They had diameter of close to 48" each.

Thai-

Sure, I will be happy to. The Rule above is based on several assumptions. The big assumption is based on a large study of many many properties that shows the AVERAGE Operating Expenses will be 50% of Gross Rents. This is an assumption that some will tell you is fact, and others will tell you is not. In my area I believe it to be very accurate. It is the best ratio I have ever found.

My math was based on that ratio:
Operating Expenses = 1/2 Gross Rents
OE=1/2 GR

An income statement says the following:
GR (gross rents)-OE (operating expenses) = NOI (net operating income)

And,
NOI=DS(debt service)+CF(cash flow)

Simply
GR-OE=DS+CF

since OE=1/2 GR we can substitue:

GR-1/2GR=DS+CF
(1 GR- 1/2 GR = 1/2 GR)
1/2 GR=DS+CF

DS=1/2 GR - CF

DS(debt service) as you know is Principle + interest. Once you know your DS plug it into a amortization schedule (I think its ok to link to this site http://www.bretwhissel.net/amortization/amortize.html if not just google amortization schedule or use a spreadsheet). If you are using all cash, use financing terms that you could get from a bank for the type of loan (Opportunity cost of the cash). Otherwise use the financing terms that you are getting from the bank.

Another example:
SFH
Gross Rent (GR): $600/m
Cash Flow (CF): $150/m ( for sfh. this is my personal goal)

Calculation of max
payment:
Max. Debt Service = 1/2 Goss Rents - Cash Flow
Max DS = $300 - $150
Max DS = $150

So the maximum monthly payment is $150/month.
Using YOUR financing options find your maximum purchase price. For me thats 7% for 30 years $150/m = $22,546.14

Some people would be happy with $100/m CF. If you are, then about $30k would be your max price.

This is also a small Principle. The rules vary, but under 50k means typically means a higher interest rate conventional or you may have to use hard money.

Tim,

I love this post from you! It is so positive and upbeat.

One thing is for sure, medical care is too expensive the way it is now. If its not fixed the aging baby boomers will be a tremendous burden.

I wish there was a viable private enterprise solution. So far it seems like there isn't. Costs have just skyrocketed recently.

Tort reform and electronic medical records seem like 2 important first steps to me. I also resent the fact that Americans pay more for drugs than other countries, when many of the blockbusters are developed here. Business is Business, and pharma should make money, but other countries who pay less benefit from us paying more than our fair share.

Kirk

Good input Mike but I think you should have gone further.

If I read you correctly you are saying as part of due diligence-

Step 1: Verify that "predictable" expenses like the ones I listed do not exceed 50% OE (operating expenses).

Step 2: If the "predictable" expenses exceed 50% don't buy it, unless you are aware of the reason for the anomaly and you can bring expense below 50%.

I would suggest a better course of action is to do the following analysis

Step 1: Find out what your Reserve per month per unit is.

a)If the Reserve is less than 15% of GR per door, then the "predictable" expenses are too high. You will be at greater risk of failing to achieve your cash flow/m/door goal.

b)If the reserve is between 15% and 20% per door, then the "predictable" expenses are consistent with anticpated expense. You will likely achieve your cash flow/m/door goal.

c)If the reserve is exceeds 20% per door, then the "predictable" expenses are higher than anticipated expenses. You will likely exceed your cash flow/m/door goal.

Step 2: Use this knowledge to adjust your maximum purchase price up or down, should you determine your Reserve value is outside of the desired 15-20% range.

For my example in my first post
15% of $600 = $90
20% of $600 = $120

I base this notion on the law of averages. The best data available show 50% average OE. These data when represented graphically are composed of points along a bell curve. When evaluating a property we should know more than "the property is somewhere on the bell curve". We need to know exactly where it is on the bell curve!

I was looking at a property that had extremely high taxes in relation to Gross Rents:

2 apts $500 ea, $1,000 Gross
Taxes: $4,250/yr $355/month
Insurance: $600/yr $50/month

50% of expenses = $500

Actual expenses (pro forma):
Taxes $355
Insurance $50
Property management $100
Expenses: $505
Reserve = -$5

Therefore I know that expenses will exceed 50%.


This is an extreme example. But I have evaluated several local properties and noted significant differences in "Reserve Expenses" When evaluating Gross rents in relation to operating expenses.

We all know that long list of operating expenses that are incurred infrequently "Reserve Expenses": evictions, roofs, repairs, vacancy, advertising, lawn, rental registry, etc... When evaluating a property using the 50% rule I like to create a mock income statement based on things I know like taxes, insurance, property management, and total operating expenses. Look at the income statement below:



There is a Reserve of only $57 per month per unit or $1,368/yr. That seems like a small amount to cover all of the "reserve" operating expenses.

Do you think that I should have a minimum "Reserve Expense" that is born out of the things you do know with relative certainty such as the taxes, HOA fees, insurance, and property management? Wouldn't this make the analysis much stronger?

If you take two properties that are exactly identical except one has higher taxes, should you enhance your analysis so you see the difference.