All Forum Posts by: Steven DeMarco

That is a fair point - a lot of those setup costs will not be recurring.

I like your idea to run the numbers for the next 12 months. I will do that to see what I should anticipate and track my progress against a "happy path" future P&L.

Appreciate the clarity on the 1031, that makes sense now.

Ouch! Having to fork over that cashflow for an HVAC replacement must have been painful, but at least you didn't have to dip into your own pocket. 

I agree that keeping the goals fluid to adjust with the market is important. I don't want to do crazy either.

I appreciate your comments and thanks for the reply - I am absolutely looking at it like a business and am in the game to build wealth. I meticulously track performance metrics, expenses, income, etc. I rarely see fully transparent posts like this so I wanted to get the numbers out there to receive actionable feedback.

Regarding REI specifically, my goal as of Sept '22 was to purchase 3 - 5 STRs within 3 - 5 years that each cashflow $2K - $5K per month.

Now that I'm 2 years in, my goals have certainly changed (although I would love to achieve those initial goals eventually). Since purchasing the STR, I have purchased another SFH + ADU that I am currently house-hacking in. The numbers look a bit more promising on the house hack. Not generating cashflow, but have reduced my living expenses and acquired an asset.

So if I revisit my goals, within the next 5 years, I'd love to: (1) be in a consistent cashflow positive scenario with my STR; (2) move out of my house hack and rent both units; (3) purchase another duplex/SFH+ADU and house hack again.

My monthly mortgage payment is about $1,400/month which includes PITI. You are right that my annual debt service is about $16K ($1.4K x 12) but the metrics I shared were over a 17-month timeline of being operational with the STR ($1.4K x 17 = $24K). Understandably a bit confusing on my end - sorry for that.

I appreciate you pointing a finger at the operating costs. I'll do my best to summarize. Again, I will show these metrics over the past 17-months that I've been operational. Total operating costs over this 17-month timeline total $32K. Also important to note that I live out of state and require some boots on ground management and travel costs to travel to the property.

Admin ($6.2K) - includes $1.3K of advertising (listing photos, FB ads, etc.), $2.1K of travel (flights & rental cars), $2.3K in software subscriptions (PMS, etc.) and $300 in meals

Management Fees ($1.7K) - PM fees, booking platform fees, etc.

Cleaning Fees ($6.2K) - pass-through charge for guest

Repairs & Maintenance ($10.5K) - General R&M ($1.5K), Painting ($1.2K), Plumbing ($1.5K), Pest Control ($500), R&M Supplies ($500), Labor ($3.5K), Linens, Soaps, Consumables ($1.5K)

Legal & Professional ($1.5K) - LLC setup & lawyer fees ($350), inspections ($1.1K)

Utilities ($6.4K) - Gas (avg. $63/mo.), Electric (avg. $121/mo.), Internet (avg. $60/mo.), Water & Sewer (avg. $107/mo.).

Please let me know if you see anything glaring or things that I can work on bringing down or eliminating completely.

It's important to note that up until I hired the full-service PM in April '24, I was self-managing from out of state and paid a local boots on the ground resource when needed. From April '24 moving forward, my P&L will look much simpler as the cleaning fees, PM fee and software subscriptions are handled by the PM so I will just see income after all of those fees on my P&L.

Regarding the 1031 exchange - that would still result in losing all the cash invested above and beyond my equity position. My understanding of a 1031 is that you essentially move the equity from property A to property B, I can't recapture my full $130K cash invested, only the current equity position of $45K. Unless I am misunderstanding your suggestion there.

Hey BP - Want some advice/perspective on my situation.

Back in 2022, I had a strong desire to get into REI to diversify my investments and pursue a new side hustle. I envisioned real estate investing as a way to make extra money on the side and continue to build my wealth. I signed up for a mastermind class that teaches you how to invest in STRs and pulled the trigger on a 2BD/1BA house in Pittsburgh, PA to operate as an STR. This was my first real estate purchase and the final sale price was $166.5K which I purchased using a 10% down second home loan. I then proceeded to dump a ton of money into capital improvements in order to make it a competitive STR (details below). 

Since owning the property, my total cash investment is about $130K for initial acquisition, capital improvements, the mastermind course and floating negative cashflow. Here is the breakdown: Closing Costs ($30K w/ $16.5K down payment), Furniture, Setup & Design ($35K), New Electrical ($14K), New HVAC ($12K), New Roof ($9K), New Landscaping ($1K), Mastermind Course ($10K), and the remainder is floating negative cashflow ($19K).

I've been operational through 17 months (March '23 - July '24) and the following metrics are throughout this 17-month time period. My total gross income on the property is $37K and my operating expenses have been $32K, leaving me with a NOI of $5K. After factoring in debt payments of $24K ($1,400/month), my cashflow (before any capital expenses) is a total of $-19K. Averaged over this 17-month time period of operating the STR, I'm averaging a negative cashflow of about -$1,100/month.

To reiterate, I've put $130K cash into this deal. From a cashflow standpoint, I've obviously generated no return. The current Zillow Zestimate for the property is $193K, which means I'm sitting on roughly $45K of equity. If I were to sell anytime soon, with selling fees, I'd be realizing upwards of a 6-figure loss assuming the Zestimate is accurate. It may not be, as I've made a ton of capital improvements and I've seen comps sell for over $220K in the same neighborhood. Either way, selling doesn't paint a good picture.

In April '24, I hired a full-service PM which has helped tremendously with bookings and appears to have started turning the cashflow ship in the positive direction. I have been consistently within +/- $100 of breaking even for the first 4 months of the PM operating the STR. Since we have gotten momentum with the new listing on Airbnb, I am booking out well into Sep/Oct/Nov at the time of writing this post and I anticipate that the next few months will produce some positive cashflow. Over time, I also anticipate that the cashflow will improve slightly as the listing continues to excel (26 out of 27 reviews have been 5-star) and book out into the future.

My current plan is to give the PM a full year to establish the listing and then revisit what my cashflow scenario looks like. As of now, I (obviously) do not want to invest any more cash. I am a far cry away from the dream of building my wealth and it feels like I did absolutely horrendous on my first real estate investment.

Let's assume we take the happy path with my cashflow situation improving and over time, I average $500/month in cashflow after things stabilize with the new PM ($6K annual cashflow). 

The estimated rate of appreciation since I purchased 17 months ago ($166K -> $193K) is roughly $26K over 17 months (about $1,500/month). It seems unlikely that this will continue into perpetuity and let's say a more conservative estimate is 3% annually, which would equate to about $6K annually in appreciation. 

So on paper, it would take me 10.8 years ($12K in cashflow + appreciation) to net out the $130K in total cash invested.

What if the cashflow situation doesn't improve, but continues to break even or even worse begins to dip negative again? What should I do? Any help, guidance, critique, insults, etc. are welcome. I just want some discussion and perspective around this as I don't have a close network of investors to bounce ideas off of.

I see, my apologies. I wouldn't consider your lack of certification or degree a limiting factor should you choose to go the IT route for your W2 income. As long as you have experience and grit, you could land a job in IT. The "job hopping" would be more relevant in the IT field based on my experience. I can't comment on if that would apply for remodeling industry careers.

In that case, I would consider buying a property that needs some remodeling work, so you can leverage your remodeling skills. You could live in the property while you fix it up. If you do majority of the labor, you can essentially eliminate that costly expense of your rehab projects. A great advantage not a lot of REIs have!

I went the STR route for the potential outsized returns and the flexibility to own a fully furnished property that I could use in a city that I often visit. In hindsight, I should've gone the house hacking route for my first property to get my feet wet with minimal capital.

@Nelson Martinez

Being relatively new to REI as well, I would say focus on the following: (1) Maximize your W2 income, (2) Save the majority of it and (3) House hack into your first property with an FHA loan as soon as you can. In the next 5 years this is certainly attainable. Once you get the first one under your belt, you will have that much more experience and knowledge to tackle the next phase of your portfolio.

Looking back, I wish I would have followed this path I'm recommending more closely. I nailed (1) and (2) but only recently realized the power of wealth generation that is possible through real estate (3). I've got one STR under my belt (purchased in Dec'22) and another property under contract as we speak to house hack (Jun'23).

(1) Maximizing your W2 income will set you on the most sustainable trajectory and securing any amount of financing will be a breeze. Being that you are studying IT, you will have great job prospects out of college. You seem like a go-getter, so I would recommend incrementally building skills and changing employers every few years to recognize the largest increases in income as you move on to each new employer. If your skill set or desires align at all with sales, I would recommend getting into a technical sales position, where the incentive compensation gives you massive income potential, above a traditional IT job.

(2) Save the majority of your income. If you have the option to live rent-free (or very cheap rent) with your parents, that is a really solid option. For me, I wanted more independence, so after college I got a bunch of roommates (5 guys living in one house) which made rent very affordable. Stash away the bulk of your income and set up a recurring, automatic deposit so you never even "miss" the money. Begin doing some light research on local markets, talk with investor-friendly agents in your area and ask them for a general range of a good house hack investment.

(3) House hack into your first property with an FHA loan. A duplex or single-family home with an accessory dwelling unit (ADU) will let you have your own space while also offsetting your mortgage. With only 3.5% down, it cannot be understated how powerful this approach is to acquiring real estate. You only have to come up with the down payment, closing costs and live in the property for 1-2 years. Then your tenants are paying down that mortgage for you while you accumulate wealth. There is so much information on this site about house hacking as a strategy to acquire real estate.

All of this advice is more or less what is set up in the book Set for Life by Scott Trench (VP of BiggerPockets). I kind of modified it based on my own experience and how it might apply to your experience. I'd highly recommend reading this book. I read it last year and wish it existed when I was your age :)

Once you've gone through this process once, you can rinse and repeat (2) and (3) every few years.

My understanding of DTI, especially with LTRs, is that if you can show lenders the monthly rental income is enough to cover your mortgage payment, that effectively "eliminates" or balances out the debt with the income.

For example, let's say your mortgage is $1,100/month and you have a lease showing your tenants pay $1,500/month to rent the property from you. Lenders will consider up to 75% of that rent to "cover" the debt. 75% of $1,500 is $1,125, which would cover your $1,100 mortgage. Your income then "cancels out" that debt. Your purchasing power is effectively the same as prior to acquiring this property.

As long as 75% of your rental income covers the mortgage, then that shouldn't negatively impact your DTI ratio and ability to obtain conventional financing. And in some cases, it can actually help you qualify!

Let's say you got a phenomenal deal, and you are leasing your property for $2,000/month on an $1,100/month mortgage. That would actually improve your DTI ratio, because 75% of that income ($1,500/month) is significantly higher than the debt ($1,100/month) associated with it. 

However, like @Chris Seveney and others have pointed out, things can go south if you can't get tenants and if your margins are slim. And eventually, once you get above 5-10 or more conventional mortgages, you will have to go with DSCR or other financing options.

Boy did I just go deep down the rabbit hole on this one! To update my calculations, I revised my scenario a bit. I would be living in the house hack for only one year. Also, I've updated purchase price according to where I'm at with negotiations. After moving out and renting both units, I'd be cash flow negative for 2 years (Year 2 and Year 3) before finally becoming cash flow positive in Year 4. I expanded the horizon to 10 years. Ultimately, this would be a buy-and-hold for me for the long-term (past the 30 year mortgage) but for argument's sake, I've done calculations on the 10 year horizon.

I'd only be putting 3.5% down and buying down my interest rate, which brings total capital invested to $46K. ($19K down payment, $15K closing costs and $12K to seed my reserves fund - more on this later). Also important to note, I would be saving money each month in rent avoidance and I'd be putting 60% of my rent savings into a reserve fund. By the end of Year 1, I will have roughly $22K of a reserve fund to float any vacancies, maintenance, capex, PM fees, etc. and the next two years of (relatively minor) negative cash flow.

Some assumptions:

- I'd be raising rents 5% annually from Year 2 through Year 4, then raising rents 3% annually from Year 5 through Year 10.

- I'm assuming annual appreciation at 3%.

- Upon move out in Year 2, I'd be saving 8% of expenses for maintenance/capex items, 8% for vacancy and 10% for PM fees.

Through that 10 year period, I will have no less than $18K in the reserves fund so feel comfortable weathering most storms of vacancy, repairs, etc. I will have accumulated $310K in net worth on my initial $46K investment, which is a 563% return, 21% annualized. 

More details: 

- I'd be "funding" my reserve fund in Year 1 only, with a one-time investment of $12K and then monthly installments over the course of the first year living there to re-invest my rent savings. Total balance of reserve fund would be $22K at the end of Year 1 when I move out and rent both units.

- Appreciation of 3% annually would bring the $545K property value to $732K property value, a total NW increase of $187K.

- Loan paydown would bring the $525K loan down to $434K, a total paydown / NW increase of $91K.

- My net worth increase includes positive cash flows from Year 4 through Year 10, a total NW increase of $32K.

- I'm not considering any tax savings during positive cash flow years. Maybe I should do a third iteration with those tax savings?

So yeah, in summary, I can invest $46K and realize a 21% annualized return to bring my total NW up by $310K. With a responsible amount of reserve funds in the beginning, a few years of negative cashflow is a no brainer to realize this NW increase.