SMARTERLANDLORDING

ADVICE FROM EXPERIENCE

Buying and Financing Properties

How To Work Backwards From The Rent To Determine Cashflow

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My previous post examined the components of a cashflow analysis by working backwards from the rent.  In this post, I want to put all of those components together by using examples in order to help you understand the analysis process and determine cashflow.

The goal here is to and apply the cashflow analysis components to practical examples so you can do two things.  One, determine if the asking price on a property is anywhere near your criteria for a good deal.  Two, develop an offer price on a property that may not be listed.  Both of these numbers will be arrived at by working backwards from the rent.

In order to develop these examples, I am going to “meld” several properties together from the area of Memphis, TN that I generally work in.  This area has a strong rental market and is in a nicer part of town.  So rents will be on the higher end, but so will prices. The numbers are however typical for the area.  However, the analysis will work for any property anywhere.

Let’s Begin.

We will look at two duplexes.  One currently on the market, listed in the MLS by a Realtor and being offered for $195,000.   The other is an off market deal in which the owner has asked you to make an offer.   Is $195,000 anywhere close to a deal?  What should you offer to the owner of the second property?

The Market Listing

The first thing we have to know about any property is the potential gross rent.  What is the amount of rental income the property will bring in each month?  After doing some research, you find that each side of this duplex will could bring as much as $750 per month or $1,500 total gross monthly rent.  This is the first number you need for the analysis.

Now Work Backwards

First, go to the Shelby County Property Assessor’s website to look up property tax information.  Here you can enter an address and get both the appraised and assessed value.  Understand that duplexes in Tennessee that are non-owner occupied are assessed at 40% of appraisal, rather than the 25% rate for owner occupied properties. The amount of tax will therefore be higher than it would for a single family home of similar appraised value.  Keep quirks like this in mind when looking in your area.

On the Property Assessor’s website we can also calculate the yearly amount of taxes.  Upon doing so we find that the total yearly tax bill for this property (which is appraised at $150,000) is about $4,200 or $350 per month.  This is the second umber you write on your sheet.

The third is the monthly insurance premium.  After talking with your insurance agent you find that your yearly insurance premium will be $480 or $40 per month .

The third, fourth and fifth numbers to write down are easy.  Simply take out 10% from the gross monthly rental income for maintenance, vacancy and reserves.  These numbers total $150 each.

So this is where we are at so far.

Property A – Listed Duplex – $199,000

Gross Monthly Rental Income                                 $1,500

Less Property Taxes                                                    $350

Less Property Insurance                                            $40

Less Maintenance                                                       $150

Less Vacancy                                                               $150

Less Reserves                                                              $150

Remaining Balance                                                    $660

Now we need to add in the cost of using other people’s money.

Most likely, you are not going to have a spare $199,000 laying around to pay for this duplex.  You are going to need to borrow that money and there is a cost for that, which is interest.  You have to pay the money back along with interest every single month.  This principal and interest payment is the last number we need for the analysis.

Let’s assume you are looking at your first or second deal and can get very good terms from a local bank.  Terms that are similar to terms anyone else would get if they were buying their own home.  As of this writing, interest rates are around 4.7% for a 30 year fixed rate mortgage.  If you put 20% of $199,000 down ($40,000 for ease) on this particular property and thus borrowed $159,999 your monthly payment would be $829.82.  You can adjust the amounts you borrow and other terms and calculate your monthly payment here.

After subtracting all of the expenses from the rental income, this property has negative cashflow.  There is no deal here for you.  This scenario is often the case here.  That is just where the market for these types of properties are.  The owner is likely hoping to sell on the retail market to an owner occupant looking for a little income.

The Unlisted Duplex

What about the second property?  The one you found and are dealing directly with the owner.  What price can you offer?  To find out, do the same analysis, but play with the principal and interest payment a bit.

On this second property, let’s assume it’s a little bigger, and the gross monthly income is $2,000.  Let’s run the same analysis.

Property B – Unlisted Duplex – $???

Gross Monthly Rental Income                                    $2,000

Less Property Taxes (Higher appraisal too)              $400

Less Property Insurance                                              $40

Less Maintenance                                                         $200

Less Vacancy                                                                 $200

Less Reserves                                                                $200

Remaining Balance                                                      $960

This property is looking a little better than the first one as there is still almost $1,000 per month cashflow before we look at the cost of using other people’s money.   Let’s keep in mind that we are looking for at least $100 of cashflow per unit or $200 per month.   That means you can afford to have a principal and interest payment of around $750 and still achieve your cashflow goals

Using the same criteria I used for the first example and assuming you put 20% down, the most you can offer for this property is around $175,000 as the monthly payment on $140,000 is just under $750.

Will the owner take that offer?  Maybe.  But I would start out with a lower offer, perhaps around $150,000 or so and see what the owner does.  If you never ask, you never get.  Plus, the owner might just take it.  If not, perhaps something creative can be worked out.

It Can Be Hard To Find A Good Deal

Both of these examples demonstrate an easy way to calculate cashflow.  Sometimes it can be hard to find good cashflow, especially in strong markets.  Be aware that I did not add any money for repairs and also assumed you would manage the property yourself, so no management fees either.  Many times, to find good deals you really have to dig deep or go into marginal areas where there is more risk.

Despite the examples I used, Memphis is a strong cashflow town.  What about your market?  Please share with your comments.

Work Backwards From The Rent

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The real estate market is pretty hot right now, but deals can still be found.  How can you tell?  There is no one size fits all answer.  Nor is there a set formula because everyone and every piece of real estate differs.  The best way to determine a deal is to work backwards from the rent.

Investment properties are investment properties because they generate some type of income.  For our discussion here, I want to focus on rental income for the buy and hold investor.  I will also assume that you plan to manage the property yourself, so no management fees are included here either.  If you plan to use property management simply add those costs on, but be aware they can vary greatly.

Let’s begin to put pencil to paper (or clicks on a keyboard) and work backwards from the rent to determine if a property is a good deal.  Let’s see if the asking price is anywhere close to what you can offer.

How Much Rent

The first number you need to write down is the estimated rent the property will generate.  Write it down as a yearly and monthly number.  This number will be gross rent.

Rental rates are determined by a lot of different factors.  Location, location, location are the first three.  After that, items such as size, condition, number of beds and baths and other amenities come into play.

You may know your market very well and be able to guesstimate rent quickly.  If not, start looking online.  Use general websites like zillow and rent-o-meter to get a general idea.  Then look for local property management websites.  You want to try and find nearby properties that are or have been recently for rent to compare prices.  Your goal is to find pictures of comparable properties so you can examine their condition.  Condition can sway rent ranges significantly.

How Much Cash Flow

The next step is to determine how much positive cashflow per month you want.  Even though this is the last number you will see in the process of determining if a property is a deal or not, you need to figure out what you want it to be ahead of time.

You can think of cashflow in terms of rate of return or cap rate.  But I just like to use a dollar figure, say $100 to $150 per unit per month.  I find such a number easy to use and work with.  It translates easily.  For example, if I want to replace $2,500 of monthly W-2 income, I can quickly determine how many units at $150 per month will I need to acquire to replace it.  It is easy to calculate and easy to see your goals.

How much cash flow you want and are able to get is going to depend on many things.  It will depend on your goals, it will depend on your market and it will depend on how you choose to finance your acquisitions.  For now, just remember that this number can be a bit fluid.

The Hard Numbers

The next step in your analysis is to write down the hard numbers.  These numbers are easily determined.  I prefer to break these numbers down into monthly amounts.  They are:

  • 10% of gross rents for maintenance.
  • 10% of gross rents for vacancies.
  • 10% of gross rents for reserves.
  • Monthly property taxes (be aware this number might increase after a sale).
  • Monthly property insurance.

The Not So Hard Numbers

There are a two numbers that still need to be factored into your analysis.  These are more adjustable depending on your personal preferences and how you run your business.

The first number is the cost of repairs.  Often we investors buy properties that are distressed and in need of repairs.  They may need new roof or HVAC equipment along with new paint and kitchen counters.  How much to do is up to you and what your market will bear.  Keep in mind of course that if you want to get top dollar in rent the property usually needs to be in tip top condition.

The second number is the cost of using other people’s money (OPM).  One of the great things about real estate is that we investors often use other OPM.  You can use your own money of course, but it often makes sense to use someone else’s.

Most times using OPM results in a principal and interest number and is based upon the rate of interest charged for a loan.  The loan amount can vary based on what you intend to offer to purchase the property and the amount of repairs you want to finance.  This number can vary based on the interest rate and the amount financed.   And don’t forget to include points, holding and closing costs.

Obviously this number can vary greatly depending on loan terms and the deal structure.  There are many ways to structure a deal and use OPM.  However you do it, just be sure to include these costs in your calculations.

The Sum Up

Once these numbers are arrived at, it is just a matter of some simple math.  The key is to arrive at your preferred cash flow by working backwards from the rent after subtracting all of the above.  If you find that you hit your cash flow target, look again and make sure your numbers are right.  Then make an offer.  Next time I’ll go through an example. I will also write in the future about how a deal that looks good on paper may not actually be so good.   Stay tuned.

The SmarterLandlording Podcast – Buying Properties Without Banks Using Creative Financing

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“Everyone always wants cash until you walk them through it.”

 

Sarah’s Website and Contact Info – Hassle Free Homes of Memphis

Stuff We Mentioned

Memphis Investors Group – The Memphis Investors Group (MIG) is the local REIA club here in Memphis.  MIG has been very valuable to Sarah and I over the years.  Sarah even met her longtime business partner at one of the meetings.  Perhaps you too can find a property, a lender or a partner at a future meeting.  If you are here in Memphis, look us up.  If not, check for a club in your area.

21 Tenant Red Flags – Scroll down to the end of these show notes to subscribe and get the free report.

 

Like the Intro Music?  Check out my good friends in the band Kitchens and Bathrooms (Kind of fits right!).  They write and play some awesome, original music from right here in Memphis, TN.

Home Flipping at 11 Year High. Memphis Leads The Way

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According to a report at attomdata.com, home flipping in 2017 was at an 11 year high.

From the report:

“207,088 U.S. single family homes and condos were flipped in 2017, up 1 percent from the 204,167 home flips in 2016 to the highest level since 2006 — an 11-year high.”

Plus, Memphis leads the nation in the rate of flipping, with the Memphis zip code of 38116 (otherwise known as the Whitehaven neighborhood) leading the pack. Over 31% of all home sales in that zip code were flips in 2017.

I can tell you from personal experience here in Memphis that prices are increasing as there are multiple bidders for every single property. To me, It is beginning to look a lot like 2006/2007.   Back then, I basically had to sit on the sidelines and watch as I continuously got over and outbid by folks willing to take a 1% cap rate. Lots of things did not make sense back them and they are beginning not to again.

My advice, stick to your numbers folks. Numbers do not lie. If the numbers make sense then buy.  If not, pass.  Do not get caught up in the exuberance and do not make a deal just because you have not made one in a while. The market will clear eventually. Don’t get caught on the wrong side of that clearing.  I picked up a lot of decent properties in 2009 and 2010 after the last crash.  Seems like I may get to do that again in the not so distant future.

9 Out-of-the-Box Questions & Tactics Multi-Family Investors Should Consider Using

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9 Out-of-the-Box Questions and Tactics Multi-Family Investors Should Consider Using

By Richard Montgomery      www.DearMonty.com

Summary: Investing in multi-family housing and apartments requires extra investigation, sometimes called due diligence by attorneys. This extra investigation and these questions are beyond what a real estate investor may do normally for a typical commercial real estate investment. As a real estate investor, once you go beyond multi-family rentals such as duplexes or fourplexes, you enter the commercial real estate area.   Here are 9 out-of-the-box questions you should be asking, or at least consider asking, before you purchase that multi-family or apartment building.

DEAR MONTY: About six months ago, three longtime friends and I decided to make some real estate investments together. Our investment goals are similar; we are each high-income professionals, share similar risk tolerance and see real estate as a long-term investment opportunity. Now, we have identified a 60-unit apartment building we are interested in pursuing. We have the standard list of due diligence items, but wonder if there are some “out-of-the-box” due diligence tactics to make certain we do not make a mistake. Can you help?

Real estate apartment investing is a series of calculated risks

Answer: Buying, owning and selling investment real estate is always a series of calculated risks. “Make certain” are strong words. No matter your methods, you cannot know everything the seller knows. Over and above the standard due diligence list, buyers have ways to discover more about a property that either encourages or discourages them.

It is always difficult to understand the motivation of the seller because many sellers do not share their core beliefs, or some may even mislead or miscommunicate their ideas to create an image of trust. As callous as this statement is, I believe it to be true in many cases. To balance that statement, self-interest is to be expected.

Choose carefully which tactics to employ

Business ethics is a subject that is not black and white. It involves various shades of gray depending on the person with whom you are talking. Choose carefully which tactics to employ with which transaction. Some sellers might not take kindly to a given tactic, while others may well have done something similar, or further out-of-the-box, themselves.

I have never witnessed any one buyer applying all of these tactics on a single property. This is a career compilation of tactics I have seen.

No. 1 – The rent roll is not enough: Where do the tenants work?

Determine where the tenants are employed. This data will be on the rental application, but not on the rent roll.

If 25 of the tenants are with the same company, and a move to Mexico is announced 30 days after the sale closes, your vacancy rate could skyrocket.

No. 2 – Visit with former tenants

Visit with multiple tenants who have moved out of the apartments.

You can determine this by comparing year-to-year rent rolls. Look for patterns in the reason they moved out.

Getting closer to work is one thing. But moving away from drug dealers is a different story.

No. 3 – Look for patterns in the vacancy swing

Get the financials both annually and monthly.

Look for patterns in vacancy swings. If you find one, learn what creates it every year.

When you hear the answer, trust it – but verify.

No. 4 – Visit the apartments in the morning- and in case you don’t see them also “good day, good evening and good night”

The quote from the Truman show applies when you want to find out what is really going on with the apartment building.   Visit the property unescorted on multiple occasions.

Visit in early morning, mid-day, late afternoon and midnight. You will learn something about your potential tenants and how the building functions.

  • Do tenants congregate in appropriate places?
  • Are there vehicles with stale damage?
  • Is the parking lot well lit?
  • Do you feel safe?
  • It can be surprising what you learn going unannounced.

No. 5 – Talk with the local police about the apartments

Check with the local police department.

Tell them you are considering buying the building and ask if you could do anything to help them in the neighborhood. You will learn if the building has a reputation.

The best thing that can happen on that visit is they will have trouble placing the property.

 

Read the rest here.

The Boom Is Here!

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The real estate boom that is.

 

How do I know?

 

The stats tell me. Check out these two.

  1. First time foreclosure starts are at their lowest point since the year 2000. Not 2008 when things crashed, but 2000! Lower than they were during the last boom.
  1. New home sales are at their highest point in 8 ½ years.

Add the following to the above:

  • The stock market continues to climb ever higher.
  • The Federal Reserve is keeping interest rates very low.
  • Adjustable rate mortgages are making a comeback.

Suddenly it begins to appear a lot like the year 2005.

What is more, I am seeing A LOT more interest in real estate these days. Everyone wants to know how to go about getting started. Anecdotal I know, but still eerily similar to 2005.

Things do not seem to be quite as exuberant as they were a decade ago but let this be a warning to smarter landlords and real estate investors. The market is definitely heating up. There are still deals out there but there are more and more people chasing them thus driving the prices up. DO NOT get caught up in the exuberance. Keep your head in the game and listen to the numbers. Remember not to bet on appreciation and do not think you will always be able to refinance out. Instead always remember that cash flow is king. I’ll say it again, cash flow is king!

Enjoy it while it lasts. I do not think we are near a crash, but we should definitely remember that nothing goes up forever. So, If you need or want to sell a property, now is the time. In fact, I seriously considered putting some of mine on the market but decided against it. I like the cash flow.

What’s going on in your market? Seeing a boom there? Let me know with your comments.

Inheriting Tenants? Protect Yourself

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When you buy an investment property, sometimes it will come with tenants already in place. These tenants can be a good thing as your new purchase will be immediately generating income. But, these tenants can also be a bad thing because you really have no idea how they were screened, how they have been as tenants or even what the details of their lease are. You can of course review existing written lease agreements, but there are landlords and tenants out there who have nothing more than a verbal agreement. There is no written lease to review.

So what you might ask.

Well, here is the thing with inherited tenants, you are stuck with them. The existing lease, even if verbal, cannot be changed by you just because you have bought the building. Your purchase does not in any way, shape or form alter the lease agreements the tenants currently have in place. You can’t raise the rent. You can’t just evict them. You can’t add rules. You can ask them to sign a new lease. You can offer to pay them to do so, but they do not have to. As I said, you are stuck with them. Stuck with them until the term of their lease is up.

Not a good place to be, especially if you have no idea what unwritten agreements might be hiding out there.

So how do you, as a landlord who wants to add the property to your portfolio, protect yourself? How do you determine what the current lease terms and conditions are?

One way is to ask to review the current leases. But what if there is no written lease? Or, what if the selling landlord is just making stuff up? It happens!

One of the best ways to protect your interests is to use an estoppel agreement. This agreement, which spells out the existing lease terms, is filled out and signed by both the tenant and the selling landlord. An estoppel agreement is a simple one page form that asks some very basic questions regarding a tenant’s living arrangements. Questions such as:

  • What is the term of your lease?
  • Who is listed on the lease?
  • How much is the monthly rent?
  • Do you pay any utilities?
  • How much is your security deposit?
  • Do you own any appliances in the apartment?
  • Are you current on your rent payments?
  • Are there any repairs that need to be made?
  • Do you have any other arrangements with your current landlord?

By getting this form filled out by the tenants you are about to inherit and the landlord you are buying the property from, you will have a legal piece of paper that will offer you some protection going forward.

How?

If a tenant later claims that his verbal lease was for a year and that you can’t ask him to leave you can point to the estoppel agreement that he signed stating that he was on a month to month term.

Or,

If when the tenant moves he claims that his security deposit was $5,000 and that he owns the appliances, you can again refer back to the estoppel agreement to determine if that is indeed the case (If it is the case when you review the agreement before closing you may want to renegotiate the purchase price.)

The estoppel agreement is a very important piece of paper to get completed when buying any property that has existing tenants. Use it every time and make the completion of this agreement a part of your purchase and sale contract. In fact, I think this document is so important I want to make it easy for you to use. So please follow this link to my Smarter Resources Page to download the estoppel agreement form that I use and protect your future buying interests.

 

Subscribe to Smarterlandlording and receive a Free Report: 21 Tenant Screening Red Flags

Podcast – Investing In Multi-Family Properties with me, Kevin Perk

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I recently did a podcast with Curt Davis over at Investor Talk Radio on investing in multi-family properties. In the podcast Curt and I discuss several aspects of investing in multi-family properties, including how to get started, financing them, the risks and rewards and much, much more. Give it a listen here.

Looking For A Property? Deal With The Owner.

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How do you find the properties you buy?

That is a question that I get asked all the time.

The answer is something along the lines of “all kinds of different ways.”

I have found properties by responding to ads in the paper, from the MLS, from wholesalers, like I said, all kinds of ways.

The best deals I have found however have come from a source you might not think of, that is the owner of the property.

If I can get in touch with the owner of a property I am interested in and if they are somewhat motivated to sell, I can likely work out a good deal for me and a good deal for them.

So for me, the best way to buy properties is talking directly to the owner.

Why?

For one thing it is just you and the owner. You can build rapport. You can both talk through what you want out of the deal. You can both tell your side of the story. You can both negotiate. You can sleep on it and call the owner later. You have more input into and ability to affect the negotiation process.

For another thing there is no one else involved. There are not 20 or even 1 other investor knocking on the door offering too much or promising things they can’t deliver on. There is not a realtor involved talking the seller out of it for who knows what reason or telling them that you are one of those “evil” investors. This is often times the real advantage.

So that is why talking directly to the owner is best for me, but did you notice the two “ifs” in there?  Those “ifs” mean that making the deal work is not always easy.

I might be able to make a deal “If I can get in touch with the owner.” That is not always as easy as it seems. I try all sorts of ways to get in touch. I write letters. I talk to lawn people at the property (I did this to get the property shown in the picture). I knock on neighbor’s doors. I will go through friends of friends if possible. But not all owners will talk to you. They simply do not want to talk to you. Plus, some owners are very good at hiding themselves. That address the property assessor has, who know where that really goes.

But, even if you can get by the first “if” I think the second one, “If they are somewhat motivated” is even more important. The property owner has to be somewhat motivated, not necessarily “fire sale and have to sell tomorrow” motivated, but just somewhat motivated. If they are not, they are just kicking tires. There is likely no deal and I am not going to spend a lot of time on it.

But if there is a bit of motivation then perhaps a deal can be worked out. Sometimes it takes a bit of effort on your part. You may need to educate the seller about what you do and what services (speed and reliability) you are bringing to the table. You may need to educate the seller on the value of their property. You may need to let them think about things a bit. You may need to let the seller’s emotions subside before you can move forward. There are all sorts of things you may need to do and every situation is different. But at least when you are dealing one on one with the property owner you know what the situation is and you know where you stand. You are somewhat in control of the situation.

So yes looking at the MLS and keep reading those ads in the paper or on craigslist because those deals do come along. But also develop ways to get yourself talking directly to the owner of the properties you are interested in. Because when you are dealing with the owner, that is often when the best deals can be made.

Is The Real Estate Bubble (Coming) Back?

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Home prices are up and rents are too. Rents increased about 5% in the 4th quarter of 2015 and about 7% for the year. It is going to be interesting to see where this all ends.