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Is my math wrong or are my expectations unrealistic?

streetcore

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Hi everyone,

I've been looking at income properties (mostly duplexes or triplexes, but some single family homes as well) in my hometown in southern Ontario (pop: 70,000). Most of the properties that have been on the market over the last year are priced around $100-150K. At first glance, these prices seem very reasonable compared to larger markets, but rents are also low by comparison. Very few properties I've looked at over the last year seem to cash flow unless the asking price is reduced by 30 or 40 per cent. I've also seen a few properties that have sold at prices that don't make sense to me at all. So I'm starting to wonder if my math is wrong or if my expectations for cash flow are unrealistic.

Here's an example of one of the nicer duplexes currently on the market. The asking price is $153K, but it only makes sense to me if the price is about $100K. At that price there would be a cash flow of about $100/door, which I've often heard is the target most investors are aiming for. Does this seem reasonable based on the numbers below? There is a long-term tenant on the main floor paying less than market value, but I also think the estimate of the vacant second floor rent may be high. So I think any increase to the total monthly rent may be difficult to achieve and might be modest at best.

Asking Price: $153,000
Down Payment: $30,600 (20%)
Closing Costs: $3000

Income Unit 1: $650 all inclusive (Long term tenant. Rent has not been raised in "a few years".)
Income Unit 2: $800 + hydro (Currently vacant. Rent based on previous tenant and it seems high to me.)
Total Monthly Income: $1,450

Taxes, Utilities, Insurance: $435.25 (Annual expenses reported by listing agent $5223. I suspect they may be underestimating.)
6% Vacancy: $87
5% Repairs: $72.50
7% Capital Expenditures: $101.50
8% Property Management: $116
Total Monthly Expenses: $812.25 (plus legal, accounting, advertising, etc)

Net Operating Income: $637.75
Yield or Cap Rate: 5% (Annual NOI/Property Value)
Mortgage Payment: $643.85 (20% down, 4%, 25yrs)
Monthly Cashflow / Net Profit: -$6.10

I'd appreciate any feedback on my calculations for this property.

Thanks very much,

Andy



 
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Thomas Beyer

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Your math is in line and totally normal.

Real estate is not a get rich quick scheme. It is a get rich for sure scheme !

That means: you have to have enough income to cover all expense to hold, say 10+ years. In ten years your rents are roughly 20-30% higher, thus cash-flow better and your mortgage is down roughly 25% from 120,000 to around 90,000. Thus you have made $30,000 on mortgage paydown alone, i.e. 100% on your roughly 30,000 investment. So, what is wrong with a 100% ROI in ten years? But wait, it gets better: likely your values are also up 25-30%. Another $30-40,000 perhaps for another 100% (assuming for now all cash-flow will gets re-invested into asset i.e. new carpets, new paint, new bathroom .. over time .. thus do not assume any real cash flow with 20% down).

So, is 200%+ in ten years unrealistically low in your opinion ?

Related post here: http://myreinspace.com/threads/what-is-better-cash-flow-or-higher-roi.26596/
 
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streetcore

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Thanks for the quick reply Thomas. I guess I'm getting too hung up on cash flow and need to start looking at the bigger picture.

I'll check out that other thread and if anyone else has any comments please let me know.

Cheers,

Andy
 

Thomas Beyer

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There is no real cash flow (as in cash to spend on vacations or to quit your job) in a 20% down asset. Yes some months you will have 100-400 extra but when a vacancy arises you need to cover that and some upgrades and then boom, your $5000 accumulated cash flow is gone in a few weeks.

Assume that over a five or better, ten year hold period you will have numerous vacancies and spend on property improvements so that my numbers above have to be moderated somewhat. If you want true cash flow, buy a REIT or put more money down, for an overall lower return ( see my link above for more thoughts on it ).

Decide if you want cash flow or maximum 5 of ten year ROI. You can't have both !
 
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kfort

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Yeah I like to analyze at worst case scenario and if that's roughly break even it's a "go". 20% down is tough to cash flow legitimately over the first <4 years as if you're getting a great deal it generally requires inputs. Unless you're running a creative strategy like furnished rentals in certain markets expect your first 5 years to be neutral (if all goes well) and then you're looking at cash flow + paydown as your reward. First few years, paydown/ appreciation (maybe) only.

Exceptions to every rule but 5yr neutral doesn't make it abnormal or a bad investment
 

Matt Crowley

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Hi Andy, I like the approach you have taken in this analysis. Here are a few things I would reexamine in your numbers:

Income Unit 2: $800 + hydro (Currently vacant. Rent based on previous tenant and it seems high to me.)

Do you need to add in the revenue from hydro? It looks to me like you are paying utilities and then tenant pays you back? I'm not sure if you have over-budgeted for utility cost.

7% Capital Expenditures: $101.50

This can be thought of as a "cash investment" into the property in future years that increases cash equity but is not a monthly cost. These big cyclical expenses are usually added to property cost on the balance sheet and increase investor equity.

Total Monthly Expenses: $812.25 (plus legal, accounting, advertising, etc)

Add these costs in. I think you are missing $300 - 600 / year unit here.

Above comments are correct. Cash flow on property is a total myth for the first several years.
 

streetcore

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Do you need to add in the revenue from hydro? It looks to me like you are paying utilities and then tenant pays you back? I'm not sure if you have over-budgeted for utility cost.

Thanks for the feedback. I'm not exactly sure how the hydro works, but there are two separate meters. So I'm thinking the upstairs tenants pays their own and the landlord pays for the main floor, plus the common area in the basement where there is a shared laundry, storage, etc.
 

Sherilynn

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Using your numbers above, but using a mortgage rate of 3%, net annual cashflow is about $600. Then bumping amortization up to 30 years, annual cashflow is about $1400.

Use caution with longer amortizations as you get very low mortgage paydown, thereby losing one of your best long-term sources of "income." I often commit to a longer amortization to keep required payments low, but then make prepayments on the mortgage at the start of each year. The net effect is similar to having a shorter amortization, and the lower required payment makes future mortgage qualification easier because DCR is more favourable.
 

SVS

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Hi everyone,

I've been looking at income properties (mostly duplexes or triplexes, but some single family homes as well) in my hometown in southern Ontario (pop: 70,000). Most of the properties that have been on the market over the last year are priced around $100-150K. At first glance, these prices seem very reasonable compared to larger markets, but rents are also low by comparison. Very few properties I've looked at over the last year seem to cash flow unless the asking price is reduced by 30 or 40 per cent. I've also seen a few properties that have sold at prices that don't make sense to me at all. So I'm starting to wonder if my math is wrong or if my expectations for cash flow are unrealistic.

Here's an example of one of the nicer duplexes currently on the market. The asking price is $153K, but it only makes sense to me if the price is about $100K. At that price there would be a cash flow of about $100/door, which I've often heard is the target most investors are aiming for. Does this seem reasonable based on the numbers below? There is a long-term tenant on the main floor paying less than market value, but I also think the estimate of the vacant second floor rent may be high. So I think any increase to the total monthly rent may be difficult to achieve and might be modest at best.

Asking Price: $153,000
Down Payment: $30,600 (20%)
Closing Costs: $3000

Income Unit 1: $650 all inclusive (Long term tenant. Rent has not been raised in "a few years".)
Income Unit 2: $800 + hydro (Currently vacant. Rent based on previous tenant and it seems high to me.)
Total Monthly Income: $1,450

Taxes, Utilities, Insurance: $435.25 (Annual expenses reported by listing agent $5223. I suspect they may be underestimating.)
6% Vacancy: $87
5% Repairs: $72.50
7% Capital Expenditures: $101.50
8% Property Management: $116
Total Monthly Expenses: $812.25 (plus legal, accounting, advertising, etc)

Net Operating Income: $637.75
Yield or Cap Rate: 5% (Annual NOI/Property Value)
Mortgage Payment: $643.85 (20% down, 4%, 25yrs)
Monthly Cashflow / Net Profit: -$6.10

I'd appreciate any feedback on my calculations for this property.

Thanks very much,

Andy



I find it helps when you step back and think big picture sometimes we can be to analytical, analyzing is great don't get me wrong but sometimes it's easy to over analyze.

Example:
6% Vacancy: $87
5% Repairs: $72.50
7% Capital Expenditures: $101.50
8% Property Management: $116

While these are all valid expenses it is unreasonable to expect consistent yearly vacancy, repairs and capital expenditures. They will be present some years and non existent the next. Also if it's in your area and cash flow is a huge hurdle for you, consider self managing its extra cash flow and great hands on learning. Another thing to consider is that rents do go up over time and increases are synonymous with capital expenditures, if you're upgrading the unit you can charge more in most cases. Legally permitting of course.
 

Matt Crowley

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^ Rents have an upward tendency and it is useful to check out Samuel's recommendation. There is no law that rents or property values are always going to increase however.

Unless you have a good reason to expect otherwise, it seems a bit silly to me that rents are going to increase and that other expenses will not. A big part of the reason why rents increase is that the cost of operating the rental increases. In the first couple years of ownership, all you are measuring is the change in nominal dollars and inflation eats away all those proceeds. The real spending power is pretty well exactly the same.

PM fees are a real cost and should be included in the cash flow. If you don't manage it, you will need to pay someone else to do so. The business makes no money unless it pays for all expenses. This will tell you if you are breaking your back with stress and after hours issues for a 1% cash return...

Until you have comparables that are based in reality from the actual building or a similar building you are not over analyzing or stuck in analysis paralysis. You are being lazy.
 

SVS

Realtor/Investor K-W-C and surrounding area
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I would agree with you 100%. I was trying to put it in a little different perspective not reccomending not to account for those things. I noticed working with someone over the summer who was very analytical, sometimes when you dont take a step a back you can analyze every deal into the ground.

That propery with -6$ cash flow can still be a spectaular investment if you know its in a strong market. The -6$ looks way worse on a spreadsheet than it would quanitfied at the end of a 5 year term.

I could be wrong, but just how my brain tells me to look at.

Although I would only consider properties in my market and areas that I already know the comparables for. When all the signs point towards growth and rent increase.
 

hope

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Using your numbers above, but using a mortgage rate of 3%, net annual cashflow is about $600. Then bumping amortization up to 30 years, annual cashflow is about $1400.

Use caution with longer amortizations as you get very low mortgage paydown, thereby losing one of your best long-term sources of "income." I often commit to a longer amortization to keep required payments low, but then make prepayments on the mortgage at the start of each year. The net effect is similar to having a shorter amortization, and the lower required payment makes future mortgage qualification easier because DCR is more favourable.

Thanks for the tip on amortization.
 

Matt Crowley

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I noticed working with someone over the summer who was very analytical, sometimes when you dont take a step a back you can analyze every deal into the ground.

Yes, exactly. When you have the comparable expenses based on real properties and historicals then you have the information you need to make a decision. Churning every expense at +/- 5%, then 10%, then 15% is getting academic.

When we have an OE budget, we take a look at cash flow and look: if rents come down 10% in a bad market are we going to cash flow? (Because rents can come down that much...as can property values!)
 
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SVS

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Yes, exactly. When you have the comparable expenses based on real properties and historicals then you have the information you need to make a decision. Churning every expense at +/- 5%, then 10%, then 15% is getting academic.

When we have an OE budget, we take a look at cash flow and look: if rents come down 10% in a bad market are we going to cash flow? (Because rents can come down that much...as can property values!)

Good Point. I have a questions with regards to your capital expenditures, how do you determine your yearly percentages? Is it based on general age or do you have a contractor give an estimate?

I always tend to look at it as something to be added to the top of end of purchase price. IE if I put 30k down and then invested 10k in a roof 2 years later I would consider it 40k down when I look at my ROI at the end. Is this wrong or just different?
 

Thomas Beyer

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Capital expenditure is a function of asset age, asset size, asset quality and desired quality & rent levels. A rule of thumb is $1 per sq ft per year, but it might be considerably higher or lower.

People have drowned in rivers one foot deep on average. (TM)
 
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Matt Crowley

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I always tend to look at it as something to be added to the top of end of purchase price. IE if I put 30k down and then invested 10k in a roof 2 years later I would consider it 40k down when I look at my ROI at the end. Is this wrong or just different?

That is straight forward and makes a lot of sense. I think that if you are partnering with someone not familiar with a cash flow statement this would be a really effective way to explain the cash requirements.

^ CMHC has a good capital replacement plan guide for anyone unfamiliar with amortization of different capital improvements: http://www.cmhc.ca/en/inpr/afhoce/exsoho/exsoho_005.cfm (this guide was put together for condo corporations but works well for investment real estate. Same process.)

I have a questions with regards to your capital expenditures, how do you determine your yearly percentages? Is it based on general age or do you have a contractor give an estimate?

What Thomas said makes a lot of sense, but I think percentages are only relevant for large property operators or very experienced investors. (He is a large property owner with a ton of OE data.) Smaller investors tend to use a lot of leverage which means that the margin for error is a whole lot smaller. You should probably go create a cyclical expense budget based on the property inspection schedule. You are right about breaking the roof out as a cash equity expense. And also how increases in rent are going to be timed with the capital improvements (a roof will not increase perceived value but a kitchen / flooring / bathroom probably will). Smaller investors that are betting it all on "going big" should dig really, really deep into these expenditures. They are a killer on cash.

Unless you buy an absolutely pristine building (or brand new), you are going to be continually investing back into it.
 

Tina Myrvang

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savings-plan-735x229.jpg


$900 a Month for 20 Years...
By Ray Reuter


So, interesting story...stick with me for 5 minutes, you'll like this. I'm sitting around the REIN lunch room chatting about real estate (weird) and it was as if the sky opened up, the fog lifted and I had this epiphany...

"My worst case scenario... if I buy the way REIN teaches... is a free and clear asset... some years down the road... that my tenants bought for me."

I think I can live with that! Here is some super simple math showing exactly why residential real estate is so cool.

Let's say you go out and buy a single property TODAY for $300,000 (call it a suited house) and based on your conservative numbers, this property does nothing more than break even every month (and we're buying in a stable, well-performing market based on the fundamentals). No cash flow - just break even.

Then we're going to assume that the market will stay flat forever. We both know the market will go up, it will go down, but assume that over the next 20 years those ups and downs equate to a FLAT market...it's still worth $300,000 in 2033.
Still with me? Good.

Now over that 20 years the property just breaks even, nothing more, nothing less. Sure we've been up some months, but we've had some repairs & maintenance, some vacancy...so, over those 20 years we just break even. Some would call this a boring piece of real estate... even a 'non-performing' piece of real estate.

Call me crazy, but guess what, I call that a $900 a month savings plan that someone else (called my tenants) paid for.

That's right - after 20 years of holding this 'non-performing' piece of real estate I'm left with the equivalent of someone giving me $900 every single month for 20 years...I call that one heck of a savings plan.

Tell me, do you put $900 away every month right now? Maybe...but that's still YOUR money, money you had to work hard for! I'm talking about $900/month that someone gave me for the last 20 years, and it's mine...all from an unexciting, 'non-performing', piece of residential real estate. Want the math?

Here it is. I purchased for $300,000, I put 20% down plus closing costs, so roughly $65,000. In 2035, 20 years from now, I sell it for the exact same price...$300,000. I get my $65,000 investment back. I pay the Realtor and closing costs and I'm left with roughly $215,000.

That's with no cash flow, that's with no appreciation, that's simply my tenants paying down my mortgage (both principle and interest) for the last 20 years and leaving me with a free and clear property.

So $215,000 divided by 20 years = $10,750 per year. Divide that by 12 months = $896/month... that someone else gave me.

Sure we can calculate opportunity cost for your $65,000 investment, but tell me, would you be even mildly happy if someone, some stranger, was contributing even $500 a month into a savings plan for YOU & YOUR FAMILY for the next 20 years????

That's like someone else contributing to your RSP fund every month. You OK with that?? Of course! Go ahead and poke holes in it if you want...

"Ray, no one gets a 20 year mortgage!" OK, do you think with some strategic planning you can have this property paid off after 20 years...especially if you bank on no cash flow? I say of course!

"Ray, what about the roof, the furnace, etc???"

You're absolutely right. But let's be serious - over the next 20 years do you think my rent is going to go up or down? Do you think my property will be worth more or less in 20 years buying in a fundamentally strong area? Heck, even WHEN interest rates go up, guess what? So will my rent! This is a no-brainer.

Maybe...just maybe, this makes sense. Bottom line - real estate is simple...it's just not easy! And we're not talking get rich quick, we're not talking some 'sexy' investment strategy that 0.1% of investors ever pull off, just a simple old piece of real estate that you rent out and maintain for 20 years that YOU have 100% control over!

IT'S SIMPLE - I invest $65,000 to make $215,000 (before tax)...I'll take that all day long, and that's ONE PROPERTY. Now imagine if you bought 10 properties just like that over the next few years (which isn't rocket surgery).

It's the power of leverage, the power of having control of your investments, and the power of being in the business of putting a roof over someone's head (a business that ain't going anywhere any time soon!!!)

Think about it, read this a few times - this stuff works.
 

ReasonableDoubt

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I'm happy to see this thread come up. After looking at many different properties almost none even break even let alone cash flow using the above methods. I am in BC so I imagine it's even more pronounced here than in Ontario. I'd like to make the leap but the math keeps giving me reason to tread carefully.
 

Thomas Beyer

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I'm happy to see this thread come up. After looking at many different properties almost none even break even let alone cash flow using the above methods. I am in BC so I imagine it's even more pronounced here than in Ontario. I'd like to make the leap but the math keeps giving me reason to tread carefully.
With low low interest rate and limited land supply Lower Mainland in BC, as well as most major cities in Canada are very tough to cash flow with 20% down. 25% or 30% down works much better in most cases.
 

kfort

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In the spirit of procrastination, i dug up the analysis i did many years ago on what i think was my first purpose bought rental property. I ran several scenarios, most came up negative cashflow (but were really quite conservative).
https://www.dropbox.com/s/yfe3qxcs69u11z8/720 original analysis.pdf?dl=0

i also ran a quick current analysis for the same property which has long since been refinanced to return my initial input (& more!).
https://www.dropbox.com/s/4sk7slqpggdta5f/720 current analysis.pdf?dl=0

Realized vacancy has been:
2 weeks upstairs
4 weeks basement
0 weeks garage

don't take anything on these analysis as being the "right way", just my way when i started. Turns out i didn't lose my shirt (yet).
 
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