Property expenses

[invst4profit]

This is a fairly good discussion on another forum that gets into the topic of what new investors should consider when trying to estimate expenses on a potential investment property.
Food for thought.

http://www.biggerpockets.com/forums/48/top...date-the-5-rule

 

[NorthernAlex]

Very interesting topic there. Thanks for sharing, Greg.

 

[RedlineBrett]

Pretty pessimistic way of looking at the expenses IMO. 50% is very high, and if you set your filter to only consider those investment properties that meet this criteria on cash flow alone you wouldn`t accumulate much of a portfolio. Do you want to be the guy with 1 AAA rated investment property or the guy with 5 AAs? Do you want $1M of stress free assets working for you or $3M of assets where you have to be actively involved? Whichever your choice no one can tell you that you`re wrong but history makes a strong case that one path will make you substantially more wealthy than the other...

The investors in this thread are also advocating including large capital expenditures into the expenses. Which is fine, as they have to go somewhere. But if you are going to do that then in my opinion you need to include the good with the bad... namely principle reduction or capital appreciation or both.




QUOTE (invst4profit @ Apr 9 2009, 09:08 AM) This is a fairly good discussion on another forum that gets into the topic of what new investors should consider when trying to estimate expenses on a potential investment property.
Food for thought.

http://www.biggerpockets.com/forums/48/top...date-the-5-rule

 

[invst4profit]

Brett you are operating on a entirely different level.

I believe they are being very realistic.
The 50% rule is a good evaluation process especially for the novice.
I have used it to do preliminary filtering for the purpose of eliminating the obvious losers.
I have seen many properties posted, even on this site, that would never cash flow. Obviously some novices do not understand the evaluation process.
As far as AA or AAA properties I would strongly recommend the novice target the one best cash flow property before concentrating on becoming wealthy. Cart before the horse sort of thing. I do not like to see there first attempt in the business go sideways on them.
Keep in mind the vast majority of income property investors, even REIN members, are not looking to become wealthy simply supplement there existing income. Most are not truly investors but rather landlords that think they are investors.
After they understand the business through there first couple of properties they can move on and take higher risks.
Personally I do not believe 50% is off the mark for the investor operating a rental business depending on positive cash flow to pay the bills. Appreciation and principal pay down are secondary issues.
The sophisticated investor moving beyond the rental business is free to evaluate there numbers in many different ways.

Kind of like the difference between Donald Trumps first property and Ma and Pa investors first property.

 

[Nir]

Thanks Greg, excellent link!

Interestingly, most investors missed the point.

I use the 50% rule myself (assuming 55% instead of 50% estimated net income if tenants pay hydro).

HOWEVER, I don`t think it is critical if you assume 40% or 60% instead. but it will make it just a little more difficult to calculate everything in the head (dividing rent by 2 is easier than multiplying it by 0.4 or 0.6 ). The Great thing about this rule is not that it is accurate but that it makes the property filtering process so efficient and it allows an initial estimation without using actual bills ignoring misleading RE advertisements calculating the "CAP" for you.

That is the huge benefit of the rule, not that 50% is much more accurate than 45%!

The above is especially true and easy to understand, if you look for the highest rent to price ratio property. Because if you buy the highest rent to price ratio property that exists (ok among the highest ratio that exist) then you buy the highest cash flow generating property ANYWAY so in a way who cares if you made a mistake estimating the cash flow, you still purchased the best cash flow generating property there is (eliminating other factors such as age etc. for the sake of our discussion).

Cheers,
Neil

 

[housingrental]

I`d like to add my voice to take the side of invst4profit and invest smart - expenses are often under estimated - and 35% when tenants pay utilities is also a good fast tool to use

 

[Thomas Beyer]

QUOTE (RedlineBrett @ Apr 9 2009, 01:13 PM) ...
... Do you want to be the guy with 1 AAA rated investment property or the guy with 5 AAs? Do you want $1M of stress free assets working for you or $3M of assets where you have to be actively involved? ..
one could argue .. one should argue .. I argue that AA properties take even more $s to repair than expensive AAA properties ..

so 50% is a good start for properties where utilities are paid by the landlord .. it would be around 35% for houses where the tenant usually pays for utilities !

 

[RedlineBrett]

One of the important things to consider is how this metric loses accuracy the higher the rents get...

What are your typical $/door numbers in Waterloo, Kingston and Toronto?

Here in Calgary on a common up/down duplex you could safely bank on 1300 up and 800 down or ~ 1050/door. Apartment style condos range from 1200-1600 per door for a two bedroom. Townhouses are in around 1200 to 1800.

I`d also be curious to know how many properties you would have to choose from if using PIT+ 50% of rents as break even... In Calgary this would be just about impossible to find without a huge DP. My best deal in recent months - a fourplex bringing in $4400/mo and netting me $1050/mo the day I took possession would be a dog to the tune of about -$1200/mo by the 50% rule.

So, nothing in Calgary would work and nothing in Edmonton would work either...

If this rule truly applies why aren`t 4/5ths of REIN members going out of business? Better yet why isn`t REIN with their years of experience and systems advising the general membership to apply this `rule` to their evaluation criteria?




QUOTE (housingrental @ Apr 9 2009, 06:14 PM) I`d like to add my voice to take the side of invst4profit and invest smart - expenses are often under estimated - and 35% when tenants pay utilities is also a good fast tool to use

 

[RedlineBrett]

QUOTE (thomasbeyer2000 @ Apr 9 2009, 07:39 PM) I argue that AA properties take even more $s to repair than expensive AAA properties ..

Perhaps AAA property isn`t the right term, rather, AAA DEAL. An "expensive AAA Property" likely wouldn`t cash flow after you chop off half the rents!

 

[Nir]

Hi Brett,

You mentioned "a fourplex bringing in $4400/mo and netting me $1050/mo the day I took possession would be a dog to the tune of about -$1200/mo by the 50% rule."
How is $2250 DIFFERENCE in caluclations possible (-$1200/mo VS. $1050/mo) when 50% of the rent is only $2200!?
Are your tenants not only paying all your expenses including insurance, property tax etc. but also adding an extra $50?

Well, I`m sure not

just curious what your actual expenses are as a % of rent (not including mortgage) that you are netting 1050/mo(?)

Lastly, it is not "PIT+ 50%" but rather PI+50% (Tax is included in the 50%)

Regards,
Neil

 

[Conrad5]

QUOTE (invst4profit @ Apr 9 2009, 02:19 PM) Brett you are operating on a entirely different level.

I believe they are being very realistic.
The 50% rule is a good evaluation process especially for the novice.
I have used it to do preliminary filtering for the purpose of eliminating the obvious losers.
I have seen many properties posted, even on this site, that would never cash flow. Obviously some novices do not understand the evaluation process.
As far as AA or AAA properties I would strongly recommend the novice target the one best cash flow property before concentrating on becoming wealthy. Cart before the horse sort of thing. I do not like to see there first attempt in the business go sideways on them.
Keep in mind the vast majority of income property investors, even REIN members, are not looking to become wealthy simply supplement there existing income. Most are not truly investors but rather landlords that think they are investors.
After they understand the business through there first couple of properties they can move on and take higher risks.
Personally I do not believe 50% is off the mark for the investor operating a rental business depending on positive cash flow to pay the bills. Appreciation and principal pay down are secondary issues.
The sophisticated investor moving beyond the rental business is free to evaluate there numbers in many different ways.

Kind of like the difference between Donald Trumps first property and Ma and Pa investors first property.


What interest rate and amortizations are these assumptions based on?

 

[MonteDobson]

For me, the 50% rule does not work. If a property had 50% expenses before financing, I would never buy it. Here is an example of a property we bought last year.

Side by side duplex:

Purchase price - $460,000
Current Rental Income - $3000/month
Mortgage payments - $1500/month
Taxes - $400/month
Insurance - $120/month
Prop mgt - $300
Vacancy/Repair - $300

This property only cashflows ~$400/month, however the expense/rental income ratio = 37%, and I am estimating high in the V/R fund as I already have 3 months rent tucked away.

I look for properties with expense (not including financing) in the range of 35% or less. The key is to put a significant amount of $ into reserve upfront, therefore, improving monthly cashflow.

Please note these are my guidelines, and my 2 cents!!

 

[GarthChapman]

QUOTE (caglah @ Apr 9 2009, 11:00 PM) What interest rate and amortizations are these assumptions based on?

The 50% allowance for expenses is BEFORE the mortgage payment. The concept is that the 50% remaining after expenses is available for mortgage payments and cashflow to the owner.

 

[GarthChapman]

QUOTE (thomasbeyer2000 @ Apr 9 2009, 06:39 PM) one could argue .. one should argue .. I argue that AA properties take even more $s to repair than expensive AAA properties ..

so 50% is a good start for properties where utilities are paid by the landlord .. it would be around 35% for houses where the tenant usually pays for utilities !

I think Thomas` numbers are about right. Our houses, which include some with suites which make our numbers a bit better, are running about 32% for expenses. We include capital repairs in the expenses total.

 

[Nir]

Hi Monte, thanks for sharing.

Perhaps wait 20 years until you have had to replace the following items at least once: roofs, water tanks, furnaces.
Then take the total amount spent and divide it by 240 months. this might add 5% to the 37% expense/rental income ratio you estimated.
In other words, obviously it is not always 50% but it is a good LONG TERM estimate in many cases. In your case perhaps 40% is a better LONG TERM estimate.

"If a property had 50% expenses before financing, I would never buy it."
Tip: if you purchased Plexes in different areas in the country for MUCH less (HUNDREDS OF THOUSANDS LESS!) then 2 things would have happened:

- your expenses would be much higher &
- your net positive cash flow would be much higher.

Interestingly, in a way, the higher your expenses the better your cash flow! Just a confusing way of putting it but the reason is you reduce your PI by half!!! --> you purchased a property for much less perhaps older too, pay much lower mortgage have higher expenses but still making much more net per unit.

That is why I believe the 10% rent ratio rule is way too low in today`s unique economic situation. should be at least 15%.
10% is good when nice appreciation is expected. today appreciation = speculation so be more aggressive in terms of price. I`m curious to know what Don`s opinion is on this as he invented the 10% rule. In his Great book he mentioned 10% just to ensure any positive cash flow even $50 a month is fine. Well, I wouldn`t purchase any property for $50 a month today even if it`s in an area ranked #1.

Cheers,
Neil

 

[terri]

it really does depend on a lot of factors, one of which is condition on property, obviously a new property or newly renovated proeprty will cost less to maintain, another is location, location will dictate how much rent you can get and whether or not you`ve going to have vacancies.

My properties sit somewhere between 20% and 25%, BUT....they are all newly renovated so maintenance is quite low and rent is quite high, I am able to do my own property management so I don`t have that cost, they are in a high demand location so I never have a vacancy expect when I`m renovating (see above).

BUT...and there`s always more buts.... I can spend 100`s of thousands of dollars on the initial renovation to get them to this state and the apts may be sitting vacant for months while I`m renovating. I do refi after the renovation so I make back up that money and lost revenue in increase in value, but it`s something to think about, you can lower the expense to income ratio but it will cost you in up front renovation fees that not everyone has the capital output to afford.

I agree that 50% is a very fair estimate, perhaps conservative, but a good guideline for first time home buyers and yes easy on the math. You just have to remember that it is just a guideline and you need to do further due diligence and look at all the other variables involved as well , like risk tolerance, cash flow vs equity upside, etc.

T.

 

[invst4profit]

C2Ventures & RedlineBrett:

Both of the examples you have given do not apply to the 50% rule now simply because you have not owned them long enough. This formula is used to estimate long term hold expenses which is what REIN advocates. You have not yet experienced the major unexpected repairs, evictions, extended vacancies, renos etc. which inevitably crop up with every property. These expenses must be estimated and are what move your expenses up from 35% to 50% on average.
However always keep in mind this is an average estimate. Yes you could only experience 35% long term but on some units you could also see 60% or 70%.
Don`t forget to add expenses like utilities when vacant, legal, accountants, deductibles on insurance claims etc, even costs as simple as advertising, paint and rug shampooing between tenants.

It was asked why we have not seen bankruptcies with REIN members yet. Maybe because they do not talk about there mistakes or maybe they have not happened yet, but they will happen if individuals starting out underestimate there expenses.

Remember the majority of new businesses fail in the first 5 years.

 

[GarthChapman]

QUOTE (invst4profit @ Apr 10 2009, 10:26 AM) C2Ventures & RedlineBrett:

Both of the examples you have given do not apply to the 50% rule now simply because you have not owned them long enough. This formula is used to estimate long term hold expenses which is what REIN advocates. You have not yet experienced the major unexpected repairs, evictions, extended vacancies, renos etc. which inevitably crop up with every property. These expenses must be estimated and are what move your expenses up from 35% to 50% on average.
However always keep in mind this is an average estimate. Yes you could only experience 35% long term but on some units you could also see 60% or 70%.
Don`t forget to add expenses like utilities when vacant, legal, accountants, deductibles on insurance claims etc, even costs as simple as advertising, paint and rug shampooing between tenants.

It was asked why we have not seen bankruptcies with REIN members yet. Maybe because they do not talk about there mistakes or maybe they have not happened yet, but they will happen if individuals starting out underestimate there expenses.

Remember the majority of new businesses fail in the first 5 years.

Greg makes valid points here. One could argue that 50% is at the high end of what to expect. It is the concept that is important. Over time landlords spend more than they initially expect to spend, mostly on maintenance, capital repairs and vacancies. The ratios will depend on four key factors
1) the type of properties one owns (apt bldgs, houses, four-plexes, etc)
2) the age and condition of the properties
3) the average amount of the rents charged
4) the quality of property management.

I suspect the range will run from 40% to as high as 50% with the average being about in the middle of the range.

Our long term expenses (8 years+) on houses in Alberta are around 42% of scheduled rents, allowing 10% for Management. We do our own management so our actual costs are around 32%. Our properties are newer and well maintained, rents are at the higher end of the spectrum and our vacancy experience is on the low side. Our costs for repairs and capital expenses are about double what we initially expected when we started in 2001.

 

[Nir]

I agree with the factors Garth mentioned and would only add:
5) Area of property or quality of tenants.

 

[Mike Milovick]

Its a good thought.

When I buy, I actually budget based on what my home inspection reveals. Older property (typically) typically requires more work than a new one as a rule of thumb.

I get the most thoroughest inspection available on the market as part of my due diligence process - and as such, maintenance costs have always been in line with my expectations.

Mike

QUOTE (invst4profit @ Apr 9 2009, 11:08 AM) This is a fairly good discussion on another forum that gets into the topic of what new investors should consider when trying to estimate expenses on a potential investment property.
Food for thought.

http://www.biggerpockets.com/forums/48/top...date-the-5-rule