The right stuff

Not The Right Stuff (for this job, usually)

Not The Right Stuff (for this job, usually)

Real estate investing is all about The Right Stuff, as defined by you, the investor.  For some, The Right Stuff is a mobile home park, for others, a Unique-Fixer-Upper-Opportunity.  The Right Stuff goes deeper than the purchase though – it goes all the way to the rock bottom of your business.

Flooring sander

Flooring sander

The right tools, materials, clothing and software are all part of The Right Stuff.  The suited picture (who some have accused of being my identical twin) is Not The Right Stuff for working in a basement, but is The Right Stuff for asking for a sizable loan.

My dad is a scientist at heart (geology) and I spent a good portion of my childhood competing in science fairs (ice crystals are anisotropic crystalline solids…for those who may remember).  This love for experimentation extends to my adult life.  Never put in a hardwood floor?  A few YouTube videos and some trial and error and I’m off to the races.  Rewiring an entire house?  No problem (zapped a few times, but I’m still typing).

The right stuff for drywall on a Friday night.

The right stuff for drywall on a Friday night.

My love for experimentation previously allowed me to believe that if anyone could do it, I could do it.  Hence the floors, wiring, plumbing, drywall, plaster, etc.  This belief has probably held me back, but not necessarily in a bad way, as I have been forced to build systems to manage both a day job as well as the rental business.

The past two years studying for my MBA have taught me many things but one of the best is: the ‘rules’ of life are there for a reason, play by the ethical rules and you’ll probably get to where you want to go much faster and with less angst than by trying to create new rules.  For me, this has meant the abandonment of the ‘I’ for the development of a team.

My company has worked with five contractors with mixed results (remember this one?).  Through all of the previous contractors, I’ve fallen back to “if anyone can do it, I can do it”, which has really stifled my business’s growth, but I am still convinced has probably helped me more than it has hurt.

But I’ve continued to try.

Which gets me to the most recent contractor I have used.

The Right Stuff

The Right Stuff (finally)

Last February, I needed a contractor to help with a downed electrical service wire (the wire going from the pole to your house).  An ice storm had pulled the wire off one of my units and I needed someone THAT DAY to assess the situation and come up with a solution.  I called around and received a recommendation to hire Chris.

On that icy day in February, Chris finished his normal day’s work, then went to my apartment, secured the wire and made arrangements to fix the service wire the next day.  Since that day, Chris has been my go-to guy for plumbing and electrical work.  When the original contractor walked off my most recent project (again, should have followed my gut), I called Chris.

A sailor would blush at Chris’s command of the artsy words in the English language and his diet may be sub-par, but his work ethic and skills are far superior to all other contractors I’ve found (and his prices are exceedingly low for the quality of his work).  Chris is The Right Stuff for my business.

I am trying to purchase a duplex in need of significant rehab (if any friends have a spare $44k, I can put it to good use and give you a good return).  I decided to ask Chris if he wanted the work, and asked him to do some of the work I had intended to do.  Chris’s conservative proposal (ie: assumed high costs, actual costs should go lower), came in at a lower cost and faster turn around than if I did the work myself.

Definitely The Right Stuff for my team.

 

Just something fun

I’ve been installing hardwood floors for the past week or so at the most recent UFUO.  I’ve now got all the hardwood installed and ready to be finished.  Then the trim (and painting and carpeting and toilet/bathroom and kitchen and…)  But I’m really nearly finished.

Anyway, I splurged and spent $1.99 to purchase a time lapse app for my phone and recorded the following:

I was feeling pretty great for myself.  I felt I set a good pace, was quick on the install, etc.  Then I found this video:

I got put in my place.

Project updates

An angel investor gave me a sizable chunk of change to take to the upcoming tax sale; I decided to celebrate by stopping in to Starbucks for a grande chai.  My angel investor not only gave me money to invest, but he also offered to help in any way in the future.

I misunderstood the definition of ‘busy as a bee’, until this past month.  Because a family unexpectedly moved out, my time has been spent either working on HBS (usually during daylight hours), 2-hrs of family life daily (usually dinner and after dinner story time – Wilson Podpie the Pileated Woodpecker anyone?), and 3+ hours of school work between the hours of 8.30pm and 11pm and again from 5am until 8am.  The beautiful weekends have helped keep everything perspective.

In addition to the kitchen renovation, our recent purchase is being reconstructed.  The demolition is mostly complete and new parts are being added.

Kitchen pictures:

IMG_20150919_171839697 IMG_20150920_140129032 IMG_20150920_174520155_HDR IMG_20150920_140143718_HDR IMG_20150912_160113023

Contractor Rehab (footer for the new wall):

IMG_20150912_163545534

Using an APOD

An Annual Property Operating Data sheet (APOD) is a very important tool to use before you buy a rental property, while you own the property and even when you sell the property.  At its most basic, an APOD is simply a worksheet to calculate your potential profit or loss.  With minor tweaks to a basic APOD, you can have a powerful tool available at your fingertips.

As the name suggests, an APOD details the annual costs required to own the rental property.  Some APODs factor in lost rent due to vacancy, costs for repairs, costs for improvements, utilities, etc.  Typically, when I ask my real estate agent for an APOD, I receive either hand written chicken scratch from the current owner, or a worksheet that seems to show the house in quite a rosy light.  When I receive these “Income and Expense” statements, I usually ignore their bottom line and plug and chug in my spreadsheet.

I developed an APOD that is conservative, meaning the APOD exaggerates the downside risk, effectively taking a worst-case-scenario snapshot of the property.  I developed this because I want to ensure that I will make money when I purchase a rental property.  I don’t have cash to burn owning a property that doesn’t throw off cash at the end of the month.  To be conservative, I slice almost 30% off of the gross rent each month (detailed below).

Here is a snapshot of my APOD:

APOD_1

We’ll start working through each column:

The first column is rather easy, it’s simply current information about the building.  I always include the address for the building.  I do this for a few reasons.  First, it is simply a record of a property I reviewed.  Secondly, I now have one additional point of data for calculating my local rents.  Lastly, keeping the address allows me to follow up on the house or building if it goes off the market.

After the address, is the current information on the asking price, current rent, taxes and insurance.  All of these figures are then used to determine potential profit from the rental.  The ‘Month to Close’ allows you to remember when you purchased the building to calculate your first partial year’s gross income.  I prefer to have each rent recorded rather than only a gross rent for the building.  This allows me to determine if certain units are under market rent.  Again, I can also compare the rent of the new building to my rentals to determine if I am over or under charging.

Note: If this is a UFUO (Unique Fixer Upper Opportunity), then input your calculated rents (see: Calculating Your Rent).  Remember, if you purchase a UFUO, your first year’s numbers will generally look horrible because you are incurring costs while you are fixing the place (Watch for the post: Repair vs. Improvement).

The taxes and insurance are usually available on the MLS listing.  If not, ask your real estate agent for this information.  Note: It is good to verify the tax information by calling the municipality.

You do not need to include the information about the building’s size, zoning, heating system, etc.  I do just to remember how the building is set up.  I am usually leery of private wells and septic systems (many other people have no problems with them…it’s one less cost for me to consider).  I also try to keep away from oil heating systems, unless it is possible to upgrade to gas or high efficiency electric.

In the ‘Loan Information’ section, you should input your Purchase Price, Term for the loan, and the rate.  Typically banks will require 25% down for a non-owner occupied investment property.  Seldom will a bank lend if you have less than the 25%…but sometimes they do.  The second property I purchased, I was able to negotiate for only 15% down, which helped my cash flow significantly.

Let’s move to the Operating Expenses:

This column is relatively self-explanatory.    Under the “Administrative” heading are your ‘overhead’ items.  If you are smart and willing to put in a little work, there should be very few costs while you only own a few buildings.

I do not have a property manager yet, but if I did, all of her/his payroll information would be located under the “Property Management” heading.  You could include yourself as an ‘employee’ under the property management heading.  Monthly, you would be able to take the cash allocated under that heading.  I don’t do this because I am trying to expand my business, so I am reinvesting all of my profits.  This rate is also 10% of gross rent (part of the 30% off the top I mentioned earlier)

Under “Maintenance”, the ‘unexpected maintenance’ is a self-calculating cell.  I arbitrarily chose a value of 10% of the property gross cash flow (the second 10% off the top).  I assume this is what is going to randomly break and will have to be repaired (This is also part of my downside risk assessment).  Once my repair reserves are adequate to cover most random expenses (roof repairs, boiler repairs, etc), I will pare back the repair reserves and add that to my profits.

The “Services” heading lists typical services that may have to be paid.  I normally pay for trash because it is a fixed monthly cost.  If you have other services or utilities, you would want to include a brief description.

For “Utilities”, I included the typical utilities for our area.  I never include phone or cable in my rent, but maybe you want to do so.  There are two free spaces for other utilities at the bottom of that page.

HA!  Now we are at the fun part.  The Income/Payments column is a LOT of fun to look through.  Our first stop is the Income.  This is where we see the gross rent for the property.  Some properties may have coin-op laundry, vending machines, etc.  The monthly income from those other sources would be included as Other Income.

When my bank evaluates a loan, they assume a 5% vacancy rate.  In order to be conservative, I assume a 10% rate (the third 10% off the top).  If you manage your property properly, this vacancy rate may be as low as 0% (which is additional profit).

The ‘Net Annual Income’ is the total potential income less the vacancy.

Next step is to subtract the loan payment.  I break out both a 15% down and 25% down, just to give you an idea of what is possible (normal commercial loans are 25% down, but sometimes banks will give you 85% LTV).  For most loans, especially if you are purchasing through a corporation of some sort, focus on the 25% number.

Taxes and insurance are the annual taxes and insurance (probably more expensive than you thought!).

The IRS allows you to assume that your asset (rental property) will be worth nothing after 27.5 years of ownership.  This is called ‘depreciation’.  The IRS allows you to deduct 3.636% of the initial value of the building, not the land, which you purchased.  This accounting happens at tax time.  Depreciation is considered a ‘loss’ to your business, reducing your taxes at the end of the year.  It’s not quite cash flow to your bottom line, but significantly helps to reduce the profit on your taxes.  Just remember that depreciation gets ADDED to an eventual sale of the building (the tax man giveth and taketh).

Now, let’s step to the last column, “Cash Flow”.

In the Cash Flow column, we account for all the income and payments to determine what our profit or loss is for the property.  Again, I have split out the 15% and 25% down payments.  The ‘Annual Income’ is the vacancy adjusted income.  The loan, taxes and insurance are rather firm numbers.  It’s tough to get the bank or the township to reduce your loan or tax payments.

Operating expenses may be a flexible payment.  One of the easier ways to reduce the operating expenses is to evaluate the energy consumption of the property.  The addition of energy conservation, renewable energy installations or energy efficient equipment, may significantly reduce the operating expenses.

The number everyone is interested to see is the ‘Monthly Cash Flow’.  This is your potential profit.  I have found that some investors insist on purchasing properties with monthly profits north of $500.  I have found that I am happy with properties yielding $100 – $300 per month (per unit).  I have friends ask me why I bother purchasing those properties when I could go on vacation or fix my own house (or buy the flat screen, new couch, new car, new…head over to Mr. Money Mustache for his take on this ‘new’ junk).  My typical response is “Do you want to give me $100 per month for the next 10 years?”  They usually say “no.”  Well, these properties ARE giving me that $100 per month, generally without complaint!

When I am going to make an offer on a property, I note a few items on the APOD.  First, I check to make sure the monthly cash flow is greater than $100 per unit.  This $100 is totally arbitrary; you could have said it had to be “1 beelllion doolars.”  Because the APOD automatically calculates these ratios, I adjust my purchase price (which is my offer) to get to the $100/unit threshold.  This offer is then my ‘highest and best’ offer.  Unless the building is in terrible condition, or otherwise warrants a lower price, I usually simply offer my ‘highest and best’ offer and let the chips fall where they may.

The next section calculates the required closing costs.  This helps me pull the necessary money together for any of these deals.  With the example above, you can see the significant difference between the 15% and 25% down payments.

Assuming the property passes the $100 minimum threshold, I then look to the ratios section.  Looking at the “Ratios” section, we’ll see the effect a larger down payment has on our money’s velocity, because we are unable to leverage our cash as much as if we had only used the 15%.

I want to make sure that my cash-on-cash return is greater than 15%.  This means that you will have all your cash back after 6 2/3 years.  It also means that for each $1 I invest, in 365 days, I will have $1.15.  This is also double the average return of the stock market for the past 80 or so years.  Now, the initial cash-on-cash rate may be low because the current owner is renting the building at lower than market rates.  If this is the case, evaluate the building first with the current rents, and then with your new proposed rents.  See how it stacks up.  To get your building to the new rents, there will probably be some friction with existing tenants and you will probably have to find some new tenants.  You don’t want to pay to own a rental property.

For my local market, a good rule of thumb for the actual value of a property is to assume five times net income.  This is only a rough guide, but does help me during negotiations or when I refinance.

The APOD is THE tool I use when I am evaluating a potential property.  Don’t force the APOD to show positive results.  If the property is not beneficial, you don’t want to buy it.  Period.  No one has enough money to throw at a poor property.  Think Tom Hanks in the Money Pit!

I have a few tweaks to make to my APOD.  Once I have those made, the APOD will be available to purchase on this website.  Stay tuned!

Calculating your Rent

The perennial problem in business is what to charge for your product.  Charge too much and you can’t sell, but charge too little and there is no profit.  How do you know what to charge for a rental?  Fortunately, there are a ton of resources online to help you decide how much to charge.

Just like any other any other product (your real estate is your product), market research will help you determine how much to charge.  Do you charge the maximum the market will bear?  Maybe.  Maybe not.  It’s possible that you may be better served to charge slightly less than the maximum the market will bear to open the property to better renters who may decide to live long term in your rental.

How I spend many nights.

How I spend many nights.

Before I even start ‘market’ research, I use a calculator that I developed to determine what I would have to charge to make the profit I want.  My calculator is a detailed Annual Property Operating Data Sheet (APOD) and is available for you to use.  Disclaimer: I developed this calculator for my own investments.  The calculator will work for you as well, but does not guarantee success; it’s simply another tool to use.  Ultimately, the decision to purchase a property is yours alone.  (see: Resources; Using an APOD <Not online yet>)

After I know how much I must rent the property for, I start my research on the local craigslist to see if my style of house will rent for what I want to charge.  A lot of property owners (myself included)

My next step is to go to rentometer.com and conduct the same search.  This allows me to see roughly how many similar properties are in the area.  Rentometer provides a good barometer for the type of properties that are in high demand.  Is a three bedroom or a four bedroom house in higher demand (aka: which can I charge more for)?  It’s easy to test your hypothesis, simply change the inputs to the search.

Craigslist and Rentometer offer a great springboard to start your search, but how much demand is there for your rental?  How can you be sure there is demand for what you want to purchase?

For this, I also resort to craigslist.  I produce an ad for my property with my desired monthly rent.  I describe the property, how many rooms, pets (or not), size of the yard, what utilities the tenants are responsible for, etc.  The one key bit of information I always include in the listing is that the property will not be available for three months.  This gives me time to purchase the house and make some small renovations.

My experience is that half of the respondents are not serious, one quarter of the respondents do not qualify as good renters, and the remainder may be good tenants.  If I am flooded with responses, I know I’m not charging enough for the property.  If I get no responses, I may be charging too much for my rental.  My non-scientific test for the appropriateness of rent is to get at least five inquiries within the first 24 hours of the post at a certain price point.

Once I have a good feeling for what the market will bear, what I need to charge for rent, and the number of respondents for my craigslist post, I have a pretty good idea what to charge.  I try to keep my properties nice, therefore keeping my rents higher.  Higher rents also tend to indicate the tenant has a job and is able to pay to live in a nicer place.

I do not want to have the highest rent on the market; tenants then start thinking that you owe them something because of the high rent.  I prefer quiet, responsible tenants, and that is worth a few dollars per month.  If rents are too low, the tenants don’t take care of the property, which can lead to costly improvements in the future.

Rent is not a static number.  Always be aware of the changing demands in your local market.  Is a developer building 1,000 new homes?  How about a new high rise?  Is a large local employer leaving the area?  All of these things affect the rent you are able to charge.

Do you use any resources I haven’t mentioned?