Rental Profits Module 6- Part 1

by MyInvestment | Feb 11, 2019

The purpose of this whole module is to zero in on specific activities associated with buying multiple rental properties. This is not all the associated activities. We are not covering financing, building your team with inspectors, The Opportunity Evaluator on the following page is an interactive spreadsheet. You are going to get this in document form so you can share it with your Investors. Because it’s interactive, if you change a figure, the other data updates automatically. Right now we’re getting $495 for the one-bedrooms. Notice gross operating income, and gross rental income. When we change that figure to $595, it adjusts the other figures so you can easily show a prospective buyer different scenarios.

This is incredibly valuable. Plug in the gross income. Currently the vacancy rate is set at 5%, but that’s aggressive. It should be 2-3%. It gives you the effective income as well as other income from laundry. We make a lot of money on laundry at that complex. You’ll see calculations for gross income coming in, as well as fields for expenses: taxes, property insurance, management, repairs and materials, utilities, supplies, landscaping, snow removal, and security.

In the expenses area, you can see the net operating income is $266,000. If someone bought this property for $2.3 million, put down $525,000 and had a loan for $1.725 million it generates a price per unit at $29,000. That means the Investor would have a debt service of $148,000 resulting in a cash flow of $117,000. This gives them a cap rate of 11.6%. That’s pretty darn good for a large complex. It’s all-brick, double-panned windows, with modern construction and wiring and new boilers and water tanks.
The debt coverage ratio is a calculated figure. Here it is 1.795. It is the amount of net operating income available for debt to cover the mortgage principle. The higher this number is, the better, because the banker is going to be looking at that information. If it’s down around 1.2, the bank might not finance the investment. Five or ten years ago they would have, but right now they’re being very conservative.

Banks want to see something like 1.6-1.8%. You can change this ratio by changing the loan amount, the down payment, and the purchase price of the property. The form is very interactive. Make sure you save it on your computer. If you can squeeze it on your smart phone, do it there too. Just imagine what your Investors will think when you give them this tool to use, the way I’m giving it to you.
The return calculator we saw first shows you what happens when you sell the property, plus your income. The opportunity evaluator, the one we used for Bevan Place, and the income expense worksheet. That’s for making the offers on rentals. Again, this is your maximum allowable offer.

Don’t worry about this, this is more true when you’re buying properties that are wholesale and need to be remodeled to rent and refinance them. On a straight rental, when you calculate what the actual purchase price should be in an emerging economy, that’s what you’re going to offer. You’re going to offer that price. Give yourself a little bit of cushion. In an emerging economy; if you chop off 10 or 20% on your initial offer, you’re not going to be competitive. Your Investor is going to get beat out every time. You need to understand that in an emerging economy you need to push a little bit to land the good deals.
Here’s why. Right now, prices are going up, and so are rents. Investors need to lock in and get in while the getting is good, get in while the prices are still relatively low to historical averages and rents are on the increase. Property values are increasing, rents are increasing, and interest rates are low. We may never see this set of circumstances again for as long as we live. Make sure your clients understand that.

Here’s the process. It’s very similar to what we did with flips so I won’t go over every nitty-gritty detail.
When it comes to multi-units, your Investors need to understand what average rents they can get for one- and two-bedroom units. Once they know that, they’ll be able to determine the true value of a property. On an income producing property, the value is more closely determined by the income rather than the market value of the surrounding area’s sales history. That’s what dictates value on single-family homes. On rental properties, the more units, the more. This income approach has weight and influence on an appraiser’s or banker’s value of the property.

A little duplex will be impacted by surrounding sales. Make no doubt about it, income is king, cash is king, whether you’re an Investor or a banker. Both want to see cash flow coming out of the property. That’s really what determines if the bank will finance it or not. Everything else is the same. Begin with the full MLS list. The Investor narrows it down to the same number of properties as before. View the properties. The Investor fills out the analysis sheets, and you do your end-of-day wrap-up before you leave the scene. Then you get ready to make their offers.

Contractors
My favorite subject is contractors. Okay, it’s not my favorite subject. It’s one of the worst parts of this whole business. It’s so hard to find good contractors, and they don’t last forever. I have had some I’ve known for years turn bad on me. At the first sign of trouble—like with women, trucks, alcohol, drugs, money or health—they seem to disappear into the dark side. Not all of them do this but an alarmingly large percentage relative to society do. I have friends who are contractors. I love them like brothers. But when %@#$ happens I have to cut them off. They can harm you as much as they can help you. Always remember this: When you are hiring contractors, even if you have solid referrals, you must do a background check just like you do with your tenants. Always make sure they are insured and bonded. Ask for these credentials.

They screw something up and they are not insured, the liability will fall directly on you as the property owner. This is not something you take a short cut on. Period! I once had a pair of contractors working with me for years. They were twin brothers who worked well together and we became friends. One was the straight man and one was the booze-swigging, whore-mongering derelict who I don’t even think had a valid driver’s license. They were some of the first guys I ever hired. I hired the straight man and then he later brought in his brother. I should have checked him out. What I discovered after years of good work was a little bit of fraud. Nothing major but I decided not to take any chances. I caught them cheating on supplies. They would buy more than enough supplies and charge me for it. After the project, they would return the excess to Home Depot and pocket the refund. It may not sound like a big deal, especially since we are only talking about a few measly dollars and cents. However, my knowledge of human nature, and the propensity for people to keep taking when they get away with a little, dictated that I act swiftly to send a message to everybody else working for me.

I had another guy try this prior to the brothers. He was dumb enough to turn in a receipt for lumber he had already charged me for. He hadn’t turned in the receipt before and thought he could use it on this next job. The problem was that he had 4” x 4” pressure treated lumber on there to the tune of $400 and this current job was an inside kitchen remodel requiring no pressure treated lumber. What an idiot! He must have assumed I didn’t check receipts. I did. I have friends who have been ripped off by their own family in business. One such situation involved over $100,000! You can never be too sure.

Embezzlement and employee theft is a huge problem in business. My parents owned a business before they retired and had to have an accounting category just for theft. And that was about 10% of business. That is ridiculous. But it is real. You need to have systems to track your income and your expenses. Expenses will really eat you alive if you’re not careful. Throw loss due to theft on top of that and it’s no wonder so many people go out of business.

You can find good contractors. They are out there. Always ask for references. Look at other work they have done. Ask their prior customers how the contractor was when it came to keeping to the schedule and the budget, and how well they communicated. Start new guys off small before you give them big jobs. Look at their appearance. Do they look like they are living the clean life or do they look like hell? Who do you want to give the keys to your property to?

Most importantly, whenever you are involved in a big job—more than a few thousand dollars—don’t pay all at once. Give the contractor a little supply money up front. Then give them a little more when they have the basic work done. Then give them another payment when they are near completion. Hold on to the last payment until the job is complete to your satisfaction. No excuses here. If you go to the final walk-through and the contractor says, “Oh, I’ll come back tomorrow and finish that little bit myself,” do not give him the last of the agreed upon payment. If he is good to his word, he’ll finish completely and then you can pay him the rest. A lot of investors fall prey to this gimmick. Even if it is innocent it is still a problem. Don’t do it!
, bankers, and appraisers, and all that stuff. There is a separately focused course for those subjects.

You can also take Rental Profits Without the Pain, the instructor lead course. It is ten weeks of interactive instruction with Q&A. And more importantly, you are associating with other investors who are doing exactly what you are doing. You share information, which is an awesome way to learn. I highly recommend it.

Now we are going to talk about the physical analysis of the property.

You have identified the properties you are going after by doing your desktop analysis. You have done everything so far online on your computer and over the phone. You have not even stepped out of the house, gotten in the car, and driven around yet.

You have probably narrowed properties down from 300 to about six at this point. That is great because these six properties are the ones you have determined to have the greatest likelihood of profiting you. This is how you do this business. Other people teach you to go out there, look at everything, and make offers on everything. They do not care about the list price or how low the offer is.

That is crazy! It is very ineffective and it is a great misuse of your time. It is a shame that is being taught, but it is.

Instead, I’m teaching you to take the high percentage shot. You will have a greater probability of success with this approach than any other. It is common sense; it is blocking and tackling.

We are talking about the physical analysis of a property. When you get out there, you want to be prepared. You are going to meet your real estate agent. If they are worth their salt, hopefully they will go through the property with you. Our guys are worth their salt. They know how to look at all the parts of a building to help you see things that maybe you do not see.

We will go through a rehab sheet here literally line by line. I am going to walk you through exactly what I do when I look at a property. Here’s my Rehab Analysis Form:

The first thing I do is identify the property. Enter the address, the owner’s name, age of the property, contact information, and who is involved there on the form. With the high level stuff, we are looking at the rehabilitation and inspection costs. You should never have to do this yourself, but if you do, you will pay for accounting fees, advertising, legal fees, an architect, loan fees, insurance, permits, and all of that kind of stuff. That would be if you were really doing a rehab project.

Most of what we are talking about here are already rented properties, up and running, in service, and showing a cash flow. You should not have a lot of the items you see listed here, and certainly not architecture fees.

Let’s go ahead to the interior. From broad to narrow, look at the kitchen appliances.How are they? We are talking about the stove, refrigerator, dishwasher, washer, dryer, and microwave. You need to make a note whether they are good, fair, or poor. If they are poor, they should be replaced. Make a note of the total for the appliances.

Then we are going to talk about the master bedroom, the other bedrooms in the house, the bathrooms in the house, and the den. Don’t worry. There is more detail further down the form.

Essentially, you want to make broad notes. It might be that the master bedroom needs new carpet and needs to be painted. You can write that stuff in. Make notes of what has to be done in the bedroom. Later we will tally these things up; we will qualify and quantify them.

How are the doors? How are the doorknobs? How are the door frames? How are the windows? How are the heat registers? Make notes through all the rooms, the master bedroom down to the den. Look at the family room, the halls, and floors in general. Make note if you need to replace the kitchen floor. If it has old vinyl that is torn, replace it. I like putting tile down. Even in my rentals I put tile down because it is more durable.

If you are buying in a bigger building, is there an elevator involved? At this point you are probably not involved with buying buildings with elevators. However, some of you might be.

Check the water heater or heaters, water softeners, boilers, air conditioning, and the heating system.

Down to the nitty-gritty, here’s what I’m looking for.Does the refrigerator have rust on the outside of it, are the gaskets (the seals that goes around the inside of the refrigerator door and the freezer door) highly damaged, is the inside missing shelving? If so, do not spend money on that refrigerator. It will cost you more to repair it than to get a new one. Replace it.

It’s the same with the dishwasher. Look at the inside. Are all the parts there? Are there signs of rust? Is there mold? Is the seal damaged or are there signs of water stains below the dishwasher?

What about the washer and dryer? I normally do not supply those on my rentals, but if they are there, you want to take a look at them. If they work, you want to leave them. I have told people with regard to washers and dryers, “I am going to leave these here, but if they break down, you have to pay for it. I only supply refrigerator and stove.”

And the same thing with a microwave. Microwaves are easy. You plug it in and you test it. If it works, it works. If it does not, it does not.

You need to tally this stuff up. A refrigerator can cost anywhere from $400 to $4,000. On a rental I might spend $600 on a decent frigand $400 on a stove.

Back down to water heaters. These have gone up in price over the years. They can be kind of expensive now.It could cost you $600 to replace a water heater. I use good water heaters and I want them to last a long time. With water heaters, there is always a top rim and a bottom rim. Look around the rim to see if there are signs of rust or corrosion.That is usually an indication that the lining inside has been breached. If the tank does not have to be replaced now, it will soon need to be.

Mark it down: new water heater, $600. Again, that is just a broad figure. It could be $400 depending on the contractor you use and the type of water heater he installs.

Water softeners are important in certain parts of the country like Florida, for example.

With boilers, if you have a hot water heating system, it has to boil. Again, look at the boiler; look at the outside. Are the left and right side panels bowing out? This is a sign that the reservoir in there has frozen and expanded and probably cracked. Are there signs of corrosion anywhere? Are there signs of rust? Is there a white sulfur buildup? That is actually a calcium buildup.Look at the valve on the right hand side; look at the regulator. Look at the copper pipe surrounding it. If it looks suspicious, assume you will have to replace it. Later on you can have a guy look at it. If he tells you, “Hey, this thing works great,” you can leave it. Better to be safe than sorry, though.

Next we have air conditioning. I generally do not supply air conditioning unless I am in areas like Florida, Texas, Georgia, or those southern areas that get hot and humid. You kind of have to have some air conditioning there. Look at the outside of the unit. If it is really rusted and corroded, you may want to replace it.

With the heating system, if you have a forced-air, gas system, you need to be careful of a cracked heat exchange. Back in the old days, heat exchanges did not crack. The ones they make these days crack and when they do, you have to replace the entire system. You cannot just replace the heat exchange.

The purpose of this whole module is to zero in on specific activities associated with buying multiple rental properties. This is not all the associated activities. We are not covering financing, building your team with inspectors, The Opportunity Evaluator on the following page is an interactive spreadsheet. You are going to get this in document form so you can share it with your Investors. Because it’s interactive, if you change a figure, the other data updates automatically. Right now we’re getting $495 for the one-bedrooms. Notice gross operating income, and gross rental income. When we change that figure to $595, it adjusts the other figures so you can easily show a prospective buyer different scenarios.

This is incredibly valuable. Plug in the gross income. Currently the vacancy rate is set at 5%, but that’s aggressive. It should be 2-3%. It gives you the effective income as well as other income from laundry. We make a lot of money on laundry at that complex. You’ll see calculations for gross income coming in, as well as fields for expenses: taxes, property insurance, management, repairs and materials, utilities, supplies, landscaping, snow removal, and security.

In the expenses area, you can see the net operating income is $266,000. If someone bought this property for $2.3 million, put down $525,000 and had a loan for $1.725 million it generates a price per unit at $29,000.That means the Investor would have a debt service of $148,000 resulting in a cash flow of $117,000. This gives them a cap rate of 11.6%. That’s pretty darn good for a large complex. It’s all-brick, double-panned windows, with modern construction and wiring and new boilers and water tanks.
The debt coverage ratio is a calculated figure. Here it is 1.795. It is the amount of net operating income available for debt to cover the mortgage principle. The higher this number is, the better, because the banker is going to be looking at that information. If it’s down around 1.2, the bank might not finance the investment. Five or ten years ago they would have, but right now they’re being very conservative.