Rental Profits Without Pain (Module 5)- Part 2
Basically use a sales approach. But I would also do it based on the cash flow approach, the income approach. And look at the two numbers and see if they are the same or different and maybe come up with some type of guestimate as far as what you would be willing to accept five years later. That’s what I would do there.
Look at both approaches and just determine yourself what you think is reasonable. What someone would pay for it and what you’re willing to accept. That’s what I would do.
So I hope that helps. There’s a lot more stuff to this stuff. I never really got into it. I didn’t really care so much about all the other projections on loans and payoff and stuff. I’m looking at the actual money in my pocket, because that’s what matters to me.
I call it the pocket test. Does it feel good in my pocket? If it feels good and I’m content with it, I’m happy, I’m good.
The Opportunity Evaluator on the following page is an interactive spread sheet. 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-paned 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 smartphone, 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.
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. If 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!
This isn’t the end. This is only the beginning. I want you to keep me posted on your progress because my goal is to have everybody into a property ASAP.
You’re getting close. You’re talking to lenders, you’re getting your ducks in a row, and you’ve identified properties. No worries. I ain’t going anywhere.
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