Numbers crunching on the fly
When searching for residential real estate, you’ll need to go and visit a lot of ugly ducklings to find a white swan. The property that screams out: profitability, high positive cash flow and excellent return on investment (ROI). Therefore, it is crucial that you have a quick and dirty system in place to analyze any given piece of real estate you need to evaluate. A system that can let you know before you even move on to your next potential rental property to examine, if the current one you’ve just toured is worthy of an offer or not.
This system, ideally, should be something you can do by rote. You should be able to crunch numbers quickly. If you need to do them on paper, fine. But as you get more experienced, you’ll find you can do the calculations in your head. Ultimately, they should take no more than a minute to analyze, once you’ve asked the right questions, scanned the listing data on the property, actually seen the property, and have done the basic math. Your ultimate goal, of course, is to be able to winnow down prospective properties to the best ones available to make an offer on, in the least amount of time possible. You can always continue the process for any “winning” rental properties in more detail prior to actually making your initial (and succeeding) offers.
Gross rent roll
Here are the main items you’ll need to plug in: On the income side, you’ll need to obtain the current rent roll. If there are any vacancies, you’ll need to ascribe a market rent for them, based on the size and condition of the unit, its amenities, and the overall location of the property. It’s simple enough to come up with a base gross yearly rental amount based on this information. Make sure you consider if the current rent roll is undervalued or not, and if so, what leases the existing tenants are under. In effect, how quickly before you can bump up their rents to full market value? Naturally, you should already have a good idea of your local market rents for like size units in different locales within the area. These must be researched before getting in your car and starting your searches.
You’ll then need to deduct your overall yearly costs in order to come up with a good guesstimate of your annual cash flow. The main items here include property taxes, which should be provided on any listing data given to you. Be sure to check that the property is within an acceptable assessment range. If it looks like the property is currently over-assessed, you’ll want to be ready to grieve the assessment to get your taxes reduced should you actually acquire the property. If the property is under-assessed – beware! You could get socked with a new assessment if the municipality decides to reevaluate the entire town, or if you make any improvements to the building that require a building permit. In either scenario, be prepared to increase the current taxes as you crunch your numbers.
You’ll also need to add in your mortgage costs, if you are not paying all cash. Remember that non-owner occupied rental property traditionally have slightly higher mortgage interest rates than conventional home loans do, as much as 1 to 1 ½ percent higher on average. And if your credit score is below the low 700’s, the rates can go even higher. You can also expect to have a higher down payment requirement than a conventional home loan. So instead of 20 percent down for a conventional home loan, non-owner occupied rental property can start at 25 to 30 percent down in most cases. With poor credit, it can go up to 40 or 50 percent down, depending upon the lending institution and their lending standards.
Another cost to consider are utilities. Do the units pay for their own electric bills? This is usually the case. However, there may only be one furnace in the building, and you as the landlord will be paying for heating costs for all the units in the building. Are the rents high enough to cover this type of cost? And make sure you get the current seller’s records for heating usage to ensure accuracy. In addition, check to see if there are any other miscellaneous fees that go with the building, such as association fees. You’ll also need to obtain data on the current seller’s insurance costs, and check with your own insurance company to see if they are in line, or if you’ll need to bump up that figure as well. After a while, you’ll acquire a sort of shorthand with your insurance agent, so you’ll be able to estimate rough insurance costs for a year on the spot.
Vacancy rate and maintenance
The last couple of cost items are strictly a function of your gross rent roll. They include a cost deduction for unit vacancy. Usually, if you’re being conservative, you’ll account for 2 month’s worth of vacancy per year for each unit in the building. In a hot rental market though, you can cut this down to 1 or 1 ½ months of your gross rent per unit. And if you’re going to use a managing agent, you’ll have to figure in a cost of roughly 10% of gross rents collected. However, they will take care of all your tenant selection and placement. The final expense to include in your analysis is an amount for maintenance. Certainly, you need to figure on at least 10% of each unit’s gross rent. A more conservative approach would be to use a 15% maintenance figure. This will help cover expected maintenance items like plumbing or handyman repairs. But it should also be enough to cover unexpected emergency repairs.
Perfecting the one minute analysis
Once you’ve done this analysis on paper a few dozen times, you’ll find you’ll be able to run the numbers in your head. And you’ll also find that you will become proficient in doing these calculations while you actually are walking through a prospective rental building. Pretty soon, you’ll find you can get the total numbers crunching done quite speedily. In very short order, you’ll find that you too will have perfected the one minute rental property analysis. Then, it’s on to the next potential white swan laying in wait for you to discover…
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