www.akerahomes.com
mfrentz@akerahomes.com
Remember: Please share this article if you find it enjoyable
Why is Calculating Expenses so Important?
I often mention cash flow in my teaching and writing about real estate investment (or investment of any kind) because of how greatly this one concept can reduce risk for any investor. By simply having a recommended amount of cash flow: at least $100/door, you are now in a place to weather an economic storm that hits any market. I live in Calgary where we have a very typical wave-like real estate market (sometimes called a bubble market) where house prices will rise for a few years and then fall for a couple of years with each high peak typically higher than the last. If you purchase a property just before the market falls, you will be paying money out of pocket for your investment which isn't all that much fun. If you lose your job at the same time or money is tight you may even lose your investment property. With healthy cash flow you can virtually eliminate the risk of ever losing your investment property. Each down turn in the market has hundreds of 'investors' losing their properties. While this isn't good for them, it is fantastic for me because I am able to purchase those properties at a discount and then make money from them on a consistent basis with very little risk. A key to investing in real estate is understanding cash flow and a key to understanding cash flow is understanding how to calculate real expenses (how much the property will cost, not how much you want it to cost).
One More Note on Cash Flow
There are ways to manipulate cash flow because you can affect cash flow so greatly simply by how high your mortgage payments are each month. There are realtors and investors who promote investment properties claiming they will cash flow, but once your read the fine print you find that they haven't properly calculated expenses AND that you may need to put a 30% down payment toward the property to make things work. This isn't a good deal! Yes, you can have more cash flow if you simply put up a higher down payment, but is that what you really want? Do you really want to tie up another $30,000-$50,000? Would you not rather purchase another property with that money and then have two cash flowing properties? Well... there are actually times when putting in more money up front can make sense. If you are already retired, don't need as much money, and aren't willing or able to look for a really good deal in an investment property but still want the relative safety of having a property that cash flows well, then it may be time to put 50% down on a property and make cash flow easy no matter what happens. This decision must be based on what you want from an investment property. Personally, I always want to put less money into each property so my money goes further, so it is important for me to get a good deal and have a cash flowing investment.
Expenses Most Investors Calculate
There is an acronym most investors use for the basic, more fixed expenses, every property has (unless you are buying with cash and won't have even a penny of debt). The acronym is PITI: Principle payment on your mortgage, Interest payment on mortgage, Taxes, and Insurance. These are extremely easy to calculate because you pay the same amount month after month or year after year for these costs.
Expenses Savvy Investors Calculate
(and most investors forget about until its too late)
What happens if you are self managing your property and you get sick/injured and can't manage for a year? What if there is an unexpected expense that you can't afford like a new roof or furnace or siding after a storm? What if the rental market falls a little and your tenants leave? What if you can't fill your property again for 3 months? What if you have tenants that are rough on your property before they moves out? Is the only choice to sell the place for whatever you can get or have the bank foreclose? Pretty much every decade in Calgary sees a fall in the market. There are different reasons for this and it will be good to cover it in another blog post some time, but the fact is that when these down turns take place there are many investors that lose their properties because they haven't covered their risk. When the market is rising everyone gets excited about real estate because its a 'can't miss' investment and then when the market falls real estate becomes a 'high risk' investment. I have news for you: real estate is never a can't miss investment but, if done properly, can be very low risk. You simply need to do your homework and invest properly. The three expenses many investors forget about until its too late are: Maintenance/repairs, property management, and vacancy insurance. If you consistently save for these three expenses in a bank account set apart for your investment properties this account will act as a reserve fund that you can always dip into in order to cover the expected costs you knew would come up even before you purchased your property. I will be writing blogs throughout the week covering each of these three expenses in further detail including how to calculate these expenses accurately, so stay posted.
A Reserve Fund?
Yes. A reserve fund. If you always have a reserve fund you won't be worrying or losing sleep because of the current local economy or a tenant leaving in the middle of a busy time for you (remember Murphy's law). The beauty of a reserve fund is that, once you own a few properties over a few years, you will get to know how much you need for each property as well as for your entire portfolio and the amount you need will go down (on a percentage basis) the more doors you own. For example, many experienced investors encourage new investors to set aside1% of the cost of every property they purchase while others may set aside $10,000 for one property, another $5,000 for the next property, and maybe just $1,000-3,000 for future properties or they may even stop putting new money into the reserve fund when it reaches a certain amount.
When Should you Calculate Expenses?
At the end of each year in anticipation for the following year? What about after you've purchased the property and want to know how much you will need to run this like a business? I suggest, actually implore you, to calculate these numbers (even if its simply an estimate) before you even put in an offer to purchase on the property. The reason I strongly suggest this due diligence is that if you don't have a good idea of your expenses before you purchase the property you also will have no clue as to whether it even comes close to cash flowing. This is part of due diligence on the purchase of a property and is called property evaluation. Once you are good at this you will only need about 30 seconds to to a quick evaluation in your mind to know the basic expenses. If you know the area you are investing in fairly well, it will take another 2 minutes to evaluate whether or not this property will cash flow with the rent it will bring in. When I come across a property in Calgary, even without knowing a particular area intimately, I can use my computer and figure out a basic idea of how much it can cash flow for within 10 min. If it looks good I move to the next step in the process. If the numbers don't work I move on to evaluate the next deal and don't waste any more time.
Here's to a profitable year in real estate investing for 2014!
If you would like to learn more about investing in real estate please
contact me at the email address listed at the beginning of this article
or go to my website at: www.akerahomes.com/investing-in-real-estate.html
No comments:
Post a Comment