Evaluating a Rental Property Investment

Rents - PITI = Cash Flow?!?!

Nonsense!

John, Ben, and Ryan discuss the real costs of owning and operating rental property.

Here are a few buzz words: cap rate, NOI, cash flow after debt...

Don't we sound smart now?

We'll de-mystify common real estate jargon to ensure you'll know what your broker is talking about when he tries to impress you by offering you "a steal at a 6-cap".

 

(Transcript below.)

Ben Shelley: [00:00:07] Welcome back to the Brick x Brick Podcast. I'm Ben, and I'm here with John and Ryan. And today we're going to piggy back a little off last episode where we talked and identified what might be your first area of investment both to do your first real estate investment and maybe if you're starting to pick up the number of real estate investments you're doing in your surrounding area. And we want to talk about the kind of ways to identify from a numbers and metric standpoint whether or not your deal is viable for you. And it's important to recognize obviously that finding out and identifying different real estate metrics is just part one of the many parts of figuring out whether or not a real estate deal is good for you or not. But nevertheless we want to take you through it. And so Ryan When do we kick off with you.

 

Ryan Goldfarb: [00:00:50] Yes. So the first thing I will... I guess it's just kind of foundationally the goal of buying investment property for me is twofold. The first part is earning cash flow that is passive income over the duration of the investment.

 

Ryan Goldfarb: [00:01:06] And the second part of the second piece of the puzzle is the equity side which is the idea of gaining equity in that property which is something that you do both by purchasing it right but also by holding it over the long haul and by paying down the principal of the loan amount.

 

John Errico: [00:01:24] Yeah I think I think that that's a really good way to frame it because you could buy an investment property and make no cash flow like no rental income but it could still be a good investment because the property could for example appreciate very rapidly either because you do something to appreciate it like going to flip or just because you bought at the right time and the broader market appreciates. So I know primarily at least up until very recently I consider myself almost exclusively a buy and hold investor like a rental investor and I almost always perform or underwrite or whatever you want to call it my investments as if there were no appreciation at all. So the power of doing that is you have to be pretty disciplined to make an investment because you're thinking OK well my rents are this my expenses are this. What if I assume that the value of my property doesn't go up at all. And what if I assume that my rents don't go up at all. Am I still comfortable with the cash flow that I'm making right now that other investors will say well you know my rents will increase at 2 percent a year or 3 percent your CPI inflation whatever and my expenses are going to be fixed my mortgage is going to be fixed to my you know B minus investment right now might turn into an investment in four or five years but that's at least not the approach that I've taken personally.

 

John Errico: [00:02:42] I don't know if you guys feel differently but...

 

Ryan Goldfarb: [00:02:43] Well I think this highlights a pivotal mistake that a lot of beginning investors make. It's that they, it's that they assume that the market will continue to appreciate and they forego what would otherwise be sound investment strategy by looking towards cash flow in lieu of the expectation of appreciation down the road. And I think particularly at a time like today you see this often when we're coming off of a period of six seven eight years of market appreciation and now the hype is strong. The market the real estate market is at its peak arguably and has soundly recovered from 2008 2009. And people are back into thinking that this is going to last forever. When the reality is it's not. If you're buying it with the expectation that you're going to make your money when you sell it because it's going to continue appreciating you're going to find yourself in a bit of trouble at some point down the line. And the way to mitigate that in my view is to buy with strong cash flow and to buy something that you're confident you can hold on to in

 

Ryan Goldfarb: [00:03:55] perpetuity. Based on what your cash flows are.

 

John Errico: [00:03:57] Yeah I think like maybe the riskiest investment that I've possibly ever seen or even was. I mean I didn't consider it for my own portfolio but I was helping somebody in California it was maybe a year ago who was buying a flip or wanted to buy a flip in California and they had this spreadsheet or this deck was really well done deck it was like 15 slides like really professional and you looking at the numbers they wanted to buy for something like 400 grand and they're going to put one hundred thousand dollars into it and they thought they're going to sell it for like 850 in a year. No there isn't. You know not that bad investment but if you look at the numbers like the comps the market comps were all at like six hundred grand right now. And the underlying assumption was that because those same properties had appreciated by like 40 percent or something in the past year or two years that it was going to continue to depreciate or 40 percent it was kind of buried in the numbers like it was really obvious as you actually click through the comps were like wait all the comps are like way below what the ARV is. So this person had reached out to me I was like look I mean if you think it's really going to continue appreciate as it has already appreciated I guess it's a good investment but no. You know it's like that's that's it. That's probably the riskiest type of investment.

 

John Errico: [00:05:11] I think you could make.

 

Ryan Goldfarb: [00:05:11] Well this this I don't want to deviate too much from what I think should be the focus of this conversation which is cash flow but this highlights something that concerns me about investors in general it's the I think there's a misunderstanding between what drives quote unquote appreciation there's there's market appreciation and then there's appreciation that you forced by buying something distressed and repositioning the asset whether that's by bumping rents or by putting capital improvements into the property and the the latter I would feel pretty comfortable assuming going in because that's something that is within your control. But I don't know that I would ever make an investment purely based on in my view speculative market.

 

John Errico: [00:05:52] It's like for me it's micro and macro factors micro factors are your house you can affect the the value of your house by doing something nice to it improving it. But the macro factors are like the broader market and you you individually probably are not going to impact the broader market by your improving real estate that's going to be factors that you control.

 

Ben Shelley: [00:06:16] Well I'll say it quickly in defence of calculating and embedding appreciation in your underwriting it is part of the fundamentals. I think for those people out there they're saying well gosh should I not account for it at all then you know it's fair it's usually standard to account for let's say 2 percent revenue growth maybe 2 percent expense growth over a certain period of time. But I think what we're saying is just be cautious about and especially understand that you need a certain amount of cash on hand at the beginning and throughout the first year of your project to to survive into it. Sorry.

 

John Errico: [00:06:43] No I mean I think that that's fair. My point is that I wouldn't feel comfortable buying a buy and hold property if at the moment that I bought it I wasn't satisfied with the cash flow I might be happily pleased with the cash flow and two or three years assuming appreciation assuming increases in rents. But if at the moment that I bought it it was not cash flowing like I wanted it to that I wouldn't buy it even if I thought in three or four years it might.

 

Ryan Goldfarb: [00:07:07] And if you're trending income at 2 percent and expenses at 2 percent just as an example granted as applies more so to a commercial property and to commercial underwriting then to let's say an underwriting for a 2-family investment property but that ultimately is driving NOI which is going to be the basis for appreciation in that scenario rather than just saying oh we're buying this at a 7 cap. And I think the market's going to be at a five cap in two years. So the energizing to stay the same.

 

Ryan Goldfarb: [00:07:36] But I'm going to see a sizable increase in the value of the property because it's purely based on the fact that I think the market is going to tighten and people are going to be buying more gas

 

Ben Shelley: [00:07:46] Which is a lesson by the way to not just look at these numbers standalone because you see a lot of people and when I when I talk to people in real estate or sometimes say well or brokers will throw those numbers at you like look look at a cap rate look at the IRR look at the NOI but you know it's a bigger puzzle and you want to try to take all of these factors into account because they wouldn't say no-ey.

 

John Errico: [00:08:03] No I said a thing I've never heard that I make that a thing.

 

Ryan Goldfarb: [00:08:06] We can make that if I just don't like and I just I think that's what it is. I think I would really go out and what I believe you're going to do well about No. I mean it's you know there's just no way I could I could maybe get on board with like Noi. But no me no noise to high class I think we're every gentlemen.

 

Ben Shelley: [00:08:28] So I want to I wanted to move the conversation to maybe two of the main types of deals that we do. I know we want to talk about rental properties so maybe for starters. I would love to actually now that I'm talking about this out loud talk about some of our methodology for flips. But for starters when we're looking at two three and four families I think it's important for listeners to understand how we identify those those properties and whether or not they're worth taking the leap. So we talk in the last episode about identifying the geographic location. Once you've identified your property I think the first thing that there is a little bit of a misperception is specifically for newer investors is how much cash you actually need on hand when you go into a deal. You know a lot of people see an investment of $100,000 and think great I just need the ten thousand dollar downpayment for a 10 percent DP but there's there's a lot more equity required I think than a lot of people realize or understand going into a deal and we talk about that a lot. So for example if you're planning on buying a property and renovating the property over the first let's let's say four or five months there are holding costs of fixed expenses that are associated as part of that purchase and so on top of the ten thousand dollar downpayment on top of the closing costs which might include origination depending on the points affiliated with your loan or legal fees which we talk about that are associated with putting together the necessary documentation to transfer the deal and close the deal. You also have taxes and insurance payments that you're going to have to make consistently on your property before you generate even one dollar of income. And so my first recommendation once you've identified that property for listeners is understand exactly how much is the total equity required even outside the downpayment before you move forward and kick that in to what you're going to be making in your calculation moving forward on whether or not it's a good deal for you.

 

Ryan Goldfarb: [00:10:14] Yeah I think one mistake people make is they they say OK I have one hundred thousand dollars cash. I know that generally speaking the kind of norm in the mortgage space is to be able to put 25 percent down. Therefore I have four hundred thousand dollars in buying power because one hundred thousand dollars as a 25 percent down payment is gives you the ability to buy afforded another property as you just alluded to. The reality is is not the case. There are circumstances where your equity requirement can be limited a little bit more to just what your down payment requirement is and that's that's generally if you're buying something that's turnkey something that's already rented and something on which you'll be collecting rental income from day one but in a lot of instances particularly if you're trying to drive value you're going to be dealing with maybe getting tenants out you're going to be dealing with some vacancy you're going to need some money set aside to do some repairs or some renovations and then you're going to need to allocate a few weeks maybe a month or two to actually getting the property tenanted and to get to the point where you are quote unquote stabilized and collecting rents.

 

Ben Shelley: [00:11:22] That is the most common misconception I think for newer investors coming in and just understanding all the kind of cash required. I know when I've talked to people this hour you know that even from from becoming maybe even institutional investors to house hacking they just don't have a full appreciation for how much cash is required on hand for their first investment.

 

Ryan Goldfarb: [00:11:40] So one thing I actually wanted to point on that point out on that front is it can be it can be really sexy to look for those kinds of like quote unquote value add plays where you can buy something and buy a three family with three tenants in there who are each paying $900 a month when you know that the market rents on that unit or $1,200 a month. But if you if you don't properly account for the downtime that you're going to have with each of those units the the upside is a little less attractive. And one thing that I I oftentimes will encourage other investors to do and something that I should probably practice a little bit more often in my own on our own projects is to maybe stagger the vacancies. So if you have those three tenants in there rather than rather than going from having a fully occupied building to a fully vacant building and to have three units to renovate at the same time and three and then ultimately three vacancies to fill at the same time whenever the units come on line to stagger home and say Okay Unit 1 she really wants to get out because she's looking to move anyway. This is just a good time for her to get out. Unit 2 and 3 are a little bit more flexible. I'll keep you in it two and three there. We'll work something out where they're here for a few more months or we'll put them on like a three month lease or whatever the case may be and then we'll do those units one by one it'll make the construction a little bit more manageable because you're just doing maybe you're just doing like a cosmetic renovation and you don't need to do anything that's that pertains to the whole building you're not rerunning plumbing entirely or you're not redoing the entire electrical system. So that's one way to mitigate the burden of sinking cash in every month after month because you'll still have maybe two of the three units paying.

 

Ben Shelley: [00:13:26] And I think that's a particularly important point because when you're underwriting your deal oftentimes people want to just put in whatever the market rent is. And it's really important I understand that even if there is a certain amount of time it takes where you know which is hard to know. But if you even knew that you know eight months down the road nine months down the road you can stabilize at market rents. There is a period of time whether it be because of what Ryan alluded to getting entrenched tenants out or having to put up with maybe below market rents in order to to expedite this process and maybe not have it to go through something like an eviction that you're probably not going to be generating those rents from the word go even after renovation. So you know one of the things to that point I wanted to talk about was sort of the beginning of of the underwriting process and I know this is a lot of what I do for. For Ryan and John so. So I guess for a smaller deal I think one of the first things that's important to do is is try to properly. Well the first thing you want to do is look at your comps right. And we kind of talked about that in the context of finding your geographic location so going to move forward from that and talk more about your revenue particularly as it pertains to rent. I mean it's. Sorry John.

 

John Errico: [00:14:30] No I was just saying maybe we can frame it in the context of explaining some of the terms that real estate investors use like cap rate cash on cash. Ah I think that the cap rate is sort of a unique real estate term that people don't fully cap rate is very broadly speaking that operated net operating income divided by the value of the asset that you buy. Normally people look. So net operating income itself is a little bit of a term of art in the real estate context generally net operating income is the revenue that you're generating from rents or from whoever you use your property minus the expenses that you're generating or that your properties accruing at any given time. Normally you don't consider debt service normally you don't consider debt service in the context of calculating it. So you like your mortgage payment interest principle would not be part of the calculation. And investors talk about cap rate. Normally they say like X cap or X numbers like a six cap would be a six percent cap rate seven capital seven percent cap rate and one of the joys of using cap rates to analyze properties even if you're looking at a smaller like a 2-family or three friendly property is that you can compare properties of different asset classes almost using the same metrics. So if you have a 2-family property in say northern New Jersey and you know that's a seven cap for some reason and you have a 2-family property in New Haven and that's a nine cap well you've essentially analyzed away all the differences and all of the details and you're just looking at one number to compare it at a high level.

 

Ryan Goldfarb: [00:16:06] I say that the general theory behind that is first and foremost the reason that I believe at least there isn't that cap rate is exclusive of debt service which is in this context a mortgage payment.

 

Ryan Goldfarb: [00:16:19] The reason that cap rates are exclusive of that is is that your financing is more specific to the specific investor and to that investors strategy than to the property itself. So the cap rate is supposed to be a means of analyzing these specific property from investor to investor be and that should not be clouded by whatever your investment strategy is like something like the cash on cash return would be or even IRR or return on equity or whatever other metric you would look at.

 

Ben Shelley: [00:16:51] And I was only just going to give a caveat to say that while the cap rate is and is a very effective metric to compare deal by deal it's important to recognize maybe two things one especially when you're working on smaller properties oftentimes in more distressed areas. Oftentimes the cap can be inflated just because the numbers you're playing with are smaller so when you're talking about what you're netting versus the value of the property right. If that number is smaller generally speaking the number the cap rate you're going to see could be eight plus versus maybe like a four to eight and a more institutional area.

 

John Errico: [00:17:20] It's a good point because when you looking at smaller properties you realize that say you're looking at a 2-family property a property with two apartments. If you for example miscalculate the rent by 5 percent that will tremendously impact your bottom line or if you say well I'm assuming that it's a 2-family but one of the units you know is a lot smaller or one of the units I just can't run for five months of the year that has an enormous impact on your bottom line. But if you had a 50 family building and you had one year that you couldn't rent for five months. Well it doesn't we have a huge impact. So in another way to look at it is so you have a 2-family building and you have two boilers and one of the boilers breaks. That's a pretty significant expense that that will very severely impact your bottom line which is if you have a 50 family house 50 unit apartment and you have some history that say costs five thousand dollars which would be like the cost of a new boiler that's not going to be severely impact your bottom line. So it's it gets into a larger question about why do large hedge funds and whatever else invest in very large multifamily properties as opposed to like a 2-family property and why the management challenges of owning a portfolio of say 10 2-family properties might be different than a 20 unit property but generally speaking one idea is because the sensitivity to expenses and incomes are way different on a two year 15 year property.

 

Ryan Goldfarb: [00:18:46] It's also important to bear in mind that these numbers are generally based off of performance they're estimates. So on paper if someone is talking about a property buying at about buying a property at a 10 cap they're generally talking about based on their projections and those projections as John just alluded to will vary a lot more for a smaller property than a larger property. Year one you may see a 2-family if you get hit with a lot of maintenance you may effectively operate at a five cap and then year two once you're stabilized if you have no tenants move out you might be looking at an 18 cap. So it's important to understand the volatility in these numbers and to ensure that your expectations are in line with that. The other thing I want to point out is that the cap rate the cap rate itself is effectively the unlevered rate a rate of return on the asset. So if you're looking at a 10 cap what that means is if you buy a property if you buy that property for a million dollars at a 10 cap with no debt whatsoever. So you don't get a loan on the property. That means that you should if it performs at a 10 cap you should earn a 10 percent rate of return on your money. And the idea is that if you're able to get a loan on top of it to get a loan on the property the cost of that loan is going to be less than the cap rate which is going to increase your returns because you'll be buying you'll be borrowing money at let's say a rate of 5 percent interest and the property will be quote unquote earning money at a 10 percent rate. So when you look at your blended rate of return it's going to be much higher than the 10 percent cap rate that you would be seeing if you bought it all cash and two to bookend that conversation on cap to both of their points right.

 

Ben Shelley: [00:20:39] If you as an individual investor are looking at a smaller project and you see in a cap and you see a 7 cap it's important to again understand that there are other factors in play so for example maybe the the property with an a cap is generating more cash in the next year two years even three years. But the seven cap property might be new construction which for whatever reason is taking time to to bring in tenants or what have you who knows what the reasons are might be in better shape for the future and that's where understanding appreciation and also not looking too closely at only one metric can be really.

 

John Errico: [00:21:12] I mean yeah it's it's a fair point. I mean with all these metrics like cap rate cash or metric yeah you're you can make amazing returns but you could have a like a 15 cap and only be quote unquote cash flowing like two or three dollars a month. Yeah. And your because it doesn't take into account the debt. Well it also meant taking the cash the properties were 30 grand. So it's different than absolute returns.

 

Ryan Goldfarb: [00:21:35] But the other thing is that these I think John alluded to this earlier this is way more of an art than a science. So you can have you can have two experienced brokers or two experienced developers underwriting a similar deal or an identical deal and one could come out to a seven cap. One could have a nine cap and when you're dealing with larger numbers that's a huge variance and it could be for various reasons it could be because one of them maybe has more experience managing that asset class. One of them may see a way to increase expenses or decrease expenses or increase income but I think that's a good segue way to the next topic which is how you arrive at the NOI and ultimately how you underwrite cash flows.

 

John Errico: [00:22:22] Know very broadly I would say cap rate is not the only way to analyze properties. So there is cash on cash return. There's I would say monthly cash flow which is maybe not like I'm like a form of formal analysis but it just a way to look at it and there there's IRR which is basically was not relevant to not particularly useful to calculate unless you're very aware of what your exit might be and when it might be. But I mean we could talk very briefly about what those are before we go on this but I mean they all use the same inputs but they have different results for you cash and cash return is very broadly a measurement of the sort of year. I'm not actually sure at a high level the best way to describe it.

 

Ryan Goldfarb: [00:23:10] It's cash on cash return displays. It's the relationship between the cash flow so the amount of money that you are clearing on an annual basis and the amount of cash that you have invested in a particular property. So if you bought this the straightest way to look at this is for something that's stabilized. So you buy at a turnkey 10 family that's already rented and already stabilized and your plans upon purchasing it are to just kind of like continue operations as they are. So it's a you buy it at a 10 cap. So you put 25 percent down so you put $250,000 down obtain a mortgage for 750 with closing costs and whatever reserves you need to put in maybe you're all in at three hundred thousand dollars invested into the property and your cash flowing thirty five three thousand dollars a month. The way to calculate the cash on cash return in this context would be the three thousand dollars a month over 12 months.

 

Ryan Goldfarb: [00:24:20] That's thirty six thousand dollars a year divided by your three hundred thousand dollars invested in the property. It's a little over 10 percent return cash on cash which is a pretty good for.

 

John Errico: [00:24:34] Pretty good depending on risk adjusted for risk strategy in the area and the advantage of cash on cash returns as Ryan alluded to is that it takes into consideration debt and leverage. And so your cash and cash return can change substantially depending on it.

 

John Errico: [00:24:50] So one common strategy in buying whole investing that we get into would be the you know the BRRRR strategy or whatever you want to call it which would be buy renovate rent refinance and then repeat. So the idea is that you buy a property you have a fair amount of equity in the property to begin with. You spend money on renovations which is even more equity than you read it out and then you refinance refinance meaning that your property is appreciated in value because of all the work that you've done for it and maybe you got a good deal anyways and you take a bunch of equity out that will very very significantly impact your cash and cash return because all of a sudden you go from say having one hundred grand hypothetically the property to maybe having no money in the property or 10 grand in the property. You can have like you know quote unquote infinite cash and cash returns because maybe even got money back just to buy the property. So those are that and will not necessarily show up in it in a cap rate analysis and we'll maybe have negative impacts in a cash flow sense because now your basis and now you're the value of property is higher and your mortgage rates going to be higher in excess of your mortgage amount is going to be higher but it will impact in a huge way your cash and cash returns.

 

Ben Shelley: [00:25:57] And I think it's just important to quickly to note that the distinguishing difference here from an actual calculation standpoint for people who are underwriting their individual deals right is for example cap rate which is dividing your NOI by the value of the property versus here where you're I'd like to turn in net cash after debt because you're also accounting for your debt service divided by the total cash invested which gives gives you a different slightly different metric and a different look when you talk about sort of your blended results assumptions and returns for how you want to approach analyzing the deal.

 

Ryan Goldfarb: [00:26:28] Yeah. Just to add a little more color to the last example the So you buy if you buy that same property at a 10 cap and you buy it all cash the 10 cap means that you're effectively going to see a 10 percent cash on cash return as well. Whereas in this scenario with leverage the thirty six thousand dollars a year cash flow and cash flow on a three hundred thousand dollar investment yield about a twelve percent return. So the idea there is you're using leverage you're using debt to juice your cash on cash returns. To John's point before about the bird strategy the idea there is to achieve those kind of infinite returns but that also kind of highlights the deficiencies of cash on cash return as a metric because what that doesn't necessarily take into account is when you receive the cash it it doesn't. It's agnostic to the timing of cash flows. So IRR is one metric that a lot of investors like to use because that quantifies in some way whether you're receiving that refinance cash whether you're like pulling your equity back out in month one or in month 13 or in month 9 or not until the very end of the project and Year 5 or whatever it may be.

 

Ryan Goldfarb: [00:27:47] So that's going to be a huge driver of returns when you're looking at things from an IRR standpoint in.

 

John Errico: [00:27:53] IRR is the easiest metric I think to compare real estate returns with returns from other types of investments. So cap rate is pretty generally only used in the real estate context. Cash and cash return I suppose could be used in different contexts but I've never never really seen it used outside of the real estate context personally but IRR you could say well I can make x percent on my my my bond or in return from the stock market or on my Treasury bill or whatever I invest there or investing in a private equity fund or any space or invest in a private equity fund absolutely or you know I can compare it to what I would make on a property investment. So IRR the only way to calculate are truly is retrospectively after you've already disposed of the asset or received all the cash you can receive. But it is possible to prospectively guess that well I could receive this cash flow at this point and I could exit the property at this amount at this point. So when we do that type of analysis which we do for the purposes of our private equity fund we just guess and say Well I think we're going to exit the property what would it be if we exit the property in a year and two years three years whatever educated guess.

 

Ryan Goldfarb: [00:29:02] Of course of course. And then to turn us back in a little bit with how it applies to I think most of what we do. The kinds of rental property that are in the two to four families base frankly in my opinion it's overkill to do a real deep dive into the numbers in this way for let's say a 2-family rental because as John alluded to before there's so much variance between between what your quote unquote cap rate is going to look like between what you're IRR is going to look like and so on and so forth. When you're dealing with such a small property and you're dealing with such swings from there a vacancy or from some kind of repair and maintenance or cap ex. So. The way that I actually like to approach most of these is to kind of I guess more subjectively the way what the cash flow is against what the equity is against what the kind of quote unquote risk and effort required is for any given deal. So just to give you an example of how how that might look. We have some stuff with some property in Montclair New Jersey which is an affluent suburb with a nice downtown big community commuter population. We also have rentals in a rental property in Newark New Jersey which has a much different reputation. So. High level I might say I'm looking for. I'm looking to clear a thousand dollars a month on this on any given rental property purchase because if it's anything below that then it's a not worth my time and b I don't feel safe enough knowing that there are going to be there are going to be weeks or months or years. And I want to make sure that I have enough cushion to weather any kind of storm but that's also factored in with a lot that's also factored in with where the property is located. So if I'm in Newark let's say I know that that is not as strong of a real estate market and in a downturn values there are going to suffer. And and there's going to be you know not as much of a pool of buyers and long term. It's a different it's a different tenant profile it's a different I would say like operational burden from a management standpoint whereas something in Montclair you're dealing with a different class of tenant. You're not generally dealing with higher income earners. So in my opinion you have a greater likelihood of achieving some kind of rent growth there because you're dealing with a population that is generally seeing wage growth which is ultimately what's going to support rent growth. And then from an operational standpoint while you may be dealing with as John and I often kind of joke about you're dealing with a lot of people who don't want to be plunging a toilet or changing a lightbulb. So sometimes you have to provide a little bit more of a white glove service when it comes to management but at the end of the day you have less concerns that they're not gonna be able to pay their rent or that they're going to stiff you on the rent or that they're going to trash your place when they when they leave. So there is an economic value to that.

 

John Errico: [00:32:11] Yeah it brings up a larger point maybe we can get into right now which is what are the inputs to all of these forms analysis and I would say the very very top level input would be rents or rental income. That's generally the you know revenue or income side of the equation. So why do we talk a little bit about how to figure out what rents are and how to figure out vacancy rates.

 

Ben Shelley: [00:32:36] Yeah sure I mean I mean just very quickly but base level right once you when you're looking at an area you know it's sort of the same way that you're identifying from last episode where you're going to invest the next step would be to look at comps to try to determine what the average rents are in the area for your specific property and unit. So I think it's worth mentioning. I know this sounds simple but obviously there's a difference between renting studios first one bedrooms or two bedrooms or three bedroomsetc. and even within that context you want to know OK are you renting individual units are you renting the property out as a whole home as a single family versus multifamilyetc.

 

Ben Shelley: [00:33:12] And then also take into account what is the unit mix within your property. So some units I think a lot of people say oh you either rent two bedrooms or you rent three bedrooms well just as a case in point I was looking at a property the other day in New Haven and these two properties were all one one bedroom and one three bedroom. So understanding your unit mix as well as important. So once you determine through comps et cetera what your average rents are going to be for those different types of units then you want to take into account I think any other factors that might make you revenue. So for example does your unit have parking space. And if it does do you rent that out to tenants. So if you're renting out you can additionally add those types of revenue streams to at least I like to to your total revenue as it pertains to rental income because I consider that again you're probably paying a parking space by month. And then as John and Ryan alluded to you want to try to discount that rental by a certain vacancy percentage which is really just a guess to how long per unit would any given unit on a given month or any given year be vacant because as we know every day you have a unit that's vacant in his day you're losing money. So it's very very important to not just include a vacancy rate but to try to be as close and as accurate as you possibly can.

 

John Errico: [00:34:23] I think it's really important what you said shouldn't be glossed over it's important to include a vacancy rate because a lot of people would say oh I have a great you know that the rental demand is really high. My area and I'm always going to find a tenant that may be true but if you have a tenant leave who just doesn't wanna renew their lease. Maybe you can line up a tenant who's going to come in right after the person leaves. But more than likely you're probably gonna have to get in there paint the unit. Do something fix it up whatever you have to do so that at the absolute minimum you're gonna spend half a month maybe more likely a month just to get the unit turned around. So even in a very very high demand market you might still have a month of vacancy. Even per year. So at the very minimum I would say include a vacancy rate in some way and then adjusted upwards if you think that the rental demand is lower.

 

Ryan Goldfarb: [00:35:13] Other factors are at play not to get too in depth there and to kind of lose sight of the topic at hand which is understanding the income and expense but there's also a difference between physical vacancy and economic vacancy. So economic vacancy is also intended to keep and to take into account other factors like not just how much money you're losing because a unit is taken but also oftentimes it's kind of embedded. It also has like a bad debt number embedded in there which would be bad a bad debt write off from an accounting standpoint is the amount that you are foregoing because of an inability to collect. So if you're in an area where you have if you have a 20 unit building in just about any market it's going to vary depending on where you are but chances are you're going to run into tenants who are not going to pay. We're dealing with this right now and one of our properties actually with arguably multiple tenants in one of the properties we have one eviction ongoing which means obviously that tenant is not paying. We have another tenant who is I would say paying habitually late and is somewhat somewhat troubling to deal with this.

 

Ryan Goldfarb: [00:36:30] Well at the generals we thought we were a white glove service but that's a separate issue but this actually highlights the importance of screening your own tenant and not inheriting tenants.

 

John Errico: [00:36:43] To be clear we didn't choose any of these tenants.

 

Ryan Goldfarb: [00:36:45] They they came with the primary vote shows us the economic vacancy kind of takes takes these things into account.

 

Ryan Goldfarb: [00:36:53] The other thing I like to think about is what does a 4 percent vacancy mean so that in most in most contexts a four point four percent vacancy is indicative of any of an extremely strong market. But when you take when you think about it in the way that John just described 4 percent economic vacancy essentially translates to I think about two weeks of lost rent quote unquote over the course of a year. So if you think about one full month one full month of vacancy is about 8 percent of the year. So if you divide that in half that's 4 percent. So essentially what that means is if you're underwriting a 4 percent economic vacancy that means that you're expecting that on average you're gonna be seeing about two months of lost rent over the course of the year which when you think about the logistics and you think about things from a practical standpoint if you have a tenant leave I would say two weeks to have one from the time that one tenant leaves to the time that you clean the apartment that you make any repairs to the time that you lease it out to the time that that person moves in is extremely optimistic and probably a best case scenario.

 

John Errico: [00:38:03] And it's another you know a lot of investors rag on rent control and rent stabilized buildings which is you know a whole different time may be warranted. Yeah but one thing that you will have in a rent controlled or rent stabilized building assuming it's controlled or stabilize below market rents is that you're probably not going to have a lot of vacancies as long as you pick tenants that are going to pay rent. So just you know other a lot of things go into the rents and the vacancy rate.

 

Ben Shelley: [00:38:31] So I guess just just to sort of go back to you know general income an expense. Right so let's just say your total revenue including rents and any other affiliated income streams are added up to one hundred thousand dollars and you had a 10 percent vacancy so that's $10,000. So you're your net revenue from rent if you proportion that altogether is about $90,000 and then what you tend to want to do is go through your expenses. So obviously there are closing costs affiliated with purchasing the property and then there's holding as well but for the purpose of just rentals probably want to start by talking about fixed and variable expenses. So for your fixed expenses as an example you're talking about expenses that no matter what happens you know through through a lot. So what's the expression like hell and high water you're gonna have to pay these and those things include taxes insurance your mortgage payment. I tend to like to include utilities as a fixed expense because even if you are passing through a lot of those expenses to tenants you're going to have to pay some proportion of that or at least that might amount of money is owed to somebody all the time.

 

Ryan Goldfarb: [00:39:33] Point out that if we're looking at we're looking at deriving NY mortgage expansion B Well that is going to fix that.

 

Ben Shelley: [00:39:41] Yeah and I at the end I was gonna maybe make a caveat. I don't know he doesn't believe me but I promise. This is how I look when you send us you're like Deal somebody right.

 

Ryan Goldfarb: [00:39:51] I know that you have it in there but I know that when I when I think about it or when I think about it and it's gonna expert anyway for anyway purposes it's tricky.

 

John Errico: [00:39:58] One the major caveat one major thing to say is that everything that we're talking about is a yearly just people that get used all these calculations that done on a yearly basis not a monthly basis or whatever.

 

Ben Shelley: [00:40:07] And this is something that I that I took from from Ryan and John but oftentimes what we'll do is we'll separate the periods even refinancing aside let's just take out of the picture where we'll calculate the cost right. Equity required and just general affiliated costs up until the time that we lease up and then extrapolate out over the course of a year to see what the property looks like stabilized for one full year which may or may not be helpful for. For you guys out there but putting that aside once you calculate your fixed expenses and will take out the make sure to take out the mortgage for the NY thank you then you would look at your variable expenses these are expenses that can change year to year.

 

John Errico: [00:40:40] So things like just to touch it if you look we're going to talk about utilities as a fixed expense so the utilities are I think a I think a big a big one to think about. A lot of investors grossly miscalculate what the utility costs will be. And they also change depending on the nature of the property. So as an example used before he might have a property that has separate heat and hot water that is not super uncommon for smaller multifamily properties particular the northeast. So each property has their own boiler or furnace or whatever and they each have their own say hot water heater. In that case you generally as a landlord will pass the cost of heating and hot water through to the tenant because there is a separate meter and system for each tenant in a larger building or in a different building. You might have one central heating system like one boiler or one hot water heater and in that case you as the landlord will almost always pay for the cost of heat or hot water. You may be in a good great world would be able to in some way pass the costs along to the tenant but if you're looking at comps online oftentimes it's not entirely clear if the unit has heat and hot water included in the unit or the landlord pays it or whatever. Having said all that that calculus is significant also because you might even though the tenants say pay for heating hot water use the landlord is responsible for servicing the boiler and the hot water heater so you might though you might gain on the fact you don't have to pay those types of utilities every month every year for tenants that pay their own heat and hot water. You might lose because you know all the sudden you have say three or four boilers to maintain as opposed to one boiler and the costs of replacing a boiler for a four family unit and the cost of a boiler for a one family unit might be a little bit different but it's not way different. So there are pluses and minuses to having separate utilities in larger buildings particularly in the Northeast. It will almost always be the case that there will be one central heating unit and one central one high well positioned say that I love.

 

Ryan Goldfarb: [00:42:52] I've seen them separated pretty pretty early and even when there's one they're not separated even when they're not separated.

 

Ryan Goldfarb: [00:42:59] I think a lot of landlords have transition to a rub system ratio ratio utility billing system I think it's called where they essentially pass the costs through to the tenants and just kind of build them build them back in a pro-rata fashion.

 

Ryan Goldfarb: [00:43:16] So regardless of whether they are metered separately or not.

 

Ben Shelley: [00:43:19] So this is from by the way I mean we got John here unbiased top property manager probably in Hudson County. I mean I I take it it's so important. I'm glad you stopped me there because it really is important like all of these calculations matter. You know if you and like John alluded to earlier as well it's like OK let's say you pass even if you pass all your expenses. If a boiler goes down you are responsible as the landlord for that payment so you also want to allocate certain capital resources to those emerging nations.

 

John Errico: [00:43:46] The overarching point is just understand the utility expenses. There are also a hidden utility costs in Hudson County as you just mentioned but you have to pay sewerage costs which is not the case in other counties in New Jersey and across the country.

 

Ben Shelley: [00:43:58] So Mayor Stack we're totally okay with it. Really.

 

John Errico: [00:44:00] I promise I love it. I love it I love it at the North Hudson Sewage Authority. One of the greatest utilities on Earth. So to the bank one way to figure it out just ask.

 

John Errico: [00:44:11] I mean you could ask the prior owner the chances of you know for a smaller multifamily property them having great records to give you are low but conceivably or you could just ask another property investor in the area like hey need to see your utility bill for a two or three family property to be able to get.

 

Ryan Goldfarb: [00:44:26] You may be able to get it from the utility itself to maybe.

 

John Errico: [00:44:29] Yeah I don't know. I mean you could try but yeah. So when you're doing your due diligence make sure to figure out that no because even in a 2-family property say you're off by a thousand dollars for utility costs are per year. That's the law. Yeah that's going to really impact your bottom line.

 

Ben Shelley: [00:44:47] Yeah I mean especially where our numbers are so when you're talking about again multi-family properties. Any discrepancy even you may think it's just five hundred six hundred dollars. That makes a big difference in your bottom line and it makes a big difference in the totality of calculation you have for a lot of the metrics that we talked about which I'll I'll get into when we finish the breakdown. So just again to quickly run through it we talked about some of our fixed expenses. So just some of the variable expenses again these are expenses that would change potentially year to year as you're you're managing your property so things like admin expenses which might be fees affiliated with filing taxes or any kind of documentation you have to go back and forth that you have to pay for things like supplies things like maintenance costs something that's also really really important to try to allocate correctly probably best to be conservative when it comes to to maintenance costs and also very important which we're very familiar with a management fee right. If most people aren't. Well I would say in the multi-family sphere you see this more often especially if you are for example a house hacker. But most people are going to pay an outside company or source to manage their property. So is there a management fee. And if so what is the percentage of your gross rent that you're paying out to that manager. So it's usually I think somewhere between 5 and 8 percent. I know for a lot of the properties John that you work on you charge a percent but that depends on some sort.

 

John Errico: [00:45:59] I think it's probably between five and twelve percent but really it really depends on the market and the property for sure.

 

Ryan Goldfarb: [00:46:05] And it could be a lot lower even for say a multi hundred unit building it could be lower three to three to five and that is I say is more more of the norm but the as a practice whether you plan to self manage or not it's it's good to put a management fee in there when you're underwriting a property because whether it's because you continue to acquire and kind of grow out of self managing or because you grow tired of self managing it's highly likely that at some point you may consider hiring or outsourcing Robert property management. And if you do that you want to know that your property can support it.

 

John Errico: [00:46:42] Yeah. And management is a whole other sphere that we can get into at some other point. But just to touch on it very briefly beyond the numbers that we're talking about just having. Either the ability yourself to manage the property or having a good property manager is very very very important and very very valuable. And I have used third party property managers that have been great some that have been really bad and it is a large component that goes into buying a property and thinking about how to rent it out and even to our previous conversation before about location. Sometimes just having a good property manager that you can trust in an area could be a factor as to why you might want to invest there and what other side too is if you buy a say 2-family property in the middle of nowhere or someplace where you don't have an infrastructure setup it's going to be hard to find it's often to be hard to find a property manager who just going to want to manage your 2-family property. A lot of property managers are interested in managing portfolios bigger properties know whatever it might be.

 

John Errico: [00:47:45] So just take that into consideration if you're investing not in your own backyard where you can't actually manage it yourself.

 

John Errico: [00:47:50] How you like think about how could I find a good property manager how much is that going to cost how it's going to be set upetc.

 

Ryan Goldfarb: [00:47:56] And that property manager is also likely going to be your gateway to a good plumber or a good electrician or a good carpenter or a good pest control company and that's going to truly inform your experience probably more so than anything outside of buying the property.

 

John Errico: [00:48:11] Like for some properties that I manage it's really like I am essentially the owner of the property because everything you know for that property will flow through me like I might be responsible for making sure that the utilities are paid that the taxes are paid. Collecting rent to have access to the bank account everything else. So to the tenants of that property I am the landlord. I manage the property they have no idea that I don't personally own or have any equity interest in it. So think about that too. You know this property manager the sort of person that you want your tenants to deal with all the time is like the face of the property to really manage to operate the the logistics of the property.

 

Ben Shelley: [00:48:51] And I think again to their point it's worth first taking into your calculation just for for both conservative purposes but also for purposes of it's likely that you'll end up using a property manager if this is one of your first investments and particularly if you're going somewhere further away from you. So if you're talking about an hour drive two hour drive or even further it really is essential but also understanding that it may well may be difficult to find a property manager for an area that you're unfamiliar with that it can be essential and can also actually in the long run cost the side help increase help juice your bottom line because if they're the ones consistently handling maintenance issues collecting rent that can be a boon for your for your total rental revenue.

 

Ben Shelley: [00:49:31] And so the only thing left to do once you have your revenue and income and expenses is to do the calculations to get you your final assumptions so you know for us these are smaller deals so we can talk in the second but what.

 

John Errico: [00:49:45] Maybe one less thing on expenses not to totally gloss over it but would be I think you mentioned too that repairs and sort of highlight the same thing.

 

Ben Shelley: [00:49:54] I'm doing the overhead.

 

John Errico: [00:49:55] You guys get into the weeds so that's another thing that property investors will often miscalculate or under overestimate the way. So I'm thinking you have a great great is maybe not the right word. There is a property manager in New Haven that we've used in the past is a real character a great guy and he was trying to sell me a property a couple of years ago that he had owned for about seven or eight years and so he was walking through those properties for five family property and he said well I said to him like why do you want to sell this property.

 

Ben Shelley: [00:50:32] And I said I juiced it and I think we've talked about this on a previous ad before. I think so. Now to talk about it again it is very relevant here.

 

John Errico: [00:50:41] Well you haven't caught that episode just yet.

 

Ben Shelley: [00:50:44] We're listening John. Thanks.

 

John Errico: [00:50:47] So yeah he said he juiced it which means that he had the everything that you have in the property has an economic life a useful life. You under describe it including the property itself but aspects of the property that have defined life terms would be the roof your boiler your hot water heater maybe some of your fixtures in your bathroom. These are the things that you install and you know that at some point you gonna have to replace them. So maybe like a cheap roof might last you 10 years a hot water heater is probably not gonna last you more than 10 or 15 years. So what he meant in that context was that he put money into the property. Day one that he bought it and now seven eight nine years later all of the stuff that you put in now needs to be replaced. So all of a sudden there's gonna be a big cost to replace the roof and the hot water heater and the boiler and whatever else. The way to look at that in the context of what I was saying with with repairs and maintenance is that those expenses that you have to pay for a hot water heater whatever are not going to be born every year like in year to year three or four you're going to have to pay money to replace a hot water heater but you're going to have to pay a lot of money after Year 10. So the way to to underwrite it or to think about it is women look at that expense and then just divide that total expense by the number of years that I have. So I might put in my budget that my repairs and maintenance are twenty five hundred dollars a year. But there might be two or three years I don't pay a dollar to that or pay ten dollars and there might be one year where I pay eight thousand dollars. So over the lifespan over the three or four year period of time and I'm looking the average might be that number. But in any given year it might not be that exact number and it's important if you look at a property you know say the owner might say oh I didn't spend any money on maintenance last year. Okay great. That does mean that the cost that you should underwrite is zero dollars. It just means that maybe you know nothing bad happened that year but next year you know this year to replace a boiler for our properties cost me a boiler and hot water heater cost me seven thousand dollars. But last year I didn't have to do anything so cost me five bucks there.

 

Ryan Goldfarb: [00:52:45] I'd like to have a distinction between repairs and maintenance and capital expenditures. So repairs and maintenance are generally classified as maintenance of existing fixtures maintenance maintenance and overall maintenance of the property. So that might be things like going and unclogging a toilet or patching a hole in the drywall from somebody who took down a picture. Little things like that that are just more so upkeep than a true replacement. I think a lot of things that John alluded to are more so classified as capital expenditures which also as you alluded to have a pre-defined lifespan and it's just an inevitability that there's gonna be concern that those are going to have to be addressed. So when you're looking at your quote unquote repairs a maintenance number it's important to take both sides of the equation into account. And oftentimes as this this also comes back to the idea of applying context to your investment. So if you're buying something that you're maybe getting a little bit of a deal on but it's an older house it hasn't been renovated needs a little bit of love. Need some cleanup maybe hasn't been lived in for a little bit. You can. You can bet that in the first year or two you're going to find out where the leaks are you're going to find out where the warts of the property are and you're going to be spending on both repairs and maintenance and probably some capital expenditure items if you didn't pick them up immediately anyway. And on the same token you may buy something that is perfectly that is turnkey and that was renovated right. And it may be reasonable for you to assume that in year one year to year 3 your repair maintenance number is gonna be pretty low because most of those items that John alluded to earlier have already been addressed and you shouldn't need to deal with them again. Let's say that John you also know manager property that was recently renovated but was not renovated to the standard that one would expect and so despite the fact that it's renovated I think there's been a fair amount of expenditures on the repairs and maintenance side just to address some subpar renovations.

 

John Errico: [00:54:50] Yeah I think the way to look at it. I think we even talked about this in the previous episode is that even though there are events that happen infrequently it doesn't mean that they'll never happen. So even if you have a property that's been recently renovated everything is OK. You could still have a pipe that will leak but just the way that it is. So I I could probably count it. You know I manage quite a few properties. I can probably count less than maybe there are one or two of the properties that I manage which is like over 10 properties each of which have multiple units that has never had a pipe leak in the time that I've managed it. And doesn't matter if the pipes are new or old or whatever it is just the way that it happens. So does it happen every day. No but it does happen. So even things that are infrequent are going to happen sometimes. Doesn't matter how old how young what the status is whatever. So the only way I mean if you really really really want to control your maintenance issues is to do preventative maintenance and I would say do it yourself. Don't rely on a previous property owner to have done quote unquote preventative maintenance because as Ryan mentioned even properties that are newly renovated you have no idea the standards that the previous construct. Contractor construction person whatever used to apply to it if you want to get it done then be preventative yourself. But I would say do it yourself and make sure it's done right.

 

Ben Shelley: [00:56:11] Yeah I mean it was crazy not to mention the idea of cap ex capital putting aside a capital reserve you know a lot of the things that we're doing here when they're smaller deals we're looking just a year one so renovation to lease up through through a full year year and a half. But even with something as small as that to looking at something over a 10 year 10 year exit you got to have some sort of proportion put aside of your of your income put aside to address these possible concerns.

 

John Errico: [00:56:35] Yeah. So that's that's a great point to bring up as well that the way that I always think about properties whether I own them or manage them is that they're that there will be a pool of money and you can call it like an emergency fund or a capital reserve fund or repair fund or whatever want to call it that is usually at least equal to the deductible of the the insurance that you have in the property but oftentimes is larger. I would suggest to be larger because for various reasons you might not want to make an insurance claim or whatever it is you want to be covered insurance but long story short is that for the first year or two of the property if you're thinking about a property as like a cash flow machine I the way that I operate and what suggest operating is taking the income that you're generating from the property you're your net operating income and putting it into a separate fund or a bank account for the property and waiting until that reaches a certain amount maybe it's 1 percent of the purchase price 2 percent of the purchase price the value whatever you want to use for me and a lot of 2-family properties it's often like 10 grand or something around there and don't touch that money at all until it gets that point once it matures beyond 10 grand start making distributions to yourself or to investors or whatever might be but keep the money in there so that you know on a rainy day if you have like and like what happened to me this year I had a seven thousand dollar expense just come out of nowhere. Well I had ten thousand dollars in my account so yeah my accounts now down to three thousand dollars but I didn't have to go into a credit card saving you know whatever might be. I just had the money sitting right there and I didn't make an insurance claim for other reasons that we can get into at some other point but but it's nice to have the security so that's I think I would highly advocate it touches back to the point before about not being undercapitalized and buying a property. This is not being undercapitalized when maintaining a property going forward.

 

Ryan Goldfarb: [00:58:22] That's a great point. And I think if you want to understand why we don't always believe in NOI when we see one or we don't always believe the numbers that a broker or a wholesaler or another investor is showing to us me then you want to understand why we're maybe skeptical about the numbers that we see it's because if you go through each and every one of these line items there is a certain artistry that goes into arriving at a particular number and that doesn't mean that there is a quote unquote a right way to do it. It just means that there are different ways to do it and whatever way you choose should be supported with with the right assumptions and the right support. So to recap on the income side we have rents, we have vacancy. Rents are going to vary based on what your rental comparables suggest. Vacancy is going to vary based on what you perceive as market vacancy and market economic vacancy. And then on the expense side we've got real estate taxes which may or may not be under assessed which may reassess at some point. And every investor is going to have a different every investor is going to have a different interpretation of what quote unquote market taxes are going to look like. We've got insurance which is going to consist of general liability may consist of flood insurance may consist of builders risks lower risk umbrella coverage. So that's going to be different depending on what your risk tolerance is and who you get your insurance through and what kind of limits and deductibles you want. We have management which can vary just on the surface based on who your property manager is but also the. Management is directly correlated to what the income is. So you can see a variety of ways that different investors will have different management numbers underwritten. You have utilities including both gas and electric and water and sewer. That's going to depend on not just what the mechanical setup is today but what it will look like in year two year three year four based on that investors plan. We've got General and administrative expenses which will vary across the board. I mean it's quite common that an investor won't even underwrite this at all. You have repairs of maintenance and kind of like tie up tied into that you may have capital expenditures. So everyone's going to have a different rule of thumb for how they underwrite that they make off of historically they may have a benchmark that they use for a specific type of asset in a specific market.

 

Ryan Goldfarb: [01:01:03] Am I missing any others? You may have payroll if you're getting into a larger property. Generally 50 units or above you may have an onsite an onsite manager maybe a full or part time maintenance person. So payroll numbers are going to be determined by that.

 

John Errico: [01:01:18] You have like snow removal trash and rental.

 

Ryan Goldfarb: [01:01:20] That's right. Yeah. We generally roll that into repair the maintenance but there was that pest control. All of that is kind of discretionary to an extent. And if you tie all of that together you have you can see how investor a may have a very different interpretation of what both revenue and expenses and ultimately NOI are going to look like and those same two investors may have a very different interpretation of what the quote unquote market cap rate is for that for a property like that in a specific market and thus may have may arrive at a very different valuation of a particular property.

 

John Errico: [01:01:55] One funny thing to mention too is I think before it got into real estate and people from afar think this perhaps is that when you look at a property an investor for the pope is going to be able to tell you all these numbers are off the haven't got you have to this and my captures this and I spent this.

 

John Errico: [01:02:10] But in reality it's not. I mean that these numbers get so fudged and messed up and also these exceptions and weird things that even a well-intentioned property owner might not have very good numbers for this stuff and even looking at the numbers for a year might not be very relevant because that year could be for whatever reason exceptionally bad or good. So even if you like even if you were to say oh I could just get all these numbers from the prior owner or just ask some investor what the numbers would be even that alone is not going to necessarily tell you the full story.

 

Ryan Goldfarb: [01:02:44] I've always looked at income and expense forecast or pro forma as an exercise and in highlighting each and every one of these line items that ultimately inform how your property operations are going to look and to be able to say hey what's going to drive taxes what's going to drive insurance maintenance utilities each and every one of those line items and kind of audit them on a more granular level and then use that to not just come up with numbers but to come up with an action plan for how to add juice that property to juice it.

 

Ben Shelley: [01:03:16] One of things I appreciate you having worked with John Ryan for a little bit now is exactly that is.

 

Ben Shelley: [01:03:21] And we'll talk very quickly to book the segment about what the numbers are at the end for for one of these smaller deals but this idea that even when you generate cash on cash and cap rate and your NOI in some ways just by delineating your income and expenses as as as specifically in as closely as you can that may actually be more helpful to inform your decisions on where and when you execute your purchase. And that's something that I've appreciated as we've tried to make action plans for investing both in places we're experiencing and in New Frontiers. And so just quickly as a bookend. So once you have everything calculated right usually what I'll center to Ryan and John is something very very simplistic actually something very basic just to give a snapshot of what the quality of the deal looks like you'll take to get there and why obviously we talked about it you'll take your rental and your net rental Rev and you're subtracting your fixed and variable expenses excluding your debt to get your NOI. And Then I like to put a net cash after debt or sometimes people just say cash flow after debt service which is the same calculation except including your debt. As part of the subtraction to see what the actual annual dollar income is for that year. And it's funny for these very small deals you know your cap and your cash on cash tend to be inflated to the point where I oftentimes don't even include it. But for the purpose of just an example let's say you know you netted your NOI is 10k and you want to get your cap rate right. Then if the value of the property is a hundred thousand dollars then you've got a 10 percent cap and for your cash on cash let's say your cash well after debt is five thousand and your total equity invested is twenty thousand and you've got a 25 percent cash on cash. So that's just a quick snapshot to tell you that it sounds pretty healthy frankly when you when you look at it suffer from an overhead picture. But as you just learned from this episode when you look at it line by line item that will help to better inform whether or not the deal is really good for you at your turn.

 

John Errico: [01:05:11] Just very briefly on debt service. So we've talked I think in previous episodes about finance but not all financing is the same. And it depends a lot on the. It could depend on your personal credit. Credit and borrower portfolio could depend on the market could depend on the type of property that you're buying. So when we're talking about multi-family properties there's residential debt there's commercial debt there's no private hard money type dead all sorts of stuff. So those numbers may not impact the anyway calculation that we just talked about but they do have an impact on your your pocketbook like your bottom line the amount of money that you're taking home per month and that that in itself could be a very important factor in the investment so like we just talked about these numbers and we're talking about as though it's a given that you would really care a lot about anyway and whatever else. But I know a lot of property investors that although maybe they're there in a way calculating anyway all they care about is the amount of money that they put in their pocket every month. And to that end it's really important to think about your debt service and all these other payments that might be the case because if you don't really care about what you're what your turn is but you just want a property that gives you five dollars a month because to you that means financial freedom or that means a vacation or whatever else then definitely absolutely look at debt service and everything else to come up with that number for you.

 

Ben Shelley: [01:06:30] And just to that point me I remember I went to a real estate program and I had professors who would just I mean hammer home you know basically the only thing you should care about is covering your debt service and if you're covering your debt service your quote unquote making money and it's obviously not that simple but that's where you get into other metrics like equity multiple and IRR on on bigger deals which could help inform your opinions. Guys I appreciate it as always. Always a hoot and a half to get together at John's apartment two to record. We got the pups and animals around us. And can we to continue on with to the next episode. Thanks guys for your time and expertise as always.

 

Ryan Goldfarb: [01:07:02] Thanks, Ben..

 

Ben Shelley: [01:07:14] He was really upset that there's more equity required than a down payment.

 

Ben Shelley: [01:07:19] He's like what I everybody got paid by my.