I will not be accepting calls after 7:07 pm CT each game day until this thing is settled. :)
Property managers and rental property owners love to talk about how stupid tenants can be. Well, it’s my experience that investment property owners can be equally stupid.
NOTE: Yes, my use of the word stupid is meant to illicit a response. Perhaps ignorant would be a better word. Webster describes ignorant as “
Landlords and Owners, here is something you need to know: Tenants that move at the end of each lease cost you money!
It’s my general rule of thumb that you need to keep tenants on average about 18 months to make sure you are making money. Especially if you are using a property manager. Why? There are so many costs to changing over tenants.
- Paint, carpet, repairs
- Lease out fees if using a property manager
I see owners squabble over repairs that will cost them $175-$200 and piss off tenants because they won’t fix something. Then the tenant leaves, they end up with 30-45 days of vacancy, some electric bills to pay and more.
If your rent rate is $1,100 /mo and you take in to account some of the other expenses you may have cost your self $1,500 – $2,000 over a $200 repair. Is that good math? Am I missing something?
This isn’t a rant. But I see it happening right now with an owner who is new to investing. I am not mad at him. I actually am trying to educate him. But I seem to be losing the battle sometimes.
Real estate investment gurus love to talk in terms of “no guarantees”, pro formas and about deals from 10+ years ago. But I want to give you an Investment Property Case Study from right here in the Kansas City real estate investing universe. The following is real though I will not give addresses or client names, etc. Not only is it real, it’s still going on right now.
THE SET UP
In 2011 I had two fund managers from the Los Angeles area of California come meet with me about investing in rental property here in Kansas City. They wanted returns formulated on rents being two times investment. That is to say they wanted an all in price (purchase, closings costs, rehab) to be $40,000 if the rents were $800/mo. Easier said than done in any neighborhood you’d actually want to live in.
So I took them out and showed them around. Then I sat with them and asked me to make it more of a 1.6 ratio or 1.7 to get in to better neighborhoods with better houses and better schools. After showing them what I could do, I went to work.
ACQUIRING RENTAL PROPERTIES
From May of 2011 to March of 2013 we acquired 56 rental properties. Most were in 2011-2012 when the market was just waking up from it’s downfall in 2008-2010. What would these numbers show if we had started acquiring in 2009!!!????!!! Most of the properties were 3 bedrooms with 1-2 baths. All were in Missouri in Kansas City, Raytown, Independence, Grandview, Gladstone, etc.
PURCHASE, REHAB, RENT
After the closing we would set to work rehabbing to rental standards. Then rent at or slightly below market as quickly as possible. With this strategy we’ve been able to hold these properties to about 6% vacancy. All investment properties were paid for with cash.
I’m not going to break down everything. Not for this post. But most of the expenses listed below were generated in the first 30-40 days after purchase…during the rehab portion of the property life. The rest of the expenses have been since they have been generating income with tenants in them. Expenses include repairs, rehabs, insurance, management, utilities when vacant…literally everything except taxes, which will add up. The income has been generated from the first tenant through to today.
Here you go. This is why owning rental property is a great investment.
Purchase & Closing Costs $1,944,191
Total Investment to date $3,211,521
Total income to date $1,212,159
The current value is based on comps with minimal additional repairs/improvements to the income property. The cost of sales would have to come off the value including but not limited to repairs for inspection requirements, realtor fees, closing costs including title fees, etc. Figure about 12% -15% cost of sales with all that in mind.
Current Value $3,807,500
Now there are differing ways to calculate your returns and I’m not going to go in to details because of the spread of months between the first and last purchase, time line of the repairs, etc. But no matter how you look at it the real estate investors that came to Kansas City have come out okay.
Fusing these two sets of results is my favorite way to look at it.
Current Value $3,807,500
Purchase Price + Initial Rehab $2,792,623
Cost v Value Differential $1,014,877
Total income to date $1,212,159
Expenses since rehab $ 420,398
Positive Cash Flow $791,761
As I said there are professional accountants out there that will give you several different formulas and of course all of this does not include the property taxes, as I noted above. Those taxes could add up to a takeaway of about $90,000. I just don’t want to take the time at this time to go in and add them all up. But in any case, those numbers are significantly better than the numbers my IRA returns. :)
Now, you may not have $3M to invest. Neither do I. But you can do one house. Or two. Get started today. Your retirement will thank you later.
If you have any questions about investing in real estate here in the Kansas City area, please, do not hesitate to contact Chris Lengquist at 913-568-1579.
Johnson County, Kansas is where I live. It’s in suburban Kansas City and the investment property inventory possibilities from the multi-family housing stock is down right now. There has been significant competition in the bids for the “good” properties. I’ve said it before and I’m saying it again. “The worm has turned.”
It should be noted, however, that I still notice a significant difference in the movement of investment property on the Kansas side versus the Missouri side of the state line. Missouri investment property candidates are selling, but at a much slower pace.
I only write all this to let you know that other investors are back in the Kansas City market. I noticed this pick up in about mid 2013 and it’s steadily built. No boom, mind you. And I consider that good. At least for our market.
Just thought I’d give you a short post so that you can follow this link regarding downtown Kansas City real estate development. Back in 2008 I was leery and shying people away from downtown KC loft purchases as investment. But six years later, while there has been no Big Bang (so to speak), KC’s commitment to downtown residences has been solid.
We now manage more than a few places downtown and are looking to manage more investment property in downtown Kansas City.
Follow the link and read up.
The more experience I have as a property manager the more aware I am about trees and your income property. Look, trees are expensive. Some types of trees are adept at getting in to your sewer pipes. (Think willow trees.) Some trees are extremely fragil. (Think Bradford pears.) And any tree is subject to carpenter ants, lightning. etc.
Taking a tree down can cost upwards of $4,000. That can wipe out an entire year’s cash flow. We have a cottonwood tree in Independence, MO right now that was struck by lightning this spring. It’s now crippled and dying and becoming a hazard to the house we manage and the house next door. $3,400 is the estimate to take it down. Ouch.
And it’s not like just anyone can do tree work. A 30′-40′ tree needs to be worked on by a professional. A professional who is bonded, licensed and insured. And check those references. You simply don’t want the liability of damage should things go badly bringing down a big tree.
I’m not saying you should buy only barren prairie houses. I am saying you should be aware of the trees. What kind of trees? How large? How old? How close to the house? (Too close to the house and they can contribute to foundation problems.) Just pay attention. That’s what I’m saying.
Let’s talk about the value of rental property for your retirement. And let’s throw away the discussions about cash on cash returns and cap rates and the like. Let’s just get down to what your retirement is going to look like if you add even one rental property to the plan. You already have social security (supposedly) that’s going to come in. You should have some sort of IRA or 401k that your employer maybe contributing to. My wife works for a Kansas school district so there is the KPERs required plan. Your state may have something similar. Etc.
But most people won’t have enough. Here is how even one rental property can help you with your retirement planning. Buckle up. Get comfortable and get out your calculator.
THE INVESTMENT PROPERTY FACTS
We’re going to base this on a lower bell curve house in Johnson County, Kansas. Not the best cash flow county but a safe, go-the-distance county where we know our investment isn’t going to turn in to a melting ice cube.
Purchase cost is $168,500. (Turn key, with closing costs.)
25% down payment at 4.875% & a 30 year amortization
Expected rent $1,425/mo = $17,400/yr
Expenses figured at 38% of Gross Rents which include;
- property management
- utilities when vacant
- basic repairs
With those expectations (based on 12 years of experience) your yearly cash flow would be a paltry $2,929 year.
THE NEXT 10 YEARS
We all know that over time real estate has proven to be a safe hedge against inflation. We also know that in the decade to come there will be ups and downs and stagnant periods and boom times and, well, if you’ve lived more than 30 years you’ve seen some big swings. So looking in to my crystal ball I can only go with history. And history in the Kansas City market tells me an average of about 3.25% – 3.5% per year over any given 10 year period.
But, I’m not even going to figure that. After 10 years we are saying that we;
- had a 2.5% per year steady appreciation rate
- only took out $1,500/yr of that $2,929/yr cash flow because of additional expenses, safety, etc
- didn’t raise rents one time until the 12th month of the 10th year.
THE 5 YEARS AFTER THAT
Now we raise the rents up to an acceptable ratio with the value of our house currently. For the next 5 years, with no variances, we go from $1,425/mo to $1,950/mo. We recalculate our expenses because we also expect those to rise. Because we had a fixed rate mortgage our annual debt service stays the same.
Thereby, our cash flow has now jumped to approximately $6,649/yr. Yet, we are only going to account for $4,000/yr in the figures below because I believe in being conservative and there is nothing wrong with having extra.
15 YEARS FROM THE PURCHASE OF OUR INVESTMENT PROPERTY
Now retirement is getting closer. Let’s take a look at where you are.
On this rental home that has been of good service to you you now have an equity position of not the original 25% you started with (your down payment) but of 65%. Because the tenants have paid down $40,250 m/l of your loan principal and the appreciation train has dropped you off at a home value of $244,000 m/l your total equity in the home is $160,500! That’s not a bad rise from your original $44,750 investment (with closing costs included).
The cash kicked off over the years doesn’t seem so bad now, either. Remember the first 10 years we weren’t figuring any rises in rent and keeping only $1,500 /yr. Times ten we have generated $15,000. Now in the last five years we have generated another $20,000 /yr in cash flow with the adjustments in rent. So that’s $35,000 more this rental property has kicked off over the last 15 years.
And we haven’t even touched on the tax advantages that your CPA has been helping you with over the years.
Essentially, your $44,750 investment in this one rental property has now become $195,500.
WHAT TO DO NOW
Now you have choices to make. At this time I turn you over to your CPA for tax planning. And we discuss the quality and condition of your property as well as the equity that is just waiting to be mined for better leverage elsewhere. Your choices include;
- Keeping the property. Your equity position will increase as likely as your cash flow increasing as rents continue to rise over the years. This is a very conservative approach but you’ll know by this time how your other investments have worked out.
- Selling the property outright. You’ll have capital gains to pay as well as depreciation re-capture. But you’ll have cash on hand for living expenses or medical bills or whatever you want.
- Sell and acquire using a 1031 tax deferred exchange. You may wish to turn this one property in to three properties for the next 15 years. We’ll have to see what the conditions are at that time.
Keep in mind we looked at a 15 year period of a steady, predictable economy. (Yeah, right.) Conditions may accelerate or decelerate this entire equation. But we (me?) sometimes confuse ourselves. We’re looking at all these sexy numbers and forget to get started! Today!
I hope this helps you when you are thinking about what even one property can do for you. Later, we can work out your particular situation if you like. You may have more cash to invest in real estate. You may have less cash to get started with your first income property. Each person comes from a different place.
Give me a call today to help you make a retirement plan through real estate investing. Let’s have A Retirement worth having.