We Earned $231/hr From Our Rental Properties in 2018

The 2018 #s are in! The biggest # we track when it comes down to it is cash flow. While cash-on-cash return comes in at a close second for priority, the main focus for us is cash flow. And while I don’t go into net worth accumulation by someone else paying down your debt (i.e. the tenants) nor do I go into tax advantages, those are hugely beneficial and worthy of their own post. Today, just cash flow. There are several rules of thumb most people use when analyzing properties for cash flow: the 50% rule, the 1-2% rule, the $XXX/per door rule, the Lobster rule, the Alexa rule, the downward dog rule, all sorts of rules. Our primary focus is $100/per door/month and 50% rules.

Wait, before we go any further most of you know I’m involved in a 42 unit apartment complex. For this exercise the 42 unit is not being considered as we are still in process of stabilizing a heavily deferred maintenance property. I’m also not sure my partners want me sharing detailed info on that asset with the world wide webs so I’ll keep this exercise to the properties just my wife and I own. However, 2019 is looking VERY promising for the 42 unit.

Moves & Acquisitions

In 2018 we sold one property (our very first rental property in Pensacola – the one we’ll never sell!) and 1031 Exchanged into a 4 plex. Other than that our focus was geared toward stabilizing a couple acquisitions that were made in mid-late 2017.

Thank You PM Teams!

I can’t say enough about our PMs. Having a full-time job and growing family (ref: How I Balance), we have very little time to focus on managing these properties, plus managing our own rentals is just not what me or my wife want to do. Thus we hire professional property managers to manage all of our properties. We have a few different property managers based on our properties’ locations being in different cities, BUT those property managers are a huge part of why our hourly # is so high. All in all, we averaged about one hour a week working with our property managers. So 52 hours a year. Thank you Team! YOU GUYS ARE AWESOME!

The Numbers

Before we get started, here are a few definitions to ensure you and I are on the same page when it comes to The Numbers:

  • Expenses column includes mortgages (if applicable), insurance, taxes, property management fees, repairs, legal fees, miscellaneous operating expenses and capital expenses. Our expenses were high this year and I get into that in more detail below.
  • Revenue column includes rent, pet fees, and late fees.

Again, I can’t say enough about our PMs and the systems they have in place to keep us abreast with situations but overall they just handle them. So here is how I came to us earning $231/hr on our rental properties in 2018:

  • 52 Hours Worked for the Year (thankful for awesome PMs)
  • $12,038 Annual Cash Flow in 2018
  • $12,038 cash / 52 hours = $231.50/hr

One goal we want our assets to accomplish are $100 cash flow per door/per month. On average we were just shy of that in 2018 so I won’t spend any time discussing that here, but I do want to address the 50% rule.

Not Meeting the 50% Rule

For those of you not familiar, the 50% rule simply states that fifty percent of your rental income should cover all of your expenses (I’m grossly summarizing for the sake of this post). And since only 1 of our properties met the 50% rule, I feel the need to explain, just how close the rest of them were and the importance of keeping separate, sacred accounts for each property to cover vacancy and the more costly, unexpected capital expense items.

  • Little Yellow House: we actually sold this property in February 2018, so only two months into the year. The sell of this property yielded a 77.5% ROI for the life of us owning this property. The proceeds from this house were 1031 exchanged into the 4 Plex – Mobile. So while we experienced a negative cash flow for the 1st two months of 2018 with this property, all-in-all, it provided a great return from acquisition to exit.
  • Duplex – Gulf Breeze: We replaced one unit’s HVAC at a cost of approx. $3700. Not having to do so would have easily put this property above the 50% rule. Thankful for the reserve accounts we established. If you’re not establishing those reserve, sacred accounts for capital expenses and vacancy, DM me.
  • 4 Plex – Mobile, AL: this was the acquisition we 1031 exchanged into from the Little Yellow House. Almost completely turn key, but we had one tenant turnover and a few large repairs to make during the acquisition process – no worries though, we bought this at a bargain!
  • Mobile Home – Pensacola: this is the property from our First Tax Deed Auction. It had a rough 2018 with a tenant turnover, vacancy, a HVAC replacement and some fairly major plumbing issues resulting in >$3k in expenses. 2019 should be a strong, stable year for this one.

In closing, 2018 was a profitable year and I am anticipating 2019 to be much better. By that I mean I’m anticipating our cash flow to almost double as a result from just the two transactions. And while most investors don’t look at hourly earnings from rental properties, my W2 background has me thinking that way. If you’re not engaged with our group on Facebook, you’re missing out on conversing with us and 4,500 other W2 real estate investors. Join Us: Real Estate Investing for the W2 Employee

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Real Estate Investing Terms: DTI

First off, what is Debt-to-Income? The Debt-to-Income ratio is one used by lending institutions when underwriting your loan (for almost anything – car loan, mortgage, HELOC, etc). DTI is a calculation they use to  measure the risk on which you’ll be able to pay back the loan you’re seeking. The lower your DTI, the less risky you are to a lender. Think of it as your golf score, lower is better.

If you have just one source of income, DTI is fairly simple to calculate. Take your recurring monthly debt divided by your gross monthly income. Expenses like groceries, utilities, gas, insurance are not usually involved in this calculation. For example, let’s assume your current situation looks like this:

  • Reoccurring Monthly Debt: $2,030
    • Personal Mortgage/Rent: $1,000
    • Car Payment: $320
    • Total Credit Card Payments: $600
    • Student Loans: $110
  • Gross Monthly Income: $6,000

DTI = Reoccurring Monthly Debt / Gross Monthly Income or in this case:

DTI = $2,030 / $6,000 = 33.8%

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BUT WAIT, there’s more! What about the loan your seeking? Let’s say hypothetically the loan your seeking will add $700 more in monthly debt. Let’s recalculate as the lending institution certainly will.

DTI = $2,730 / $6,000 = 45.5%

Most lending institutions will consider you an acceptable risk if your DTI is less than 43%. Remember the lower your golf score, I mean DTI, the less risky you are to a lender.

BUT WAIT, there’s EVEN more! You and I are both here because of buy & hold real estate investing. So let’s assume you’re relatively new, have 2 properties in your portfolio and are seeking a loan for a 3rd property. DTI becomes increasingly more complicated to calculate the more properties and the more loans you have in your personal name but one of the reasons why I encourage you to build your team AND a solid relationship with a local bank is because it makes this process much easier as you start acquiring more and more properties. Using our original example, let’s do some more math!

  • Reoccurring Monthly Debt: $3,258
    • Personal Mortgage/Rent: $1,000
    • Car Payment: $320
    • Total Credit Card Payments: $600
    • Student Loans: $110
    • Rental Property #1 Mortgage: $415
    • Rental Property #2 Mortgage: $823
  • Gross Monthly Income: $9,625Gross W2 Income: $6,000
    • Gross Rents Property #1: $1,375
    • Gross Rents Property #2: $2,250

DTI = Reoccurring Monthly Debt / Gross Monthly Income or in this case:

DTI = $3,258 / $9,625= 33.8%

Making up the debt/income numbers as I go along, I found it extremely weird two of these examples both came out to 33.8%

By the way, check with your lending institution to ensure you understand their seasoning time frame. In this example, “seasoning” is how long a rental property has to be occupied to count the gross rents toward your DTI calculation. Most seasoning periods fall between 6-18 months but best to ask your lending institution what they require. In my examples, all properties are seasoned, except for the 3rd one you’re wanting to purchase.

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  • Reoccurring Monthly Debt: $3,258
    • Personal Mortgage/Rent: $1,000
    • Car Payment: $320
    • Total Credit Card Payments: $600
    • Student Loans: $110
    • Rental Property #1 Mortgage: $415
    • Rental Property #2 Mortgage: $823
    • Potential Rental Property #3 Mortgage: $722
  • Gross Monthly Income: $9,625
    • Gross W2 Income: $6,000
    • Gross Rents Property #1: $1,375
    • Gross Rents Property #2: $2,250
    • Gross Rents Property #3: $0 (once seasoned will be $1,700)

DTI = Reoccurring Monthly Debt / Gross Monthly Income or in this case:

DTI = $3,980 / $9,625= 41.3%

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Still under that 43% mark we’re striving for and if you have a great relationship with the bank and all other items check out, you should be on your way to close.

Also, gross rents minus the mortgage on a rental property does not equal cash flow. This is a common misunderstanding of the term and if you’re investing for cash flow, you need to ensure you’re calculating it accurately. More detail on cash flow here: REI Terms: Cash Flow.

In closing, DTI is just one factor a lending institute will consider when evaluating you and underwriting your potential next loan. Make sure your properties are seasoned properly when doing your own calculations but more importantly work on the relationship with your local bank to understand what all they require.

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Real Estate Investing Terms: Net Operating Income

OK, ok, full disclosure, this one is really for me. When recently analyzing a real estate investment opportunity, I added an expense that is not considered an operating expense and it totally through off my evaluation of the #s and almost resulted in a very offensive offer. Sometimes offensive offers are required, but always take a 2nd look or obtain a fresh set of eyes to review your analysis.

Back to the basics, I started this blog as a way to create a knowledge base for myself, a repository I can reference over and over. As I combed through my own articles I discovered I had not approached the topic of how to define nor calculate Net Operating Income, also known as NOI. Future self, you’re welcome. (I know I’ll have to reference this again soon).

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As we walk through this post, let’s work through an example. We’ll keep it simple and easy and analyze a duplex that receives a total of $1,000 month for rent ($500/each side). Also, when I talk about analyzing I’m talking about what historically the rental property has produced, not a pro forma. Pro forma = lies and any add you seeing “rents could be XXX of dollars more than they are now”is almost always a lie. If it was that easy the current owner would have done it by now, something is fishy. Always question this lingo, and always buy on the historic run rate of the property, not how it can potentially perform. Make sense?

First, let’s start with a definition. Net Operating Income is defined as the annual income generated by an income-producing property after taking into account all income collected from operations and deducting all expenses incurred for operations (thank you Google).  More simply put:

Net Operating Income = Operational Income – Operational Expenses

Operational Income is fairly straightforward. Any income being produced by your rental property is operational income. Rent is the most obvious. Laundry facility income is a second source if you have one on your property and/or storage facilities located on the same property are all considered part of your operational income.

Pro Tip: for a more advanced way to compute Operational Income, compute Gross Operational Income which is calculated by subtracting Vacancy & Credits from Gross Potential Income. More on this subject later, want to keep this post introductory. 

Operating Expenses are a little more involved. By that I mean, what is an operating expense and what is not an operating expense. Property management, utilities, insurance, property taxes, lawn maintenance/care, home maintenance or repairs are the main operating expense categories. Mortgage payments are not considered an operating expense, which is the incorrect expense I spoke about earlier – practice makes perfect.

Working through our example, looking at the #s from an annual, historical view where both tenants have always paid rent, $1,000/month, on time:

  • Operational Income = $12,000
  • Operational Expenses= $7,593
    • Property Management = $1200 -> 10% of income
    • Utilities: $0 -> tenants are responsible for all
    • Insurance: $1,164 -> annual premium price
    • Property Taxes: $978 -> they are what they are
    • Lawn Maintenance: $600 -> you take care of this for your duplex tenants, you’re a nice guy!
    • Maintenance / Repairs (total for both units): $3,651

Net Operating Income = $12,000 (Operational Income) – $7,593 (Operational Expenses)

NOI of $4,407, but is this good? And don’t confuse NOI with cash flow. And no, this is not good.

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Why is Net Operating Income (NOI) important? 

For starters, NOI is important so that you can ensure you have enough monies to cover additional, non-operational expenses and still cash flow as desired. For example, we now know mortgage expenses are not included in calculating the NOI, but it is a very important expense we need to ensure is paid monthly. With an NOI of $4,407 ($367.25/month) and desires to cash-flow according to our criteria, this doesn’t leave much room to pay a mortgage.

In this scenario, the expenses seem to be a little high (target operational expenses @ 50% of rental income), so one of a few things is the issue. Either (a) ran into some capital expenses during the past year, which you should always plan for, separate post, (b) rent is not high enough (c) this is just a bad deal! Further digging will give you the answer.

Pro Tip: With Property Taxes, be cautious with your future projections. Even though we are analyzing here based on historical property run rates, increase in property value thus property taxes may increase with a higher sell price than current property appraised value. This can eat into your cash flow quickly. Any concerns, give your county property appraiser a call to discuss. I’ve always found mine to be helpful.

 

How I use NOI in Analyzing Potential Rental Properties

Most commonly I use NOI for two scenarios: (1) to quickly analyze deals like we did through this post to ensure it will cash flow like I want and (2) to derive at an offer price for a potential rental property, especially for commercial properties (office buildings, 5+ unit multi-family, & apartment complexes). To derive at a fair offer price for a commercial property you divide the NOI by the current market CAP Rate. A separate, more advanced posts.

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Real Estate Investing Terms: Cash On Cash Return

When performing the Cash-on-Cash Return napkin test, I won’t further analyze anything that is below 12%. The target is 15% and higher but if we can still hit our $100/month cash-flow minimum, we’ll consider it with a lower CoCR.

real estate investing cash on cash return

 

Cash-on-Cash Return or CoCR

CoCR = annual cash flow before taxes divided by total cash invested

The best way I understand CoCR is like this. … For the scenarios below, let’s pretend I have $50,000 in my Pensacola bank account.  We’re going to make a lot of assumptions here, but remember this is just a napkin test.

Scenario 1: I pay $50,000 cash for a 2 bedroom/2 bath single family house that yields $700/month in rent and Cash Flows $300/month. Over the course of the year (assuming 100% occupancy) my Cash Flow is $3,600 (i.e. $300/month x 12 months). So I take that $3,600, divide it by the $50,000 I spent on purchasing the home and that yields a 7.2% Cash-on-Cash Return for this Pensacola house. Compared to the return I receive on my savings accounts, this is an improvement, but not what we’re looking for on a Pensacola real estate investment.

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Scenario 2: I pay the same $50,000 as a down payment on a $250,000 4-plex multifamily property (most Pensacola banks require 20% down on a rental property). This 4-plex is made up of 2 bedroom / 2 bath (just like our single family residence in Scenario 1). Each unit of our 4-plex brings in $150/month in cash-flow. Less cash flow than Scenario 1 to accommodate for the mortgage payment each month. Again, assuming 100% accuracy for the year, we now have $150/month x 12 months x 4 units = $7,200. Since we used the same $50,000 as a down payment, we divide $7,200 by that same $50,000, giving us a 14.4% Cash-on-Cash Return.

Actually, if this were a real world scenario, Scenario 2 is within range of passing the napkin test and would continue on through our Tripod of Investing Criteria It doesn’t hit the $200/month cash flow # just yet, but more due diligence will reveal if we can increase rents or add another source of revenue from the property to bring those #s up.

To compare, let’s say I just keep that same $50,000 in my Pensacola savings account. The current APR is <1% but sticking with easy math, let’s pretend it is 1%. My return on that “cash” is 1%, or, very horrible…only $500. Considering inflation rates, my return would actually be negative, but that topic is for another post.

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Cash-on-Cash Return (used in another way):

I recently changed insurance providers because of this one property and scenario. My insurance was coming up for renewal and thought, what the heck, let’s shop. Sure enough it was worth it. Once my, now new, insurance provider reviewed my policy and last home inspection, he came back with amazing news. If I installed Hurricane Clips on my roof, my premium would go down approx. $394/year. Cost to install the Hurricane Clips = $965, yielding a Cash-on-Cash Return of 40.8%. I’ll take it! More details of this scenario coming out in a future post. Stay tuned.

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Real Estate Investing Terms: Cash Flow [example]

Because we focus on buy & hold rental properties in Pensacola, Cash Flow is the most important metric we look at when considering an acquisition.
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real estate investing pensacola fl

Caution: This post goes technical real quick and my geeky side does come out 🙂

Most people, even some experienced Realtors, think cash flow is the gross revenue generated from a rental property. Unfortunately, that is not true.  Cash Flow is similar to Net Operating Income, but also includes some calculations for future expenses. Let me explain…

Cash Flow, as I calculate it, is the Monthly Revenue minus ERMVITC.

Monthly Revenue – ERMVITC = Cash Flow

What is ERMVITC?  Glad you asked.
Expenses (General): these include utilities, garbage, mortgage, property management fees, etc. You should be able to obtain exact #s for these variables.

Repairs & Maintenance: I typically estimate these between 5-10%. The range is based on the amount of repair work done prior to placing a tenant. The work performed up front, the lower the percentage and vice versa.

Vacancy: Also estimated between 5-10% based on the property, current tenant situation, and neighborhood.

Insurance: Insurance carriers always vary, so I encourage you to shop around. While underwriting a potential acquisition I stay conservative an estimate $100-125/unit.

Taxes: usually a known quantity by visiting your county’s Property Appraisers site.

Capital Expenses: I typically estimate these between 5-10% also. The range is based on the amount of repair work done prior to placing a tenant in the property and covers such things as a new roof, bath room remodel, appliances, etc. And just like RM,  the more work performed up front, the lower the percentage I use in my underwriting and vice versa. 

 

Here is a real life example of how I evaluated a Pensacola property for acquisition. This property is fairly old and needs some repairs so I’ll be using 10% for Repairs & Maintenance as well as 10% for Capital Expenses. This property should stay rented fairly easy so I’ll use 7% for vacancy. I’ll also be using 10% for Property Management Fees, the tenant is responsible for all utilities, there is no HOA and I’m purchasing this Pensacola property with cash, so no mortgage payment. Let’s do some math!

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Monthly Rent: $750

Expenses: 10% of $750 = $75 (for Property Management)
Repairs & Maintenance: 10% of $750 = $75
Vacancy: 7% of $750 = $52.50
Insurance: $125/month
Taxes: $840/yr or $70/month
Capital:  10% of $750 = $75

Add up all of our estimated expenses:
$75 (E) + $75 (RM) + $52.50 (V) + $125 (I) + $70 (T) + $75 (C) = $472.50

$750 (Monthly Rent) – $472.50 (ERMVITC) = $277.50 (Cash Flow)
 
 

Based on these calculations, this meets one of our investing strategy criteria. Now to further evaluate this property with our other criteria before making an offer.

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Real Estate Investing Terms: Capitalization Rate

Cap Rate…it’s not science rockets!? Wait, did I say that wrong?
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real estate investing pensacola fl

Capitalization Rate (Cap Rate for short) is the measurement used to reveal how well a real estate investment will perform or is performing. I look at 3-5 investments in Pensacola a day and Cap Rate is one of the factors I consider when investing or deciding to hold onto or let a property go. There are many ways to calculate Cap Rate but I do it by dividing the annual net operating income by the original capital costs (or its current market value). I explain why the potential to use different denominators below.

The example we’ll use for this post is a SFR with a purchase price of $50,000 and after all monthly expenses are paid, I expect $350/month in positive net cash flow (or $4,200/yr.), So, the net operating income for this property is $4,200/yr. Cap Rate is calculated as follows:

  • $4,200 / $50,000 = 8.4% Cap Rate
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A couple of resources we use, put Pensacola property appreciation between 1.2-1.8% annually, on average, for the last 30 years. For this calculation we’ll land in the middle using 1.5% appreciation. 

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Using our same example, let’s fast forward 10 years down the road. Now that I’ve owned the property for ten years, I want to see how this piece of property is performing against other properties in my portfolio. To recap, I purchased the property, made some improvements and some natural appreciation has occurred. Forcing appreciation by improving the property has allowed me to increase rents over the last 10 years. By doing so, this property’s annual net operating income is now $6,000 and with 1.5% appreciation for the last 10 years, the property is now worth approx. $58,000. After owning the property for 10 years, my Cap Rate calculates as follows:

  • $6,000 / $58,000 = 10.34% Cap Rate
At the 10 year mark, if I use my original purchase costs to calculate Cap Rate, my cap rate would look like this:
  • $6,000 / $50,000 = 12% Cap Rate (higher, but not an accurate insight on how this asset is performing today)

Cap Rates are used to compare one investment to another. If I’ve owned the Pensacola property for years, I use the present market value as my denominator. If I’m underwriting a property for potential purchase, then my denominator is my expected initial costs.

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