Lex Levinrad explains how to calculate your positive cash flow on rental properties and how important it is to treat it as a business.
Listen in for a great tip to calculate if your rental property is a good deal or not, by comparing the cost of rent charged to the cost of the property.
Mike: Welcome back to the FlipNerd.com REI Classroom where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. Now let’s meet today’s expert host.
Lex: Hi, everyone this is Lex Levinrad with the Distressed Real Estate Institute and I’ve got another lesson for you guys on REI Classroom. Today we’re going to be talking about managing rental properties and cash flow.
Mike: This show as sponsored by PassiveRental.com.
Lex: On previous lessons we spoke about the advantages of buying rental properties long term but what I want to do today is I want to cover with you, first of all how to manage rental properties and also the details of the cash flow and how you break that down.
A couple of rule of thumb things that’s good to have, make sure you’ve got a notepad and pen handy, write these down. First of all for cash flow there’s an old rule of thumb that’s called the 100 times rent rule which says that if you’re buying a property for more than 100 times rent it’s going to be expensive.
If you’re buying it for less than 100 times rent it’s going to be cheap. If a house rents for $1000 a month a hundred times rent will be $100,000. If you can buy a house let’s say for 50,000 and rent it for 1,000 a month, you’ll be buying it at 50 times rent and it would be a screaming bargain. If you come across something like that make sure you give me a call.
In the previous peak, let’s say in 2007, we saw prices go up to 200 times rent, even 250 which is very, very over valued. So you can keep yourself, as a good rule of thumb, stay under the 100 times rent, try and buy properties for no more than 100 times rent and you should cash flow.
Another rule of thumb that’s good to have is what’s called the annual gross income. What you do is you simply take the monthly rent multiply by 12 and then divide it by your purchase price. Let’s say a property rents for $800 a month and you multiply that by 12, that’s $9,600.
If you bought that property for $96,000 then you would be earning 10% on your money assuming you purchased the property for cash and without factoring in the taxes and insurance. That’s called the annual gross income and in certain markets right now in the United States those are very high, as high as 25% of annual gross income in certain cities.
A lot of cities are known as good rental areas, for example Cleveland and certain cities in Texas and Tampa, Atlanta. We’re located in Florida and we have right here in the counties we live in, 12-13%, 15%. I routinely buy proprieties with annual gross income about an hour north of me of 20-25 even 30% sometimes. If you look out there, there are bargains.
While we’re talking about rental property, your component, we’re talking about rental income. Let’s say rental income is 800 a month, you need to look at your payment, your mortgage payment is basically you’ve got four components to it. It’s got principle, interest, taxes and insurance. If you use something like a hard money loan to get into your property initially, then you might not have any principle payment. You might just have interest, taxes, and insurance.
Once you get some kind of long term financing in place if you refinanced, then you’ll have principle interest, taxes, and insurance. Interest payment is simply what it is, if you’re borrowing money from someone you’re paying them 10%. That’s your interest payment. If you have a long term mortgage in place and your mortgage is at 5% let’s say, on a conventional refinance and that’s your interest rate.
Principle is simply how much you’re paying towards your principle and that’s reducing your debt payment. Taxes are a fixed thing. You can pull up on the [inaudible 00:03:51] website in any city or county in this country. Insurance is also a fixed thing. You can call any insurance agent that specializes in properties and figure out what your insurance costs are.
If you take your gross rental income, let’s say a $1000 a month and then you take your mortgage payment, let’s say your mortgage payment is $1,000 a month, add to your payment the taxes and the insurance so you figure out what your net is. Once you have your net you can see how much cash flow you have and typically a good rule of thumb is you need to buy properties with positive cash flow.
When I’m saying positive cash flow I don’t just mean like $50 or $100 because things break when you have rental property. You have things that you need to repair. If you want to be super conservative, this is a very conservative assumption, but I like to assume that out of every 12 months of rent you will loss one month to a vacancy. Meaning a tenant moving out and replacing with a new tenant and you will lose another month to repairs. Meaning a house that rents for 1,000 a month somewhere during that year you can spend as much as $1000 in repairs.
On average if you look at a bunch of different houses what you’ll see is some have repairs of less 200-300. But others have bigger repairs, maybe an AC system or something that goes. It’s a little bit more. That’s a good conservative rule of thumb.
Now the final thing to note is with rental properties, you’ve got to treat it like a business. If a guy owes you rent or a lady owes you rent and they don’t pay on time, you have to have them move out and find another tenant. Different states have different laws. Some states are landlord friendly states and other states are tenant friendly states. If you’re thinking about being a landlord, clearly it’s beneficial to do it in landlord friendly states where it’s easier to evict a tenant and put a new tenant in.
Just remember with rental properties focus on positive cash flow. Property has to have rental income greater than your expenses and not just $50 or $100, but more than that. Remember to take all the benefits, the tax advantages, depreciation, appreciation, etc., into consideration. Once again this is Lex Levinrad with the Distresses Real Estate Institute and thank you for watching today’s REI Classroom.
Mike: PassiveRental.com is your source for turnkey, done for you rental properties. If you’d like to be an investor and not a landlord, please visit PassiveRental.com, to learn how to purchase cash flowing professionally managed rental properties in the hottest rental markets across the country. We can also help connect you with financing for your next property. Invest the easy way today and get started by visiting PassiveRental.com.
Please note, the views and opinions expressed by the individuals in this program do not necessarily reflect those of FlipNerd.com or any of its partners, advertisers, or affiliates. Please consult professionals before making any investment or tax decisions, as real estate investing can be risky.
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