By Ray Reuter
Over the past five years I’ve analyzed thousands of real estate deals, from pre-builds, to flips, to apartment buildings and everything in between. Not only do I analyze deals for myself, but this is something I’ve done for other investors in a consulting position as well. I’ve seen a lot of deals.
More importantly, over the same years I’ve bridged the gap many times from theory to real world property performance. I see how my own investments perform and I’ve reviewed property performance for many fellow investors. There are some surprising discrepancies between theory and real world (as with anything).
I am going to walk you through the biggest pitfalls I’ve witnessed in the world of property analysis, to guide you away from lofty promises down to what you can really expect from your real estate investments.
And no, I’m not going to walk you through the property analysis spreadsheet - odds are you’ve already gone through the ACRE program and you should have access to the REIN property analyzer. This is about aligning your analysis as closely as possible to real performance.
Here are some property analysis pitfalls to watch for:
- Rent – this might seem harmless enough, but almost 80% of analyses that come across my desk have delusional or inaccurate entries for this incredibly important aspect. Far too often investors have no clue what the property of interest will actually rent for.
Sure, it sound well and good to say ‘I think $1200 seems about right’ but how well is your property going to perform if the REAL market rents in the area are $900? Or what if the market rent is actually $1800 and you let the property go because it didn’t cash flow based on your analysis?
Knowing the real market rent for your property is critical. As a strategic investor it is your job to know the market rent and to be fully in touch with your competition. And if you really want to be on top of your game I strongly suggest visiting your competition, not just viewing listings on line. There is no better way to assess where you stand in the market than to visit the same units that your potential clients (renters) are!
So, in order to properly analyze your next investment, or your first, you must get clear on the REAL income you can expect.
- Vacancy – after rent, vacancy is the most common calculation that gets botched. Believe me, there’s nothing I work harder for than ZERO vacancy…but I certainly don’t use 0% when analyzing a deal, after all, vacancy happens.
Generally the proformas I see range from 0-3% for vacancy with many investors leaving vacancy out altogether, but the bulk of the investment world just seems to throw out 3% as a general rule of thumb.
I’ll tell you right now, analyzing your properties at less than 3% vacancy is a dangerous game, especially in the single family world. If you’ve ever had a tenant leave, had a unit turnover, you already know that it can often take a bit of time to get the property rent ready again – paint, cleaning, repairs, etc. It can also take some time to find a new tenant, especially if the current tenants weren’t very clean or they don’t make it easy for you to show the property.
It is very common to see a month of vacancy when a unit turns over, even more so when you have a management company handling everything for you, as they have other clients to deal with as well. No heavy math here, but a single month of vacancy on a single family home is equivalent to 8.3% vacancy…almost triple the typical 3% estimate. Heck, even two weeks of vacancy will net you slightly over 4% vacancy for the year.
Yes, zero vacancy is possible, but it takes a lot of work AND planning! Do yourself a favor, budget 8% during the analysis stage and then work hard to hit ZERO (while maintaining top rents AND great clients of course!).
- Repairs – repairs and maintenance are probably one of the more difficult aspects to assess and plan for with your real estate. There are so many factors that impact this figure: age of the building, level of maintenance done in the past, style of building and building components, and the often looked over aspect of property location.
Again, like the vacancy, this expense is often grossly underestimated during the analysis stage OR estimated without taking into account the points I mention above. For instance, some really strong rental markets like Edmonton have a high cost of labor and this quickly translates into increased operating expenses! Where I might be able to get work done quickly and cheaply in one market it might cost me a pretty penny in another.
One quick personal example would be a minor garbage issue I had in Edmonton recently (I live in BC). My bill was over $350 to clean up a small area in the alley (no appliances, no large items, just a bit of crap). If this same situation occurred where I invest in BC, the expense would have been $50. Now granted my place in Edmonton rents for more (and both factors were part of my analysis and decision to buy) but these things can add up quickly, so pay attention to where you invest and whether you self manage.
My personal rule of thumb is 8-10% of gross rent on a single family home that is over 5 years old, 8-15% on older properties, 3-5% on new builds, and between $700-$1200 per door per year on a multi-family building.
But again, you must pay attention to:
Age – at about 15 years old larger (and more expensive) components such as furnace, water heater, and roof start to go
Style – certain HVAC systems need more maintenance (if you see the word steam be very careful!), some flooring types don’t last, some window types are junk, etc.
Maintenance – just like a car, how well was the place taken care of? Have the gutters been overflowing for years and rotting out areas?
Don’t let repairs scare you, they are a cost of doing business in the real estate world, but you need to control your costs as best you can. I mitigate some costs in this arena by doing the work myself – yes, some people say it’s not worth your time, but I rather enjoy doing some of the minor tasks.
Bottom line – things will break, much faster on your rentals than your own home, so budget for them appropriately.
In the end, I’ll leave you with one piece of advice on rental real estate that goes against what many folks will tell you – real estate is not always passive income, it takes a lot of work even if you have a property manager. But the one thing that will save your bacon is your willingness to take charge and do whatever it takes to make it work. Got vacancy? Advertise yourself, sell the deal, get it done. Got a maintenance issue that’s bleeding you? Step in and fix it, don’t sit back and pay bill after bill because it’s easier. Rental real estate is a business first and foremost, and if you treat it that way, like your own personal startup, you can be incredibly successful.
Ray Reuter is a real estate consultant and an investor who owns single and multi-family properties in Alberta and BC. He received his BSc from the University of Kentucky and an MSc (abt) in Entomology from University of California, Riverside and has been trained through REIN’s REIA program taught by the Dragons’ Den Business School. Ray works with clients of the REIN by helping them with the real estate investment questions, marketing strategies and property analysis. Reach Ray at email@example.com.