Welcome to episode 4 of the Real Estate Investing Roadmap Podcast! I’m your host, Matt Jones. I’m an avid investor and full time Realtor located here in beautiful Pensacola, Florida.
Last time we were together I covered house hacking strategies in detail and today we are going to build on those strategies by talking about how to run your numbers when considering whether or not a property would make a good house hacking investment for you. To be clear the numbers we will talk about today are for house hacks where you will live in the property and use it as a rental either while you are there or after you move out. If you are doing a live in flip or any kind of house hack where your goal is not cash flow then you’ll want to concentrate your analysis on the investing model of that strategy. Everyone is different so this is just an example and I encourage you to make sure that you run your numbers and evaluate properties in such a way that helps move you closer to your goals.
My main metric for considering a house hack deal is the return on investment that I will achieve when I no longer live in the property. I don’t want to under-value the savings that I will get from living in the property, that is huge from the standpoint of advancing yourself financially but if the property won’t have cash flow once I move out then the advantages while I live there just aren’t worth it for me to buy that property.
Ok, lets dive in!
For those listening and not watching this episode, I encourage you to check out the youtube video at youtube.com/@realtormattj to see this written out on a white board.
For this example we are going to say that you are considering a home priced at $200,000
I need a couple of pieces of information before I can run my numbers.
Mortgage Principal & Interest
Property Taxes
Insurance
Market rental rate
In reality you can only estimate these numbers and that is fine. I encourage you to update your numbers as you are able to verify exact figures but for your initial cash flow analysis it is completely fine to use the best estimate that you can find. Don’t get caught in analysis paralysis here, you need to analyze frequently and quickly up front so you can decide whether or not to pursue a property. You move your estimates from pencil to pen as you finalize numbers when you move through the offer and closing process.
Let’s start with the principal and interest on your mortgage loan. I used mortgagecalculator.org and assumed a 3.5% down FHA loan, i put 0 for taxes and 0 for insurance because we are going to estimate those separately. The principal and interest portion of your monthly mortgage payment assuming 5.5% interest and 30 years would be $1176.
Taxes will vary widely by state and even city but there are other factors that can have a large impact on the property taxes of a property such as how long has the current owner had the property and is it their primary residence? The answers to those two questions can impact the taxable value for the current owner in a way that provides a large tax savings that the new owner of the property will not qualify for. I always check the current property taxes when available but I also like to compare them to my expected property tax try and avoid being surprised by a large property tax bill. For our example, let’s say that I can see that the current owner paid $950 in property taxes last year but that, based on my research average property taxes for this area are .85% of the property’s market value which would be $1700. I want to use the higher number since I expect the county to reassess the property after closing. Where did I come up with .85%, well for our example I made it up but often this is a number that you can arrive at by talking to your local tax assessor, studying recent sales in the market where you are buying or by asking your real estate agent, your lender or even your title company for an estimate. Once you have a property under contract, at least in my area, your title company can do a more thorough tax estimate for you.
So I take the $1700 in estimated property taxes, divide it by 12 months and I have my figure of $141 per month for property taxes.
Next you’ll need to estimate insurance. This is easier in some states than others and here in Florida it is one of the more challenging line items to estimate accurately. Insurance varies significantly by area so don’t just use my number, I recommend talking to your agent or an insurance broker about what number you might want to use for the area where you are purchasing and any other factors to consider. For our example, I’ll use 1% of the property value which would be $2000 per year. Since we are analyzing the monthly cash flow I will need to divide $2000 by 12 months which gives me $167 per month.
The last line item I look at on the expense side of the equation is miscellaneous expenses. Miscellaneous expenses would include any owner paid utilities, lawn care, pest control, hoa dues or anything else that you as the owner will pay that doesn’t fall in the other categories.
Now I need an estimate for the market rental value of this property. Your real estate agent should be able to run a market rental analysis for you but for the sake of convenience and time I recommend doing your own quick and dirty version. If the numbers work, or they are close to working, have your agent do a market analysis and then update your figures accordingly. For our example let’s say that this home rents for $2,000 per month and meets the 1% rule.
Rent: $2,000
Less:
Mortgage P&I $1176
Est. Taxes $141
Est. Insurance $167
Misc: $0
= $516
This is where many people stop and call the difference between rent and the PITI their net cash flow. Many people will use this number to brag about their high cash flow but they are lying to themselves and lying to you. Not finishing the equation to get your real cash flow is a great way to go broke in real estate
Let’s look at the numbers a little more in depth to help you get a more realistic projection for this property.
Rent: $2,000
Less:
Property Management $160 (8-10%)
*For several reasons It’s a good idea to estimate property management in your numbers even if you plan to self manage. 1) You want to give a value to your time 2) Circumstances change. What if you have to move across the country or even to a different county? What if you hate property management and want to get it off your plate? What if you are physically or mentally unable to manage the properties at some point in the future? Even if you plan to self manage it’s a good idea to have room in your budget to hire a property manager if you had to or wanted to at some point in the future. In most areas you can expect to pay around 8-10% for a competent property manager.
Vacancy $100 (5%)
*We’d all love to have that tenant that comes in and stays for a decade but in reality most tenants move every couple of years. You’ll want to account for that in your numbers. It’s also important to have a sense of urgency when it comes to making repairs between tenants and finding a new tenant. At $2,000 per month every day that the property sits empty costs you $67 in lost rent so time is of the essence.
Repairs/CapEx $200 (10%)
*I personally use 10% for repairs and CapEx combined but there are times when it would make sense to use 10% each or even more than that when your renting a home that is in major disrepair. There are also times when it makes sense to estimate less than 10% like if you bought a new construction home. Some investors prefer to carry a home warranty which will also impact this number. The reason that I use 10% is because I typically fix up a property after I buy it and I don’t usually have many repairs for the first few years so I am able to save up a buffer of unused repair and capex money before I have major expenses.
Miscellaneous Expenses: $0
*On single family properties I expect the tenant to pay for their own utilities, lawn care and pest control if they desire it. If it is in an HOA I do typically pay that expense but our example house is not in an HOA.
Mortgage P & I: $1176
Est. Taxes: $141
Est. Insurance $167
Misc. $0
Net Cash Flow = $56
Way different than the original estimate right? The good news here is that your cash flow will probably go up over time as rents increase. Another thing to consider in today’s higher mortgage rate environment is that lower rates in the future would mean a rate to refinance to a lower rate which could significantly bump up your cash flow.
While I’m not super excited about $56 in cash flow I also am not discouraged by this number. Remember, real estate makes you wealthy over time by working for you in more ways than just cash flow. Mortgage paydown, appreciation in the value of the property and tax breaks are just some of the other benefits of investing in real estate. We covered those more in depth in the episode titled “why invest in real estate” so be sure and check that out if you haven’t already. You can also find an easy to follow written explanation on how to run your numbers on my website which is RealtorMattJ.com.
So $56 per month in cash flow equals $672 cash flow per year. Assuming that you paid 3.5% down with an FHA loan and paid all of your own closing costs, lets use 2.5% for closing costs, then you have $12,000 of your own money into this property. $672 annual cash flow divided by the $12,000 you have invested equals a cash on cash return of 5.6%. I’d love to see that number at 10% but in a hot market a cash on cash return of 5.6% wouldn’t be a bad return at all.
Side note: now that the market has cooled a little bit, you might be able to get the seller to pay for your closing costs and that would boost your cash on cash return to 9.6% because you are now dividing your $672 in annual cash flow by your $7,000 downpayment.
Ok, let’s go back to the scenario where you paid your closing costs & downpayment and you have $12,000 of your money invested. To complete the financial picture here let’s look at your total expected return:
Annual Cashflow: $672
Annual Mortgage paydown in the first full year: $2,734
*This will go up every year until you pay the property off
Expected appreciation in value 2.5%: $5,000
*This is the expected value based on a conservative view of long term appreciation trends. As we’ve seen in recent years your property can go up much much more than 2.5% per year. It’s also possible, although more rare, that it could go down in value in a given year.
Tax Savings from depreciation: ???
Total expected annual return: $8406
Total expected annual return on your investment as a percent: 70% !!
If you wanted to be a little more conservative and leave out appreciation the numbers would look like:
Total expected annual return: $3406
Total expected annual return on your investment as a percent: 28.3%!
Those are powerful numbers. What would it look like if your returns stayed steady and you held the property for 20 years? Well, with the more conservative approach you would have made over $67k on your initial $12k investment between cash flow and mortgage pay down. If you include appreciation that number jumps to $168k over the same 20 year period. Real estate combined with time can be an incredibly powerful tool to make you wealthy. Imagine if you were able to buy one property per year or even every other year. What would that do for you financially?
The numbers we just covered are not limited to house hacking. You can use this model to run your numbers on any rental property investment although you should expect that your downpayment will be higher on most non house hack deals.
If you are going to rent out part of the property while you live in it then a good additional exercise is to figure out how much money you will save on your monthly living expenses but I’ll remind you that, unless you plan to live there for a very long time or you plan to sell the property when you move, the number that matters more is always going to be your cashflow and return after you have moved out of the property.
To really get the process of running your numbers down pat you can watch this video again or send an email to [email protected] and I will send you a written breakdown of how to run your numbers when analyzing a rental property or house hack.
Thanks for tuning in to another episode of the REI Roadmap podcast!