Play the Bigger Game

Posted by Matthew Lindsay on Wednesday, January 16th, 2019 at 7:01pm.

Real Estate Investing

Once you start talking about real estate investing, everyone wants to join the conversation. There are a lot of opinions thrown around on how to do it, personal experience, and maybe even their family’s strategy for investing.

At Precision Home Group, we base everything off of facts and thorough research. We make sure to fully understand an investment, before we present it to potential clients for sale or purchase. We make sure that whatever deal we put our name on is well thought out, ran efficiently and well represented.

Overall, we have seen a trend of people purchasing small deals, and trying to make a quick buck through flipping, wholesaling. We have also seen an increased utilization of people trying to invest with other people's money. The downside to this is that these investors are not educating themselves fully before jumping into these properties, and find themselves owning investments that don't make sense, don’t produce income and cost them money in the long run.

It’s an automatic red flag for me when I see little to no money being invested into a property. Anytime there is a low barrier to entry, it tells me the deal is not worth it.

For example, many people purchase a multi-family fourplex because it has the option for a low down payment and is easy to get into. However, with the low down payment the loan typically requires the buyer to owner occupy one unit for a year. Most people come to me with the idea that they can live in one unit for free, have two units pay the mortgage and one unit pay the expenses. This sounds great! But, typically it does not work out and does not take into account things like maintenance, repairs, reserves and management.

Take, for example, a typical fourplex here in the Anchorage area:

 

Purchase Price: $520,000

Down Payment: 3.5% with a FHA loan

Annual Debt Service*: $41,088

*Annual Debt Service based off of a FHA loan with 4.8% interest and 30 year term and amortization

 

Owner Occupied Fourplex

 

Actual Rental Income

$40,740.00

-Vacancy Rate

5%

=Effective Rental Income

$38,703.00

+Other Income

$0.00

=Gross Operating Income

$38,703.00

-Operating Expenses*

$6,180.00

=Net Operating Income

$32,523.00

-Annual Debt Service

$41,088.00

-Reserves at 2%

$650.46

=Cash flow Before Taxes

-$9,215.46

 

*Expenses do not include maintenance, repairs or management

 

What the above graph shows, is that if you owner occupy this fourplex it will cost you $9,215.46 per year. Now, most people would try to explain this away and say that this cost is lower than a typical annual home mortgage, which is true. But, when purchased as an investment that argument is void. We need to see a positive return which this property does not supply.

When we take a deeper look at this property, we also realize that this would be something that the owner has to manage themselves, along with repairs and maintenance. That is time you are putting into the property and not getting paid for. A true real estate investment should be one that is passive, where the owner earns cash flow monthly after the property pays for third party management, all expenses and reserves.

After reviewing these numbers, it is apparent that the only way to solve this problem, is to increase the income of the property. The only way to do this substantially, is to get a bigger property with more units. This is actually less risky than a fourplex because vacancy becomes less of an issue. When you have one unit vacant in a fourplex, you are at 75% occupancy while one unit in a twenty-plex you are at 95% occupancy.  Additionally, while the purchase price of properties go up, so does the income when purchased correctly. With higher income margin, a property can afford proper management services, expenses and offer monthly cash flow.

This is what we mean by “playing the bigger game”! It takes longer to get into a bigger property, but the wait is actually worth it because you skip the small game and start playing at a level that allows you to win from the get go.

If you are looking to get into a property that makes sense, or need help analyzing a potential property, reach out to me at 907-302-1011 or email me at matthew@precisionhomegroup.com

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