6 Numbers You Need to Know Before Buying a Rental Property

16:52Brandon Turner:So it is more of an art form. You do have to use factual current data, but none of it is 100 % foolproof because, again, it is a future value we're trying to predict.

17:03David Greene:Yep, and that's why I always recommend being conservative. You know, you shouldn't pick the highest comp that you see and assume that you're going to get it. If you do, fantastic. But you do not want to rely on getting the best possible comp. You might have a weird week. There might be a bad month. There might be who knows what's going to happen the day you list that property. Don't assume you're going to get the best. you're better off being, I think, conservative with all these numbers. That's a general advice. It's just being conservative with all of it.

17:31Brandon Turner:Yep. Most real estate agents, if you ask them to comp a property for you, are going to give you a number that comes from a range. So they may tell you, hey, I think ARV is 200 ,000, but they're pulling that from a range because they pulled multiple comps and they have an idea of what's on the low end of that range and what's on the high end of that range. So when you're talking to agents, make sure you tell them, I would like conservative ARVs. If I ask you for a comp, give me the middle to the low end ARV, not the tippity top, and that will help protect you. Great advice. All right. This is an important metric for flippers.

18:09Brandon Turner:But as Dave said, it's also an important metric for rental property owners, because essentially every deal turns out to be some sort of a flip, because you're probably going to refinance at some point, or you may sell that asset at some point. So this value is important. But there is another value that is far more important to rental property owners, and that is rent comps.

18:32David Greene:I love rent comps. I think this might be my most important metric in today's day and age. It's basically the ARV for rent. If I'm going to do a BRRRR project where I intend to hold on to this property, for me right now, the ARV, of the value of the property is important because it's my guidelines to make sure I'm not overspending, that you're finding the right deal. But for immediate performance of the deal, the rent comps matter more. I wanna know, yeah, maybe I can rent out this unit for 1 ,200 bucks. I put 30 grand into this property. Am I gonna be able to rent it for 1 ,300 bucks or 1 ,800 bucks?

19:07David Greene:Because that's a pretty big difference. And to me, that's super important because I think I've explained on this show, my sort of formula for deals right now doesn't need a cash flow day one, but after stabilization, after I do a renovation to it, it's got to be seven, eight, hopefully, percent cash on cash return, maybe even higher than that. And so, yes, your repair budget is important to that. But knowing what I can realistically rent things out for is probably the most important number I spend the most time thinking about, I'd say, underwriting a deal right now.

19:41Brandon Turner:I think you said a word in there that was kind of important. You said, realistically rent things out for? What do you mean by that?

19:48David Greene:It means that I take whatever an agent or property manager tells me and then I discount it by like 20%.

19:54Brandon Turner:We're joking, but we're serious. I'm actually serious. That's what I do. 100 % should do that.

20:02David Greene:It's not even that I think they're lying. I just like to be conservative about it. This is how I underwrite deals. If you tell me you're going to rent it for$1 ,600, I'm going to be like, well, if there's a bad month, I want to be able to make lent it for 1400 and still be able to make money. And so I usually with rent comps, especially in this kind of market, I take the low end of the comps. To me, the most important thing is that I'm going to be able to lease it actually. So I look a lot at like vacancy data too in my rent comping and sort of adjust for that. Like if I could rent it for 1600 bucks, but it's going to take me two months, I don't care.

20:38David Greene:I'm not doing that. If I can rent it immediately for$1 ,400, I'm using the number$1 ,400.

20:43Brandon Turner:This is a place where a lot of new real estate investors lose profitability because we get excited. We find a deal. We're like, oh, it's going to rent for$1 ,800. It's awesome. I'm getting it for this price. I'm going to fix it up. It's going to be great. Then you stick it on the market and your property manager comes to you and says, hey, we're not getting any bites at$1 ,800, but I got a solid candidate at$1 ,650. Great credit score. Great job. Yeah. great history. Can you get to$1 ,650? To me, that's music to my ears. Great candidate with a little bit of a discount, I'm taking that all day.

21:17Brandon Turner:But if you underwrote it at top rents and now you're losing money renting to a great candidate at a little bit of a discount, that's not a position you want to find yourself in.

21:25David Greene:All right. So that is rent comps. We got to take a quick break. But after that, we're getting to the numbers that really matter to most investors, which is how much cash you're bringing home each and every month. Stick with us. We'll be right back. The rise of the tech-savvy investor is here. You don't need a huge team or tons of overhead to manage rental properties. Just the right tools. So, I want to tell you about how I use RentReady to get ahead. For landlords who treat their time like capital and recognize the cost of sweat equity, this tool gives you everything you need to scale. Rent collection, tenant screening, maintenance accounting, so that you're organized come tax season, and you can run numbers in preparation for future deals.

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25:56David Greene:welcome back to the bigger pockets podcast me and henry are going through the six numbers you have to know you shouldn't be buying deals until you know these six numbers just as a reminder we've talked about current value or as is value equity after repair value we've talked about rent comps henry what's number five ah this is the one that gets people both in

26:16Brandon Turner:flipping and in rental properties. This hooks people. I don't understand.

26:22David Greene:How do people miss this? But please, let's make sure no one else misses it ever again.

26:27Brandon Turner:We are talking about holding costs, guys. This is what it costs you.

26:32David Greene:To run a business.

26:33Brandon Turner:To run a business. And it can smack you upside the head, both with flipping and with rental properties. But they're a little different with the two different strategies. So let's talk about flipping first. Holding costs as a flipper is your debt service. Most flippers are borrowing money to buy properties and renovate them. And a lot of flippers used high interest products like hard money or expensive private money. So we're talking nine to 15 % interest rates on some of this money. And a lot of these products are interest only. And so you have a hefty mortgage payment on a property that doesn't produce any income because you're renovating it.

27:17Brandon Turner:No one's living there. And so these mortgage payments, it baffles me sometimes when I look at Flipper's numbers and they aren't paying attention to how much money they're going to spend over a six to eight month period in paying the debt service on this property.

27:33David Greene:That's crazy.

27:34Brandon Turner:It will eat your profits alive. And the other mistake they make is they don't budget the holding costs for long enough. They say, oh, I'm going to buy it all renovated in 60 days. It'll take 30 days to sell. I've got four months of holding costs budgeted. And then it takes you eight to 10 months to get that property done and sold. And now your holding costs doubled. And if you're paying something like between two and five grand a month, your profitability can go out of the window in a heartbeat if you go over like that. So you must prepare for holding costs and you must budget for at least two to three months longer than you think you need the money for.

28:14Brandon Turner:And that's a semi-experienced investor. If you have never done a flip, you need to double your timeframe, easy, out of the gate, double your timeframe on your holding costs. But the holding cost most flippers forget about isn't the debt service. They know they got a mortgage to pay. The holding cost they forget about is utilities. You got to have the power on, you got to have the water on, you got to have the gas on toward the end. Like some of these things, they creep up on you. It can be anywhere between 500 bucks a month to a grand or$1 ,500 a month that you weren't planning on spending that now you realize, oh yeah, I've got that holding cost.

28:51Brandon Turner:Now, where holding costs truly bites people in the butt is the landlords because a lot of people still tend to think they make money because their rents are higher than their mortgage payment. It drives me insane. And that's not true. There are so many more expenses or holding costs that you have to consider when you're a landlord that you need to be underwriting into your deal because you do have maintenance. That's going to happen. You're going to get a phone call. It's going to be annoying. I literally got one as we started this podcast. I have to replace part of my HVAC unit. And they were like, here's a bid for eight grand.

29:30Brandon Turner:To me, that's a capital expense and that should be part of your holding costs. Not only do you have maintenance, which is a normal wear and tear stuff breaks, you got to fix it, but you have capital expenses like your HVAC and your roof. These things that don't last forever and they're expensive. You need to be budgeting some money every single month out of the rent, setting it aside so that when these things come up, you've got some cash to be able to take care of those things. But I think the two that really bite people in the butt in holding costs are vacancy and property management. And I say property management for those people who want to self-manage.

30:06Brandon Turner:For people who are planning to operate with a property manager from day one, they typically budget for it.

30:11David Greene:Yeah, usually underwrite it.

30:12Brandon Turner:But a lot of us investors just getting started are like, I'm just going to manage it myself. And you don't add it into your underwriting. And then as you grow or you just get tired of managing properties, you need to outsource it and you lose your cash flow. Because now you got to pay somebody 10 % to manage it.

30:27David Greene:Yeah, I definitely didn't budget for it when I started.

30:30Brandon Turner:But vacancy to me is the killer because most people, if they do think about it, they don't budget enough vacancy. What do you put in for vacancy at most places? Again, you need to understand what's the average vacancy in your particular market. Every market is different. And so you need to ask property managers what they think the vacancy rate is in your market to understand. In my market, it's about 5%. but I'm never just going to budget 5 % for vacancy. I'm typically going to double that because I want to be able to cover at least one to two months rent if somebody moves out and there's a longer turnover.

31:05David Greene:Yeah. For single family, I do eight because that's one month, basically 8%. But for multifamily, I usually do less because if you have a four unit, you're not going to have three of them turnover in one year, most of the time. But that is one thing also I want to add is turnover costs. Some people loop that in with repairs too, but a lot of times it's just normal wear and tear. When someone moves out, you had a tenant there for five years. You're going to have to put new carpet in. You're going to have to throw on a coat of paint. You're going to have to fix some holes that they somehow ripped out of the wall.

31:33David Greene:You're just going to have to do stuff like that. And it's better to just budget that in right there. But this is the thing that separates people who succeed in rental property investing and don't. Because I see on Instagram every damn day, someone's like, oh, I thought I had all this cash flow until I had a turnover and then I had to pay two grand and all my cashflow's gone. That wasn't cashflow in the beginning. Like if it wasn't budgeted in, it wasn't cashflow. That was revenue that you had that was coming into your business, but it wasn't cashflow. Cashflow is profit. And you don't calculate profit without your expenses.

32:12David Greene:That's not how it works.

32:14Brandon Turner:Absolutely. Gross revenue, not cashflow. And you gotta remember too, guys, you should have a framework for what you set aside for these expenses, but it can and should shift based on the property. If I'm buying a hundred year old house, I'm gonna budget more maintenance and more CapEx than I would if I'm buying a brand new asset. You have to adjust the underwriting.

32:36David Greene:And especially if you're renovating, you can actually bring down your maintenance and CapEx expenses because you're gonna do it upfront.

32:43Brandon Turner:So if you do this properly, if you budget your holding costs appropriately, then when you do have a surplus of income coming in, you truly do have positive. Numero six is cashflow. Dave, tell them about cashflow.

33:03David Greene:Cashflow is actually quite easy. And we're gonna actually, I'm gonna give you a bonus one. We're gonna talk about two numbers, cashflow and cash on cash return. We just basically gave you the definition of cashflow before. Basically your gross revenue, all the rents, pet rent, coin op, laundry machine in your rental units, All that stuff minus all of your expenses. And we're going to count all of your expenses. It's not just taxes and insurance and mortgage. We're talking vacancy, holding costs, CapEx, repairs, property management. All that stuff needs to go in. And what you're left over with, that's actually your cash flow.

33:36David Greene:That's the profit that your business is generating. Now, it's super important that you calculate this right. But I actually think cash flow itself, like the absolute number, is not that important. Like people, you know, like I think cash flow itself is important. But what I don't like is people like I want two hundred dollars a month per unit. What does that mean? Did you invest ten million dollars to make two hundred bucks a month? That's a terrible deal. Did you invest ten grand to make two hundred dollars a month? That's a great deal. That's why I think cash on cash return, return on equity, those are the metrics that really matter because it measures efficiency.

34:19David Greene:And that is what I care about as an investor is how efficiently is my capital and my time making me money? Because if I'm investing a ton of time and a ton of effort to make a 2 % cash on cash return, I'll just put it in a savings account. I can earn 4 % right now, right? So you need to understand the rate of return, that measure of efficiency. And that's where cash on cash return comes in. And so the way you do that is you take your cash flow that we just talked about, your annual cash flow, and divide it by the total amount of money that you've invested into that deal. So if you're making$8 ,000 a year in cash flow and you invested$100 ,000 into that deal, that's an 8 % cash on cash return, which I think is a good cash on cash return.

35:03David Greene:That's a deal I would probably do. So that's what I would recommend really focusing on. You need to know cash flow so that you can calculate cash on cash return.

35:12Brandon Turner:Cash flow is a measure of success. I want to buy a deal that cash flows because really that tells me is that I bought a decent deal. What it doesn't tell me is how profitable that deal really is. So cash flow, I think it's just kind of grown this almost personality where it's like cash Cashflow is what you need to retire and quit your job, but that's not what truly builds wealth. Equity is far more important for those things, but cashflow is more a measuring stick. Are you buying a deal that at the end of the day, the property is paying for itself? That doesn't tell you if it's a great investment as a property.

35:52Brandon Turner:It just tells you this deal pays for itself.

35:55David Greene:Right, it doesn't. If I told you, Henry, I have a fourplex that I spent a million dollars on and it earned me$500 a month in cashflow, you'd probably say that's a pretty bad deal, right? Like that's not a good use of my money. And I think people need to sort of just like back this out a little bit, because if you just think, if you have a goal to, let's say, get$10 ,000 a month in cashflow, like that's your ultimate goal 10, 20 years from now. If you're earning an 8 % cash on cash return, you're gonna need$1.25 million in equity to do that. If you're earning only a 4 % cash on cash return, then you're going to need$2.5 million in equity, meaning you're going to have to earn twice as hard.

36:37David Greene:And so I just don't, I think it's sort of trivial to say, okay, I'm making 400 versus$500 per month. My goal is always to keep that rate of return as high as possible. Cause that means I have to do less. I can buy less properties. I have to work less, right? Like that just means I have a better quality of life because my deals are more efficient. Yes. Well, all right, Right. There we have it. That's six, six and a half. We gave you six and a half. We lied. Six and a half numbers that you need to know. There are obviously other things that you can calculate. I literally wrote a whole book with all sorts of other numbers that matter to you.

37:13David Greene:But if you're new or maybe you just don't like overanalyzing things like I do, these six numbers can absolutely tell you whether or not you're having a good deal. Everything else on top of that is kind of gravy in my opinion. These six numbers are what you need to know about every deal. And if you don't feel confident about these numbers, don't buy that deal. Like you have to feel like you know these numbers inside and out and you feel like your assumptions about these numbers are right before you pull the trigger on anything.

37:42Brandon Turner:I think we covered a lot of ground, but I really want people to understand the importance of studying these numbers because the more you're comfortable with these numbers, the more you're going to be comfortable with making offers and actually getting real estate deals that make sense. When people are uncomfortable in a deal, it's probably because they didn't have a great grasp of one of these concepts.

38:04David Greene:Well, thank you all so much for joining us. Two resources for you guys, if you want them, if you want to learn more numbers, I literally wrote a book called Real Estate by the Numbers, you can check it out. Or once you have a firm grasp on these numbers and you want to go run deals, the BiggerPockets calculator, if you have a pro membership, you can put all six of these numbers into those calculators. It'll do all the math correctly for you. And you can tell whether or not you have a good deal. That's all I got for you today on the Bigger Pockets podcast. Thanks, Henry. Thank you all for listening.

38:31David Greene:We'll see you next time.

38:53David Greene:more about real estate investing or to sign up for our free newsletter, please visit www.biggerpockets.com. The content of this podcast is for informational purposes only. All host and participant opinions are their own. Investment in any asset, real estate included, involves risk. So use your best judgment and consult with qualified advisors before investing. You should only risk capital you can afford to lose. And remember, past performance is not indicative of future results. Bigger Pockets LLC disclaims all liability for direct, indirect, consequential, or other damages arising from a reliance on information presented in this podcast.

39:19David Greene:Attention, passive real estate investors, Make sure you have the Passive Pockets Summit on your calendar. Better yet, plan on attending it in Denver, Colorado from April 30th to May 2nd. This conference is built exclusively for the LP or limited partner. It's a great place to network and talk current deals and current strategies for accredited investors investing in real estate deals right now. Go to PassivePockets.com forward slash summit for all the details and use a coupon code podcast to save you$50. Hope to see you in Denver.