TAO of Flipping and Investing in Real Estate - Part 4.3 - Monthly Expenses
In the art of flipping and investing in real estate there is always a part of the puzzle that some will almost unanimously agree on — the expenses that you will account for over the course of each mortgage payment you make on your investment is this important puzzle piece. Understanding what deductions you will account for and properly applying this to your monthly mortgage will ultimately tell you how much cash flow you will have each month, what your offer price will most likely need to center around, and give you a over-all understanding of how much cash will be going torward the payments and maintenance of your new investment.
There are 7 things you will need to account for when you are purchasing a house for investment or even to flip; understanding what they are and how to properly apply them to your monthly mortgage and cash flow will help make you be successful in investing. Pay close attention to this section, because it is one of the most important areas of investing that many people either don’t grasp, or overlook. The 7 things you need to account for in your deductions are: mortgage, taxes and insurance, rent loss, maintenance, HOA, management fee, and holding and closing costs. I will share information about how much you should alot to each area and explain why each is important in figuring out your montly house payment and cash flow.
As a precursor, it is important to remember that these 7 expenses we will cover both make up the over-all monthly payment and your allotments for necessities to assure you are minimizing your calculated risk of your investment. By accurately and carefully applying these expenses, you will essentially lower your risk to an amount that is easily acceptable by investor standards and will make your liability low enough to warrant any purchase that meets this criteria.
#7. Mortgage - Whether you have an A.R.M. loan, seller carried loan, or one from the government or bank — you will be responsible for making a monthly payment to a loan company that will require you to pay somewhere between 80-95% of your loan payment as interest and as little as 5-15% as principal in your first 3 to 5 years fo your loan. In a 30 year fixed loan, you can expect to be paying more toward your interest than your principal until near the 10th year of the loan. As you can see, most of your mortgage payment will go toward your loan holders interest for at least a few years.
The mortgage payment will make up the bulk of your payment on your investment, so be sure to pay careful attention to what your interest rate is and how long your loan is for. Most lenders will charge a premium interest rate for loans that are considered for investment, so keep this in mind when attempting to purchase a property with the some purpose of investing or flipping it. Secondly, some loan holders will require you to pay your taxes and insurance along with your mortgage, this is often considered an escrow holding — the lean holder will essentially have you pay your taxes and insurance along with the mortgage to then and they will in turn make the payments on your behalf for your taxes and property insurance.
#6. Taxes and Insurance - Your taxes and insurance are most likely paid by mortgage company unless you are able to manage your own escrow in which case you are responsible for paying your property taxes and insurance yourself. This usually will make up about 15-30% of your mortgage payment depending on what state and city you live in.
Be sure to shop around for a good insurance company; much like your car insurance, there are many different companies you can choose to go with for home insurance, and some offer great deals for having multiple houses and your car attached to the same owner. As with shopping for insurance, be sure to try and address the property tax cost for your investment as well. Most counties will allow you to lobby to have your taxes lowered for your property if you can justify why you may be paying too much. If you can get comparables for other houses and find what they are paying for taxes, see if you can get yours lowered to be more comparable to theirs. Believe it or not, this is a very good strategy that often works and more importantly will lower your over-all taxes if successful.
#5. Rent Loss - Anytime you own a investment property or a flip, there will be some downtime on the unit. This needs to be compensated for and the best way to address this is by adding approximately 10-15% of the total monthly mortgage as a expense. If your mortgage payment is $1000.00 dollars a month, you could add $100.00 to that and virtually say that you need to rent the house for 1100.00 a month to cover not only your mortgage every month, but also to account for 1 to 3 months of rent loss or downtime for repairsand finding a renter. By doing this, you are putting a fail-safe buffer into your expenses that will allow you 1 month of no tenant and still be able to make your mortgage payment without out of pocket expenses. It is important to always add this into your expenses and if you can succesfully account for more than 1 month of rent loss added in, the more buffer and time you have for getting that house rented out!
#4. Maintenance - No matter how old or new a house, there will be problems and you will be responsible for fixing them. To help alleviate this worry, you should always try adding about 5-10% in expense to the mortgage fee for repairs and upkeep. By doing this, you can have money set aside to make any last minute or annual repairs that are needed on the property. Some of the most common repairs are water heaters, HVAC, plumbing, and sometimes roof repairs. The average cost for a major repair is $1200.00 dollars annually; so having this buffer will not only help to cussion your costs for any repairs, but will lower your over-all risk because you have alloted for repairs in your monthly payments.
#3. HOA - Most sub-divisions have what is known as a Home Owners Association (HOA), these HOA’s will provide services such as monitoring neighborhood restrictions, maintenancing community ammenities, and maintaining the over-all upkeep of the sub-division grounds. Associated with this service is usually a fee that is paid monthly to the association for the services. This is a expence you will be responsible for whether your renting the home out, or preparing it for a flip. Typical costs can range anywhere between $50-100.00 quartely and are usually paid at the beginning of the calendar year. Failure to pay your HOA fees can result in law suit and ultimately foreclosure of your investment, so keep on this cost, it is important–if your in a sub-division that has a HOA.
#2. Management Fee - Do you do all the rent collection, repairs, late night phone calls, coordinating showings and even managing the bank accounts all yourself? Whether you said yes or no, you still need to add a management fee into your monthly expenses. If you are paying someone to manage your investment or flip you are most likely paying the typical 10% of the monthly rents toward this fee. Again, this will need to be added into the monthly expences that you will add to your monthly mortgage costs. So be sure the calculate this into what the house rents for, so it is covered. If your managing the house yourself, do you work for free? Of course not! You need to be paying yourself, so still be sure to add this into your expenses.
#1. Holding and Closing Costs - These fees are typically associated with flipping or selling a home, so if your only investing and plan on renting out your property, you may use this in your analysis of your monthly house payment cost, but it is not necessary. The holding and closing costs are the fees associated with the mortgage payments you will make while the house sits waiting to sell and the ultimate closing costs you will pay to close the escrow on the property.
The holding costs can add up quickly if your property takes 2, 3 or even 4 months before it is ready to sale, so be sure to account for this in your purchase price, so that when it comes time to sell, you arent going negative! Additionally, when you sale the home, you will be responsible for paying for some closing costs — usually .5 to 1% fo the total sale price of the property. If you are selling a $100.000 home, you can be sure you will be paying about 5-7K in holding and closing costs.
If you put all 7 expenses together, this is what it may look like in your spreadsheet:
$ 50,000 Purchase price of home worth about $100,000 that will rent for $1000.00 a month
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$ 375.00 Monthly Mortgage (principal/interest)
$ 200.00 Monthly Taxes and Insurance Fee
$ 100.00 10% of Monthly Rent for Rent Loss
$ 50.00 5% of Monthly Rent for Maintenance
$ 15.00 HOA Fee ($15.00 x 12)
$ 100.00 10% of Monthly Rent for Managenet Fee
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$ 890.00 Total Monthly Expenses
As you can see, on a home that was purchased for $50,000 dollars and is worth about $100,000, you may come up with a total monthly expense of $890.00. This left us with a cash flow of about $110.00 a month and will give us peace of mind because we have made every effort to account for any expence that can be thrown at us. Of course, with any formula, we cannot account for EVERYthing that can happen, but for the most part, we will be able to sit back and let this property develop and become a true investment.
In the case of buying and selling a property to flip, we need to apply everything to our purchase and sale price that was listed above accept we also need to calculate in the holding/closing costs to determine whether the house is a good deal or not. I will next show you how this is done in the next spreadsheet:
$ 50,000.00 Purchase price of home worth about $100,000
$ 2,700.00 Monthly Holding Cost ($890.00 x 3) (same as monthly expenses)
$ 2,000.00 Closing Costs for SALE of $100,000 flip
$ 3,000.00 Closing Costs for PURCHASE of investment flip
$ 6,000.00 6% realtor fee for Sale of Flip
$ 15,000.00 Repairs (this is variable, could be less/more)
——————
$ 78,700.00 Total Expenses for Purchase/Sale over 3 Month Period
This could potentially give us a 21,300 profit for the sale of our Flip! We purchased a property that is worth $100,000 in great shape for only $50,000 and after all oyr expenses and selling the property, we realized a profit of $21,300. This is only an example of how a typical flip may look, but I hope you get the idea.
The whole purpose of taking the time to do the calculations for our expenses is to lower our calculated risk. As long as the risk is low and we can purchase the property for a price that can warrant, based on our formula, it will not only be a sound investment, but a profitable one.
Class Dismissed!