Active Rain July 15, 2011

Think You Have $500 Cash Flow? Think Again

I hate to rain on a guy’s parade.

As a colleague from another industry sat across my desk, we pondered why his home, listed with another broker prior to meeting me, had not sold. Looking at the market activity, his bottom line and what it appeared he’d get were about $10,000 apart. My suggestion was to lower his price and be done with it. He was not excited about that prospect, and said he was considering renting the place until the market turned around. Among the first questions I asked was what his cash flow position would be if he were to lease the place. He thought it would be about $500, which would be a $6,000 annual profit. 

God bless him. 

Having done the landlord thing I knew that if the surface appearance of $500 positive cash flow simply compared rent minus mortgage, my colleague was in for a rude awakening. So we teased it out, and to his credit, he approached the discussion with earnestness -no easy task when it’s your place. 

Here’s a summary of what I told him could happen to that $500 every month, assuming *100%* occupancy. 

  • Insurance. You have to convert your policy to a landlord policy for a non owner occupant. Does that raise or lower the premium? I think we know the answer there. 
  • Water bill. Tenants don’t pay the water bill in a condominium, the landlord does. Who uses more water, renters or owner occupants? I think that answer is also fairly obvious. 
  • Taxes. While they are often already in the mortgage, they tend to change in one direction only here in New York: up. 
  • Routine maintenance. My friend is selling because he is buying a bigger home for his family. His new home with have a furnace, central air, plumbing and electrical systems which will require routine care. So will his old home. That fixed cost will double, unless you like living dangerously and don’t peform routine maintenance on the systems in a tenant occupied home. Which leads us to…
  • Big Ticket items. A landlord with $500 cash flow is better known as a landlord who is one new furnace away from having his year’s profit decimated. The same goes for the central air, and things like water heaters and garbage disposals also chip away. You wouldn’t believe what tenants flush down the toilet and put in the garbage disposal. Plumbers aren’t cheap. 
  • Tenant foibles. Like the great Derek Jeter, some things don’t show in the stats- you have to tell the story. Such as the following: 
    • Tenant: The dryer is broken!
    • Landlord: But it is 2 only years old
    • Tenant: It won’t heat up! I can’t dry my clothes! You have to fix it!
    • Landlord: I’ll be right over…
      Sure enough, the dryer won’t get warm. Until the landlord pulls out the lint screen, which by this time has a family of alpacas stuck to it, because the tenant never owned a home and always had a coin laundry back in their apartment in Yonkers. Yippee. 
      The landlord rationalizes he did not have to pay a repairman, and tries not to think that his quiet evening with his family is wrecked, or his tenant is a doofus. Kumbaya. 
  • Wear and tear. Tenants have been known to punch holes in things. And they put flooring and painting contractors’ kids through college. Replacing carpeting eats away at cash flow. So does replacing broken windows floor tiles, and garage door openers. Trust me.
  • Guests. Lovers. Grown kids and extended family. None of whom are on the lease, but often visit and never leave. And they have no accountability to you, but the neighbors notice. These are the hole punchers. 
  • Pets. I could write a book on this one. Cats especially, for some reason, but say goodbye to the carpets. And yes, you’ll be repairing th hardwood too. And oh. That. Smell. 
  • Security Deposit. Yeah, they’ll try to use that for the last month’s rent in some cases. Sorry. 
  • Quality of life. Then there is the being joined at the hip to people who punch holes in things, run the furnace like it’s a rental car, run the water like they are baptizing the Philistines, and sometimes may not pay their rent on time or return phone calls. If you’ve ever waited in your car at 9pm waiting for this son of a person to get home so you can ask where the missing money order is, you’ll know it’s not cool like in the Sopranos. 

For $500 a month? No, try for NOTHING. Especially if you are in the 40% tax bracket. Here’s a better idea: If you want to get $500 a month extra, wait tables on the weekends. 

I topped out at 14 units 8 years ago, and I still get jitters when I hear the phrase “lot line cleanout.” If you are moving out of town, you’ll need to pay a property manager, which also effects the bottom line. Think about that if you are relocating from Westchester to Jebip. My colleague needed a far bigger margin or to just lower the price and sell it. 

If this sounds antithetical for a broker to talk folks out of real estate investing, it isn’t. I deal with professional investors, not weekend warriors, because the late night infomercials are a lie. 

I sleep better at night. I hope my friend will now as well.