Mindy: Welcome to the BiggerPockets Money podcast show number 322, Finance Friday edition, where we interview Pam and talk about taking a deep look at the true cash flow scenario of your rental portfolio.
Guest: My husband and I, we talk a lot about, well, do we want to do the cash out or do we want to keep them paid off for increased cash flow? We do have four properties paid off right now. Um, we were toying with the idea of refinancing two or three of them to help pay off the private lender.
Mindy: Hello, hello, hello. My name is Mindy Jensen and with me as always is my sunshine on a cloudy day co-host, Scott Trench.
Scott: That’s me beaming Mindy.
Mindy: Scott and I are here to make financial independence less scary, less just for somebody else. To introduce you to every money story because we truly believe financial freedom is attainable for everyone, no matter when or where you’re starting.
Scott: That’s right. Whether you want to retire early and travel the world, go on to make big time investments in assets like real estate, start your own business, or analyze your portfolio and consider selling some of that real estate. We’ll help you reach your financial goals and get money out of the way so you can launch yourself towards those dreams.
Mindy: Scott, today we are talking to Pam and she has a very interesting set of circumstances with regards to her investment portfolio. She has been investing over the last three years, gathering, uh collecting real estate properties, and now it’s time to analyze those and see if they are worth holding on to.
Scott: That’s right. Uh Pam has a very, I I would imagine a very common situation for some for investors who have been using variations of the BRRRR methodology, um where they’ve got built up a lot of equity, but it’s a little hard to cash flow in some situations and maybe some of the properties don’t cash flow um because they’ve been doing enough of a rigorous analysis on that cash flow and really accounting for things that are phantom expenses that don’t show up every month but you have to plan for like vacancy, like maintenance, like CapEx. Run those numbers all the way through on every property in your existing portfolio and any property you’re considering buying and make sure that you’re cash flow positive. You don’t have to get a 10 or 20% cash on cash return, but you have to be positive uh in order to sustain it in this business according with conservative assumptions over the long term, in my opinion.
Mindy: Yes, and you said the V word, Scott, vacancy. We didn’t even talk about vacancy on this episode. Uh because she has really great properties that don’t have any vacancies. She said that she’s got people that have been there for since 2015. Um but that is something that we uh forgot to talk about. Uh vacancy should be estimated at 8%. A lot of people will say 5%. It should be estimated at 8% because 12 divided by 1 is or 1 divided by 12 is eight. I don’t know. A whole month’s vacancy is 8%. And hey, if you estimate high and then you come in a little bit lower, you win.
Scott: Yeah.
Mindy: If you estimate low, then you lose.
Scott: And and what do you do if you don’t if you can’t get the numbers to work on a cash flow basis with conservative assumptions, you use less leverage or you wait or you or you you pick a different market or a different strategy with that. You you don’t have to make again, 10, 15, 20% cash flow each month to get into this game. there are appreciation and amortization benefits, but you can’t cash flow negative uh because it’ll just suck money out of your life and make things miserable in the downturns, the the handful of downturns we’re going to we are going to experience over the next 50 years.
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Mindy: You just said the G-word, Scott. You said this game to get into this game. Real estate investing is not a game. It is a business. And if you treat it as a game, you will lose every single time.
Scott: But you’re not the only person who calls it a game. Everybody calls it a game and it’s a huge pet peeve of mine. I call it a game. I just I’m so competitive. I take my games very seriously, Mindy.
Mindy: Okay. You, okay, that, you know what, I will give you that. But everybody else does not get a pass on this. You cannot call it a game, it’s a business and you have to treat it as such. All right. Now, before we get into Pam, the content of this podcast are informational in nature and are not legal or tax advice and neither Scott nor I, nor BiggerPockets is engaged in the provision of legal tax or any other advice. You should seek your own advice from professional advisors, including lawyers and accountants regarding the legal tax and financial implications of any financial decision you contemplate. Pam is a real estate investor who has been focused on increasing her real estate holdings the past three years. She and her husband have a great income and have been reinvesting their cash flow back into their real estate portfolio, along with using a hard money lender to fund more purchases. But now they’re at a crossroads. Continue with the BRRR strategy in single family homes or pivot to multi-family. Pam, welcome to the BiggerPockets Money podcast. I am so excited to talk to you today.
Guest: Hi. Thank you for having me.
Mindy: Thank you for coming on.
Scott: Welcome.
Mindy: This is going to be so much fun because we’re going to talk about our favorite topic, money and real estate. So, let’s jump right in. What do you make, where does it go, and then let’s talk real estate.
Guest: Okay. Um, well, I have a couple of businesses. Um, I used to teach writing lessons, so I still have a little bit of that going on. so it brings in um, a little money, play money every month. Um, I have a bookkeeping business that brings in net about 18, 1900 a month. Um, my husband and I work for a property management company. He does the maintenance. He’s maintenance director. Uh, I’m the CFO, so I do a lot of numbers. Um, so together we and both, let’s see, he’s a 1099 pay. Um, and then with my net that totals roughly 12,000 a month. Um, the average of the rental income as it stands now is about 7,500 a month. Um that in because we just signed a lease, so maybe 8,500 a month. Um and then just sales if we’ve decided to sell one over some time, um I just averaged that out uh to be about 4,800 a month.
Scott: Oh, you’re saying when you redeploy that the proceeds you might be able to generate an additional 4500.
Guest: Well, I maybe I didn’t explain that well enough. Um, okay, so for the house sale, that was initially supposed to be a rental, um but five months later it not being rented, the best strategy with the way the prices were, we decided to sell. So we made some money there and I just average that out um to be about 4,800 a month.
Scott: Oh, okay. What’s the lump amount of that sale proceeds? Is that sitting in your bank account?
Guest: Some of it is. We paid off, we paid a big chunk to our private lender about 50,000. We walked away with 108. Okay. We bought another house, I’m sorry. We bought a rental, um turnkey how the tenant, uh that was 33,000, paid our private lender 50, and then we had the we paid a credit card off, the business credit card. That was maybe 10,000. Um and then we still have 20 left of it, which we are planning to purchase another property that will be a little bit of pretty big renovation project to be a rental.
Scott: So, so if if I were to summarize your monthly income, excluding this sale, I could say that your your wage income, the dollars you’re earning is $12,000 a month. Your bookkeeping business is bringing in $2,000 a month and your rental business is bringing in $8,500 per month once you get that next place rented with with the new tenant. And that’s a net cash flow. That’s not gross rent. That’s in the cash flow you’re able to spend on an average basis from the from the rental property portfolio.
Guest: I believe so, yes.
Scott: Okay, that’s awesome. That’s 20, 22, $23,000 per month pre tax. That’s phenomenal. So big incomes.
Guest: Yes, but I feel like we’re paycheck to paycheck.
Scott: Well, that’s why we’re here.
Guest: Yes, exactly. Yes.
Mindy: I just want to point out before we go any further, if you’re spending every dime that comes in, you are paycheck to paycheck. It doesn’t matter how much of that is coming in. So, let’s look at where that’s going and see I saw something. So, we do get your numbers ahead of time and I did see something that I’d like to maybe reframe as we are uh as we’re we’re going through your numbers. So, let’s look at your numbers the way that you’ve shared them and see if they still are how I’m thinking about them. So, what is what are your expenses look like?
Guest: Um so I separated it category like personal and business because that’s where it gets a little um confusing. We usually always have some sort of remodel going on, which is where a big chunk of all that money goes. Um and like I said, we just recently finished one remodel. Um, we have a signed lease. We did receive our first paycheck or rent check from them that is through a management company. Um so I feel like the business miscellaneous category that I have will, will trim down quite a bit. Um so for personal side, um our mortgage for our primary home is 1400 and that’s taxes insurance. Um our insurance bills every month are 1475 and that’s big one is health insurance because the I’m a W2, um but they don’t have medical. So my husband is the 1099 side, so he doesn’t have medical. so that’s about 1,000 and the rest is life insurance, which we have a term policy. Um and I that’s in car. Awesome. Travel is a big one for us. I just averaged that out for the year and that was about 800 a month, um mainly because we have properties in out of state. So we do go a few times a year. Um my general category needs to slim down. Um general merchandise and clothing, 866. Yes, it does include some Amazon. Um also, you know, like trips to, I don’t know, if we have to go get a card or just general items needed for the house. um, there’s just that’s my big lump category. Um, we do have a boat, um that we own and part of that boat money is where we house it at the marina, it’s called a dominium. I don’t know if you guys have heard of that, but it’s like a condo for the boat. So that monthly payment is in there that includes dues, it includes um property tax, um our payment to the dominium, we bought that on land contract that ends in September. Um so that’s roughly about 750 a month uh for a year. It also includes like other maintenance with it. It’s basically our cottage.
Scott: How much so we we were trying to to tally this up, we’re we’re um, how how much is this coming out to per month?
Guest: 9500.
Scott: 9500 per month. Okay. Uh and you’re bringing in $22,000 per month. Um so while there’s a lot there and there are things to cut, um you should be not living paycheck to paycheck based on that spending uh and your income, which is what we’re going to investigate um today. So with that. So you should be able to accumulate a lot of those things and many of the things you said there are perfect. Like this is not a, oh cut your boat um thing, you know, with with that. uh you you’re earning enough income to pay for some of these luxuries um with that very uh cuz you guys are doing so well. Um, let’s go through your uh net worth and balance sheet here. And let’s start with cash. How much cash do you guys have?
Guest: Personal cash 12,000 and I know we have about 18 to 20 in the business account, in the real estate account.
Scott: And then what’s the biggest is the biggest portion of your net worth the real estate?
Guest: Yes.
Scott: Let’s walk through that. What does that look like?
Guest: We have nine rental properties, um valuing 1.5 in today’s equity. And where are these located? I have three, we have three in Scottsdale, two condos and a house that are Airbnbs. Um, and then we have properties in Flint, Michigan that we use for long-term rentals.
Scott: And those are six six properties there?
Guest: Yeah, um and counting. We we are under contract for um another one and just signed another contract today for a a quick wholesale flip.
Scott: So it it looks like we’ve got about a $175,000, 100, about $200,000 in retirement accounts and then maybe another 5 to 10,000 in after tax brokerage accounts there. Is that sound about right?
Guest: Yeah, we use um I use personal capital. So I have everything in there and yes, that that sounds right.
Scott: Before we get into what’s the best way we can help you today, I’d love to hear a quick story about how you got into this position. Can we do a quick background on on your journey with money?
Guest: We grew up not poor but lower middle class and and my dad was dealing with layoffs. I worked for the big three. Um so there were times where we had to pinch quite a bit. Um, and then fast forward college, uh I went to college, student loans, that kind of thing, got married quickly after school. um, and then that didn’t end very well. Um, I did have a 401K at that time that I lost uh after the marriage. So I was starting over basically at 28. Um, I did have my horse training business which paid for my lifestyle but I wasn’t able to put anything away. Um, then my husband and I met and he has a very similar uh money background as I. So we got along great. Um, and uh, we decided we’d be a great team to do some real estate because he was a builder. So we loved all those shows that came out in 2005 and 6. Um, so we thought flipping was it. This is great. Um, then the market crashed. so uh we kind of lost that. Um, got some very bad advice from our real estate agent that said, just let them go back to the bank like everybody else because I can’t sell them. Had no clue about renting, no clue. no clue that there was even property managers that could handle everything for you. Um, so that kind of was a harsh learning lesson. Um, we had to file bankruptcy in 2011, but it’s kind of been the best thing that’s happened. We’ve learned from that. We lived with cash for forever. Gosh, probably until 2018. So we went seven years just if we didn’t have the cash, we didn’t buy it. We had no credit, we had no loans, we had nothing. Um, we did start building from there with the prepaid credit card. We each had a $300 prepaid credit card and we lived off of that surprisingly. Um, but he had done some car sales at that time. Um, all his remodeling kind of was going under, uh with the economy the way it was during that time. Um, and then fast forward 2018, we decided um, actually, let me back up, when we were going through that bankruptcy, we couldn’t get like we lost all of our properties, our primary home. um, I had a condo that went back to the bank. Um, and we have this private lender who my husband had done some business with before and he was our saving grace. Um, we were able to buy a house, a home with him on land contract. so he paid cash for it. Um, so we found a nice home and fixed it up, that kind of thing. We stayed there for three and a half years, sold in 2013, had a nice lump sum, walked away with some money. So our first live in flip, I suppose. Um, and then we found this great property 2014, 2015, also our plan was a live in flip because we did well with that other one, or we had a five-year plan for that house. Uh, and we stuck to it pretty well. um, we used that chunk from the first house, did the remodel, lived there for six years, sold that in 2020. Um, and then um, 2018, 19 was when we started buying real estate. So we learned that I learned about a thing called cash out refi. Had no idea what that even was. I had no idea if we could even qualify for a mortgage and they qualified us and we walked away with the check of 230 some thousand dollars were like, I can’t believe that just happened. So we paid our our private lender off and we had money left over to buy our first rental. We bought a turnkey rental, uh, it was the wonderful first property. Um, and that’s, you know, that’s how we got going. Our private lender said, why did you pay me off? Do you want more money? So we borrowed more money and did it again. We bought, we bought some more turnkey rentals and um, that’s where we ended up here.
Scott: Awesome. And and has most of that, most of the rentals been financed with cash out refinances, or have you been accumulating cash in a substantial way over the last 3, 4, 5 years as well from your saving and uh, incomes and job?
Guest: I would say yes to both of that. Um. Yes, to both of that. We did get a line of credit on those three properties. Um, because like on paper, we looked like we owned them all. Um, and we bought some more properties, paid him off again. Um, so a bit of the burst strategy. Um.
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Guest: I don’t know that a lot came from our income, honestly. I think a lot of it was just the moving of the properties.
Scott: Well, great. Let’s we’ll let let’s unpack this and I think that we have um that background was really helpful. I think we’ll have some clues in that background as to um opportunity areas that we can that we can begin attacking. Um, my belief is that your situation that you articulated to us is one where you’ve got a really strong income, you’re building, you have all these rental properties, um you’re living paycheck to paycheck and you can’t figure out why cash is leaking out of the system instead of depositing into the system on a regular basis. And I think I’ve got some hunches about why that may be happening. So, um, and let me start with the real estate portfolio. Let’s talk about um the types of properties you own. Are these properties in good condition when you buy them?
Guest: Most of them, no, which is why I think we’re we were had been leaking so much money um into the renovations. Um, for instance, the one we just finished, we paid 40, we put, I think we only put maybe 15 or 20 into it if not, I don’t even think that much, 13 to 15. Um, and we’re in the process of refinancing that right now and it appraised for 101.
Scott: And what will what what would a $101,000 property rent for in that area? This is Flint Michigan, right?
Guest: Yes. Um, a thousand. We got we’re we just signed the lease. Near Detroit?
Guest: It’s an hour and 20 north.
Scott: So you’re getting a close to 1% rule property here. Um, how do you think about expenses on that property? What what what are you what are you paying on a monthly basis?
Guest: So before the refinance, all of my flint properties are usually about 285 a month. That’s insurance and tax and utilities because I got to pay the water and electrical.
Scott: Maybe at the most in the summer, $350. Actually the winter cuz that’s with the heat. So, 285 to 350. Do you have a mortgage on any these properties?
Guest: When we do the cash out, yes, and that payment will be 612 and that includes everything.
Scott: Okay, great. And that includes everything. So that’s principal, interest, taxes and insurance.
Guest: Correct.
Scott: And then utilities and water come on top of that. What are utilities and water?
Guest: Well, that will be covered by the tenant will pay that. Um but previously, uh winter is usually the most expensive at 130 a month. Most of these properties don’t have a lot of insulation, so they leak uh hot air. Um so you pay for that. Um the water we generally don’t even use, but there’s a service fee, so our bill is always $57 a month.
Scott: Uh any other expenses that go along with that property? So you got 612 in pity, insurance goes to the tenant, and then the then the water is $57 per month for water. I’m sorry, utilities goes to the tenant. Um and then then then the water is $57 per month.
Guest: So my expenses are will just be the mortgage pity, 612.
Scott: Great. And then what do you what do you pay your property manager?
Guest: 10%.
Scott: So we have 100 bucks a month for the property manager. And what’s the placement fee on that?
Guest: Half a month rent.
Scott: Okay. So you’re going to pay us 500 bucks.
Guest: I’m pretty sure.
Scott: And that’s going to be every two years?
Guest: Actually, what’s interesting about this area, it’s so popular for rent, that nobody moves. We have tenants that have been in those turnkey houses we bought, they’ve lived there since 2015, 2016. Um, so knock on wood, we haven’t had a turnover yet. Um, which is pretty amazing. Um so that hats off to our property managers for finding great tenants as well, um cuz I think that has a lot to do with it.
Scott: Okay, great. What do you budget for maintenance expenses?
Guest: Well, they have a live-in maintenance guy. So, that’s my husband. So it’s just time really. Um, maybe materials.
Scott: Okay. Let let’s um I would I would recommend you put 5% away for maintenance at at the minimum, maybe 10%.
Scott: Go ahead, Mindy.
Mindy: I was just going to say with a move planned in the next year or so, you’re going to need to have maintenance scheduled or uh accounted for and also, um I would start uh looking for maintenance people now so you can have them working on your properties in conjunction with your husband so you can test them out because uh things will break, things will break more frequently when your husband isn’t there to fix them, it will seem, and you’ll be like, why is this so expensive all the time? Um, because on paper, $1,000 in rent and $612 in mortgage payment is almost $400 in my pocket, but it’s not. It’s it is now you’re $100 for the property manager. Okay, now it’s $300 in my pocket. Well, now you’ve got $100 for maintenance. Now it’s $200 in my pocket. And you’ve got uh these were rehab, right? These were turnkey. What is the state of the roof, the the big systems, the like if everything’s brand new, you need a whole lot less in CapEx. But if the roof was 15 years old when you bought it, um, you’re going to have to budget for a roof a lot faster.
Scott: Yeah. So correct. So that that’s a that’s a good thought process here. So we have maintenance which is costing you something. It’s not nothing because there’s materials that you have to pay for, which you will have to budget for the maintenance person when you move. And then the other part of this is CapEx. And this this is what’s going to kill your cash flow when we go when I tell you this, this is not going to be good news um with this. Uh on a property in in Denver, Colorado, I would not estimate less than about $250 per month, per month is a capex allocation because every year I’m going to have some problem with one of my units across my portfolio. And that problem is not going to be three grand. It’s going to be 5 to 10 grand, right? When I got to turn a unit because the tenants trashed it, it’s 10 grand to to get to to fix the the floors and the walls or whatever with that. And that’s going to happen every, you know, in your case less
call it every five years, um because you have long tenant, but you’re still going to have to plan for 10 grand each unit every five years, you know, at the minimum, which will come out to $250 a month and that I believe is what’s killing your cash flow um here and why why your business is not actually spitting out cash into your bank account on a regular basis in the way that you’re anticipating with it. Um do you have a reserve for that? Do you count do you account for that that CapEx piece in the cash flow?
Guest: I I do have a reserve as far as we we do have a line of credit that has 45,000 available if we need to tap into that. Um, I do have my private lender, uh and we do have some cash. Um, but I do feel like I need a whole bunch more sitting aside for that kind of stuff.
Scott: I agree with that and we’ll come back to the cash position in a second. But right now I’m I’m I’m trying to to point out the cash flow on this unit. So let’s go through the numbers that we just put in place, right? We have $1,000 in rent, we have $612 in your principal interest, taxes and insurance. So now you have $388 in cash flow per month. $100 of that is going to the property manager. So now you have $288 per month. and I would bet that between CAPEX and maintenance, you should be budgeting $300 per month cuz I don’t think you can get away with less than that over the long term. So right now your cash flow is not positive on this property um on a on an average basis over a three to five-year period. You’re going to have many months where it will be positive and will deposit money in your bank account, but you also have those those big turns um where $5,000 is going into that property and that wipes out all of that um overall. And so that’s that’s the major problem here and I would estimate that this this same situation could be going on in other of your properties um with that. Do you think that’s that a fair do you think that that’s uh what what what’s your reaction to that?
Guest: Well and that’s that’s a very good observation because my husband and I, we talk a lot about, well, do we want to do the cash out or do we want to keep them paid off for increased cash flow. We do have four properties paid off right now. Um, we were toying with the idea of refinancing two or three of them to help pay off the private lender. Um, so I it that comes into play I would think based on the cash flow on other properties. So do I start analyzing, do I just start analyzing each one like this and or do we do it as a whole?
Mindy: I would analyze each one like this and I would go a little bit further and say because the numbers that you shared with us were personal and business all together, I’m wondering if your personal income of $12,000 a month is subsidizing your rental properties and that is also making you feel like you’re living paycheck to paycheck? because $12,000 a month in a relatively low cost of area living should be, I don’t want to say knocking it out of the park, but it should be really, really comfortable and I think that each individual property should be, I don’t want to argue with Scott and totally derail this conversation, but I would challenge you to figure out CapEx for each one of your properties. What is 123 Main Street’s roof age and system’s age and appliances and see, oh okay, a roof is $15,000 and I have 10 years left on this roof. So 10 times 12 months is 120 months and
Scott: $15,000 divided by 120 is $125 bucks a month.
Mindy: Yeah, so you need to save $125 a month for the roof. If the furnace is about to go out, that’s $5,000. Let’s say you have a year left on that. Now you have $5,000 divided by 12, you need to save $416 a month to replace the uh furnace. And I don’t know if you can get a $5,000 furnace because do you have to have AC where you’re at? I’m not sure. I mean, you need it. Are you required?
Guest: The furnace, with most of our houses, they’re in really good shape.
Guest: Okay.
Guest: Um, we do have a few that need a roof maybe in five years, like you’re saying. Um, several, we put in AC units, those were 1600 new. Um, so those are good for a while uh as part of our remodels. Um, also most of the furnaces are in great shape, probably, but there are several properties that we need to start thinking about that in the future. Um, but we can get a new furnace in them for, they’re not giant houses, so maybe 2,000, 2,400 is what I would start thinking about.
Mindy: I think it’s a good thought exercise to see. Okay, I have nine rentals, six of them are awesome and three of them aren’t. Dump those three or think about dumping those three and looking at different properties that would be better for your bottom line. Somebody, there is an investor out there who will think that those three are amazing properties.
Guest: Yes, so that’s funny you mention that because there’s one condo in in Arizona that we use, it could really use a remodel to to really be attractive, but I mean it’s a little workhorse, but I I feel like it is negative cash flow and with the values where they are in Scottsdale, I was thinking about maybe listing that one. We do have um some of our private lender money wrapped into that one at 10% interest only. So, it’s very hefty, which is why we were toying with refinancing some of our paid off rentals in Flint to pay him down because of the interest rate.
Scott: So, let let’s I I think I think that what what what the homework assignment Mindy and I would have for you is to one, analyze each of your properties for cash flow right now. pretend you’re buying it and go through the exercise and and when when we go through that exercise, make an estimation for vacancy. I would recommend you estimate 5 to 10% vacancy. 5 to 7% if you think your market’s really good because that’s one month of vacancy per year um with that and I think that that’s that’s a good conservative estimate. I would put in $1,000 a year at minimum for the home maintenance. These are not capex. This is like problems you’re fixing, ant infestation, um AC broke, fridge, ice machine broke whatever with that, right? You’re going to have to send somebody there once a year per unit, maybe once twice a year to fix things up. And then I would do the CapEx exercise that Mindy just suggested, think about all the things you might have to replace in the property and back into them. Um, it will probably come out to well over 100, $200 per month on the property um for that. And and that will that will inform you. So when you get a when you get that, and let’s just use those numbers, you know, we’ve got $1,000 in rent, we got $612 in principal interest, taxes and insurance. I think you’re going to be underwater from a negative cash flow perspective on at least this property and maybe some other ones, and that’s a really good thing to think about. Okay, I want to own the property free and clear, um, and not have a debt on it, and then all that will improve my cash flow. That’s one way to to resolve that or I can sell it and try to redeploy into a property that will cash flow um on a standalone basis. But I think this is a root cause of why you’re feeling like cash is never filling up the coffers um, on a monthly basis. I don’t know if I’m not sure. Um, you know, during the the refi which was recent, I got hit with the interest rate going up. Um, what I was usually getting these cash outs for five and a half to 6%, they were tolerable for business loans. Now that one was seven. In my mind, it’s still cheaper than the 10 I’m paying, so it was, you know, worth paying him a chunk. Um, but we haven’t closed on that yet, so, um but that is in underwriting.
Scott: Yeah. Well, well it sounds like you have some the the financing situation is is also a concern. So, how much do you have in total outstanding debt across your portfoli to the private money lender?
Guest: 200.
Scott: $200,000 at uh at 10% interest. So you’re going to pay $20,000 in interest per year on that.
Guest: Correct. Yes, our payment to him is 1600 right now.
Scott: Great. And how much you said the asset value is 1.6 million?
Guest: Yeah, of those, yes, of those nine, um, yes, 1.5 and some change.
Scott: How how do you how do you feel about that valuation? Are you being spot on? Are you a little conservative? Are you a little aggressive?
Guest: A little conservative because I I try to be conservative when it comes to that. Um, but I don’t want to be overleveraged. I think the last I looked that puts us at about 50% equity based on the liabilities that we have.
Scott: Okay. And your total so that means you have you have $200,000 in private private in this private loan, and then you have how much in mortgages against those properties?
Guest: 690.
Scott: Okay. So you’ve got $900,000 in debt, $890,000 in debt and 1.5 million portfolio. So you have $600 Yeah, that’s not 50%. Well, it’s a little over 50%, but but it’s it’s in the you have hundreds of thousands of dollars in equity here, about $600,000. Okay. Um, so here here so when you said that your business is is generating $8,500 per month, how did you how did you derive that number?
Guest: I took my um I think it’s in my income statement and I I did um divided that out per month. So for the year like for 2021, um gross rents were 77,000.
Scott: Okay. So you divided that by 12?
Guest: Yeah, and then I was thinking more about um what that number I originally gave you on the spreadsheet was the rent coming in, like our net coming in from property management.
Scott: Okay. So you so you have you have uh a certain amount of rent coming in each each month and then your property manager is taking a chunk 10% out of that and then distributing the balance to you on a monthly basis. and that’s what you’re calling the 8500 a month.
Guest: Yes, yes, that’s after property management, correct.
Scott: Okay, great. So here here’s here’s the the issue with that. You’re not generating $20,000 a month in in profit. You’re generating $12,000 a month from your jobs and then you’re generating perhaps even a negative balance on these rental properties because we talked about how, you know, those those 600, that $690,000 in debt that you have will easily be costing you four to $5,000 per month in the principal interest, taxes and insurance payments. and then you also have $1,600 on top of that going to the private lender. So that leaves you with $6,000 or so in total expenses. and then you have $2,500 to cover the maintenance and CAPEX and vacancy expenses on your nine property portfolio. So I I think that the my hunch here is that this portfolio is costing you money on a monthly basis, not building not not putting money into your pockets on a monthly basis.
Guest: That’s what I’m feeling. Yep. So so what do we do about that, right? Well, the what we do, the first thing is go go through the exercise that Mindy just described and get the cap back allocation on each one of these properties. Then we will give you a free pro membership for the bigger pockets, for bigger pockets. Use the calculator um you can you can keep using your own spread sheet whatever, but use our calculator and run the numbers on each one of those properties using with those CAPEX assumptions and determine which ones are going to be cash flow positive and which ones are killing you because I bet you you have two or three that are killing you and a handful that are cash flow positive.
Guest: So I can do that um in my accounting software per property.
Scott: Okay.
Guest: I can run a P&L on each one and then just add that CApex. Um so I can do that as my exercise.
Scott: I’d also encourage you to do it in the calculator because the calculator will be forward looking. It’ll allow you to make assumptions about that and you can ask people about but you can do it in both, but it’ll be it’ll be easy there and I think that will help you say, okay, I know I that’s what I’m probably going to average. Is that driving with the reality that I’m getting in my accounting software downstream here with that over time. And I think that that will be helpful and that will give you a sell, refinance or hold um decision on each of your properties. And I bet you you will sell several of them with that.
Guest: Yeah, um, we have a lot of our own capital into the Arizona properties. Um, based on selling some, we had a few flips, sold a rental, and then deployed that into the Arizona properties. Um, so I liked the idea of maybe selling the one condo getting that money back um and paying down that lender to get rid of that large payment because really they only performed really well in February and March, the rest, I thought was break even, but I don’t think they were break even when we add the portion that we pay our private lender. We were underwater. Yeah, Mhm.
Scott: I ain’t going to Scottsdale in July. Yeah. That would be very slow months.
Mindy: I would also go back to the personal spending. Um I have been publicly tracking my spending and I track it very granularly because I want to know all these different categories. I have basically um necessary categories and frivolous categories and some people say that travel is necessary and some people say that travel is frivolous and Maslow’s hierarchy of needs, I don’t think travel uh appears at all, but you do have $800 a month in travel expenses. Those are business expenses if you’re visiting your properties. So, uh, of course, I’m not a CPA, talk to your CPA to make sure that you can write them off and that you are um planning them properly so that they are write offs. But you have uh general as at 866. I would challenge you to go in and see what exactly are you throwing in that general category. The last thing I want to bring up is the boat that we didn’t talk about. I used to live on a lake. I had a boat in my backyard and we never used it. The two happiest days in a boat owner’s life are the day they buy it and the day they sell. And I don’t have any judgment if you want to keep your boat because you use it all the time, but keep track of how frequently you use your boat and at $750 a month, could you go and rent it like on a weekend if you’re just doing it like once a week or like once a month? Could you rent it for less than that and not have your very own boat?
Guest: Well, the plan with the ultimate five plan, um was that we will be living on the boat back in Michigan in the summers.
Guest: Oh, how big is it?
Guest: And Arizona. It’s, it’s got two births, they call them, like bedrooms. Um. Okay. So, it’s like 30 ft. Okay, It’s a cabin cruiser. It’s our mobile cottage. Yeah. Oh. Okay. And with the dominium, um, that’s the summer home, the ultimate goal. And then Arizona for eight or nine months.
Mindy: Okay. So then that is a a conscious expense. Great, perfect.
Guest: It will go down as of September by 500 bucks.
Mindy: So that’ll be 250 a month.
Guest: Yes.
Mindy: Okay.
Scott: Yeah, I I don’t I don’t know about the boat specifically with that, but I agree with everything Mindy just said there. I think that fundamentals, um, I I I think that this, you know, the reality of your situation is you need to do go back to fundamental analysis on each one of those rental properties and then your personal P&L, which is even more important. It actually generates way more, you can generate way more cash flow from your personal P&L than you can from your rental property portfolio right now. So that’s that’s the cash flow situation. and when you’re sitting on $50,000, if if in a few months, you’re sitting on 50 to 60, 50 to $100,000 in cash in your bank account and you’re like, I’m confident that I’m generating four to $5,000 a month in free cash flow, I guarantee you things will be much better from a overall perspective. You’ll be like, okay, I have a path to doing this. I don’t have to get to F five tomorrow, uh and live on the boat, but like it this will automatically happen and life is life is good. Um, but but that will be a there will be a lot of analytical homework that I think you should do this week because the market is turning right now, right? Like some properties are going going up and down. do it now, figure out those properties. This is this is not going to be a fun 40 hour week for you. do put your 80 hours or 100 hours in and get this done and then make make some plans. Get your uh husband on the same page with that and say, we’re not going to hold cash flow negative assets. That is not a good plan. You know, that’s a good plan if you can hold on for 30 years, but who knows what what’s going to happen in 30 years? You know you can hold on to a cash flow positive asset for 30 years.
Guest: Right, and I think one big thing that you pointed out, um, we weren’t considering the CAPEX in the future because what if we do reach our fie, but then five years in, we have thousands of dollars worth of expenses on these houses. So I I that was a good eye opener.
Scott: As a real estate investor, your business is your properties, your you know, the debts, the assets and liabilities in that portfolio, the cash flow they’re producing and your reserve, right? There cash is the asset that is negatively correlated with real estate, right? When real estate prices are plunging, the value of your cash is going up um in that case. So you you got to capitalize the business conservatively. I I think a good rule of thumb, everyone disagrees um with this. So go, you know, you go in the forums and you’ll get 50 different people saying 50 different things. But my rule of thumb would be 15 to $20,000 for that first property in reserve and adding on a buffer of 5 to 10,000 for each additional property that sits in that business bank account. That’s comfortable capitalization for a rental property portfolio. Go on Bigger pockets right now and ask where can I find a Heloc on my rental properties? Nobody can find one because the market is not is not that yeah. So all these people who are like, oh, I’m going to find I’m going to capitalize my my investment portfolio with a rental property Heloc. Nobody can find one. I if anyone who has a lender that can do a helic on an investment portfolio, please send it to me at Scott@biggerpockets.com. We’re going to make them rich um because we don’t we don’t no one can find a solution. So like So, so you need the cash because it’s when the market is like those all dry up when the market is not um when interest rates are rising with this. So that that would be and and that’s just part of your plan. So your pie plan is, I’ve got $100,000 in cash across my 15 units and then they produce this much cash flow and I take the cash out whatever it gets above 100 grand. and that’s how I’m catching my life.
Guest: Gotcha. Okay, gotcha. Okay.
Mindy: Awesome. Well, Pam, this was a lot of fun. I think this is going to be helpful for a lot of people. I think there’s multiple people in a similar position where they think that their property is a rock star property and yet they can’t really figure out why it’s not quite as rock starry in real life and, you know, it’s, I think you’re in a great position to sell and 1031, I want to give you some words of caution, get a qualified intermediary ahead of time. do not close on the first property until you have found the second property. It’s still a hot property, it’s still a hot market. but, you know, really make intelligent choices with your 1031 because there’s very strict timelines. If you miss a timeline, if you take possession of the money yourself, like there’s so many ways to blow a 1031 exchange and then you’re paying capital gains taxes. Long-term capital gains on the ones you’ve held for more than two years, uh shorter term capital or more than a year, Scott is it more than a year? It’s more than a year. Um shorter term cap short-term capital gains on the ones that you have held for less than a year and um, just if you can avoid those taxes and just kick that town can down the road, do that instead. So, uh, yeah, lots of great people.
Scott: I I’d advise doing this quickly. This is overwhelming. you’re going to have a long week maybe two uh of of this figuring this out. analyze those properties. Mindy’s absolutely right and I completely forgot about that. There are tax consequences of that. The tax and 1031 stuff should not wag the tax tail does not wag the business dog.
Guest: Plus um, buyback appreciation I have to consider as well.
Scott: That’s right. So the 1031 exchange will help you avoid that. Oh good, okay, I see. Or or at least defer it. So, but that should not affect your decision whether to sell or not. The decision whether to sell or not comes from your analysis if it’s cash flow negative and it’s going to take significant money out of your life every month for the next 10 years, I would recommend selling that property um regardless of whether you’re able to complete a 1031 exchange, but talk to the accountant to see if the 1031 exchange can be a beneficial way to defer those taxes.
Guest: Okay, yes, and he’s amazing.
Mindy: Awesome. Well, thank you, Pam.
Guest: Thank you so much for your uh world of advice here.
Scott: Yeah, hopefully this was helpful. I I know it was overwhelming. There’s a lot going on here. We’re trying to be as as valuable as possible with that. I know there’s big changes there. Um, we’d be interested to see.
Guest: Yeah, no, it was super helpful and I I you know, the BiggerPockets community is buy more, buy more, buy more and well now what? We buy we bought a bunch. Now what do we do? And it’s exactly that. Analyze.
Scott: You want you want to buy more when your financial position is strong, you’ve got a really good found uh foundation with that paying of cash, you can hold on to the asset for the long term and it produces at yeah there’s an argument about whether it should cash flow or appreciation is more important. I invest in Denver because I believe that appreciation is more important over the long term, but none of my properties negatively cash flow. They just produce less cash flow than I would get in a market like Detroit perhaps or or the Midwest in a general sense.
Mindy: Okay, Pam, thank you so much and we’ll talk to you soon.
Guest: Thank you. Bye.
Mindy: Okay, Scott, that was Pam. I thought you gave her some really excellent advice on just going through and making sure that the properties are actually cash flowing. I think people see the rent and the uh mortgage payment and think that what’s left over is their cash flow and really diving deep into the numbers is so important to make sure that you’ve got a really great rental property.
Scott: Yeah, I I can’t stress enough that Pam won here, right? The the market has carried up the value of those properties, hundreds of thousands of dollars in wealth has been created, equity has been created um due to their their activities. But the fundamentals are not in my opinion, strong enough in that business where I would want to hold on to it on for the next 5 to 10 years. I think that I would want to hold on to a business where I believe in the value of that property going up over time and where I believe that it will put money into my pocket on average every month for the next several years with a strong capital capitalized position with a cash reserve that can hold the buffers for when I inevitably will have that, you know, that roof is supposed to last me 15 more years. It may only last me eight. I need to have that cash ready ahead of time um to be prepared for that event, right? It may go it may go out tomorrow. I may have a leak tomorrow and have to and have to fix it. So I think that’s really, really important when we go through this. So to recap the overall situation, Pam and her husband are making 12,000 bucks a month, I’m spending 9500. So that may there may be puts and takes before and after tax. So on average, they’re probably only accumulating one, $2,000 per month, which would be fine except for their rental business is probably taking that out of their position because of the negative cash flow. We said just from the debt, we’re spending $6,200 a month in uh in debt service, um principal interest, taxes, insurance, and then the interest payments on the uh private loan. And that doesn’t even account for the vacancy, CAPEX, maintenance, um utilities when they’re aren’t rented. Those types of expenses that are definitely hitting them and sucking cash out of their lives. So, the way we solve that is we do a unit analysis by each property and say, what’s this property performing like today? what’s it going to perform like over the next couple of years? And that will tell me to buy, hold or refinance each one of those properties. And I believe that they’re going to have work to do. And then lastly, I think it’s important to have that framework in mind about what I want to do and what a strong financial position looks like, and then move quickly to get to it. Not because, you know, we’re we’re terrified of the market or anything like that. But because that market volatility there, they’re all dependent on like it’s because of the market, right? Because because they’re dependent on the market uh to produce uh wealth gains or decreases. That’s a that’s a position that’s very volatile compared to the investor is going to hold for 20 years a cash flow asset. So I think they should move very quickly. I think there’s a lot of homework to be done there and uh I’m excited to see how it turns out for them. So, again, all in the context of a big win. Can’t don’t want to overshadow that.
Mindy: Yes, I think we didn’t do enough to celebrate the fact that she has done really well so far. But now is the time to re-evaluate what she’s got. Um, I will say that I think my advice might have been a little bit different if she was investing in a different market, but Michigan is not known to be a rapidly appreciating market.
Scott: And her advice would be different if she had already refinanced those properties at low interest rates. So, if she had gotten if she if these if these were on 30-year fixed rate mortgages at three and a half percent because she refinanced or bought them in 2016, 2015 and were cash flowing, no way we be selling right now, right? Like that I’m not selling a property. That’s how that’s how my portfolio looks with that. I’m not selling that. But because she has to refinance the properties at probably six and a half, 7% interest rates at this point in time to pay off her 10% private loan, that’s where the sell decision I think becomes that much more uh of a of a factor.
Mindy: Okay, Scott, should we get out of here?
Scott: Let’s do it.
Mindy: From episode 322 of the BiggerPockets Money podcast, he is Scott Trench and I am Mindy Jensen saying, saying stay out of trouble.
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out of trouble.
