One of the things I am hearing all the time around this industry is “-if you want to be successful, run your properties like a business”. What does this mean? It means if you want to be a real estate investor that builds wealth exponentially and sleeps well at night you need to have systems in place to take care of anything and everything that may come up. Running a successful business is about creating these systems. We recommend using a system called “The Big 6”.
“If you want to be a real estate investor that builds wealth exponentially and sleeps well at night you need to have systems in place.”
The Big 6 is a set of metrics we use to analyze and set the budget for rental properties. The Big 6 include your mortgage, property taxes, insurance, maintenance, vacancy, and property management. The numbers we use to determine the amount we budget for each month all come from actual North Peak affiliated market industry standards.
These numbers do fluctuate a little based on which market we are in. It is important to customize your budget based on the type of investment you are working with. A perfect example of this is the difference between a turnkey investment property and a rehab property. You will need to budget more for maintenance and capital expenditures on a property that has not had the roof or floors replaced in 20 years. A second example is a difference between insurance costs in a single family residential vs multi-family commercial.
Here are the numbers we recommend and why:
On average, you should plan on spending 50% of your monthly income or less on your mortgage. However, if you are buying rental properties in cash you won’t have to worry about this one.
Although taxes can vary from state to state, spending at least 1% is a safe assumption. This does not include any special taxes that may be due in the area you choose to buy in. Call the local tax assessor to find out.
This will also vary by area and what kind of property you invest in. On a single-family home in a B-C neighborhood, you can generally plan on spending anywhere from $30-$80/ month.
All properties will need maintenance, even turnkey properties. Saving for maintenance is what keeps you sleeping well at night. This way when the call comes in from the management company on Monday morning telling you the pipe in the attic exploded and the plumbing, drywall, and painting bill is going to cost $2,000 you don’t have anything to worry about. The last 2 years you have been saving monthly for this scenario. You pay the bill and move on with your day unharmed.
Studies show on average one room in twenty will be vacant in most markets. Generally speaking the Midwest markets are much more “renter heavy” than the west coast but even so, you should always budget for the down-times when you don’t have a renter paying your mortgage for you.
Property management 8-10%
If you are not living in the same city as your rental properties we highly recommend using a property management team to run your rentals. Property management takes care of finding tenants, replacing tenants, maintenance, collecting rent, etc. This will help you sleep at night, maybe more than any other item. Worth the money, trust me.
If you haven’t already seen it, please feel to watch Grant Diggles’ Whiteboard video demonstrating how the “Big 6” work.
A couple notes worth taking:
First of all; do your own homework. North Peak will always provide you with a Proforma that will highlight these import numbers and break it all down for you to make it easy. With that said, I like to run the numbers myself for any property I have a real interest in. I always run the numbers for the best and worst-case scenario. I want to know what this property has the potential to do for me as well as what will happen if things don’t go as planned.
Second; I always add in some extra numbers like an increase in rent, inflation, and property upgrades. U.S. inflation averages 3%/ year. This means rental rates go up too, as do the costs of just about everything else. Also, if your property or area are getting more desirable you have the ability to raise the rent as well.
Third; you might be asking: “What about utilities, lawn care, garbage etc.?”. In single-family residential, the tenant usually pays these bills. In multifamily commercial the landlord pays. Definitely, something to factor in if you are planning on investing in large multi-family properties.
Lastly, I encourage you to practice. When you see the turnkey Tuesday emails come out, check out all the proformas, get used to reading them, run your own numbers and compare them.
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