Rental Property Café™- Episode 3 - 6 Common Rental Property Budget MistakesReal Estate Coaching
I've invited my friend Veronica Woods to join me in an ongoing conversation about building a real estate toolkit called The Rental Property Café™. Please send your ideas and suggestions for topics to firstname.lastname@example.org.
What you'll get from this video podcast:
THIS WEEK ON THE RENTAL PROPERTY CAFÉ™ VIDEO PODCAST
In this episode, real estate financial planner Cynthia Meyer and real estate advisor Veronica Woods talk about the 6 common rental property budget mistakes that they have seen rental property owners make -- and what real estate investors can do to avoid them.
“You can’t improve what you can’t measure.” – Veronica Woods
“…it's important to know whether you're losing or making money, especially as you get more and more properties. To look at it at a portfolio perspective, you really have to know the numbers of each individual property in terms of the numbers and operating income. Are you generating positive cash flow?” – Cynthia Meyer
“If you're getting a loan to buy the property, the banks really kind of force you to have the initial reserves in your bank to allow you to get the loan approved.” – Veronica Woods
“The budget is your overall financial plan expressed in numbers.” - Cynthia Meyer
About the Rental Property Café™:
The Rental Property Café™ podcast offers a real estate tool kit for busy professionals who are building a real estate portfolio. In each episode, our co-hosts Cynthia Meyer & Veronica Woods explore ways to grow a successful real estate business while growing your career.
About Cynthia Meyer
Cynthia Meyer is a financial mentor, CERTIFIED FINANCIAL PLANNER™, CFA® Charterholder, real estate investor, blogger, and the founder of Real Life Planning. She offers unbiased financial planning and learning resources to real estate investors. Cynthia is a first-generation rental property owner, who built a rental property portfolio with her husband, Steve, while they were both building their careers. She lives in NJ, where she balances teenagers, her financial planning practice, and a rental property business.
About Veronica Woods
Veronica Woods of Daniel Woods Real Estate, real estate advisor and investor, is passionate about helping her clients create wealth, legacy and lifestyle through real estate. She works with people to buy, sell, rent, and develop residential and small commercial real estate in Delaware County and Philadelphia, PA. An MBA in finance from the Wharton School, Veronica also shares her real estate wisdom with new investors on her YouTube channel.
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The Rental Property Café™. Co-Hosts :
- Cynthia Meyer, CFA®, CFP®, ChFC®
- Veronica Woods, Realtor®, MBA
Transcript: Rental Property Café™- Episode 3 - 6 Common Rental Property Budget Mistakes
[00:00:00] Veronica Woods: Welcome to the rental property cafe podcast our third edition. Hi, I'm Veronica Woods a real estate advisor, along with my cohost...
[00:00:14] Cynthia Meyer: Cynthia Meyer real estate financial planner. Good morning. Good morning. What's in your cup this morning?
[00:00:20] Veronica Woods: I'm still drinking my second cup of coffee, but it's a mid-eighties here in the Philadelphia area. So I should really be drinking some water to keep hydrated, but I'm excited to still chat with you on video today, even though you may hear some fans blowing in the background, hopefully, it's not too distracting.
[00:00:43] Cynthia Meyer: Oh no, not at all.
[00:00:44] And yeah, it's pretty warm up here too. I guess what I'm about two hours north of you and I'm drinking some tea in my XY planning network mug, which they sent me for some reason that I like it. I'm very happy and looking forward to getting outside today. So after tax week, especially.
[00:01:00] Veronica Woods: That segues into our topic for today. Talking about the numbers of real estate investing. I know that's a topic that we both share the love for, and really helping to coach our investor clients to pay attention to the numbers, not just when you first buy the property, but through their whole life line of the whole life cycle of owning the property.
[00:01:24] Cynthia Meyer: Veronica, you're so right and today we're going to talk about some of the common rental property budget mistakes that both of us have seen people do through the course of our businesses. And we have a slightly different perspective on it. For me, I often see people that are unrealistic about their rental property budgets or unrealistic about how a property is going to cashflow or what they should include in the budget. Veronica because you work more with professional investors what do you see?
[00:01:56] Veronica Woods: Oh, I would say I see the same thing. So I definitely worked with a lot of newbies. But they're open to looking at the numbers. They know that when they first make the investment, they're conscious of the numbers have to work. So they know it. They don't know what those numbers are and I see the same thing that you see that their expectations aren't realistic. It's important that I tell them it's important to know whether you're losing or making money, especially as you get more and more properties to look at it at a portfolio perspective, you really have to know the numbers of each individual property in terms of the numbers operating income. Are you generating positive cash flow?
[00:02:39] So I definitely see the same concerns. Especially, if you don't have a financial background. It's just something that's foreign to some folks. And it's hard to know whether you have the right assumption.
[00:02:53] Rental Property Budget Mistake #1: Underestimating All The Variable Expenses
[00:02:53] Cynthia Meyer: You're absolutely right. In my financial planning practice, I encourage people to think about, this is described as passive income, but real estate is also a business. You have to run it like a business. I think kicks off that the number one rental property budget mistake that we see people make, which is underestimating all the variable expenses. Right. It's not too hard to figure out what your mortgage and your property taxes and your property insurance is cause you may be having that deducted every month by your mortgage, right? But things like maintenance and repairs, utilities, garbage, water, landscaping, or snow removal, capital expenditures, like putting in a new washing machine or even figuring out what is a good vacancy rate, right?
[00:03:39] There are assumptions that impact what those assumptions are. I would say that probably underestimating maintenance cost is the biggest component of that. Maintenance costs ideally should be 1 to 4% of the purchase price based on the age and the condition of the property.
[00:04:00] The newer home may be figure 1% of the purchase price and the older fixer-upper Victorian could be up to 4% of the purchase price. This is a mistake that new homeowners make too.
[00:04:11] Those aren't expenses that happen every month. You have to plan for them and set aside reserves so that two or three years down the road, when you need a new air conditioner or you have to replace the roof, you have saved up for it.
[00:04:26] Veronica Woods: Yeah, I just piggyback off of the thing that you mentioned about an older home. Especially if we have watchers or listeners in the Northeast where there are a lot of older homes.
[00:04:37] If when you first purchased a property, you don't do a major upgrade of the systems and mechanicals, you could just count on that your average maintenance costs are going to be a little higher. If you were buying an older home, you definitely want to err toward more of the conservative point of view for that kind of property.
[00:05:01] Cynthia Meyer: When you have a new investor, Veronica, what do you encourage people to use as the vacancy?
[00:05:05] Veronica Woods: It really depends on the neighborhood. Everything in terms of having good assumptions, you don't want to take a big picture assumption of somebody in LA when you're in Baltimore. Right? You really need to think about how long it's going to take you to find a tenant. And then there's a handy formula.
[00:05:24] Maybe you can put it in the show notes where you can take how long it's going to take you to find a tenant and back into what that would be on a monthly basis. That's really the best way to do it. Really think about, is this an area where it's going to take you a month to find a tenant? Or is this an area where it's going to take you three months to find a good quality tenant? And I should emphasize that.
[00:05:46] Cynthia Meyer: That's a really good point. I know in our personal rental property portfolio, my husband and I, over time, we realized that there's always a month turnover. Where we are not going to turn a property over in one to two weeks, there's always a month to do some repairs or painting and maybe replace the carpet if that's needed. We always plan for at least a month vacancy when the property is turned over.
[00:06:08] Rental Budget Mistake #2: Not Budgeting Enough For Turnover Expenses
[00:06:08] Veronica Woods: And and I should say, or we forgot to mention this. We have six tips. They're not in any necessarily order of importance, but we feel like these are all things that you should think about. I'll jump into mistake number two which is not budgeting enough for these turnover expenses. Like you said, it may take 30 days to do that work, to prepare for a new tenant. You may not have that every year but depending on the size of the unit, especially if it's a smaller unit of, let's say studio, the two bedroom apartments, they just naturally attract more turnover just by the nature of people who want to live in those properties.
[00:06:50] That means when you're, two years in, you need to make sure that you're accounting for maybe having a higher expense during that month. The areas where I see most of the expense happening are either cleaning, painting, and flooring repairs. I always throw in the wild card. The thing that you can't see when the tenants living there and they didn't tell you about it.
[00:07:13] So until you do that final walkthrough with the tenant, and you can see maybe there was a slow leak from a seal around the windows. So that's the unexpected wildcard that you may not even predict. But even if you have the best of tenants, they took great care of the property. There's always some surprises.
[00:07:32] So I say, kind of safeguard that every, let's say two, three years on the low end for a tenant probably vacating and then having this bump and expenses.
[00:07:46] Cynthia Meyer: You're so right, because in my experience, as a rental property owner, there are always things that you don't expect, which means that you should expect them. You're going to have a new towel rack or replace the railing on the stairs. There's always going to be something you just don't know exactly what that's about.
[00:08:03] Veronica Woods: And I forgot to say also related to the turnovers, there's actually an expense to getting a new tenant, whether you pay for a realtor to find the tenant, or you do it yourself. There's marketing. There's time showing the property. There's screening applications. There's a number of expenses that you only get when the property turns over that you should have in your budget.
[00:08:29] Cynthia Meyer: We use a property manager and I think that leads to our third most common mistake.
[00:08:36] Rental Budget Mistake #3: Not Including A Budget For A Property Manager
[00:08:36] Veronica Woods: Yes, and I do property management work as part of my business supporting clients. The number three mistake is to not include the expenses for this property management job in your budget.
[00:08:50] Even if you're doing it yourself, someone is doing the work of managing a property from collecting rents, to talking to the tenants, to handling all the legal paperwork. All that is a job. Now, even if you've planned to start out with managing it yourself, it's important that the numbers will continue to work and you're still being profitable.
[00:09:14] If by chance you have to outsource it at some point in time and this happens. Sometimes it's unpredictable and say your job relocates to another part of the country. You're too far away. You suddenly become busy with another priority, or God forbid you get sick. I have a client. She was planning when she retired early, thinking that she would manage her rental properties. She had six or seven properties, and then she had a medical crisis. So all of a sudden she could not physically take care of her properties and she outsourced that to my company. We were able to jump in, but luckily, she had the cash flow to cover that expense. So it wasn't a big deal. But if you're thinking about after the fact, it could be a very stressful situation to not be able to do a quality property management job.
[00:10:07] Cynthia Meyer: That's an excellent point. I would say as somebody who works mostly with professionals who have significant real estate side households, as well as some professional real estate investors, there's an opportunity cost. What else could you be doing in your life that you could be more productive in terms of your time or your income?
[00:10:24] That you could turn over to a professional property manager? And obviously it's totally your choice, but you may have to do it at some point. So it's good to know how much it's going to cost if you're going to need to do it. And is your property still going to be profitable?
[00:10:39] Veronica Woods: I think that the main point is that there's some benefits besides use of your time to, and this isn't this podcast, isn't about the benefits of using a property manager, but as it relates to the budget, the property manager can help you track those expenses in a way that the novice or newbie just isn't used to it, and help you organize that data in a way that you can make sense of it over time, as well as maybe help you negotiate lower repair costs.
[00:11:11] You have smaller holdings, just one or two properties. You're not going to get the same discounts of whether you had 10 or more properties. And then that's where you can really start negotiating with vendors about deals. But if you're small, there are benefits of managing the budget or managing your repair expenses specifically, if you were using a property manager.
[00:11:33] Rental Budget Mistake #4: Not Prioritizing Building Cash Reserves
[00:11:33] Cynthia Meyer: I totally agree. And our personal experience, again, using a professional property manager, it can be faster, right? If we need something to happen they might be able to get somebody there the same day or the next day. So I also appreciate that. The fourth most common rental property budget mistake that I see, and I'm wondering if you see it too Veronica, is just not having sufficient cash reserves and not prioritizing building them over time when you add a new property to the portfolio. I encourage people to add to their cash reserves every month. As we mentioned in the beginning of the podcast, reserving for capital expenditures, for vacancy rates, for planned spending down the road, any repairs or turnover expenses that you're going to make.
[00:12:22] Figuring out what that is upfront and putting that money away in a separate savings account. Ideally, segregating it in your QuickBooks or whatever system you're using to track the rental property budget. It is making sure that you have enough cash reserves in case the worst happens.
[00:12:39] Don't be overly optimistic about how much rent is going to come in and how little you're going to spend. And we think we've all seen this during COVID right?
[00:12:47] Veronica Woods: Yeah.
[00:12:47] Cynthia Meyer: There are tenants who can't pay their rent and you're not able to turn over the unit. But you still have to continue to pay all the expenses.
[00:12:55] Rental Budget Mistake #5: Not Monitoring Your Budget Actuals vs. Your Budget On A Regular Basis
[00:12:55] Veronica Woods: One thing when, if you're getting a loan to buy the property, the banks really kind of force you to have the initial reserves in your bank to allow you to get the loan approved. But I think you also, as you're managing the property over time, you also tested about, do you really have enough reserves for your investment, which I'll segue over to the fifth mistake, which is not monitoring your budget actuals versus your budget on a regular basis.
[00:13:32] I find that the end of the year is a good time to look at your budget against them, the actual performance. Cause month by month could vary depending on what happens. We were talking about when you have a turnover, that's going to be an unusually higher month, but once you get a full 12 months, you have enough data that really compare. Now, if you just bought the property, I would compare your actuals versus your original assumptions before you bought the property. If you've had the property for a few years, every time we're looking back at the previous year and see if there are any trends that you should watch out for. Are there months, a lot of them so you were negative? Are there trends in certain types of expenses? Like you're having a lot of plumbing expenses? Are you thinking about planning to take care of one of those larger capital projects soon? Putting that in your budget on a kind of schedule or plan basis really helps you better manage the property overall. As well as help you direct where your rent should be. Obviously, you want to charge the market rent, but you also want to make sure that market rent coverage you're operating expenses so that you're actually making money.
[00:14:46] A lot of people get in the hole is because they're charging below-market rent and then they're wondering why they're not profitable. But that is a cause to raise your rent. Now you can't just jack up the rent on people. If you have an existing tenant, you have to go according to your lease and that should prescribe what the increase would be as well as when you can communicate that.
[00:15:10] If you're seeing that you're running a little low, or you have a planned capital expenditure, that might be a good time to raise the rent by 5%. That's the standard in terms of best practice and not raise the rent more than 5% on an existing tenant.
[00:15:27] Now, if the property is vacant, that's why there's a lot of opportunity to really recalibrate the rent when there's a vacancy. Because then you can make sure that their new tenant is going in right at market rate. That could mean that you might need to do some repairs or some upgrades, and were to make sure that let's say the $1,500 a month rent on your block, your house looks like that.
[00:15:53] But it may be worth it to invest in those incremental repairs if you can raise your rent by a few hundred dollars.
[00:16:01] Cynthia Meyer: There's a lot of opportunity right now, in my opinion, in general, in the market, not as much in single-family homes where there's a lot of competition for new homeowners, but in these small multi-families and small apartment buildings. That's a good way to think about it. If you're looking for something, maybe it needs a little refresh. Some minor repairs. Some new appliances, for example. Some changes in the bathroom to make it so it's going to be attractive to that market rate rater. So those are really good points.
[00:16:33] Rental Budget Mistake #6: Not Tracking Your Budget At All
[00:16:33] Cynthia Meyer: I would say number six, and you touched on this a little bit Veronica is, I see folks who just aren't tracking their budget at all. As you said, comparing your projected budget to the actual result is going to help you be a better investor. Now, real estate at investing in direct investing in properties is a learn-by-doing experience and it's going to help you be a better investor. It's going to help if you're actually profitable. The point is to run and track the numbers in using any tool that you prefer. In our real estate business, we use a combo of an Excel analysis of the entire portfolio which I also do for clients.
[00:17:13] And then QuickBooks. But there are many ways to track your numbers. There are different free calculators online. Any favorite that you have in terms of number tracking Veronica?
[00:17:25] Veronica Woods: Really you name some of the same ones that I use. I think that the key thing is the one to put the numbers in the system that you can use, but then you have to look at them. They have a property manager. They're giving you reports every week with insight of what's going on, but if you're not looking at them, then you can't make sense of them to make the strategic decisions. Because you can't figure out what you need to turn around if you don't know where you stand.
[00:17:50] You can't improve what you can't measure. It goes with real estate as well. You don't know like do. I have a rent problem? Do I have a repair problem? Do I have a tenant? So it's, you don't really know how you can turn your situation around if you need to.
[00:18:07] Cynthia Meyer: Yeah. Whether it's an individual rental property or it's a portfolio of 20 properties and syndications and loans that you've made for others. The budget is your overall financial planning expressed in numbers. So you gotta track.
[00:18:20] We've got many great ideas in the hopper. We hope that you will watch the next one up and see some of our previous recordings. If you have an idea about a topic you'd like us to tackle, leave it down below in the comments and please subscribe.
[00:18:37] Veronica Woods: And if you're watching this on our YouTube channel, definitely give us your comments. We want to hear from you.
[00:18:44] Cynthia Meyer: In the show notes, we're going to drop some resources that relate to this budget topic. And if you've got comments, questions, things you like or don't like about the podcast, please let us know, drop them in the comments below.
[00:19:01] Subscribe to the channel or email us at email@example.com.
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