Over the past 5 years of investing in real estate, I’ve learnt my lesson about the hidden costs when you invest in real estate, which are, repairs & maintenance (R&M) and vacancies
As a result, when I invest in properties these days, I don’t mess around, I use realistic numbers, so that I don’t overpay for a property.
Why do I do this.
Because when I’m analyzing a property to purchase, if I use the Realtors numbers, which as I talked about in the Hidden Costs When Investing in Real Estate - Part 1, for repairs and maintenance, its probably going to only be 5% of the rental income, and as I talked about in Part 2, for vacancies, it's probably going to be the markets rate, which let's say is only 3% in your market, which it currently is in my market.
And I’ve seen Realtors use these numbers when running projections for their clients, which will result in a very nice looking cash on cash return on investment (ROI).
Here’s a property I’m currently looking to invest in here in Windsor-Essex County.
This is a fourplex that according to the Realtor is a money-making machine, $36,000 annual income.
And it sure looks like it, especially if you don't factor in the hidden costs of investing in real estate.
See below for yourself.
As you can see, based on the income, less the mortgage payment and expenses, in which I used 5% for my R&M costs, and 3% for my vacancy cost, combined with wanting a 10% cash on cash return, my analysis is showing me that I would easily offer over list price, $277K (its currently listed for $249K).
Many investors think like this, especially beginners, and since they don't consider he hidden costs when investing in real estate, they will bid this property up to over list price, paying $277K to get there 10% cash on cash return, as a result of using these unrealistic numbers.
In reality though, and reality will hit hard and fast when you invest in real estate, you will not get that 10% cash on cash return, because as I talked about in Parts 1 and Parts 2, you will have more repairs & maintenance, and you will have more vacancies.
So, let's look at how much you SHOULD pay for this property, to obtain a 10% cash on cash return, based on more realistic numbers, factoring in the hidden costs when you invest in real estate that I talked about in Parts 1 and Part 2.
To recall from Part 1, you need to include the FUTURE repairs and maintenance that you will incur at the property, so that you get a more accurate picture of the costs that you will incur, not just the NOW repairs and maintenance that you think you will incur, such as fixing a toilet, or a leaky pipe, or maintenance on the furnace or AC.
The same goes for what I talked about in Part 2, and the vacancies you will incur over the long term, not just the now vacancies, which investors will think, and even claim, are 0%.
That the tenants will never move out, and if they do, you have a tenant lined up to fill it ASAP, thus never having it vacant for even a month
Investor tip, you will though, because you don’t want to just put anyone in your property, rushing to fill a vacancy so you don't have it sit vacant for a month, and you most likely will have to do repairs to the unit to get it ready to be re-rented, which will most likely have it sitting vacant for a month or maybe 2.
Once you you’ve taken these hidden costs more seriously into consideration, as you can see below, the numbers change dramatically, and to obtain a 10% cash on cash return, you’d only pay $235K.
By not paying being more realistic and including these hidden costs, many investors end up overpaying for properties.
Then when reality strikes, and they end up having to use up there cash flow they thought they'd get, or pay out of pocket to cover these hidden costs, they stop investing after.
This is why beginner investors lose on there investments.
Because they don’t use realistic numbers for these hidden costs. They don’t run their own numbers, instead relying on the Realtor’s numbers, which many don’t even include these hidden costs in their analysis. I’ve gotten emails in the past from Realtors and there was no mention of these costs at all, thus, greatly inflating the cash flow the property generates, and the return you’d make.
Or investors to do include the hidden costs in their analysis, but they include them using the usual 5% benchmark for repairs and maintenance at the property, and the markets vacancy rate.
DON’T DO THIS.
As I talked about in parts 1 and 2, you need to think long-term, extrapolating out the future costs, such as the replacement of the roof, the furnace, the AC, that you will have to pay for maybe every 10 years, and extrapolating out the vacancies you will have, for when your property might sits vacant for a month, every 2 years.
And when you do this, when you include these hidden costs, not the NOW costs only, you will become the smarter investor, a better investor, AND you will get a more realistic picture of your ROI, so that you don’t overpay for an investment property.
WHAT TO DO NEXT:
Learn more about how to analyze a property, so you include these hidden costs in your analysis, by enrolling in my FREE REI Bootcamp, where I'll show you how to analyze a property the right way, as well as how you can start investing in real estate right away.
Enroll in Real Estate Investing Bootcamp