Why You Shouldn't Avoid Low Cash-Flowing Properties | REIal Talk | EP. 70

Hello. Welcome, Freedom fans. Welcome to Real Talk.

Yeah, it's Real talk for real estate investors.

Episodes 70. I get it. Yeah. It's real. Yeah. Chris Sonneno is our director of property management. Yep. I'm the president CEO of Freedom Real Estate Group. Aaron Davis. Chitchat about cash flows today. Yeah.

And all the wonderful things that go into calculating that and planning for changes. As we mentioned the vlog, there's lots of things and variables that can feed.

Into that and then all the adjacent considerations that we should be thinking about that affect our cash flow or maybe would offset or supplement ways that we make decisions in addition to the cash flow. Right. Yeah.

And doing it in a way not just from. We're gonna do a little bit from, you know, our end the business and also flip side, because we're both investors, we're doing from the consumer end as investors a little bit. Kind of see how we make decisions.

Yep.

And then what we should be looking at as an investor as a whole.

You made a good point in the vlog. We talked. I was talking a little bit about some experience I had with homeowners association fees and all that kind of stuff. And not. It's not a huge impact on our portfolio on the properties that you. Your team manages or on the properties that we renovate and sell to our investors. But it's one of those things that are out there, and there's a lot of other considerations that don't necessarily apply to most of the assets that we. That we manage for our investors. So let's. We should. Maybe we should talk a little bit about our kind of portfolio and the typical properties that we address, not because it's the only thing to consider, but it. It lends a little perspective to the context.

Yeah.

We talk about. Right. So we have. We do a lot of older properties, Dayton and Cincinnati and surrounding areas. Middletown's a big one. And a lot of single family homes.

A lot of single family.

Most of those don't have, to your point. HOA and condo associations kind of thing. So that's, you know, a lot of the context that when you and I talk about it, we usually start there and then there's exceptions or. Yeah.

Variance.

Yeah. Yeah.

So majority of our portfolio, most of our. Our product is, you know, a high C, low B class, some mid range B class, higher B class assets pretty even split. Probably 45% are multifamily and the rest are single family homes. From a product standpoint. From our portfolio standpoint, about half or pretty much even split, single family versus Multi family.

Yep, yep. So we've talked about the pro forma and that kind of thing and how people buy. And we have, you know, a lot of people care about cap rates and cash on cash, both the dollar amount and then what's the percent? And those are important factors for sure. Right. But I've always felt like the, the, you know, the appreciation of the property was a missing variable people don't consider.

Right.

And then, you know, what do you do with maintenance costs? What number should you assume? And all these things that, like, everybody's got their own way of doing it.

Right.

Oh, you should assume X percent of X. I saw somebody the other day is assuming a percentage of a percentage of the value of the property as opposed to a percentage of the rents collected.

Right.

You know, you've got. What's the right way to do it? I mean, it's like, what's the right way to predict the future? Right. There's not a perfect, it's not a perfect science. Yeah, yeah.

And that's a good point. So the pro forma that we were using was a general, like, percentage of asset value.

That's right.

As just a base, as you said, there's outliers. When we started asking the questions like, but what if.

Right, that's right.

All of a sudden we're like, that's a good, let's see some real data. So we pulled some information for portfolio about what's been sold last year and then say, okay, what are our clients spending on maintenance expenses? What is the real cash flow? Like what actually is getting brought in for rents.

Yeah.

And then we were able to maybe shift a little bit of what our pro forma looked like to try to make it a little bit more.

Yeah. You know, the biggest impact for me is the cons. The fact that we spend a lot of our time talking with the customers who are going through the hardest situation. Right. Somebody destroys their property or that, whatever, they have an expensive repair or whatever on a turn or whatever. So that occupies our minds a lot as the, as the, you know, product and property management leaders and. But the reality is the vast majority of our investors have very good performing properties with a few of those hiccups.

Like little to no issues.

That's right.

Yeah.

Yeah. The vast majority. And we don't think about that a lot. You and I don't. Day to day, because we're just mailing them checks. So those, those don't provoke a lot of conversations. Right, right. I mean, unless we're reading thank you notes. Right. So, you know, building. Prof. Like, who do you build the pro forma around? Like the worst case scenario, the best case scenario. So I think where that takes me in terms of cash flow, is that the reason we tend to think about, oh, I need to make sure that that's a good cash flowing property. Whatever, you know, 200, 400, whatever your good cash flow number is, is. It should be, it should be a variable. But how much cash are you sitting on? How prepared are you for, you know, the worst case scenario that could happen? If you own that property for 20 years, you're going to have it at some point, you know what I mean? So, you know, are you buying this property to, to get rid of it in two years, or is this something you're holding for 20 years? That's a variable. How old is the property? How recent was the renovation? How thorough was the scope of the renovation? The, you know, what's the, what's the capital appreciation potential in that given area? Those are all important considerations, right? Yeah.

And you know, that kind of brings us into like every product that comes down the line, every real estate deal that exists can serve different investors with different strategies, different ways. The numbers are all roughly the same. It's just, what's that investor's preference? And so having that conversation of are you holding it for three to five, refinance after three, like, are you planning to hold it for a year, force the market and sell? Like all of those things also matter from a management perspective. Also how that performer performs. Yeah, like all that matters. And so building a marketable piece of data like a performer in a way that services all types of investors with all the different strategies is interesting.

Here's kind of where we landed in terms of what, what do we start with when we show investors, and I don't think it's an all inclusive list of details in our pro forma. What I think it is is the critical things you can't not consider, right. And so we included, you know, taxes, some estimate for insurance, a calculation for a mortgage payment based on current rates, actual rent numbers because the property is rented. So we can look at that actual rent that's coming in compared to those relatively fixed costs, right? And say, hey, that's what our cash flow is. And then we added to that considerations for two big variables, maintenance and vacancy and appreciation, neither of which we can really know, right? We can kind of estimate based on past performance. And I think we used a 3%. You know, 3% would be a huge exaggeration if we have this kind of like, you know, flat year that we're expected to have, you know, if you ask the fortune tellers, it would be super low if we have another year like we just had where things go, you know, 5, 10% appreciation, whatever else we just threw in this, you know, kind of macro middle of the room average or whatever, 3%. I think it's kind of conservative if you're going to hold a property for five plus years. Right. But we threw that in there and we threw in some, you know, consideration for maintenance. But, but the thing is those are guesses. Right. And my recommendation is be prepared for a meaningful appreciation of your property over time. Be prepared for some big expense in maintenance of your property at some point in time. Whether it's six months from now or six years from now, you're going to have some big expense. At some point you're going to upgrade, you're going to need to replace a furnace at some point. Hopefully not in the, you know, if you're buying a turnkey property, it shouldn't be in that first year. But however you buy your property where at some point you're going to have.

To have some expenses, you're going to.

Have some capital investment into that property. Right?

Right.

So I think you should add to our perform pro forma a bunch of other variables. You know, if you're going to cash out and refi every five years as the property appreciates, then you should be thinking about.

Right.

Interest rate changes are potential. Right, Right. Our interest rates now have gone up a couple of percent in the last few months, but we're still not historically high interest rates.

Right, Right.

There's no promise they're going to be 3% again next year. So anyway, you can take some historic guess as to what that might be in five years when you want to refinance. But that's a whole nother thing you could speculate about. Right. Depreciation of the property, refining, taking cash out, etc. That a lot of people like to mess with. Yeah. So I, you know, rambling a little bit. I got my caffeine in me. That's there's, there's not a set like I have to have X amount of dollars per property.

Right.

I think I was mentioning before that if I was buying, you know, some condo with everything's brand new.

Right.

And the roof is counted, you know, that is taken care of by somebody else, the landscaping is accounted for, somebody else, et cetera, et cetera, and I'm cash flowing 100 bucks. That's a lot easier pill to swallow than 100-year-old property that's got a tenant paying that's been there for six years, but property hasn't been touched in a decade. Right.

And there's cash flowing the same $100.

Yeah, I'm not going to buy that for $100 in cash flow.

Right, right, right. And then, and honestly like that, that I mentioned this in the, in the blog too is, you know, I go back to 8% cap rate because that always seems to be the number. But an 8% cap at Dayton is very much different than I mentioned Westchester. But like even Beaver Creek or any of the other like surrounding suburbs of Dayton, it's a very different property and astro and everything. So I mean, and those of you that aren't super familiar with our market, like we're talking about $100,000 property and Dayton at 8% cap and a $220,000 property at an 8% cap.

Yeah.

Those are very, very different properties and they're going to perform very different. Maintenance is going to be different, tenant experiences be different. And I'm not deterring away from Dayton. It's definitely a good place to have lots of appreciation going on there. Lots of investors buying and doing all the things to make that a good asset. But the higher class properties, you have to account for other things.

Yeah. Property versus A, you know, B plus class property, you have to account for different things.

Right.

Like some maintenance and some turn and that kind of thing. Right, yeah. Collections I think is going to be, I'm a little bit concerned about collections in the long like over the next year because rents have all just gone crazy. Right, right. Meanwhile, people who are paying rents. Yeah, we saw some wages increase over the last year, but man, rents have moved a lot.

Economy bumped what, 8% maybe, supposedly. Yeah, yeah. Rent increases, national nationwide average, 20% increases.

It's concerning to me.

Yeah. And so some of the conversation we've had in IPM with our clients is we got to pump the brake. We, we can be aggressive with rent increases, but keep in mind, like our tenants haven't increased their, their household income the same rate that we're wanting to increase the rents.

That's right. We have. We, you know, fortunately our economy has seen some big moves in wages, but I don't think it's as big as the, as the inflation and rent prices.

Correct.

That's concerning to me a little bit. And we're going to keep our eye on that. Collections will be and not just here.

I mean, not us all over Yep.

Will be an issue. So I think there's a. We don't want to be on the 120th percentile, you know, when it comes to rent, setting rents or whatever. Like, you don't want to turn a property every year.

Right, Right, exactly.

You'd rather have tenants in there. The longer the better, but you also don't want to leave money on the table.

Yeah. So then you ask the question. Okay, yeah. Money on the table. Like, is it. Is it better to drop my rent by a hundred dollars a month?

Yeah.

Play the long game with appreciation and just keeping the property nice. Keep tenants happy, keeping them in there. That way, when three years down the road, that tenant decides to buy their house or their kids move to college and they decided to move to Florida or whatever fancy things they're doing, then you can turn the property and push the market and have that experience and. And then the extra cash flow.

Yeah.

When the market's in your favor. We're talking about two different markets here too. We're talking about a asset value market and the rental market that were kind of in tandem. So a lot of our performance are built off of asset value, the arv. Whereas a lot of the value I bring to this conversation is what are our rents? Are they real? Because we could market a property all day long at $180,000 and try to sell a cap rate. But if I can't rent it.

Right.

Some way.

Rent number.

Right. If I can't rent it where it's gonna set the owner and the residents up for success long term. Like, we're just shooting numbers on a board. Right.

I really like this. We've committed recently to having properties rented as opposed to forecasting rents.

Right.

When we sell our single family turnkey product, it's been a great move for us, actually, both in terms of, like, instead of guesstimating the cash flow and sometimes we're $50 short, sometimes we're $50 high or whatever. Right. So instead of guessing the cash flow, we're just selling the actual cash flow that's. That exists today.

Right.

Which is better for our investors. But, you know, at the end of the day, even if you rent the property first, but you've escalated the rent too high and created a volatile situation, there's a little bit of a risk too. Right. Creating a turn every year, or are you keeping your tenant there for three plus years? Right, right. There's a difference between those two things. Right. There's a cost that comes with turning, and there's also generally a Cost that comes with having to evict somebody because they're not paying in time or whatever. So assuming that that's a percentage of the, the potential turns or whatever. So those are considerations, I think in your cash flow calculation too. Like it's X cash flow, but I'm really straining my renting my rental population.

Right.

Then how promising is it?

Right, right. So exactly.

I think that matters a little bit too. What other thoughts come to mind when you think about that cash flow number? My number is 3, 300 bucks a month or whatever people are thinking.

You know, we talked briefly about like understanding what our end buyers goals are with the property. Like that's very, very critical and for multiple reasons. You know, the, one of the, and arguably maybe I'm just biased because of majority of my job is here, but that tenant experience matters. So if we have a client, this actually just happened recently, unfortunately. A guy bought two or three properties from us, held them for a year and now we're kicking out tenants because he wants to sell them retail. Because the retail market's hot.

Yeah.

And it was like, well that's not what this product is.

So being very, very clear together with that strategy. So it's not going to work well.

Right. And then now it's like, well, we've luckily established good rapport with the tenants. Like it doesn't always work out, but sometimes we're able to place them somewhere else and give a different owner good experience. Right. So knowing that up front, like hey, this is your strategy is what you want to do. Now granted that's subject to change, market changes, somebody may decide that Tennessee is a better market, you know, down the road we get that. But knowing that when we're, before we get fully through a contract and we're signing at the closing table, you know, we know, okay, hey, this is the, this is the experience this person wants. That sets us up for success too, because then I'm able to help provide that. But it does ultimately go back to how we present all of the numbers.

Yeah. I think kind of your strategy is a good point. So if you consider, for instance, another thought came to mind if you're thinking about a single family home as a rental to purchase as an investment and let's say it hasn't been renovated. It's, you know, the fixtures and the improvements or whatever are old or minimal over the last decade plus it's cash flowing really good, you know, per your purchase price and your rent income. But all the fixtures and stuff are dated. Well, you, you know, you've got to be prepared to make an investment there. Right, Right. So you're, you know, let's say you're making $600 a month in cash flow or whatever, but, you know, you're about to get hit with a, a $15,000 bill whenever that person moves out or something fails or whatever else. Right, right. You know, that, that, that's a spectrum. Right. That's not a single thing. Like has it been renovated? Yes. Or has it not been renovated? Whatever. That's a spectrum. And some of that has to do with the, you know, just the quality of the product that's in the home. Is it, is it all hard tile or is it carpet? Right. All those little things add up. Right. Those considerations add up. So I think, you know, when I think about buying my 10th single family home, it's freshly renovated, it's a lower cash flow and I've got good cash flowing. Portfolio 9 Other properties that are cash flowing. Well, I'll take that risk. You know, cash flow, it's been renovated, so my likelihood of having to buy a furnace or, or replace cabinets or these kind of like big things that happen occasionally is lower.

Right, right.

And I've got cash flow from the rest of my portfolio, so cash hits not going to kill me. And I see that property as being in a good area and the appreciation of it is, is, is promising. So that, that move makes sense. If it's my first single family home, it's the only, you know, the only thing in my portfolio that's a little bit, I'm a little less likely to kind of ride the, the hiccups of the cash flow that might come from a property that's got dated fixtures and whatever else.

Right, right.

So anyway, those are, that's another consideration. I think it's just. How much other cash are you sitting on to ride the wave that might come from a potential renovation? Whether it's because the property hasn't been improved much lately or because you don't have enough cash or other cash flow sources.

Yeah. And that comes, I mean, that comes down to just financial planning and making sure that true. If you purchasing a property, you plan for those things that are not. No, you're not going to know that those things are going to come.

Yeah. And if you can't do that a little bit, like buy a mutual fund, like, you know. Yes. Super safe mutual fund. Somewhere that requires no attention or. Yeah.

Really.

I mean, investment or whatever.

Whoever said real estate was easy was wrong. It's, it's, it's hard and it is very risky. However, it's very rewarding if you do it well. And there's going to be, you know, luckily in this organization we went through the grinder and pain for you.

Yeah, true.

So, you know, most of the time like we're, we're at a position where you're at the end of the project and you're taking over. We're just passing something off.

Buying a turnkey product is a different thing.

It's a different thing than by doing burst strategy or something where you're, you're having to go through the whole thing. You're actually more risk of losing in that situation than buying something that's already been renovated and it's actually cash flowing in the way it's projected.

Sure, you do miss a little bit of that opportunity when you. We take hits sometimes. Buy, improve and capture that capital improvement or whatever. That's, that's how, that's how we make money. So we also lose money a time or two, but we do it in volume so we get away with it. But try it as a first time investor or maybe your second property or whatever. Oh, I'm going to buy that property and improve it long distance or whatever. That's a risky move, man. And I'll, I'll tell you as the executive running this whole operation that does that at scale, that is a risky move. And I've done a couple of those actually. I've bought and sold individually or whatever, renovated and improved, whatever. And you can do it, you can do it well. And there's probably money to be made both in that improvement and then ultimately the cash flowing of the, the rental property. But just collecting rent and paying bills is a little bit easier. I would still advise anybody who's buying a rental property, even if the cash flow looks promising and you set aside X percent for maintenance, whatever else, like you still don't know, like things could happen, right? Your tenant could get, could get fired from their job and you know, they don't have a bunch of savings and whatever else, they're, they're a month away from not being able to pay their rent. Right. Like these random things can happen and when they do, you want to be prepared for that. So I, I still always advise people who are buying rental properties to have a little egg set aside and account for vacancy or unexpected renovation.

A few years ago, act of God had tornado come right through the middle of Dayton.

Like, I mean, that's right. And you would sit around and wait for the insurance or you want to get it done and get. Get renters in there within weeks, not months. Right.

Deal with the insurance in the back. I mean, there's so many different variables and go into how things could unfold.

Yeah.

The good thing, we mentioned this at the beginning. I don't know if it was in this podcast or in the blog earlier, but we had mentioned, you know, we. You and I, spend a lot of our time while you put. Putting out fires, you know, dealing with the more difficult situations, unhappy owners and tenants, things that we're trying to mitigate. But out of a portfolio of nearly 600 units, we're talking about 10 or 15.

Yeah.

Over the course of a few months.

Just mail checks. Yeah.

Most of them, they're just like rent comes in, we cut a check and they have cash flow each month. There's not a question. Actually, I have to go reach out to them. Like, hey, are you doing okay?

Because we haven't heard from you in a while. Yeah.

You know, so knowing that most of the clients have a really good experience kind of keeps the wheels turning a little bit because then we know we're doing a good job and we're keeping it moving. So anything we're doing like these performas and all that is to improve.

Yeah.

So when that buyer comes back or we bring in new buyers, they have a new experience.

I heard about an issue recently where an investor was concerned about some plumbing repair or whatever. This is a 200 cost. Why is it so expensive? And you know what I thought about? What it made me think right away was if that is a devastating situation for you, you shouldn't have invested that money into a rental property. You know, if a $200 expense is something that you, you couldn't account for or be prepared for or, or engage in productively, if that felt like an overwhelming thing, then you shouldn't invest it in it.

Yeah. Now, if we have a plumb. A $200 plumbing expense every single month for six months, well, sure, that's not a 200 expense anymore. And then I understand you're wondering.

Wondering why things aren't getting resolved.

Right. But yeah, we just had a similar situation where it was something weird like we hadn't done. It was a client that purchased a property didn't do a lot of exterior work, but like tenant moved in and I guess they set something heavy on. On the. The back porch and the porch sunk a little bit.

Oh no.

It's like, well, okay, well, we can mitigate that. But what we didn't front is that a tree had also Fallen and had hit part of the support beam. And then when they set that down, you know, it's like, okay, well now we have to mitigate a tree, we have to mitigate a porch. And that would have been just a couple hundred dollars, just sending our guys out there, nailing a couple things together turn into a thousand dollar tree removal. But there's the things like that's when your insurance becomes your friend.

Yeah, that's right.

But again, that's one of those things that you can't put on a performer like, oh, hey, on August 5th, you're going to have a tree fall.

That's right.

Here's $1,000 bill.

That's right. You should, you should account for the unknown to some extent. And if it's a single family home, it's worth 150,000, $200,000 you should set aside. I mean, I would, I would hold on to $10,000 that I'm, that I'm ready to put in that property. Or if, you know, you can, if you set aside a little egg, you can do that across multiple properties because generally speaking they don't all happen at once. Right, Right. So it does. It is true that the larger your portfolio grows, the easier it is to manage. Right. You have cash flows that are offsetting other concerns as they come up. That's why I always, I think that first deal, it's more important to have money set back and it's also more important to be careful about the condition of the renovations and the, the cash flow.

Yeah, I have one client that I actually, I told him that when he, he bought his first like five or so. And I think he's up to like 17 or 18 now, but he bought first five. Most of them are single family, I think one or two duplexes. And then he was having a little, couple cash flow, cash flow concerns because like three of them went faking all at the same time. And we're trying to shuffle money around. And I told him that strategy, I was like, you know, we should probably do for the next year is try to set more back, take a little bit less for yourself, set as much back as you can, build up a nest egg. And I was like, and then I'm like, you can probably talk to your tax accountant. But a good strategy would be toward the end of the year, pay down your loans, get one of those things paid off. And then he ended. What he ended up doing is he paid off one of his properties and opened up a home equity line against that property and uses the funds from the home equity line to pay for repairs. I see, so.

So he's a better cash position. Maybe not getting his high cap rate or whatever, but he's in a better cash position.

Yeah. And he's essentially.

The waves don't shake him as much.

Nope. Now he doesn't. We're about two years into this, so he's, and he's like, oh, this has changed the game for me. He's like, I can now save money, buy more properties and I have to worry about expenses because I have this guy paid off and I'm able to, you know, use. It's essentially a house credit card.

Yeah. Glad that worked out for him.

Yeah.

Yeah. I mean every, every situation is case to case. Right. I, I think the, maybe the best general advice is if, if it feels a little bit too close.

Right. Like. Right.

Just barely going to be able to do it.

Right.

Like as long as nothing happens. If you're having to qualify your good, your good decision with as long as X, Y, Z. No, don't do it. Right. Don't do it. You know, prepare yourself for things that could happen that way when it does, you know, you buy a property 18 months in, you have to turn over tenants. Right? Right. Oh, okay, that stinks. I gotta paint walls, you know, I gotta lose the rent that month or whatever. You know, hang ups happen. You're not, you're not devastated. Oh, how are you gonna pay the mortgage? Right. You're prepared for it, it's not a big deal. And you don't lose out on the opportunity to move quick and get, get the next tenant in there because you're worried about where that thousand dollars is going to come from. Right. When you're, oh no, I can't, you know, how am I going to pay for these, this little, this turnover or whatever and you get delayed and you're two months out, you're two months later, whatever, then you're costing yourself money.

Exactly.

Exactly. Anyway, yeah, cash flow does matter. Like many things, the solution to, to the problems that it could create is having a little more money. Right. So just go buy yourself more money, guys. If it was only that easy. Yeah, cash flow matters. I think it's, it's nice to be able to. When you're careful about planning, you can afford to be smart about investing and you know, respond to the hiccups that happen when you cut it a little bit too close. Then you, you put yourself in a volatile situation costing yourself more money. Well, do we hit everything? I believe so. Absolutely. Pretty nothing else to talk about.

No.

Yeah.

You and I both know we could do this all day long, so obviously we do. Yeah.

Yeah, we do. A lot. It's fun work. All right, guys, thanks for listening. As always, invest smart, live happy, my friend. Fans, nothing on this show should be.

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