#23 - How to Analyze a Rental Property Pt. 2!
Episode notes
Follow on Episode to #20 - How to Analyze a Rental Property where we dive deeper on what levers to pull to see if you want the deal!
Transcript
Auto-generated transcriptGenerated automatically from the audio and formatted for reading. Nothing has been reworded, so expect the odd mis-hearing, and no speaker names.
Welcome back to Curiosity. Class. The podcast where we breakdown complex topics into easy to understand ideas and bite sized. Pieces. My name is Jeff Albaum and I've been a curious person my entire life. Inspired by Albert Einstein's quote. If you can't explain something simply, you don't understand it well enough. We aim to make learning accessible and engaging. On this show, we're going to bring you experts from various fields ranging from personal finance to physics. To. Help you understand everything from 401(k)s to how airplanes fly. So let's dive in and satisfy our curiosity together.
What's going on, everybody? Welcome back to another episode of Curiosity Class. Today we're going to be doing a follow on episode to the episode I did about how do you analyze a rental property and what we're going to do Because I realized we never talked about like we got to the point where it was negatively cash flowing and then we kind of ended the episode. And So what I thought would be interesting is let's say you get to that point, you did a quick back of the napkin math and it negatively cash flowed. Should you just move on? Should you just scrap that deal entirely?
Or are there levers you can pull to make that deal more appealing or attractive? So that's what I wanted to do today was like go through what are those levers you can pull? And what are some areas or things you can do that might take a deal from being in negative cash flow territory to being in positive cash flow territory. So that's what we're going to do today. So let's dive in and get started. All right, so this is the spreadsheet we were working at, we're working on last time and just some quick high level overview to to remember where we're at.
This was AI believe it was a duplex we're analyzing in Saint Louis. The purchase price was $170,000. We are putting 20% down. Our interest rate was 7.5% amortized over 30 years, 30 year fixed rate mortgage. We were anticipating $1700 in monthly rental income and then these were our monthly operating expenses. So property tax insurance we got from the realtor listing. Remember we found our total payment and then we said OK, based on that, what is our mortgage going to be, what is our property tax, etcetera. And so if you remember your mortgage, what most people call their mortgage is actually four different things.
So it's principal, interest, taxes and insurance, which is you can use the the acronym PITI, PITI. So that's if let's an industry jargon, if you want to say, hey, is that my principal and interest or does that include taxes or insurance when you're asking for what your total payment is going to be good, good fun tip there 200 bucks a month for maintenance because things break and you're going to need to to replace them. 10% for property management fees, 10% for utilities and then a vacancy reserve of an additional 10%. And So what that got us to when we were analyzing this was the following after all of our operating expenses and we got remember we just talked about our net operating income or NOI as being almost $700.00 a month, but then remembering that that does not include our mortgage payment.
So after we account for a mortgage payment, we're in negative cash flow territory. So in this example, we left it that we were negatively cash flowing $250 a month. So obviously not ideal. However, I wanted to run through ways that we could levers we could pull to change this and maybe take this from being a deal that we would not be excited about to deal to being a deal that we are excited about. So the first lever that I want to show you how it kind of effects things is the purchase price, right? This is one of the largest levers you can pull to really change a lot of your outcome.
There's a lot of adages people talk about in real estate, you make your money on the buy, the price is right, like all these things and, and the purchase price really is at the end of the day, a huge, huge, huge part of if a deal is a good deal or a not good deal. So the list price was 170. Let's see what happens if we offered 150, right? What does that do? Just changing that alone, nothing else already we're closer to being in, well, we, we basically are negatively cash flowing less than we were before, right? Which makes sense. We're paying less for it.
So inherently our monthly cost should also be less, right? OK, so let's see what happens if we drop this to 1:30. Now we're so close. So we're right there on the cusp. So I think we've gone far enough down on the purchase price. Now let's say we also expect reasonably that we can rent this for $1800 a month, right? Because this is another great lever is if you can get more in rental income. Like sometimes you buy a deal and the rents are what's called below market. So maybe you know, or your property manager tells you that hey, this is a super appreciating area.
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People are really stoked to live here. It's rented for $500 now, but we could for sure get 650 out of all of them. Like this is a very common scenario, right? So maybe you think you can get $1800 a month in rent when they were previously getting 1700. So now all of a sudden we're in positive cash flow territory, right? We are positively cash flowing $60.00 a month. So a couple things to say about spreadsheets and and spreadsheet math. The only thing that this guarantees, the only thing that the $60.15 guarantees is that you will not have $60.15 hit your bank account probably ever if you actually were to buy this deal in real life.
Spreadsheets are really helpful for directionally understanding is this a good deal or not good deal However, it's really, really hard to put all of the variables of the real world into a spreadsheet to give you an accurate understanding of what dollars amounts are going to hit your bank account every month. As an example, we're, we're kind of giving ourselves the leeway of saying, OK, our maintenance reserve is $200 every month. That means every month we're putting aside $200 into a maintenance fund, so to speak, right? So every month 200 bucks.
So if we've owned the property for three months, we should have $600 in our maintenance reserve. But maintenance doesn't know and doesn't really care how much money we set aside for it, right? So we might get a maintenance bill, we might need to replace something or do something that we get a bill for $1000 and it might happen in month 3, right? And so we only have $600.00 saved up, but we owe $1000. So now shoot, we're in the whole 400 bucks, right? So that's how real life works. So don't be surprised if you, you know, you go through this math and then you buy the property and you're saying, wait a second, I'm not rent, I'm not getting $60.00 every month.
Like this is not real estate's not good. You need to look at it at a little bit over a longer time horizon. So at the end of the year approximately you should have 60 * 12, which is $720 in positive, positive net pure profit and cash flow. And so if you're directionally in that ballpark, you're like at the end of the year after all is said and done, after all your maintenance, all your expenses, whatever, you're up, so to speak, 720 dollars, then this is pretty accurate, right? So maybe it's not exactly accurate on a monthly basis, but on a yearly or annual basis it is.
So just a quick note on spreadsheet math because it's, it's very important. So we so far we've talked about the purchase price and the rental income you can get. Let's take a look at some other levers and see what else we can do to make this deal more attractive. So maybe we can find a new lender or a different lender that is able to get us 7.3% or you can do something called buying down or paying points on a loan. So you pay an upfront cost and then over the course of the loan, your, your interest rate is lower. So maybe we can find one or pay a lender a little bit more to get a 7.3% rate.
There's only so much you can drop this, right? Like everyone, this is being recorded in November of 2025. So right now rates are actually kind of high and it's unclear when or if they're going to come down. If we were recording this in November 2021, you know, people could get sub 4% rates on investment properties like it was just a different time. So you can't really find that in today in 2025's market. But there is a little bit of of leeway and wiggle room here. So now let's turn to our expenses because there's the two things you can do is you can raise, you can increase income or decrease expenses, right?
Property taxes and insurance. There's probably not a ton of leeway here, definitely not with property tax, but maybe you can find a less expensive insurance policy. So maybe it's only 130 a month instead of 150. Maintenance reserve, it's probably wise to keep as 200. But maybe as an example, you spend money up front. So let's say you have a big lawn at the property, you're looking at big grass area and it costs 50 bucks a month to mow the lawn. And so you say, OK, well, I can continue to pay that $50 every month or I can pay a couple $1000 upfront and put in turf, which obviously does not need to be mowed or, or kept up in the same amount of as, as grass does.
So maybe you can drop this maintenance budget to 150 a month. Property management is probably good at 10%. There's not a lot of leeway you can do there, but it never hurts to ask. You can say, hey, I would love to keep working with you. I plan to buy more properties. Are you open to working out some sort of system where you know, right now I'm being charged 10% when I get to 3 properties that you manage, can you charge me 9%? Is that reasonable? Right. So there are some way, some leeway here. And like nothing is, this is all very like it's a negotiation.
So it never hurts to ask these questions. And your property manager is very free to tell you no. Our policy is 10%. That's what it is. If you want something less, go somewhere else and you can say, OK, understood utilities again, there's there, there's not a lot you can do. There are some things you can do. For example, you could do something called bill backs where you you charge your tenants like a set fee for water or for electricity. If you're paying for utilities in your name, there are some cool like you can, if your property is, is metered correctly or metered in this way, like you can have separate water meters for each unit, which is really easy to say like OK, unit A is using this much water, unit B is using this much water.
But if you only have 1m for 2 units, it's kind of hard to say like how much water unit A versus unit B is using. So you know, there's, there's a little bit of leeway, but not a ton. And vacancy is probably wise to keep it 10% as well. So we made a couple changes. Now let's see what that does to our total deal. So if we go back here now, we're in pretty solid territory, right? 150 bucks a month in in positive cash flow. So this is something that's definitely worth taking a look at and understanding like, OK, is this something that we're interested in pursuing?
But I just wanted to show how you can maybe take a deal that at least in the first pass is not something that you're interested in doing and doesn't seem like a quote UN quote good deal and levers you can pull to make make it a better deal. And the last thing I want to say is about purchase price. So maybe some of you were thinking of, wait, it was listed at 170. Who would ever take 130 for this, right? And the list price of a piece of real estate is not set in stone. It's kind of an arbitrary number. Actually. There's a, there's market dynamics in play.
So if you offer 20 grand, you're unlikely to get a property if it's listed at 170, right? But if you offer 1:30 and no one else offers anything, you're actually very likely to get that property, right? So a couple more things to say on this is there's nothing stopping you from quote UN quote low balling every property that you make an offer on. However, the real estate industry is actually pretty small. And especially if you're investing in primarily a single market, you don't want to earn the reputation of being someone who just low balls people because it's that's not nice.
You're not being a nice person. You're not it's not pleasant to work with you if every property that you offer on you're just saying 20 grand, 20 grand, 20 grand, right? Like the agent who works with you is not going to like working with you. You're not going to make a lot of friends that way. So don't do that. The TLDR that being said there, you know, you also don't have to offer what the list price is every time. So just because it's listed for 170 doesn't mean you have to offer 170 in this instance. You can say, hey, I ran the numbers based on my numbers, I'm going to offer.
The most I can do is 130. Is that reasonable? They might say no, They might say yes, right? And you can even say hey, I'll show you my numbers like this is what I'm seeing. Let me know where you disagree, right? But you always want to make sure that you're looking out for at the end of the day, like it's, it's your investment. So you need to be the one doing the diligence and and not letting people tell you the numbers and making sure that you're comfortable with the numbers that you come to. So that is a little bit of what to do and the leverage you can pull for a real estate deal for the investment property.
I hope that was helpful. I hope you liked it. If you did and you want to see more of this stuff, let me know. Please feel free to like and subscribe and follow Curiosity Class on Spotify and Apple Music. And as always, I very much appreciate your time and thank you for listening. Bye everybody.