REI – Analyzing a Property as a Rental

This week is a bit of a follow-up to last week’s article about finding your breakeven point. I covered what you needed to look at and why it was a good idea to know what your breakeven point was before you get into a business. Now I will apply similar principles to Real Estate Investing.

Today, I am going to go over what I look at when I evaluate a property to add to my portfolio. My strategy for real estate investing is Buy and Hold, meaning that I buy properties and intend to keep them long term, renting them out to tenants.

Cost Assumptions

For cost assumptions, I use the asking price, and an estimated cost of improvements (rehabbing property) & estimated closing costs (approximately 3% of price of property).

Finance Assumptions

Use a mortgage calculator to determine monthly debt service payment. Set the desired term (15 yrs, 20 yrs, 30 yrs, etc.), down payment, and interest rate.

Gross Rents

Gross Rents are the total rents expected to be collected on a monthly basis. This can be rent form a single-family home or a multi-family property such as a duplex, triplex, or larger apartment property.

Vacancy

To account for vacancy and deduct a percentage from your gross rent before deducting expenses. I generally use a conservative vacancy percentage like 10%. While I will more than likely not  have 10% vacancy in a year, accounting for it helps me to ensure the  property will always  cash flow.

Expenses

So, once I have a property to analyze, the first thing I do is verify the expenses. For the most part, the costs should be relatively the same, with the exception of property taxes. 
I account for the following expenses:

• Property Taxes
• Insurance
• Maintenance & Repairs
• Utilities
• Advertising
• Administrative
• Variable Cost Property Management
• Lawn Care / Landscaping
• CAPEX

Property Taxes can usually be found on the local parish or county assessor’s website. You just have to search for the property address and all of the details for the property are listed. Who owns it, what municipal assessed value is, what the property has sold for, and what the city and parish/county taxes are estimated at for the current year.

Insurance can be estimated by getting a quote from your insurance agent/provider or if you have a similar property, you already have an idea what the cost is.

Maintenance & Repairs covers anything short of replacing major components of the property.
Utilities are what you expect to pay for utilities while doing turnover or when the property is unoccupied between tenants.

Advertising is the costs for paid advertising to attract tenants.

Administrative are the costs for anything administrative to do with operating the property as a rental. This covers book keeping, accounts payable, accounts receivable, etc.

Variable Cost Property Management is a percentage of gross rents paid to a property manager to manage the property. I account for this as an expense even though I manage my own properties so in the event I decide to engage a property manager, I already have that cost covered and don’t have to worry about adding a PM cutting into my cash flow.

Lawn Care/Landscaping covers grass-cutting when the property is not occupied and/or if the property is a multi-family property where the tenants don’t normally take care of the lawn.

CAPEX is an amount put aside to cover major repairs such as replacing the roof, appliances, flooring, plumbing, electrical, etc. That way, you have the money to cover these repairs instead of worrying where to get the money from.

The Analysis

Once I have gross rents, vacancy, cost assumptions, and expense values collected, then the analysis of the property can begin. I use a spreadsheet to conduct my analysis and it is set up to tell me what I need to know. There are inputs for all of the items listed so far.
I enter the asking price, my desired finance terms, estimated gross rents, and estimated expenses.
I then evaluate whether or not my targets are met at the property’s asking price. If it does not, I then start adjusting the price downward until I reach my target numbers.
For me to consider a property a good deal, it must meet the following criteria:
Cash flow >$100 per door and have >12% Cash on Cash Return, if financed
Cash flow >$400 per door and have >6% Cash on Cash Return, if purchased cash
Be in a decent neighborhood

Cash Flow
Cash Flow is the amount of money from gross rents (revenue) remaining after expenses and debt service are covered.
Cash on Cash Return 
Cash on Cash Return is the annual amount of return you get compared to the amount of cash you spent to acquire the property.

By comparing gross rents, total costs, expenses, debt service, and returns I am able to decide if a property will be a money-making addition to my portfolio. By continuing to add properties to my portfolio that cash flow, I get closer to my “Freedom Number”. Where my passive rental income covers my personal costs and expenses, so I don’t have to worry about needing a job.



And, as always, let me know what you think in the comments. Ask questions, tell your story.



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Business Finance: Knowing Your Costs or How to Find the Break-Even Point of Your Business

"The break-even point (BEP) in economics, business—and specifically cost accounting—is the point at which total cost and total revenue are equal."

This week’s topic is knowing your costs for your business or the Break-Even Point (BEP).

Before starting a business (or buying one), you should understand what your Break Even Point is. The BEP is where you have enough revenue coming in to cover all of your expenses. It means $0 in profit, but also that all expenses are covered.

Knowing what your BEP is can be beneficial in evaluating how much of your product or service you will have to sell to begin generating profit. It is always better to have this information before engaging in a business rather than trying to figure it out after you are already involved.


Direct Expenses

When determining the BEP, there are some differences between how to calculate this information for a Service Business and a Manufactured Products Business.

• Service Businesses are fairly easy in that you only need to tally up your direct expenses. This could be done on a monthly basis, but if you have expenses that come up at different times of the year, it is easier to estimate a total annual expense and divide it by 12 to give you a monthly expense amount. (At least that is what I have found when analyzing rental properties). 
• Manufactured Products Businesses are slightly more complicated in that you need to understand what the Gross Profit (GP) on the products are. Gross Profit is the Total Sale Price minus the Cost Of Goods Sold (COGS – materials, labor to assemble). Once you know what your GP is, you will be able to calculate the BEP for the product.

Indirect Expenses

The next step is to gather all of your indirect expenses. This can include rent, utilities, sales, and distribution expenses. Anything that is not directly involved in the provision of a service or the manufacturing of a product.

Once you have all of your numbers, you can calculate your BEP.

For Service Businesses, your BEP is the sum of your direct and indirect expenses. If you bring in enough revenue to cover just those expenses, you have broken even.

For Manufactured Products Businesses, you simply divide your indirect expenses by your GP % to arrive at your BEP.

Example: Indirect Costs: $20,000; GP: 31%; $20,000/0.31= $64,516.13


As I stated above, it is a good idea to have this information before you are involved in a business. Once you understand where you stand with reference to a BEP, you can start to work on optimizing you costs & methodologies to increase efficiencies, lower costs, and lower the overall BEP for that business.


And, as always, let me know what you think in the comments. Ask questions, tell your story.



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Overspending, Why And What to Do about It

This week, we are going to talk about spending, spending habits, and debt. As I related in a couple of previous posts, My History With Money, Pt. I & My History With Money, Pt. II, I had a bit of a spending problem. While the majority of my debt was from my mortgage, I was having trouble keeping up with payments and just keeping cash on hand. Hopefully, I will be able to provide you with some insight into why we spend and get into debt.


First, here are some statistics I gathered on income and spending in the US:

• The average pre-tax income for people living in the US in 2016 was just under $75,000.
• The average annual expenditures for people living in the US in 2016, including food, housing, transportation, discretionary spending, and insurance was slightly over $57,000.
• Add to that, the average amount of taxes paid between local, state, and federal in US as of last year is about $10,500.
• What you wind up with is about $8,000 a year (or $666.67 per month) of savable/investable income, based on averages.

The problem with averages is that it smooths out all of the variations in the data. In simpler terms, not everybody can recognize that excess money at the end of the year.

Here’s another bothersome statistic: 43% of Americans in the US spend more money than they make, according to the Federal Reserve.

The most common reasons people spend more than they make.

How to address the reasons listed above

If you are in the situation where you are spending more than you make and/or are in a lot of debt, the first thing to do is commit to changing your habits and then doing some things to change your situation.

Budgeting:

Be aware of what money you have coming in and what money you are spending. Break out your spending between necessities and discretionary. Necessities are electricity, water, gas, mortgage/rent, food, transportation. Discretionary spending covers items like cell phones for every member of the family, cable, internet, visits to the casino, cigarettes, beer, and similar things that are not vital to your survival.

Figure out approximately what percentage of your monthly income is needed to cover each necessity and allocate a little more than that requirement to be put aside to cover each one. I suggest putting cash into envelopes labeled for each one. By putting a little more into the envelope, that will help to cover variances in income and costs. This idea is actually based on the ideas put forth in the book Profit First by Mike Michalowicz. The book is aimed at entrepreneurs trying to get their business to a profitable state, but the principles apply to personal finance, also.

They KEY thing is to not touch the money once you put it aside unless you are paying the bill it is dedicated to. 

Make sure you are also able to put aside an emergency fund. The amount should be approximately three times your monthly income/take home pay. This goes a long way towards keeping your life steady in the event of bad weather, vehicle breakdown, illness, etc.

Try to stick to only spending on necessities until you are comfortably out of debt. Then start looking for ways to invest some of your “profit” to make you more money. (Since I am not a financial advisor, I can’t offer advice on how to invest that money, but I will cover my thoughts on the matter in a future post.)

Credit cards: 

Only use them if you have the money to pay for what you are purchasing and can commit yourself to not spending the cash on anything other than paying your credit card bill.  If you have a balance on your credit card, don’t use it at all until the balance is paid off. Only then should you use a credit card to buy stuff.

If you already have a balance on your credit card or even multiple cards, work on paying off those balances first. There are two approaches to methodology when doing this, either start paying extra on the card with the highest interest rate and balance, if you can make yourself do that regularly without getting disappointed or pick a card with the smallest balance and pay it off first. This will give you a self-esteem boost by way of accomplishment.

DON’T PUT ANYTHING ELSE ON THAT CARD!

After the first one is paid off, take the monthly allotment of your income that was dedicated to paying off that card and start adding it to what you are paying on the next card. Keep doing that until all of your cards are paid off.

PAY OFF YOUR BALANCE EVERY MONTH!

This is crucial for not accumulating debt. It may even be better for you to have a charge card like American Express, where you are required to pay it off every month.

Don’t “float” your balance from one new card to another without paying it off. It ends badly.



Psychological Reasons for Spending

We are constantly being bombarded with advertising trying to influence us to spend money. Whether it is buy a new car, get the latest phone, or use our credit card to buy your dreams. Advertising implies that if we don’t spend, we are a lesser person. Don't believe it!

Yes, you do need some of the things you see advertised, but you don’t need to go broke or get in debt to get it.

Buying things to feel better about yourself actually make you feel worse in the long run.

DO something to change the things in your life you don’t like. Don’t waste time worrying about the things you can’t change, because it will only make you feel worse.



And, as always, let me know what you think in the comments. Ask questions, tell your story.



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REI: Kick Yourself in the Ass Gotchas

Image from US Patent #6,293,874..."User-operated amusement apparatus for kicking the user's buttocks"

Today I am going to cover some things that we experienced last year while rehabbing a house acquired to become a rental.

This was our first acquisition, so I wanted to be thorough in analysis, planning, and execution. I had a home inspector check for problems with the house. He checked the electrical, cooling, foundation, plumbing, water heater, and roof. Issues were pointed out with the electrical, gas valves, air conditioner ductwork, and a couple of other minor things.

I brought in the following for estimates:

• An electrician to fix the issues pointed out by the inspector and to add GFCI outlets near the sinks.
• A plumber to replace supply valves & faucets in the kitchen and bathroom, gas supply valves for the stove and water heater, and to re-route the overflow drain for the water heater.
• A HVAC contractor to replace the ductwork.
• Multiple contractors to bid on the rest of the rehab stuff.

I thought I had things well covered. I was wrong. The first shock was that we had to replace the whole interior HVAC system. The furnace part was rusted through and a fire hazard. That wasn’t too bad, as we had a buffer in our budget for overages and $4,200 wasn’t going to kill it. (That price did include replacing the duct work.)

The next surprise was after the first tenants moved in, they attempted to wash clothes and the washer drain overflowed into the utility room. A phone call to the plumber and a day of trying to unclog the drain, it was determined that years ago, when the neighborhood was converted over to municipal sewerage, the original owners never bothered to tie in the utility room drain to the main drain line and just left it connected to the main field drain in the back yard, which had since collapsed, thus restricting flow and backing up into the utility room. Add another day for the plumber to route a drain through the wall and across the back patio (most likely the condemned septic tank) and tie it into the main drain line at a total cost of approximately $700.

Caveat: We will have to eventually add a full drain line underground tied into the main system. 

#SilverLining: We will now have the drain necessary to convert part of the utility room to a half bath at some point, increasing the value and desirability of the property.


At one point, the original owners of the house upgraded the windows to vinyl double-paned glass. In doing so, there were gaps in between the windows and the sill in some rooms. I notice them, but in triaging everything that needed to be done, they kept falling to the bottom of the priority list. And, they never got done. Additionally, we kept finding wasps in the room where the gaps were the biggest. It seemed unrelated. The tenants actually correlated the gaps with the wasps continuously appearing in that room and asked for me to fix it. It didn’t take more than some expanding foam and caulk, but, like the other items listed here, I should have recognized the issues and fixed them prior to the tenants moving in.  Total cost for the fix: about $25.

So, for the next property we purchase, I will make sure that we check all drains for restrictions, ensure all trim are sealed, and plan to continue to have the HVAC contractor evaluate the heating & cooling system. This will help to save extra work that we did not budget for and aggravation for us and the tenant in getting the issues mitigated.

If you have rental property, have you run into things like this? Let me know in the comments below.

And, as always, let me know what you think in the comments. Ask questions, tell your story.



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Equipment Automation – Drilling Fluids

Various pictures of industrial and oilfield automation. The bottom center, top center, and bottom right images are of the DRU.

Today’s topic has to do with Equipment Automation, and more specifically, Drilling Fluids Equipment Automation.

First, a brief history of drilling technology:

• Early drilling systems used the equivalent of a heavy chisel hanging on a cable down in a hole to “drill” for oil. The “cable drill” would be raised and lowered rapidly to break the rock, thus deepening the hole.
• Later systems put a bit on the end of lengths of pipe and rotated the pipe to deepen the hole.
• Drilling fluids were introduced to cool & lubricate the bit and carry the cuttings out of the hole. They were consisting of water and other chemicals to maintain density and viscosity.
• Invert Emulsion Muds (IEM) were later developed to further inhibit interaction between the drilling fluids and the formation being drilled.

The main tools used to maintain the drilling fluids were a rheometer, a tool developed to test the viscosity of paints to ensure the pigment particles remained suspended, and the mud balance, a tool used to measure the density of a fluid.

***The above history does not contain all innovations, reasons, or details***

Up until 2015, the mud balance and the rheometer were still the two main tools used to monitor the properties of drilling fluids. They additionally use other tools, such as retorts to determine the fractional content of oil, water, and solids in a fluid, chemical titration to test things like alkalinity, calcium content, & chlorides content, in addition to HTHP filter press, a tool used to measure how much of the liquid portion of a drilling fluid will “leak out” through a porous medium, usually filter paper, across a standard differential pressure.

Prior to 2015, quite a few companies have worked on automating drilling fluids testing, including the company I work for, Baroid, a part of Halliburton. 

**Disclaimer: I am part of the group that worked on this** 

The testing covered varied from density meters to simulated viscosity to solids analysis. The main issue was that the results were either inaccurate or the specific test itself was not necessarily a must-have.

We initially built or had built various automated prototypes of testing apparatus. One was a fully automated retort. If you are not familiar with a retort, it is designed to bake the liquid out of a measured volume of fluid at a high enough temperature to also separate out oil and water content. This test allows drilling fluids engineers (or mud engineers) to determine how much oil, water, and solids are in a fluid. It also allows them to calculate the amount of high gravity solids (desired) and low gravity solids (not so desired) contained within the fluid. The approach the company we contracted for a prototype took was to just automate the manual process. So the result was a big box that took in a measured amount of fluid, cooked off the liquid, reheated the liquid to separate the oil and water, then used LASERS! to measure the amount of oil and water. 

They had also included a mini-CNC arm inside the box, specifically for the cleanup part. It would pick up a “retort spatula” attachment to scrape the dried mud residue from inside the retort cell, then it would pick up the wire brush attachment to get the final bits of dried mud from the cell walls. There was a vacuum component that sucked up all of the dried mud residue and dust while the cleaning operation was going on. It was kind of amazing to watch!

Alas, as amazing as it was to watch, it was not practical as a field application precisely due to the amount of moving parts…there were way too many things to break down. Too many things needing hands-on attention during its operation. When a piece of equipment like this is sitting 100 miles offshore, that is too isolated to be able to send someone every couple of days to clean it out or fix something.

We realized that we needed to focus on the critical measurements for running drilling fluids. The properties measured on the most frequent basis are density and rheology. Additionally, as part of the automation strategy we developed, density, rheology, and fluid temperature are the primary inputs for our real time drilling and hydraulics simulator.

Our first unit was dubbed RTDV, Real Time Density & Viscosity. It was a good start, but was not able to provide us with accurate results. Based on extensive analysis of the RTDVs operation, we started a redesign project based on lessons learned. The biggest issues were lack of continuous unattended operation, inaccurate rheology readings, and the ability for air or gas entrainment to affect the density readings.

The next generation unit was named DRU or Density Rheology Unit. It captures a pressurized density, approximately every 1-2 minutes, and a full 6-speed rheology every 10-20 minutes, depending on ambient fluid temperatures because it heats the fluid to a set testing temperature.

It was deployed on late 2015 on a commercial basis and received industry press and awards on 2016.

Our goal is to automate all fluid testing. What’s funny is that when we say that, drilling fluids engineers ask if we are trying to get rid of their jobs. That is just short-sighted thinking.

As things currently stand, in a 24 hour period, just to accomplish the standard required tests, it takes about 6 hours. That’s a full 25% of the day spent in a lab, possibly not paying attention to operations. And that is for only four sets of test results.

Yes, there are opportunities to check on things while tests are running, BUT, What if the fluids engineers didn’t have too spend all that time conducting tests? And what if they could see those test results more frequently? How much better could they maintain the fluid properties?

There are other companies coming out with new technology and have the ability to measure a few properties, but I don’t think that they have the broad vision for an integrated suite of sensors in addition to a plan on what to do with the data once it is captured. 

But I do. 

But we do. 

Look to the future…

Let me know what you think in the comments. Ask questions, tell your story.



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