Last week I was talking with a fellow-landlord, Kevin Sandlin, and we began discussing his rental property. His tenants are moving out and he is considering whether it was good time to sell his rental property or just hold on to it. His preference is to sell now but he is concerned about trying to sell it this late in the year – typically the slowest real estate sales months. So now he is considering to continue renting his home. Such a dilemma! Now that the market has heated up for both real estate sales and rentals, I hear about this dilemma more often than ever. In fact, even I may be changing my tune since my August post, To Rent or Not to Rent.
You may recall from that post that my tenants told me they will be moving out and they felt as though they had done me a favor by queuing up another tenant for me. This is indeed nice because the only thing I hate more than a water leak at midnight is a vacant unit in December! HOWEVER…..I am still a bit foggy-eyed from a 2009 real estate hangover and holding real estate is something I had sworn off forever. Yet now we have a real estate market is forcing me to reconsider.
I have had time to reflect on my rental home and I estimate I have an opportunity to increase rent by nearly 20% with a new tenant – a significant bump in my cash flow situation. Is cash flow king? I think yes, it is, and it is calming my urge to sell. Perhaps this once-sworn-off property will live to see another Favero lease. Perhaps.
To be sure, I am getting out the magnifying glass and taking a closer look. Over the years I have developed a relatively robust spreadsheet that conjures memories from my Real Estate Finance classes in college; this spreadsheet helps me evaluate any potential real estate investment. Stripping it down for simplicity, I evaluate cash flows as below:
- Potential Income (rents)
- less Vacancies
- plus Other Rents (parking, fees, etc)
- equals Effective Gross Income (EGI)
- less Management Fees (in my case, I call it the “I hate being a landlord” fee)
- less Operating Expenses (property taxes, dues, insurance, repairs, utilities, etc.)
- less Replacement Reserves (I use 10% of rent for this value because I cringe at the thought of replacing a roof)
- equals Net Operating Income
- less Debt Service (mortgage)
- equals Before Tax Cash Flow
- less income taxes (somewhat complicated but basically estimated by taking EGI less Operating Expenses less Interest Expense from Debt less Depreciation equals Taxable Income multiplied by Tax Rate equals Tax)
- equals After Tax Cash Flow
There are a number of other considerations beyond cash flows, but for now, this where I am focusing.
Am I missing any major expenses or considerations? Do you face these same questions? I know it is a good problem to be facing, but I struggle with it nevertheless.