The Most Commonly Overlooked Expenses in Real Estate Investing
“Don’t worry about failure, you only have to be right once.” – Drew Houston
Mark Ferguson, who is a realtor (sells hundred of homes a year), an investor (has flipped over 100 homes and owns 16 rental properties), and an author (has written 5 books), is one of many speakers who will be presenting at the 1st annual Best Real Estate Investing Advice Ever Conference in Denver, CO February 24th to 25th.
In a conversation with Mark all the way back in 2014, he provided his Best Ever advice, which is a sneak preview of the information he will be presenting at the Best Ever conference. His advice was also featured in the Best Real Estate Investing Advice Ever: Volume I.
What was Mark’s advice? He outlines the most overlooked expenses by buy-and-hold and fix-and-flip investors.
Mark’s Real Estate Background
Mark was exposed to real estate at a very young age. His father was a real estate agent and also did fix and flips. As a result, Mark got started in real estate by helping his father with flips during high school. Having been exposed to real estate at such an early age, Mark told himself that he would never get into the real estate industry. Instead, he went to college and obtained a degree in business finance.
After graduating, Mark could not find a job in the world of business finance, so he decided he would do real estate part-time, only until he found a job. In 2001, Mark re-entered real estate as an agent, and struggled for a long time. He did not have a niche, he didn’t have any goals, and he wasn’t great at talking to people. This all changed when Mark found the REO foreclosure niche. He started listing REOs, started making goals, and his career took off.
In 2010, Mark began investing in single-family rentals, purchasing 16 properties over the next 5 years. In 2013, Mark took over his father’s existing fix-and-flip business and real estate sales team. He has been focusing on that business as much as possible. If being a real estate agent, a buy-and-hold investor, and a fix-and-flipper wasn’t enough, Mark also started a real estate blog, “Invest Four More,” where he writes articles about his past and current experience as an agent and investor.
Real Estate is Very Region Specific
Mark’s real estate agent, buy-and-hold, and fix-and-flip business models focus on single-family residences in the Denver area. Within the Denver area, Mark’s target sub-market is 50 miles north of the city. In this area, prices are more reasonable and he can acquire a property between $80,000 and $150,000. The reason why Mark focuses on single-family instead of multifamily properties is two-fold:
- Since he focuses on SFR as a realtor, he knows the properties very well, so he can get a much better deal and make more money on a SFR compared to a multifamily
- Real estate is very region specific. He pays considerable attention to different parts of the country and the different terms that people get. For whatever reason, Colorado has horrible cap rates compared to other parts of the country. It is hard to find any multifamily properties above a 5% cap rate.
Due to these two reasons, Mark can be much more successful with SFRs than he can with multifamily in his specific market. He focuses on buying below market value through short sales, REOs, estate sales, etc., so he can make money as soon as he buys the property.
Overlooked Expenses: Buy and Holds
Rents have shot up in Mark’s market over the last couple of years. As a result, he can purchase a SFR for around $120,000 to $140,000 that will rent for $1,500 a month. If he were to purchase a multifamily property, he could get a 4-unit with 2 beds and 1 bath per unit for $250,000 that might rent for $2,000 a month. Compared to most parts of the country, this is backwards, but again, real estate is very region specific.
When investing in SFR rentals, Mark strongly advises that you invest for cash flow. Many people get caught up in a rising market and just buy any investment property they can find. However, they neglect to take a closer look at the actual numbers and operations. People get in trouble because they think that if the property rents for $1000 a month and their fixed expenses (mortgage, taxes, and insurance) are $500 a month, then they will cash flow $500 a month. They factored in the fixed expenses but they overlooked additional expenses, like vacancies and maintenance. If the market goes down and they cannot maintain the $1000 a month in rent, then they have properties that are not making money and they cannot sell, so they are stuck. When you invest for cash flow and figure in all of the additional expenses, if the market goes down, you will still make money and can weather the storm.
Advice in Action #1: When investing for cash flow, make sure that you are figuring in vacancy and maintenance costs on top of your mortgage, taxes and insurance:
- Expect at least a 5-10% vacancy rate, even if the historical rates are much lower
- One eviction or bad tenant can create that 10% pretty quickly
- A little harder to estimate because it varies depending on the property’s condition, age, and how good your tenants are
- Figure at least 10%, but more often 15-20% for maintenance and capital expenditures
- If you need to replace a roof, these costs can add up pretty quickly
These rates are a percentage of the properties gross rent. If your gross rent is $1,000 per month, figure in $50 to $100 a month for vacancy and $150 to $200 a month for maintenance.
On the fix and flip side, Mark can purchase a property for $80,000, put in an additional $15,000 to $20,000 in renovations, and sell it for $140,000 to $150,000. Being all-in at $100,000 and selling for $150,000, one would think that the net profit is $50,000. However, in reality, this is not the case. After factoring in holding costs, carrying costs, financing costs, and all the other costs that many people do not consider, the profit is closer to $25,000.
As a fix and flipper, you have to understand your actual costs. In Mark’s example above, if he overlooked the additional expenses, he would have expected a $50,000 profit instead of the actual $25,000. If the numbers were even tighter and he expected a $20,000 to $25,000 profit, he would have ended up breaking even or potentially even losing money on the deal.
Advice in Action #2: When performing a fix and flip, make sure you figure in the additional expenses on top of the rehab budget. These expenses include:
- Holding Costs
- Financing Costs
- Everything else that goes on during the course of a flip
Most experienced fix and flippers account for most of these additional expenses, but Mark finds two other surprising costs that many flippers still overlook:
- Higher Than Expected Repair Costs – Mark has been fix and flipping properties for a long time, and every single time, the repairs end up being higher than expected. You don’t really know how much work a house needs until you start getting into it and really have a contractor take a look at what is there. There are always hidden surprises, especially on larger renovations and when you are knocking down walls.
Advice in Action #3: To account for these surprise costs, Mark always adds at least $5,000 to his repair budget automatically. On a $20,000 rehab, that is an additional 25%. Commit to doing the same.
- Longer Than Expected Project Time – Similar to Mark’s experience with the repair costs always being higher than expected, the same holds true for the project time. The length of time it takes to flip a property is almost always longer. There is a huge difference in holding costs if the project time is 4 months vs. 6 months. That extra time can result in up to $10,000 in additional expenses.
Advice in Action #4: Mark always tacks on an additional two months to his expected project time, and adjusts his holding costs accordingly. Commit to doing the same.
Want to learn more about raising property values and rents, as well as a wide range of other real estate niches? Attend the 1st Annual Best Ever Conference February 24-25 in Denver, CO. It’s the only real estate investing conference whose content and speakers are curated based on the expressed needs of the audience. Visit www.besteverconference.com to learn more!
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