The Hidden Costs When You Own Real Estate - Part 2
"This property is going to cash flow like a cow".
I still remember my partner and I thinking that as we were running the numbers on this 22 unit mixed use commercial building in Windsor, ON.
At the time, only the commercial unit on the main floor was rented, and the 2nd and 3rd floor, with a total of 21 units, were almost all vacant, except for 3 of them.
As a result, the property was being sold at a huge discount due to the fact it wasn't generating much income at all.
Plus, it needed a ton of work. Here are some of the pictures of the residential units on the 2nd and 3rd floors before.
The owner just wanted to sell the property, as he didn't have the capital to renovate it, nor the patience to try and rent the units.
Up until this point in my investing career, all of 4 months, I had only bought 3 properties, all duplexes, so this was a huge jump, and if I had to do it over again, I wouldn't have bought it until I had more experience, and a lot of time on my hands.
However, the numbers were just too good to pass up, and the thought of making almost half of my salary I use to make working full-time, made me drive right in.
Anyways, back to the reason for this article...
I learned quickly that when you're running your numbers, especially when your a beginner investor, you don't give much consideration to the other hidden cost when you own real estate....
VACANCIES!!!
When we ran the numbers, we had projected the cash flow the property would generate when fully rented; all 21 units, plus the commercial, and the detached garage, would bring in around $2,000 per month!
Between my partner and I, that was going to be over $20K each, in our pockets.
Boy, we're we wrong!
Not only did the renovations take twice as long to do, to get the 2nd and 3rd floor ready to rent, which meant more money out of our pocket to pay the mortgage, pay the bills, since just commercial units rent wasn't near enough to cash flow positively.
But, actually renting the units once they were ready to rent didn't happen over night. In fact, it took months, years actually, and even to this day, we are still trying to fill the vacancies at this property.
I think in the almost 5 years of owning this property, only 1 month have we had the entire property full.
Sure, when we analyzed the property before purchasing it, we did consider this hidden cost, but we just fluffed it off, figuring maybe 1 unit vacant a month max.
STUPID US!
I've learned from this experience, and I now give vacancies much more consideration before buying a property, because it truly will affect the return on your investment, and in turn, will affect the price you're willing to pay.
In the end though, it still comes down to the fact that you can't predict the future, but you can be prepared.
This is why now I am much much more conservative when analyzing a property I'm looking to buy and hold as a rental, using a minimum 1 months rent as my vacancy cost for the year when running my projections.
This way I don't make the same mistake I've made before, and can paint a worst case scenario of the potential cash flow the investment property could generate.
Because lets face it, you are going to have vacancies at your property.
Even if you hear other investors says they always have full occupancy, let me tell you now, that is total BS. Your property will never 100% be fully occupied the entire time you own it.
You will always have vacancies. So you need to include this cost before you buy it in your analysis.
Even if your property or unit only has turnover once every 5 years, well during that turnover, you're most likely going to have to spend a month to repair the unit, to bring it back to its former glory, so that it's ready to rent and will bring in the highest rents, and it's also going to take another month until the new tenant moves in.
When you do the math, that's 2 months of lost rent due to the unit being vacant.
As I shared in Part 1, the hidden cost when you own real estate; repairs and maintenance, if you were to extrapolate out 2 months of lost rent over 5 years due to the unit being vacant, the total cost each month that you should factor into your analysis would be $33/month.
And, lets say that maybe you expect your unit to have turnover every 2 years, well that's a cost of $83 per month.
See below for a breakdown.
This is why I now use 1 months rent as my vacancy cost for the year in my analysis, which is actually $167 per month on rent of $2,000 per month.
Because this hidden cost will rear its ugly head when you own real estate, and you need to make sure you're including it, otherwise you could be overpaying for the property, thinking that its going to generate X amount of money each year, when in reality, it might only generate Y amount, as a result of this other hidden cost you will incur when you own real estate...
VACANCIES.
Wondering how to make sure you capture this hidden cost when analyzing a property?
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