Latest / Cash Flow for Life / Chapter 11: Cost Is an Iceberg
Transcript
- 00;00;00;06 - 00;00;28;14 Chapter 11. Cost is an iceberg. In this chapter, we're going to talk about the costs involved in the purchase of a rental property. Many studies have shown that as much as 75 to 85% of the body of an iceberg is hidden below the water surface. And just like an iceberg, many of the costs are hidden below the deal, within the walls of the property and within the closing of the deal. 00;00;28;16 - 00;00;56;03 Now, while there won't be a loss of life involved, don't let your rental property purchase become a movie with Titanic in the title. In the next chapter, we'll go into detail about the financial calculations and analyzing the numbers in order to select the right property and ensure the cash flow you desire. In this chapter, we'll be examining the many costs involved in purchasing and managing a rental property. 00;00;56;06 - 00;01;24;21 Some of the calculations in the next chapter will use this information, and the concepts in this one costs to buy the purchase price, down payment and mortgage. The largest costs are most obvious and visible part of the cost iceberg. The purchase price of a home is the single largest cost, though financing will mean that you're not out anywhere near as much that cash. 00;01;24;24 - 00;01;52;28 Remember leverage. We have discussed mortgages and the factors that will enter into your selection of the best mortgage for each purchase. The interest rate will determine your payments, and you'll be very much on top of that rate and the monthly principal and interest rates for your rental home. Now that we've identified the portion of the iceberg above the water, it's time to look at the many cost items that affect your cash flow but may not be as visible or apparent to you. 00;01;53;00 - 00;02;21;08 Other mortgage related costs. We mentioned that these costs differ significantly based on where you're doing the borrowing. While many Canadian brokers get all of their compensation directly from the lender, many US brokers charge various fees to get the loan done. That's commonplace. Which of these will apply to your deals will be something you'll need to investigate. Origination fee. 00;02;21;11 - 00;02;51;11 This is usually based on points of the mortgage amount, meaning a percentage of the loan amount. Usually, this is a fee charged at the closing between 0.5% or half a point and 1.5%. One and a half points. So for a $100,000 loan, this would be between 500 and $1500. This is definitely a negotiable fee in most cases, but not all. 00;02;51;13 - 00;03;22;11 Early in your relationship with the mortgage broker. You may not have the clout to ask for cuts in this area, but as your business increases and becomes more important to that mortgage broker, you should definitely be thinking about negotiating this fee. You don't know unless you ask. Credit application or mortgage application fee A flat fee, usually between $100 and $500, is charged to do credit checks and prepare a credit report for the lender. 00;03;22;13 - 00;03;50;06 This is one that you may or may not be charged, but do a thorough check of any fees to see if it's their processing fee. This is an arbitrary fee to process your application, and it's not charged by all mortgage brokers, but it's the one to look out for. Appraisal. Passing along the cost of an appraisal of the property's value to the buyer is the normal procedure for most loans in the United States. 00;03;50;09 - 00;04;22;17 The buyer will be liable for a charge, usually somewhere between $300 and $500 for this appraisal, reappraisal, or appraisal review fee. Although they have existed for a long time, these fees began to show up more frequently after the US mortgage crisis beginning in 2006. Some of the blame for the mortgage mess was laid, the feet of appraisers who were accused of inflating values to satisfy lenders desire for more deals. 00;04;22;19 - 00;04;49;10 Whether this was a significant factor or not. Lenders became much more cautious. Many deals will end up with a request by the lender for a new appraisal, or an official review of the appraisal. While this can't be anticipated in every case, if required, it will add a cost that can be comparable to the original appraisal fee. Mortgage servicing or escrow fees. 00;04;49;13 - 00;05;23;11 Lenders usually want control of the payment of taxes and insurance to protect their interest in the property. They don't want the borrower to get behind on taxes or stop paying insurance, so they require that money be placed in an escrow or trust account for the payment of these items by the lender. While it's your money and not really a cost of the deal, there's a small cost added in many cases to pay the servicer the entity to handle this money, to collect the payments from you, and to pay the taxes and insurance. 00;05;23;14 - 00;05;44;24 Most of this money is just a prepayment by the buyer to cover the first six months to one year of taxes and insurance, something you would have to pay anyway. So it's a cost you've already evaluated over the entire ownership period of the numbers of the property. Just watch out for and be aware of additional fees to administer this other property. 00;05;44;24 - 00;06;12;19 Inspection and verification costs in determining whether a deal will make it to closing. There will be a number of inspection and investigating activities, all of which carrying costs. A survey. Unless the property is a condominium with no land ownership. You will often be required to survey the property to determine if the true boundary lines, as well as any encroachments or easements across those lines by neighboring properties. 00;06;12;21 - 00;06;39;09 The exact location of the home and other improvements will be drawn. The payment for the survey is normally a negotiating item, with local customs dictating whether it's custom for the seller or for the buyer to pay. However, it can be negotiated in the contract, title, insurance and binder or commitment insurance to protect your title, and ownership is provided by a title insurer. 00;06;39;11 - 00;07;05;25 In many areas, the title company also handles the transaction and closing functions as well. If so, there will be a fee for the title's basic services separate from the title insurance. The first thing you'll normally see is a title insurance binder or commitment. This document tells you that the title insurance company promises you a policy at closing if certain conditions are met. 00;07;05;28 - 00;07;30;29 It will also note any items or situations that won't be covered by the policy. The cost for this binder reflects the fact that deals don't always make it to closing, and the title company wants to get paid for the record search that it does to create the binder. Whether you close or not, the premium for the actual title policy is separate and based on the level of coverage you choose. 00;07;31;07 - 00;07;54;07 With some options available to the buyer who pays for the binder and the policy is negotiable. However, it's often common and in many areas for the buyer to pay for the binder and the seller to pay a significantly higher amount for the policy premium. Inspections. There are a number of inspections that may be done to determine the condition of the property. 00;07;54;09 - 00;08;40;14 They can include the following. General structure. Foundation roof equipment. Heating and air conditioning. Mold. Destructive insects. Radon. Soil wells in private septic systems. Asbestos. Lead based paint. Often a general home inspector can combine several of these together in one inspection, depending on the area or type of utilities. Some inspections are not necessary. The buyer generally pays for these inspections, and the cost can vary considerably from 300 to well over a thousand, depending on which are selected. 00;08;40;16 - 00;09;08;02 Legal and other documents, deed preparation and any other services that may require an attorney will result in a cost for someone. These costs are often negotiable, but local custom usually provides some history for who pays. The normally small cost of recording documents at the courthouse will be borne by the buyer or seller, depending on what stated in the contract. 00;09;08;04 - 00;09;34;18 If documents must be priority mailed or shipped, those charges will be on the settlement statement charged to the buyer or seller, depending on the documents and their use. Wire fees and notary fees, though small, shouldn't be forgotten. Every dollar that goes into your purchase has an impact on your ROI. Your return on investment cost to hold and rent out property. 00;09;34;20 - 00;09;58;18 Hey, Scott. Harold over at the Smith Street property. Just called to say that the plumbing is backed up again. What's wrong with those guys? I'm not sure, but this is the third plumbing bill in two months, and it's killing our cash flow. Let's figure out if it's the plumbing or the tenants lifestyle. Owning rental property is a business, and businesses have costs. 00;09;58;21 - 00;10;23;10 It's a natural part of doing business and nothing to fear. It's a problem only if you fail to anticipate a large enough chunk of the cost iceberg. Education, planning and budgeting will not only get you through, they will get you through very profitably. And that's why we're here. Our goal is to eliminate for you the expensive process of trial and error. 00;10;23;13 - 00;10;47;14 There's our goal again. We have experienced many surprises in the area of rental property management and maintenance costs over the years. With this book, our mentorship and our courses and our coaching, you won't have to go through these problems situations because we have already alerted them to you upfront. Don't forget to get your additional resources at the audiobook resource page. 00;10;47;20 - 00;11;15;12 Key com slash cashflow for life. Audiobook. Taxes. Property taxes are just part of the deal. Learn how tax assessors work, how they value your property, and how the levees that they use to calculate your taxes impact you. While there is usually not anything you can do to reduce property taxes, at least understanding how yours are calculated is important. 00;11;15;14 - 00;11;35;18 When a notice of a tax levy increase is in the news, you should be able to quickly do a rough calculation to see how it's going to affect and impact your cash flow, and maybe consider if a rent increase should be in the plan in the future. Insurance. You will have some control of the cost of property insurance. 00;11;35;21 - 00;12;01;28 You'll want adequate coverage for replacement of the property or damage repairs, but you'll also want to be covered well for liability with tenants in the home. Liability is very important because lawsuits are more common than house fires in many areas. Minimizing costs should always be a concern. But be careful about insurance. Compare policies to verify what makes premiums higher or lower. 00;12;02;00 - 00;12;24;25 Notably, full value replacement coverage is usually more expensive, but it will pay out enough to rebuild the property. A less expensive option would offer you set a value that you'd have to check on now, and then an upgrade for appreciation. This isn't a bad thing, because you may want to check this in conjunction with an anticipated rent increase. 00;12;25;01 - 00;12;48;25 Management. You may never hire professional property management services, or your business may grow to the point that it requires one in the future. Or you might say from day one. Heck no, I'm not managing tenants. I need someone to do that work for me. Whatever you decide is the right decision for you. However, you should always consider management as a cost of doing business. 00;12;48;28 - 00;13;12;29 In other words, pay yourself if you're doing it. Always keep it in the numbers and pay someone, even if it's yourself. Now, you don't have to cut a paycheck if you don't want, but always consider that there is some cost involved in what you're doing as an owner manager. If you're using employees or subcontractors for management functions, don't forget to budget this in when you're running the numbers. 00;13;13;06 - 00;13;40;25 In the next chapter, we'll get into Cash flow worksheets and loving the numbers. Legal. You may think that getting an attorney at the beginning and getting things lined up for forms and tenant applications will be a one time expense. And it might be. However, add a little something into your budget for every property. This will build up some allowance for unexpected legal expenses, even if it's a one hour consultation before an eviction. 00;13;40;27 - 00;14;08;01 There will be times when you'll need to consult an attorney, so we might as well budgeted in upfront a vacancy and credit losses within the limitations of the current market supply and demand. You can control your rental income by setting your rents. However, this controls only anticipated gross income because you will experience periods when the anticipated income doesn't make it into the bank account. 00;14;08;03 - 00;14;35;17 For example, vacancy leases expire and tenants move around even if you manage to keep them through the agreed upon lease period. You'll experience vacancy between tenants if you're doing well at lining up new tenants in anticipation of tenants moving out. You could still have lost income while units are being cleaned, ready for new tenants, or perhaps even rehabbed or renovation for increased rents besides lost income. 00;14;35;19 - 00;15;02;11 There's the cost of painting, cleaning and other maintenance between tenants. Make sure you factor this into your budget when setting rents, credit loss, things happen and people run into financial difficulty. It's life. Good interviews, tenant checks, credit checks and tenant application forms can help minimize problems with unpaid rent. But there will always be some of this in your future. 00;15;02;13 - 00;15;28;18 Rental property owners generally develop numbers for vacancy and credit losses based on their experience over time. You can probably find out what the average number is for properties in your area. It's expressed as a percentage of rental income, and you can budget for it and build it into your rents and your projections. Maintenance and repair. Maintenance and repair is mandatory. 00;15;28;19 - 00;16;03;16 It will happen and it covers a lot of ground structure, maintenance and repairs for broken windows, exterior and interior wall repairs, doors, floors and other structural components. Mechanical repairs and replacement, including maintaining heating, air conditioning, and appliances. The budget should also anticipate periodic replacement of the equipment, landscaping and yard maintenance, plumbing and electrical maintenance, and repairs and general maintenance on other elements of the property. 00;16;03;18 - 00;16;33;03 The building and the structure. Over time, you'll build some really great historical numbers that will help you budget for new properties in the future. Also, we can help you with pegging down some of these estimates to avoid missing too much of the submerged iceberg costs. We're getting you out of the drain of trial and error improvements. We're working on lifetime cash flow and generational property ownership. 00;16;33;05 - 00;17;03;24 As long as a property is generating acceptable cash flow and return on investment. We will normally want to keep it. Why sell it if it's paying you every single month over time? Improvements and renovations will keep the property rentable and even allow us to raise rents, in many cases, keeping long term property improvement projects in mind will allow you to project rents and maintain or increase cash flows over time. 00;17;03;27 - 00;17;31;15 Action steps. We'll get into some real number crunching in the next chapter. For now, familiarize yourself with these various cost items in this chapter. Try to get a title company or real estate agent to give you a sample closing or settlement statement showing all the costs to the buyer and the seller, or get a truth in lending or cost estimate from a mortgage broker to determine many of the costs involved. 00;17;31;17 - 00;17;49;05 Get both if you can and if you can't get them, simply just ask them and write it down. What's next? We're finally going to share some of the numbers. You'll get some calculations for cash flow, as well as other evaluation methods and numbers for rental property.