Real estate returns

A bit of background: I work in corporate finance, but have started getting into RE investing in my free time, so my knowledge of the space is pretty limited.

I recently finished renovating a duplex, and have secured rents in each unit with an average of $900. My fully loaded mortgage is under $800. My question is, what am I missing? Even after OPEX, I'm still planning on walking away with about $700 / month pretax, and this seems pretty high. Is all small time real estate this profitable? How do the margins do when you start scaling for more units?

Every REIT I've looked at has trash returns (no offense to anyone who does that for a living), so I'm just trying to understand the disconnect.

Thanks in advance...

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Comments (27)

Jul 13, 2020 - 5:45pm

Your mortgage is under 800k, I imagine?

Look, without knowing any details of your returns, there are a few things to understand.

First off, a duplex-type building receives (generally) far more favorable financing. And probably more favorable tax treatment from the local municipality.

External issues aside, you also have to be prepared for major costs that you aren't anticipating. Sure, right now you're walking away with $700/mo pretax. What happens in January when you have a leak and it costs you 10 grand to repair the roof and the damaged interiors? All of a sudden you're looking at a loss for the year. Or when your assessment goes up. Or the local water/sewer provider starts charging 10% more. There are a TON of ways to blow a hole in your budget that you don't see when you look at your basic day 1 opex.

But more to the point about scaling, REITs can't do this. There are millions of your types of units in this country, and because of the size, most professional developers or owner/operators don't want to chase these deals. It's why they are considered such amazing buildings for beginners to aggregate a few of to start building a balance sheet. They're relatively inexpensive and because it's a "amateur" asset you can find really good deals. A REIT isn't chasing that deal because there is no way to scale that profitably. You could do 10,000 of them a year but the amount of staff needed would far exceed your profit margins. There are certainly smaller guys who play in the 5-20 unit space; I can name like 3 off the top of my head in NYC and there are obviously hundreds more. But even then, you're talking about a far more expensive and competitive market than the kind of asset to which you are referring

Jul 13, 2020 - 5:56pm

Lol, my mortgage is less then $800 / month (not 800K, I wish I could afford that!), but great answer.

It will be interesting to see what s*** storm blows through within a year or two. I'm really just hoping to dump everything back into the mortgage so I will be able to use this place for HELOC credit for future disasters be it on this or other properties, and avoid the huge cash flow hit altogether.

Per 100K in property value, how much cash do you recommend keeping on hand?

Jul 13, 2020 - 10:19pm

I've thinking about do this for a while. How were you able to get comfortable taking personal liability for anything that happens at the property? For example one of your two tenants is casually leaning against your railing which breaks, they crack their skull and are brain dead, and then the family sues you for damages of millions of dollars. They'll go after all of your assets and you'll be working the rest of your life paying them back.

Generally the way around this is an LLC but it's basically impossible to find a lender that will finance such a small deal SPE as borrower. If your lucky enough to find a willing bank then they'll have network and liquidity requirements generally at 100% of the loan amt. And 20% - 50% of loan and for the liquidity requirement.

Jul 13, 2020 - 6:38pm

agree; in terms of cash reserves-
only thing that matters is the age of the building/deferred maintenance. When you bought it, what did the property condition report or bank appraisal flag? What are historical rent collections? Do you have responsible tenants? Assuming tenants pay on time and aren't troublesom in addition to the property having no signifigant deferred maintenance; I would keep a cash reserve of 3 months mortgage payments/taxes/water & sewer. Looking at it per 100k of property value on a duplex is useless.

Jul 13, 2020 - 7:47pm

Are you accounting for vacancies/collection issues? I know someone that grew his rental portfolio from 1 to 12 properties over the last few years, he had a full time job, but did well reinvesting cash. However, Covid has straight up destroyed him, tenants not paying at all and refusing to pay going forward. So he has to go to court to fight to evict them, but states are favoring them against landlords. Theres always something you dont see coming that can cost you big.


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Jul 13, 2020 - 10:15pm

So you're saying:
Rent: $1,800 per month.
Opex: $300 per month
NOI: $1,500 per month
Debt Service: $800 per month
Net Cash Flow: $700 per month.

Over the course of your year, things will happen. Assuming you're paying a property manager, I would expect your expenses to be in the $700-900 per month range and net cash flow be around $300-400 per month.

Jul 13, 2020 - 11:30pm

Agreed that his NOI profit margin is way too high. I generally see 60 - 65% for apartments and that's at scale. He's running north of 80% on a 2-unit. I don't think $300 a month covers taxes, insurance, repairs and maintenance, bad dent, general vacancy loss, capex reserves, management or leasing fees (or a reasonable hourly doing this yourself).

Just considering your tax expenses alone...An annualized $1,500 NOI a month at a 7.0% cap rate with 80% assessment as % of vale at millage rate of 100 your reassessed taxes are $2K per year.

Jul 14, 2020 - 12:19pm

How are you spending that much on maintenance? I literally rebuilt both bathrooms (with tile), hung drywall throughout both units, painted and installed new counters / appliances (granted they were cheap) that I got from a recycle center, and sanded / polyurethaned the floors for under 12K.

Only thing I'd be worried about is the roof, but even then, a brand new roof can't cost more than 10K and that will last many years.

On the tax issue, if I invest all EBT into the mortgage, can I avoid it all together?

Jul 14, 2020 - 1:13pm

Tax and Insurance are probably rolled into the "mortgage" payment. Most guys aren't budgeting capex reserves on a duplex nor are they paying a manager. It's basically vacancy and straight physical maintenance.

Most Helpful
Jul 14, 2020 - 1:39pm

Your expenses are way too low as said by others!

2-4 unit product is going to be self managed so expense weight (expense to EGI) should be around 28-35% vs around 33-38% range if you hire a third party manager. You can get a RESI loan at 75% LTV which should help...regular apartment deals are fooked today due to DSCR constrtaints.

If you are doing a simple back of the napkin analysis, you want to get close to a 6% cap on cost which is your stabilized NOI after renovation divided by your total costs (asset, fees, renovation budget, etc). 5.5% to 6% cap on cost is what I would want in most markets but might be different in a market like NYC. For your analysis, garbage in garbage out... if you have bullshit expenses then you might get a 9 or 10% cap on cost.

Also depends what risk profile investment you are buying. If you are buying a turnkey product, and someone is telling you that you can lift rents 10% in this market, then you might be in trouble.


  • 3
Jul 15, 2020 - 2:01pm

This place was a fixer-upper, and helpful answer. Also, unless it's endangers the foundation / stability of the building, most issues can be fixed with a pail of joint compound or caulk. Don't mean to be that guy, but my tenants aren't in any position to sue lol.

Jul 15, 2020 - 2:38pm

Sounds like we have roughly the same property. I have a duplex with with 1850 gross rents - $900 & $950. My mortgage is $735 a month on a 20 year AM. I expect to make about $4-8k this year from it after everything (property taxes, insurance, mortgage, mgmt fees, capital expenses, maintenace, etc.). Last year I poured a ton of money into it putting in new appliances and LVP flooring, but it looks damn good, holds up well, and makes cleaning up during tenant turn over a breeze. Units turning over faster = more money.

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