If you ever get into real estate investment, there will be an acronym in which you will become quite familiar. PITI:
PITI is related to mortgages, and encompasses the monthly payments required to satisfy the contract and not default. Each month you will pay off interest and pay down the principal for the duration of the mortgage; e.g. 15-years or 30-years. Property taxes , usually paid in your monthly payments are collected yearly, and are based on an appraisal of the property by the tax assessor. The State of Oregon has an option to pay it all at once for a discount or into three separate payments, but for most mortgages you will pay property taxes on a monthly basis directly to the lender alongside the principal and interest payments, and they pay the yearly lump sum from your account. Lastly, home owner, liability and mortgage insurance payments may also be rolled up within the mortgage payment, or done separately, based on the lender’s preference. Regardless of whether everything is rolled into an individual monthly “mortgage payment” or you pay taxes and insurance separate, these represent the costs associated with acquiring the property. We will have an example of how to determine PITI later in the article.
NOTE: Oregon Veterans with a 40% Disability Rating or more from the VA may file to have their property taxes to be exempted, which in turn will reduce your PITI payments. If this applies to you then please refer to this exemption notice from Oregon Department of Revenue to see how you can file.
The next element you need to calculate is the rental income you can expect for the units of that property based on comparables within the market. A comparable is simply a similar property that is currently rented out within that neighborhood in order to draw a comparison.For example, each unit in your quadplex has two bedrooms, one bathroom, a kitchenette, an individual one car garage in an adjacent structure, and individual door access. You check, or better yet have a Realtor or Property Manager check for you, numerous apartments in the immediate area to determine what the current market rate for a similar unit is going for. They need to be nearby, less than a mile if possible, since nearby amenities, services, and attractions play a big part in the value of a property; including rentals. Let’s just say the going rate for a comparable unit is approximately $1,000.
When it comes to rentals there will be two other variables you will need to take into account when determining its cash flow.
The first is the vacancy rate since you need to plan for times in which you may not have a tenant occupying one of your units. The vacancy rate that most investors utilize is 8% of the rental price. This as a fraction is about 1/12th or one month of a year of twelve months in which the unit will be unoccupied and not earning you income. That lost month covers the time the unit is vacated, put on the market, refurbished, and occupied by a new tenant.
$1,000 (Rental Price) X 8% (Vacancy Rate) = $80 vacancy rate per month
The second is the Property Manager fee if you decide to utilize one to manage tenants and care for the property. While property manager fees vary from firm to firm, the standard rate investors use to calculate is approximately 10% of the rental price. You can save money by handling tenants and repairs yourself, but the value of a Property Manager is the freedom it provides you from having to handle all that yourself. You won’t have to deal with problem tenants, marketing units for rent, late night work orders and they understand the fair market value of a property as the economy shifts. Additionally, they may be able to secure discounts with certain established contractors for repairs and renovations that you may not be able to secure since you are new to the market.
$1,000 (Rental Price) X 10% (Property Manager fee) = $100 fee per month
Taking that rental price and subtracting both the vacancy rate and the Property Manager’s fee will provide you the assessed monthly revenue generated by each unit for each month of a year. Take note that when you calculate everything you don’t include the income from the unit that you occupy, only the others, but do include that additional manager’s fee if you wish to utilize their services for repairs to your own unit. As a result, the income for the example should look like this:
$1,000 - $80 - $100 = $820 per unit
$820 X 3 units = $2460 per month rental income
$2,460 - $100 (additional manager fee) = $2,360 monthly revenue
Note: You may choose to have a small percentage separated from your monthly revenue in order to have a slush fund to help with emergency repairs and maintenance, but homeowner’s and landlord’s insurance can help compensate for destructive and negligent tenants.
Since PITI payments are monthly, and rental income is monthly, if the income is greater than the PITI then you have a positive monthly cash flow; simple, yes! The real difficult step is finding the property and negotiating a good price. There are numerous avenues for identifying potential properties, but one key element is finding one whose owner is distressed. While the method for identifying such an owner warrants its own article, the basic premise is that the owner is in dire straits for one reason or another, and is desperate to part with their property as soon as possible. This means they would be willing to accept an offer at a lower price in order to be rid of the property and get cash in hand. It won’t necessarily be easy to find such a property and owner, but they do exist and you have all the time in the world to use your VA Home Loan Program benefit, so there isn’t necessarily a rush.