Hello friends. Welcome to another episode of Ask Marco. I’m your host Marco Santarelli. And we have got some great questions that came in. So I decided to do another episode of the Rapid Fire Listener Questions. I kind of liked that title, so I might keep using it. So today I’m going to talk about three or four questions that came in and hopefully I can address these. And I think they’re going to be helpful for many people because these are questions that are not your typical questions, but they’re good questions to ask.
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So let’s start off with the first question here from Maria and Maria writes in, she says, hi Marco. I have a question regarding the numbers you and other turnkey providers use on the cash flow analysis. For example, I have seen that if the monthly property management fee is 10%, this goes into the, APOD, which is a, an abbreviation or an acronym for Annual Property Operating Data.
It’s essentially your income and expense statement. So if you just look at a profit and loss statement, that’s basically what the APOD is. So she goes on to say, but what about the lease-up fee and renewal fee that may vary with each property management company? Those fees should be prorated into the monthly percentage to get a more accurate monthly cash flow. Why don’t most providers include this and make you think you are getting 200 to $300 per month, monthly cash flow in the first year. And then she goes on to, well, first of all, that is a good question. She goes on to illustrate this by saying, let’s assume the monthly rent is $940 a month. That’s pretty specific. So that must be your property. And the property management fee is 9% of the rent, which works out to $84 and 60 cents. The lease agreement is for two years and the lease-up fee is one month’s rent.
What percentage then should I use on the APOD for property management services? I would like to know your thoughts. Thanks. Okay, Maria. Great question. Thanks for writing in here is my answer to your question. So you need to, first of all, understand that the part of your, APOD or your profit and loss statement at the very top that we call vacancy allowance is your budgeting for future vacancies. Now I’m going to break this down a little bit. So bear with me here. So you have your gross income or more likely your gross scheduled income, and you deduct your vacancy allowance from that gross scheduled income. And what you have is your effective net rent. That’s basically your gross collected rent or what you might call net rent that they can see allowance is what you use to budget for these turnovers and these vacancies.
So it’s not part of the expense, which is further down on that page, which is referred to as your property management fee. Your property management fee is really that 9% you’re talking about per month for managing the property. It is not a lease-up fee. It is you can break it out as a separate expense if you want to, but from budgeting or profit and loss statement perspective, it’s at the top. It’s part of your vacancy allowance. Now you will see people as in investors use all kinds of numbers here, they’ll use anything from 3% on the low end to 10% on the high end. I personally like to use five or 6% as my vacancy allowance. In other words, what I am budgeting or forecasting as my vacancy on average per year. Now I don’t get a vacancy every year. In fact, most of my properties don’t have vacancies for multiple years, but let’s just assume that you’re going to have a vacancy per year, which in my opinion, as a worst-case scenario, if you have a good property and in a good neighborhood.
So when you do the math, if you have one month of vacancy per year, that works out to be 8%. If you have one month of vacancy every two years, that number is 4%. Those are the actual numbers. What you use to budget is up to you. I would recommend you use something between four and eight. I like using five and six, eight, I think would be a good conservative number to use, but that vacancy allowance is what you’re budgeting for the lost rent on your property. And it really is not an expense item that you would count, um, for your lease-up fee. Now, having said that some property management companies have a one month lease-up fee. So they’ll keep the first collected month rent when they lease it to a new tenant. Some property management companies have a different number. I’ve seen 75%.
I’ve seen a number that have 50%. So it’s a half-month lease-up fee and not very often, but every once in a while, I do see a company that does not have a lease-up fee. So this keep in mind is a negotiable thing. You could shop for a property management company that has a different management fee, but you could also negotiate this upfront before you start working with a management company, or if you’re a good client, a good customer of a property management company. And let’s say you have more than one property under management with them. They’re probably going to be far more willing to work with you on that. And I would almost guarantee that they’d be willing to negotiate that if you have multiple properties and, or you’ve been with them for a long time. So as far as that lease-up fee, yeah, it ultimately will affect your return on investment, your cash on cash return.
Because when you start looking at your actual numbers and you are deducting the lease-up fee, which is not part of your vacancy allowance, but it is an actual expense, then you will see what your true costs are. So you can budget for it. You can budget for it in the vacancy allowance that you put at the top of your APOD or your profit and loss statement or your proforma. But when it actually happens, then it becomes a true expense and that will show up in your reporting or on your books. And it will be labeled as whatever you label it as a lease-up fee turnover fee, et cetera. That is separate though again, from your property management fee, whether it’s 9% like you site or it’s 8% or 10% or 7%, those I would keep us separate line items. All right. I hope I’ve answered your question, but you know, just to your comment at the very beginning, there are different companies, not just turnkey providers, but different companies and different investors will lay this out differently in their books and on their performance and their APODS and cashflow analysis.
So you might see it represented differently in different places, but at the end of the day, when you know everything I should really say at the end of the month and the end of the year, when you look at the numbers, you will see what your returns, cash flows and ROIs are. So it’s still there, but do budget for it, count it as part of your vacancy allowance. So bump those numbers up and then you’ve got it covered. And then when it actually happens and it’s an effective number, you can put it in your books as an actual expense, and then you could have real numbers to measure against. So I hope that helps Maria, if that didn’t shoot me an email and I’ll, uh, be happy to go into it with you in more detail.
All right, next is from Dave, Dave. He says, hi, Marco. I have had the pleasure of working with your team to purchase a couple of properties. And I have to say that your podcast was the one that finally got me to take action last year. Thank you for your continued education and motivation. Dave, I’m happy for you. So congratulations!
Could you help me to understand how cash flows when you’re using a home equity loan from a primary residence to purchase a rental property? So Dave outlined two scenarios here. So let’s address these separately scenario one, Dave says, let’s say I own my primary residence worth $300,000 free and clear. Okay. So no mortgage. If I took a home equity loan of $100,000 on my primary residence to use as a down payment on a $400,000 rental property with the lender covering the remaining $300,000, would my cashflow need to cover two mortgages, for example, paying off the home equity loan and the lender at the same time, the lender being the new mortgage purchase money on the new rental property.
So the short and simple answer is yes, obviously, if you’ve got financing on the new purchase, the $400,000 rental, in your case, you don’t have a choice. You’re going to be paying principal and interest or interest only if that’s the type of loan mortgage loan that you have on that property with the home equity loan you’re going to have at a minimum. And what’s typical is an interest-only payment. So you can take a hundred thousand dollar loan home equity loan. And those are typically structured as interest only payments with the principal portion being optional. And you can have a term usually up to 10 years that can be extended or renewed, but it’s up to you whether you want to pay the additional monies towards the principal, but you don’t have a choice. You’re going to be paying interest every month on that. So the cash flow from that new property will have to service the mortgage on the property itself.
Plus, what you want to do is take that cashflow and funnel that towards the monthly payment required for your home equity loan. Now, the question now becomes what is the cashflow in that property? This is where, you know, it really comes down to what are you buying and where, and what is the financial performance of that property. It might be a cash cow and you have great cash flow. And you’re able to put that towards your HELOC, your home equity loan, or line of credit. I actually am rereading your question here. You mentioned a home equity loan. If it’s a loan, it’s probably principal and interest payment. If it’s a home equity line of credit, then that’s what I was talking about before, where you have typically a 10 year term and it’s interest only with the principal being optional payments. On top of that, that’s the assumption I made, regardless of what it is, whatever cash flows you have leftover from that rental property is what you should or would put towards the home equity loan or home equity line of credit.
Ideally, you’ll want to have more cashflow than what your monthly payment is. Now, if you do great, if it’s more or less a breakeven, okay, that’s fine. You can just keep paying it off, you know, as you normally would, regardless of where the source of those funds come from, if you have a negative cashflow, well, obviously you’re going to have to be pitching in each and every month, a little extra to cover the home equity loan or line of credit. Now, at some point down the road, you’re going to want to pay off that home equity loan or home equity line of credit. And if you are able to pay that off over 10 years, using the cash flows from the property, great, well then you don’t need to do anything else, but if you want to pay it off sooner than one way to attack that, and I’ve talked about this in previous episodes is as your property appreciates and you get to a point where you can refinance to pull some cash out, that’s what you would do.
You would essentially wait, whether that takes a year to five years, whatever it is, you can refinance at some point, hopefully, you know, the rates haven’t gone up a lot and I don’t expect them to, but if you can refinance the, pull some of the equity out and use that to pay down or pay off that home equity line of credit, well then great. And you’ve essentially financed your down payment. And if you can’t do that, then hopefully you’ve got cash flows that are in place to pay it down over that 10 year term or whatever the term of the loan is. And as you raise rents, you’ll increase your cash flows over time. You’ll be able to pay that off sooner, but this is really just a math problem. You need to map it out and make a few assumptions, but you can map this out over a five or 10 year period and just see how the cash flows from the property cover that home equity, loan, or line of credit.
So it’s not complicated. It’s actually pretty simple math. So again, if you need help with this, Dave just contact my team or myself and we can kind of run through it with you, but this is not a complicated problem. And I think a lot of people actually do this. And we’ve been in an environment for the last 3, 4, 5 years where we’ve seen above average or above normal rates of appreciation, especially last year and this year. And I’m going to talk a little bit more about this in an upcoming episode about the housing market. So we’ll get into that whole appreciation scenario, but I don’t know what market you’re in, but if you’re in any of the markets that we’re in or some of the other markets that have been just on fire lately, you should not have an issue with additional equity in the property in the years to come to be able to refinance, pull some cash out tax-free and pay off that home equity line of credit, just keep your business affairs straight. Keep your books straight, work with your CPA tax advisor or accountant, whatnot, just to keep everything in line and you will be fine.
Now, Dave, you did have a scenario two here. This is the easier part of this you asked. What if I use the hundred thousand dollars that you pulled out from your principal residence to purchase a property without a lender in this case? Is it correct to assume that the rent on the property would only need to cover paying down the home equity loan, short answer? There is, yes, because you have no other financing, is it correct to assume that the payments to pay off the home equity loan would be paying principal back to my principle residence and the interest would go to a bank. I was scratching my head a little bit on this because I think you’re trying to ask something that’s not coming through clearly, but just to finish reading what you have here, is there any way to structure the loan, such that you are paying yourself back the interest?
I guess that’s possible if you structure it in a way where you are setting yourself up as a lender, but I’m not sure how you would do that. Maybe talk to a CPA about that, but to your previous question, yes, you are essentially using the net operating income, which is the cash flows from the property income minus expenses before any debt service to pay off the debt, which is your home equity loan or the line of credit. So essentially what you’re doing is you’re using your home equity line or loan as the mortgage financing for the property. It’s still one loan that you have against that property. However, what I will tell you is that’s not the best way to go about it. And here’s first and foremost, you’re not going to get the best terms under a loan scenario that way, compared to getting a conventional loan or a mortgage loan where you can actually have a low interest rate in the three or 4% range amortized over a 30 year period, because I have yet to see a home equity loan or line of credit that actually amortizes over 30 years, it might exist. I just don’t remember seeing one in recent past.
Usually they are set up to be over a 10 year period. So you have the added benefit of having that longer term. And it’s also fully amortized, which also provides you the benefit of being able to accelerate the payments are paid off early and often without penalty. So I don’t think that’s the best scenario or strategy for you. I’m a firm believer that you should take advantage of the cheap, low interest rate financing available today from lenders all over the country that are lending 30 year mortgages, even 15 year mortgages, whether interest only or fixed for a period of time and then becoming adjustable or ideally a 30 year fixed rate mortgage. So that’s the best way to go. And don’t forget, you also get the benefit of leveraging your investment capital. So the hundred thousand dollars that you pull out on your property as a home equity loan or line of credit can actually be the down payment for one larger property, like a duplex triplex.
I mean, you’re talking about a $400,000 rental property, but it can also be the down payment on say three single family detached homes that are, you know, in nice markets, nice neighborhoods. And they’re, you know, your typical three bedroom, two bath type of home, because that’s enough to do that. I mean, if you have 25 to $30,000 per property, that’s a decent chunk of cash for a down payment. So that’s the approach I would take unless you’re looking for a multiunit that is, you know, three, $400,000 in purchase price. So, Dave, I hope that it helps you a good question.
Thanks for writing in, and I’m going to do one more quick one here, just because I am going a little bit longer than I wanted to, but Jonah, I believe it is Jonah writes in and says, hello. I have been thinking about investing as a limited partner, an LP in a real estate syndication, but I am curious about the tax benefits specifically travel.
I own a few single families and always enjoy being able to travel to them, to see the property and visit with the property manager as an LP, innocent indication. Would I be able to deduct travel to visit the property LPs aren’t involved in the day-to-day? So I’m curious if I would be able to claim the usual travel deductions such as flight, hotel food, et cetera, in this scenario. Thanks, Jonah. This is a good question. I will be honest with you. I don’t know specifically how you would treat that because the tax laws have changed a number of times here in the last four or five years, since 2018, actually 2017 and 2018. I know that they tightened up on things like food expenses, and then they opened that up and made it lacks again, post-COVID the way I look at it. And at the end of the day, I want you to talk to your tax advisor or your CPA about this.
And I’m not the one qualified to answer this question, but from what I know is unless you are running your investments as a business, which everybody does and should, but if you are actually running it as a business where you are operating a business, not just a passive investor, but you have other things going on, then you probably can write all those things off or deduct most of those things as deductions in your business, your LLC, or maybe even personally, because I know that a lot of investors will make the argument that they travel to go and visit other real estate investment options and meet with real estate brokers and agents and property managers and whatnot as part of their business, as part of their due diligence and an investing process. I’m not sure what else to call it. So yeah, I would imagine if I had to guess, I would say, yeah, you absolutely could write these off because they are legitimate expenses.
They’re expenses made with the intention of generating a profit. And so if you can show this as being a business expense with the intention to make a profit, then you probably can write it off. So I don’t want to be the final word on this. Again, talk to your CPA or your tax advisor, or if you want shoot me an email and I will put you in touch with someone who will be in my opinion, ideal for working with you on this stuff and showing you not just whether you can or can’t, but how you can. It’s always good to have creative tax advisors on your team that can show you ways to make things happen rather than just being completely black and white and saying, yes, you can. No, you can’t. That’s fine. But if there are ways to do something, maybe not the way you’re doing it now, but if you can change a few things and I know CPAs and tax advisors that do this all the time with all their clients on a day-to-day basis, they’re out there to show you how to minimize your taxes and take advantage of additional write-offs. And they’re there just to be a strategic partner for you. So if you’re interested in that, just shoot me an email and I’ll make an introduction for you. Okay, Jonah, thank you for the question.
I will answer more questions here in the next couple of weeks. I got a number of them that I want to go through, but that is it for today. So if you have a question about investing finance real estate or whatever, it may be, maybe even just a fun question, a personal question. Maybe I’ll answer a couple of those on these episodes. Who knows? I think that would be fun. Just go to passiverealestateinvesting.com and just click Ask Marco and shoot that over to me and remember to subscribe to the show. If you are a first-time listener, we would love to keep you posted each and every week. When a new episode is dropped, share the show with your friends and family other like-minded people, cause I’m sure they would like to learn just like you are, visit us on iTunes and leave us a rating and review greatly appreciate it. And I do read them all. Thank you for listening. I will see you all on our next episode.
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