Jorge and Rafi discuss 4 tips to accurately calculate your cap rate because as an investor. You can use the cap rate to negotiate prices and identify deals that are right for you.
They discuss taxes, vacancy and maintenance costs, insurance, and rent price increases.
Rafi: Good afternoon and welcome to another edition of the Graystone brown bag sessions, I am Rafi, Chief Operating Officer of Graystone investment group
Jorge: and I’m Jorge Vazquez CEO of Graystone Investment Group.
Rafi: And of course, as always, we have the beautiful and today curly Stephany in the background.
Stephany: Hello, guys.
Rafi: She’s producing and making us look better than normally. Jorge, where can they find us?
Jorge: Rafi, they can always find us on homes4income.com
Rafi: excellent, and don’t forget to subscribe to our YouTube channel. The link is in the description of the video. When we get to 100 we give out a $100 gift card until we get to a 1000 and then we’re going to give out a 1000 dollars.” “I don’t know about that” “we’ll see”.
For those of us that are watching us live, we have a very important announcement. Tomorrow, Saturday, December 9, 2017, we are going to be part of a great seminar. You want to talk about it, Jorge?
Jorge: Absolutely, the season of the wholesaler. I encourage a lot of you that it’s your first time investing in real estate to go because there’s going to be a lot of knowledge shown there. And we’re going to take it really basic. It’s a tryout for other seminars in the future that will perhaps be more complex. This one will be very basic so if you been on the sideline thinking I want to invest in real estate this is the one to go to for sure.
Rafi: This one is a take action seminar. So, if you’re already doing it but know you can do it better, this is the seminar for you.
Rafi: So, if you’re doing real estate investment already but want to get better this is a great seminar for you. If you’re a starter and are ready to take action this is a seminar for you. We are doing this seminar in partnership with his capital group. Rick Mallero, Sam Ally over there and with Greg from Outfast realty. So, you’re going to have a perspective from short term investing and a perspective from long-term investing. So, we’re going to cover a lot of bases and it’s free. The cost is zero, nada zilch.
We want to share the info with everyone. So, December 9, 2017, the season of the wholesaler. It will be at the Hilton garden inn, let’s do this: Stephany will go to Eventbrite and she’s going to copy it into the comments of the video.
Rafi: Again, I hope to see some of you there. Those of you who are watching us live today, I don’t know how many people we have live, but please join us tomorrow December 9, 2017, at the Tampa Hilton Garden Inn. The information will be in the comments. Stephany will be putting it in right away.
Rafi: So, great tip today. For those of you that are doing long-term real estate investing you have heard a lot about cap rate. Cap rate this, cap rate that, today we’re going to go a little bit more in depth into it.
And we’re going to give you some, I call these advance tips, I think not everyone uses these items to calculate cap rate, and then, guess what, you don’t get an accurate, accurate, accurate cap rate. But before we go into the advanced part, in a nutshell, cap rate, what is cap rate?
Jorge: Cap rate illustrates the return you’re going to have in that investment. So pretty much just like when you get a disclosure or a cd when you open up a cd at the bank or you open,
Rafi: People still open CDs?
Jorge: Yeah, yeah, sometimes. You get that disclosure that says .001%. it’s the same way. The cap rate tells you how much you’re expected to make on your investment.
Rafi: Excellent, and how do you basically, calculate cap rate?
Jorge: So pretty much you take the annual income and you divide it by the expenses. And then pretty much you 8 take all the expenses out minus, I’m sorry you take all the income minus all the expenses out.
Rafi: Then you divide that by the investment you have in the property.
Rafi: So, rough example, you have a property that you bought for $100,000, and you are renting it the whole year and it nets you about $10,000. Well you divide 10,000 by 100,000 and your cap rate in that example will be 10%. And that’s what most people when you get a property and you want to make a quick collection that’s what you do. You just take the rent and multiply it by 12, divide it by how much is the house and go “ah the cap rate is this.”
Wrong. Wrong. And that’s what we’re going to talk about today, 4 tips to accurately calculate your cap rate because it’s key. You can use the cap rate to negotiate prices, you can use the cap rate to say yes or no to a property.
It’s one of those calculations that is very important that you know exactly how to do.
Jorge: And to identify if the deal really fits you, if it’s the right deal.
Rafi: Absolutely. So, the first item that you also want to include in the calculation of the cap rate is taxes and insurance. Uncle Sam has to eat. Talk to me about taxes and insurance and why it’s important to include in this calculation.
Jorge: Because it’s a fixed liability. Because you’re going to have it for the rest of the life of the investment. So, you definitely have to have it. I think my challenge to a lot of investors out there is the question, “are you calculating year two for taxes and year two for insurance?”
Rafi: So, let’s calculate year one first. For year one you know maybe when you close you know the taxes for that year and they told you they were $1,000 in taxes. Why do you want to use year 2 taxes when it’s year one? What happens with the taxes in year two?
Jorge: Right that’s a good question, but really, in reality in the first year you don’t have the exact tax amount until those taxes register in year two. Until your sale registers, you’re not going to see the true number of your tax liability because those taxes on the outgoing year are going to be based on the previous sale. Whenever that property sold years ago. In other words, you could have taxes from a property this year, from a property that has never been sold, or that has been sold decades ago. In reality, you have to put a little bit of increase in your taxes when you’re calculating it.
Rafi: Quick example guys, quick example. You buy this house from Granny Smith—by the way granny smith is a type of apple, that tells you I’m hungry—you buy it from Granny Smith, she bought the house 15 years ago and the assessed value at that time was $50,000. You bought the house for $125,000. This is a great deal, it’s worth $200,000, but she bought it at $50,000. When you close, the taxes are based on the $50,000. But guess what’s coming next year, Uncle Sam saying “hey, it’s $125,000 now.” So, your taxes most likely will double in that example. So, if you calculate your cap rate using year one taxes you’re going to have maybe taxes of $500. We want you to use year two, so calculate taxes on the $125,000 that you paid, ok, and that’s what you’re going to use to accurately calculate your tax rate. Because you’re going to have your asset for—this is long-term investing—you’re going to have it for three, five, seven years. Most likely six of those seven years are going to be the higher ones. So, you want to be conservative. Again, the tip is to use year two taxes for cap rate calculation.
Now, insurance: you talk about insurance also as a tip. Anything specific that you want to talk about using insurance in the cap rate calculation?
Jorge: Rafi, obviously the prices of the properties keep going up or down for that matter and you want to make sure you have the right coverage. You know at the beginning you might think, this is what I need. Year one. Year two, things are going to change, is the property worth more? So, you want to make sure you’re flexible. You understand that insurance is not just a fixed cost that you leave forever. You get a hurricane, you get something major that damages your property, you’re not fully covered.
Rafi: Now in terms of insurance, this is again where you need to make sure that you have the right team. You need to have your insurance agent make sure that you’re covered the way you should be. We’re giving advanced tips, this is a mega advanced tip: Public adjuster, write it down.
Rafi: Public Adjuster. If you have one on your team, have the public adjuster look at your policy. It happened to us, we have a public adjuster that we use for our, some of our properties that were damaged by the hurricane this year, and one of these guys said that “your policy sucks.” No, he really looked at it from our perspective, most likely insurance agent if it’s a good one is also going to look out for you, but at the end of the day, they work for the insurance company, right? A public adjuster works solely for you.
Jorge: Rafi, after I saw the check that he was able to get us,
Rafi: Oh my god.
Jorge: I was wondering, why didn’t we get other properties with damages. So yes, it makes a big difference.
Rafi: We’re not going to talk about numbers here, but let me tell you. We are going to give out this example. Before we had the public adjuster, we had a claim on that property and it was, I’m just going to put out a number here, $5,000. And after the public adjuster insurance company and us, we got more than double that.
Jorge: And the insurance company sent you the check right away. They wanted to trick you right, a little bit?
Rafi: Yeah, that’s their work. Insurance companies work not to pay claims. I’m sorry if I have an insurance agent—By the way, we love insurance agents—If it’s on my network, my bad. But, hey, their business model is “how can I collect the most premiums and pay the least claims.” It is, they’re shareholders, that’s what they do. You need to make sure is that you use the insurance expenses to calculate cap rates. But make sure that you have the right policy when you’re doing that. Again, we’ve talked about year two taxes and we’ve talked about insurance, making sure that your policy is there. Those two items are going to subtract from your rents, from your income. Ok, so if you have, again, $12000 annual income let’s say, in rents, then you have to subtract whatever you pay year two in taxes, you have to subtract what you pay on a correct policy from the cap rate calculation. Correct?
Jorge: Absolutely. And adjust your policies. Rafi, like you said in the past, if you already did a claim, and—by the way, if you put a brand-new roof, you put a brand new everything—perhaps it’s a good time to lower or increase your deductible, your premium.
Rafi: Absolutely, absolutely. So, the next item here, let me see. Oh, we have a question. We have our weekly question. From Melly James. “Why are you both wearing sunglasses inside during a live feed?” Melly, first, thank you for joining. We really appreciate it. We get this probably, once a month we get this question. Melly, it’s a way—we are in Florida, the sunshine state—and when we started doing these live feeds it was a way of having fun, differentiating ourselves, but like we do always when they ask the question for a brief moment we’re going to take them off. Are you ready?
Rafi: 3, 2, 1. This is for you, Melly. This is for you.
Jorge: By the way, the reason why we do it is because other people don’t do it.
Rafi: Yeah, we like to be different, have fun.
Jorge: And I’m sure you’ve seen a lot of people, nowadays everyone is on Facebook live. You see these crazy dudes with sunglasses, jackets, and you’re like “what is going on.” So, we got you.
Rafi: Thank you, Melly, for the question. I really appreciate it. Awesome, Melly is in Tampa too. Melly, I hope that you can join our seminar tomorrow. If you join our seminar tomorrow, I will make sure that we take a picture with you, and without sunglasses. How about that? So, we will do that. I see that Dalia also joined. Hope you get better, I know you’re a little bit under the weather. So, again back to the tips. The number one is to make sure you use the year two taxes and the correct insurance. The number two tip on how to accurately calculate the cap rate: it’s vacancy and maintenance reserves. Expand a little bit on that.
Jorge: Rafi, to make it simple for our audience, it’s one month for vacancies. What we do, one month, and one month for vacancy. Vacancy, what is vacancy, it’s the time that you’re expecting to have the property vacant. Whether, and some people say, “well I’ve had my property for vacant for 2 months, or, I’ve never had my property vacant for the past 4 or 5 years.” It’s just an average. By the way, if it’s always occupied, more for you more money at the end.
Rafi: Be conservative. You know, for example, you can find what is the vacancy rate in your area. You can ask your property manager. Property manager, property manager, property manager, I’m stuck but, property manager you can ask him. In Tampa, right now the vacancy rates are pretty low. I would say probably between 3-5 percent. We use 8 percent. We assume like he said, one month is going to be vacant. But, by the way, if you know the property is going to have repairs that are going to take 2 months, then it should not be one month; it should be 2, 3 months. So, talk to your property manager, he should be able to give you that information. But again, that number, subtract from the income. A rental that nets you $1,000 per month, but, now instead of $12,000 per year, it’s going to be $11,000. So, when you’re making the calculation now, instead of starting with $12,000, start with $11,000. So, $12,000 minus vacancy, $11,000, minus taxes and insurance—and I know it sounds like “’man, these guys are subtracting”—we just want you to have an accurate, conservative cap rate. We prefer for you to estimate $8,000 and get $9,000, instead of the opposite—estimating $9,000 and getting $8,000. So that’s why we talk about it. Now the next tip, this is one that is one of those that, the first time I saw it, the first time Jorge showed it to me, I was like “really.” Maintenance reserves. Duh. But at the same time, how many people don’t include that in the cap rate. We have seen it countless times. So, talk to me about maintenance reserves and how you calculate it and get there.
Jorge: Absolutely. we typically use the same thing, one month for reserves. And the reserves and vacancy, they go together. So, let’s say you have two months of both. Sometimes you might use both months for the vacancy or sometimes you might use the 2-month budget for the repairs. But we typically calculate one month. A lot of people miss it because there’s no action on your part at the beginning. It’s something that consciously you got to do. Put some money aside. But it’s not something you see, it’s not something you’ve got to do something about physically. But it’s extremely important.
Rafi: You’re going to have them.
Jorge: If you don’t account for that, then your cap rate is going to be way lower at the end of the year.
Rafi: Here’s another mega advanced tip. We’re not giving advance tips, we’re giving mega advanced tips. Ask your property manager to keep a reserve for you. Ok? I know that Jason Fix from Graystone Real Estate does that. Basically, he asks you, “what’s your maintenance reserve for this property?” you say, $1,000. Basically, what he does is he keeps that on his side so you don’t see it. It’s there for when he needs it. It also speeds up the process of work orders. So if something happens, instead of calling you, “hey I need the money,” he has it, speeds it up.
Jorge: It doesn’t hurt as much.
Rafi: Tenants are happy, and all that kind of stuff. So, mega advanced tip, talk to your property manager and have him collect and keep a maintenance reserve. Very important, there’s a log. A good property manager has software, you know, that goes into it. And has an accurate log of it, but if he has it, you don’t see it. When it happens, you don’t feel it. And not only that, he replenishes that. So, let’s say that you have a maintenance reserve of a $1,000. And there was a work order for something that was $150. So, the next time that rent comes in, he’s going to take that $150 and put it back into the reserves and send you the net. So, he always keeps $1000 in reserves. That’s, again, mega advanced tip. But it’s a great one because from your side when you see that little amount going to your checking account, you know that’s yours. You don’t have to put it aside. A good property manager, a great property manager can do that for you. So that’s a mega advanced tip on that one. Let’s see, Matt Nagy joined too. Matt Nagy from Graystone Acquisitions. Oh man, he has that great house in Brandon. I don’t know if you received that email in your database, but check it out. That’s great, I think it’s on 26th. Stephany, where is that house in Brandon? Is it 26th?
Rafi: I think so, yes something like that. Check it out. I’m sure most of you are in our database or you will join by going to homes4income.com.
Jorge: Yeah, it’s 626 S Echo Drive in Brandon.
Rafi: 626 S Echo Drive, that’s as great rehab house. That looks amazing.
Jorge: It’s very hard to find good stuff over there.
Rafi: Who’s Carmen Viruette?
Jorge: I have no idea.
Rafi: You’re going to have trouble when you go back. Saludos, Dona Carmen. So, moving on. We have the next tip on calculating an accurate cap rate. Of course, management fees.
Rafi: Property management fee, because we are all going to use a property manager. Ok. Again, that’s also added to the expenses of the property, correct?
Jorge: Absolutely, like you said too. You can find a good tenant on your own. It’s easy to find a good tenant. It’s very easy to verify just the basic stuff. But you’re not going to be able to find the background check and do all the extra stuff that a great property manager does. And at the end, you don’t want a good tenant you want a great tenant. Someone that’s going to stay there 10 years.
Rafi: Absolutely, absolutely. And again, it’s something that you add to the expenses. So again, the bad thing is that so far, we’ve been subtracting, subtracting, subtracting, from the cap rate. From the rental income. Guess what, the next step you’re going to like because we’re going to be adding. The next tip is second-year rent increases. Of course. How frequent and what kind of percentage should you do the rent increases?
Jorge: That’s a good question, Rafi. I think the first year after the lease is over and every year after that you should always increase your rent even if it’s only a little bit. Some property managers have the misconception, or they think “this is a great tenant that’s going to stay there for 10 years.” Things keep going up in price. You’ve got inflation going on every year no matter what. And you don’t want to handicap that tenant by saying “oh I’m not going to change anything,” I’m sorry, “I’m not going to increase the rents next year,” and five years from now you can’t even afford your own property because taxes are higher so it’s very important that you start even if it’s a little bit. I suggest a minimum of 25%.
Rafi: $25 you mean?
Jorge: I’m sorry, $25.
Rafi: You almost killed me; my rent went from $1,000 to $1,300.
Jorge: Or a quarter of a percent. That’s what I mean. $25, $50. Increase depending on the market as well.
Rafi: I was going to say, look at the market too. If you see a market that is hot, let’s put it that way, in terms of rentals. That is going 5-10% every year, then try to match the market. But at the same time, this is where a great property manager will help you because he knows the situation of the tenant. If it’s a tenant that’s tight and is paying rent. A good tenant but is barely paying rent, all that kind of stuff, then it’s a good tenant paying on time but being stretched. You know, how much up can you go, versus a tenant that is ok, whatever, all that kind of stuff. A nurse, a doctor, something like that. You can then go to market. But I think, bottom line, what we are trying to tell you here make your tenants get used to an annual increase. $10, $25, $50, make them used to it. We’re not saying run your good tenants out because that’s not what we want. Vacancy is the biggest expense that a landlord has, so we don’t want that, but $5, $10, $25, $50, depending on the market, make them get used to getting that.
Jorge: So, look at the market, look at the situation where your tenant is at, see how much in reserves you have used for that tenant, see the vacancy, and maybe you can take a little bit from the vacancy and repair budget, and say “ok, since I’m not getting hit on these two, maybe I cannot increase the rent as much.”
Rafi: Alright, so for those of you that are doing the math, nerds like me. Let’s go over this very, very quickly. We’re going to have rental income, just the gross amount of rent you receive in a year. We’re going to subtract the annual amount of insurance to that rent, we’re going to subtract year two taxes from that rent, we’re going to subtract a vacancy allowance—we recommend at least one month—we’re going to subtract a maintenance reserve. A great property manager will take that out for you, we’re going to subtract management fees from that rental income, but then we’re going to add second-year increases to that number. All that number that we came up, that net rent income. So, $12,000 minus $1,000 from taxes, minus $1,000 from insurance, etc. That number, you’re going to divide it by the cost of the property. How much was the acquisition cost for that year? That’s going to give you your cap rate, ok? So, guess what, most of the time, year one cap rate goes down. You have to, on that amount you bought the property, you have to include if you have to repair it. So maybe you bought it for $80,000 but you have to put $20,000 on it. So, your acquisition cost and your cost to get it rented is $100,000. But guess what, the second year, you have much less repairs, and the rental income starts going up, and everything starts looking probably better if you have a great property manager that takes the property to the next level.
Jorge: Absolutely, one of the biggest tips that you could get from this is asking for year two. What is the cap for year two rather than year one. Year one—by the way, Rafi, if you buy a distressed property, you don’t know, you have the best intentions of fixing. You put a new AC, roof, you do all this, but you never know what’s behind the walls until the tenant is there. So, a lot of times, don’t count on any type of returns, anything substantial on year one. Focus on what is my cap rate on year two, is going to be more conservative.
Rafi: Excellent. Now again, if you’re watching this live don’t forget that tomorrow December 9, 2017, we have our seminar that Stephany put the link to the registration there. It is a free event tomorrow all day we’re going to be there from 9 to 3 sharing all the knowledge. So please if you’re watching this live, hope to see you there. And Jorge, where can they find us?
Jorge: Rafi, before that I want to add again. I want to push the seminar because there’s a lot of people out there looking for the right seminar. Especially people that are also starting that are thinking of investing in real estate, but they’re not interested in buying a book, they don’t want to be sold anything. We’re not going to sell anything, we want to give back to the community everything that we’ve learned from the past 20 years, and it’s once in a lifetime. After that, I think our seminars will be more complex, but this is the time to jump in. Your family, friends, anybody that you know.
Rafi: Take action.
Jorge: And you can always find us at homes4income.com where you invest, we do the rest.
Rafi: Don’t forget to subscribe to our YouTube channel, the link is in the description of the video. It’s been a great live session today. I think the information today was awesome.
Jorge: I think it’s pretty accurate. I mean, if you take all the steps, you’re going to get a more accurate cap rate.
Rafi: Excellent, excellent. We’re going to thank Stephany, our producer in the background. Thank you, Stephany. They want to see her on this side. People are clamoring. We have to come up with one. And, for all of you that joined, thank you very, very much. Hope to see some of you tomorrow at the seminar and don’t forget to join us every Friday around this time for our next Graystone Brown Bag Session. Have a great day.
Graystone Investment Group
Graystone Investment Group is an experienced real estate wholesaler in Tampa Bay. We serve clients who flip homes in as little as 30 days, as well as clients who hold high cash flowing rental properties.
Unlike other wholesaling groups, we provide clients with a turnkey process at no extra charge. We find properties that we resell to investors at discount prices, while also connecting them with private financing. We also coordinate with rehab and management companies we’ve worked with for years.