Unexpected Expenses

Hopefully the example in the previous section (see below for link) convinced you that (pardon the cliché) less is more when it comes to rental agreement investing for cash flow. Unexpected expenses happen; sometimes furnaces stop working and need to be replaced, sometimes tenants stop working and need to be replaced. The first step is minimizing your exposure for these unexpected costs, by reducing your rental inventory to the minimum number of properties needed, which requires you to maximize your cash flow from each by owning them free and clear of any mortgages or liens.

Second, you'll have to budget for these expenses, as they will happen to even the most efficient property manager. Once again, the easiest way to budget for these is to maximize your cash flow per property, and put aside at least $1,000 per property from that cash flow. This is extremely important, because if you're caught with your pants down when expenses arise, and you can't afford to pay them, it will cost you twice as much to address those expenses. Damage to a property grows worse over time and affects other systems, tenants get aggravated and are liable to sue or abandon the property, unpaid mortgage payments ruin your credit and amass penalties… you get the idea.

Valuation Tactics: Thinking Differently

Most real estate investors (and all homeowners) consider the value of a property to be whatever someone else is willing to pay for it (AKA market value), and they arrive at that figure based on what similar properties (comparables or comps) have sold for recently. However this figure reflects only one number: how much money the property can command as a SALES PRICE.

Appraisers refer to this as the Sales Comparison Approach to real estate valuation. However, appraisers are also trained how to calculate a different kind of value, based on the Income Approach, or how much a property is worth based on how much income it's capable of producing from a rental agreement.

While we won't be using the exact formula that appraisers use, the point is that some properties have a massive discrepancy between their sales comparison value and their income value, and it will be your job to identify these properties as possible investments for cash flow. In a later chapter we'll go over some tips for finding such properties, but for now, start thinking in terms of the relationship between market rents respective sales prices. A good deal, from an income perspective, might include buying a property for 50 times the market rent that can be charged for a rental agreement on that property, and a mediocre deal might be buying it for 80x rent. Keep an eye on this relationship, as you scout for neighborhoods and properties; you'll be surprised how often they are disconnected.

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