Don't Get Fooled By Your "Cash Flow"

Dan Austin: [0:01] Welcome to the Collecting Keys Friday Focus. Welcome back to another Collecting Keys Friday Focus. I'm your host, Dan Austin, aka investor man Dan, and I'm coming in with some Friday energy. Although I am recording this on a Thursday, I want the energy for you because if you're listening to this, you're probably a wealthy real estate investor, and you're driving out to your lake home for the weekend. Summer's winding down, we've only got a couple more weekends left, and you gotta enjoy that nice boat that's being paid by your cash flow from your real estate. Or perhaps you're a new investor and you are gonna spend the weekend turning a unit. Either way, you're doing the right thing. And today I'm here to talk about cash flow that can pay for your boat or help you quit your w two because it's something that's been on my mind. I run our portfolio and manage all of our properties. And it always kinda grains my gears a little bit when I'm watching gurus run easy numbers and round numbers and say, see, this is how you get cash flow, and you do that 10 times and you can quit your w two job. They're not completely wrong, But what they don't talk about enough is that cash flow in real estate, especially residential, is variable. And it's variable because your expenses are variable. And you don't know when things are gonna fail. And when you have a lot of roofs and a lot furnaces, a lot of hot water tanks and properties and windows and doors, things do fail. And when you don't have a lot of them and they do fail, they can drastically affect you.

Dan Austin: [1:37] So that's what I wanna talk about today. And to do that, I wanna go through a real world example, run through some numbers on one of the rental properties. It's a single family home that Mike and I own. I think this will be a really good demonstrative example here. So let's start off with the gross rents. This single family home, it's a basic three bed, two bath home in our home market here in Spokane for $2,200 a month. That's what we that's our gross rent. Our PITI, otherwise known as principal interest, taxes, insurance is $1,200. So follow me here. We have $1,200 for for those, and that's about as fixed of an expense as you get. Your principal and interest, if it's a fixed note, are going to be a fixed number. Your taxes and insurance though will go up on an annual basis. I mean, that's just how the world works. Maybe you're in a market that's appreciating and they're friendly with taxes and your tax are gonna go down. It's unlikely. Next thing we have, we have roughly a $100 in landlord paid utilities. We like to pay water and sewer for our small residential because it's a leanable utility and we don't want people to stop paying and then us have to pay a lien with with fees and all that. So that's what we do. Operating expenses, we budget 10%, $220. Capital expenditures, $220, 10%.

Dan Austin: [3:01] Those are good round numbers. Now I can dive deep into when you have a larger portfolio, do you really need to do that? And the arguments, the answer is no. At that level, you need to do it for your portfolio and you need to make those numbers as accurate as they can for you. I'm trying to do this example in isolation with one property, and maybe you keep doing this till you had five properties or something like that. Anyhow, operating expenses are things like your lawn care, your maintenance, little minor repairs here and there. Capital expenditures, CapEx are major things that you have to fix once every five, seven, ten years. Might be all new hard hard flooring, hard surface flooring, it might be a furnace, might be a roof. Now, sometimes they are categorized differently when you're talking about for tax purposes. But we like to think of them as those large items in the home that are gonna have to be replaced on a longer cycle time. And then we do, you know, 5% is a very good estimate for vacancy and lost lost rents or rents you couldn't collect. For us in this case, 5% would be a $110. So if you add all those expenses up for the PITI all the way down to that vacancy, that essentially subtracting that from $2,200, essentially leaves us with $450 in cash flow a month, which honestly, that's really good. Now cash flow before set asides is much higher after our because our actual expenses that we have to pay every month on this are actually the $100 in utilities and the PITI for 1,200, which is 1,300. So our actual, like, just coming right out the door, the cash flow is much higher.

Dan Austin: [4:38] However, we know those items have to be taken care of, and they're going to come up not on a monthly basis, maybe every six months, maybe every 12 months, but we budget monthly for them. And this is where I'm gonna get into my point. Let's talk about this. So you get $450 a month in cash flow from this place, which equals $5,400 a year. That's your profit. That's awesome. $5,400 a year. So if you did that 10 times, that would be $54,000 a year. That is almost the average household income across The US, which I think is like 55 or 56,000. So you could do really well with 10 properties, but that cash flow could be variable. What if you just bought this property and you went twelve months? Now so so you did twelve months, so you have $5,400 in cash flow. And then you you actually didn't spend anything on opex, anything on capex, it's all sitting there. That's $300 a month. That's another $3,600 in maintenance reserve you saved up, which is really nice. So that is $9,000 total saved up. What if at this point in time, your furnace fails? This has happened to Mike and I. We've had furnaces fail before we even finished the renovation on a burr project. We had furnaces fail right after we do a burr.

Dan Austin: [6:02] It stinks. It's not great, but it does happen and it happens more than you think and it's an expensive single item. So in our home market, furnace with the air conditioning coil stack and everything is gonna be somewhere around, guess what, $9,000. These numbers are working out really well for us here. So there goes your cash flow, there goes your operating expense, and your CapEx reserves. $9,000. You just basically broke even. But another thing that happens at after twelve months is a lease usually comes up and a lot of times renters like to move. You don't always get lucky and get long term renters out of three, five, seven, ten years. If you do, you're probably falling behind on rents and that's why they're staying there. So my point being is after twelve months, you're gonna have to turn the unit and you saved a $110 in your reserves for vacancy and lost rent. Well, let's just assume they paid all the rent, so it's good to go. And you have $1,320 in your reserve account, which is great. That's just about a little over half a month's rent, which is which is awesome because it is very hard to turn a unit with in less than two weeks. Because you have to get in there, clean the carpets, touch up paint, do whatever, and then you have to go out there, get this thing marketed and leased up, and somebody moving in paying you rent by the fifteenth of the month because most people move out on the thirty first.

Dan Austin: [7:24] That's hard to do, but in a tight rental market, you can do it. So let's assume we do that. Mike and I know that it's about on a really easy light turn. It's around, it could be $2,000 to turn a unit and that's paying for your handyman to go in there, you know, testing everything out. We're usually cleaning the carpets. We're touching up paint. There's just things that you inevitably have to do. So average for us, it's about $2,000 a turn. Let's assume that our cash flow reserves basically are eaten up by that first two weeks. We're essentially negative $2,000 for the year. Now what if you had 10 properties that all failed their furnaces and all turned at the same time, you would have lost $20,000. That's a $20,000 loss for the year. And if you were expecting those 10 houses to produce $450 a month, or what is that? Let me do the math here. $54,000 a year. Well, you did not pay your own mortgage because you just lost out on 20,000 instead of making 54. Now that's extreme, that's not gonna happen, but it will happen at least to one of your houses depending on where you're at in your life cycle of these items. And I bring that up because I've seen and hear about a lot of people, they got into real estate a year ago, two years ago and they scaled super fast. They bought five, ten, fifteen, twenty properties and they're operating really well. But guess what, Those things do happen and they do break and so when we look at our portfolio, Mike and I were at 40 plus doors or something like that, we aren't looking at it as those doors will produce x amount of cash flow based on a pro form a basis because that's really what we're doing.

Dan Austin: [9:09] We're looking at a pro form a when we're saying we're budgeting 10%, 5%. That's all pro form a. Those aren't actuals. You don't know your actuals until they occur. So if we're if we're looking at it on a pro form a basis, we don't look at it for what is that bottom cash flow. We're not saying four fifty. We know from history that that four fifty on any given year, not every year, could actually be 300. Right? So if we if we're collecting say, $20,000 a month in in net income monthly from our portfolio, it's highly unlikely that that pro form a 20,000 is going to actually be 20,000. Sometimes it might be a little higher actually. Most times what we can actually draw as owners and go spend, discretionary spend not reinvest, is gonna be less than 20,000. And it might be something more like 17,000, might be 15,000, but you just don't know. And that's what people don't get. So don't go out there and quit your job on a pro form a basis. Realize that sometimes these bad things do happen, and you're just gonna have to roll with it. Now I will add that as your portfolio grows, you don't need to have 10% reserves for all of your properties. That just becomes excessive. Then there's there's a thing called the law of averages. And honestly, every furnace isn't gonna go bad. And so you can have reduced reserves, but you need to know what that reserve amount needs to be.

Dan Austin: [10:32] And that will be based on how quickly you can refill those reserves if something bad happens. So one more one more point I want to make is as you're looking at properties, and you're hearing people say a lot of cash flow on a certain property, whether it's like a single family home, what you need to look at is how are they getting in? Is it an STR? Makes sense, they might get more cash flow. Is it just a single family, old school rental property, boomer real estate? If it is, and they're having a lot of cash flow and somebody's trying to sell you on a deal, be cautious. Because in real estate, cash flow is arguably deferred maintenance. The more cash flow you're pulling out is deferred maintenance because it's really easy to make your your OpEx look bad or good. Just don't spend money on OpEx. Don't replace the carpet when it needs to be replaced. Don't paint the walls. Don't caulk the shower. So that's just a word of the wise, just be cautious because cash flow may mean deferred maintenance. Anyhow, sorry, I'm rambling at this point. I hope what I'm saying here is coming across the line and that is that cash flow is variable when you're running your analysis for a property. It's pro form a. Those aren't the actual numbers and bad things do happen and that's part of being in real estate. So the numbers don't always come out to be as good as you'd hope they'd be. And that means you should not be quitting your job because your pro form a tells you you should. You aren't financially free yet.

Dan Austin: [12:01] You're gonna have a little bit more buffer in there. That's all I'll say. I'll stop there. If you enjoyed this, if you hated it, let us know. Really appreciate it. If you go up to the top corner here, top right corner of your phone or however you listen to this, click subscribe, write us a five star review. Let us know you liked us. If you didn't like us, you didn't like this, still give us a five star review. Still subscribe. Still download. It's really important for us to to get the word out, to have those analytics so that that Apple and Spotify and things bring us to the top. Follow me, investor man Dan on Instagram is the best place to get me with the DMs. Follow Mike at Mike underscore Invests on Instagram as well. Let us know how these things are going. If you disagree with my point here, I'd love to hear it. Hit me up in the DMs and like we'll talk about it. We'll get on the phone, we'll chat about it and and go down in go down in the depths of cash flow with me. So anyhow, we'll catch you guys all next Friday. Have a great weekend. See y'all. Thanks for listening to this collecting keys Friday focus. Be sure to subscribe wherever you listen to your podcasts.