Well, today we're going to
talk about one very simple concept, the break even calculation.
You'd be surprised at how many investors do not do this
before they invest their money.
So if you're buying a business or investing in real estate,
please stick around for just five or 10 minutes
because this very simple concept can save you lots of headache in the future.
So the reason I did
this video is because right now a lot of, you know, we have income actually flat
or down in many, many businesses and certainly in a lot of investment.
Real estate expenses are way up, which we're going to talk about in a minute.
And of course, I continually talk about the rising debt costs.
As we all know, the Federal Reserve is continuing to raise interest rates.
So specifically with real estate,
there are several things that determine income.
So clearly you've got what we call your growth potential rent.
And then beyond that, you have your vacancies, your bad
debt, your skips, your evictions.
And basically from that, you have your net income.
So when people throw around 10% vacancy, they might be talking about
physical occupancy, which is very, very different than economic occupancy.
And that's what we're going to focus about today,
because the difference between physical occupancy and economic occupancy
are often stuck in these numbers right here.
So the next issue are expenses as a landlord and a property manager.
We're getting killed on every single one of these issues property taxes,
utilities, insurance management, payroll marketing, maintenance
and capital expenses are all going up each and every day.
When these go up,
cash flow goes down and profitability goes down and returns go down.
Unless, of course, your income is going up.
But right now, income is not going up.
So a lot of you might be shaking your head going, yes, can I understand that?
What does that mean to me?
Well, about ready to show you how under standing your break
even calculation will be very important as you continue to communicate
to your lenders and your investors and raising money in the future.
So we already talked about income and we know what that is.
It's the physical and the economic occupancy.
And we talked a little bit about expenses already,
but we haven't discussed yet is the debt and of course, we all know that's a bit of
a wild card depending on the actual loan that you might or might not have.
If you have debt that's maturing or perhaps it's short term
in either case, and you're now going to have to adjust
to these higher costs, it's going to affect your cash flow negatively.
The real question is how much income do I need to actually break even?
And this is something that you need to keep top of mind at all times.
Let's look at a hypothetical situation.
So we have 300 units at $100,000 a unit and we paid $30 million for the property.
In this particular property, let's just assume
that I put 20% down or 6 million and I finance 24 million
and the average rents are $1,000 a month or $300,000 a year.
So the maximum potential rent
for this property, other growth potential rents is $300,000,
which is based on the market, which is easily calculated
by just taking your 300 units.
Times are $1,000.
That is your gross potential rent and you're not going to get more than that
unless the market allows it.
Now, let's assume for a moment that you have 270 occupied
or that's 30 vacant, 30 and a 300.
That's a 90% physical occupancy.
So a lot of times managers will tell you, I'm 90% occupied.
Well, that actually is fairly meaningless because as we talked about earlier,
you've got vacancy, skips, bad debts, all the other things
that can calculate into this physical occupancy issue.
Yeah, people moving in, moving out.
You might be physically occupied at the end of the month at 90%,
and one day later on the first
or the second, when people move out, you might be 85% physical occupied.
So you need to take a look at the next category, which is economic occupancy,
which is really the only meaningful indicator.
Economic occupancy is actual rents
collected, not other income reds collected against your gross potential.
That is the most meaningful number that you need to pay attention to.
So after all the noise of people moving in, moving out evictions,
all the things that can happen, nothing to do with expenses, by the way,
you only calculate the rent collected against the gross potential threat.
And in this particular case, you can see
that if we collected $260,000 that were at 86%
economic occupancy, this is going to become very important.
So this number is going to become increasingly more important as we're
heading into the future, because now more people are competing for more tenants
and there's going to be more vacancy as people compete for occupancy,
they're going to be offering discounts on their beds
and you might even see some concessions coming in the future.
All, of course, lower your economic occupancy.
Now let's take a look at the operating expenses.
And I don't have time to break down every single component.
So let's assume for a moment that your expenses are $150,000
or 50% of your gross potential income.
Now, as you all know, operating expenses can vary widely
from city to city, county to county, state to state, depending
on insurance costs and property taxes and utilities,
all the things that it costs to run a property.
I get that.
So in many states and many cities, you might have lower operating expenses,
but that's not the point here.
The point here for this analysis, we're going to use 50%.
So the next category is, of course, debt.
And if you take a look at your debt costs on the $24 million
to let's say you originally had some kind of a bridge
loan at $24 million and originally it was at a three and a half percent.
Now, those rates could be closer to 6%.
So the difference in the actual debt payment each and every month
is, let's say $105,000 a month at three and a half percent based on a $24 million
loan versus today on a 6% based on a $24 million
loan of about $143,000.
So as you can see, this is a significant difference
in the actual monthly cost of debt.
So if we take the economic occupancy up to 60, and I sure hope that you're able
to maintain that moving into the future, but this could go up and it could go down.
If rents are going up, then of course the summer can potentially go up.
But if competition is more and more fierce, it actually could be going down
and expenses.
Of course, we just pegged for this video at 150.
So in this scenario, you can see we have about $110,000
net operating income, which is just barely the difference
between your economic occupancy and your expenses.
Now your debt costs on a three and a half percent
loan at $24 million is about $105,000 a month, leaving
you merely $5,000 a month of cash flow, which is not much.
So on this scenario, all you do
is you take your $255,000, which is your 150 expenses,
plus your 105 debt.
You divide it into your gross potential rent
and that gives you an 85% break even.
Stay tuned, because now we're going to talk about what happens when that goes up.
So in this scenario, you can see I used every exact number
with the exception of the actual debt, which has gone up to 143,000.
And as you can see, we're now in a negative cash flow
situation, which, again, $260,000 economic occupancy,
150,000 in expenses,
$110,000 in a Y, all the same.
143 A debt, a -$33,000.
So in this scenario, again, you take the 150
plus 143, which is 293, you divide that into your 300
growth potential red and you're now sitting at a 97% break even.
So this break even analysis is something that you need to watch
as a syndicator or real estate investor because as your costs
or expenses go up and down, as your costs for your debt go up and down,
and more importantly, as your economic activity,
the amount you collect, not your growth potential, goes up and down your break.
Even analysis is going to change each and every month if these are variable.
So in this scenario, there's nobody making money here.
There's only a few ways out of this mess.
One is increase your occupancy, their economic occupancy.
But as you know, you're capped at the market at $1,000 a month.
You're probably not going to reduce your expenses that much.
And who knows what's going to happen on the debt.
So cash is king here, guys.
Please be aware of this break even calculation
because you need to understand where you are at all times.
This here could eat up all your reserves and you might be in an even worse
situation in the future.