aimee: all right. welcome, everybody. we're so glad to be hosting this webinar todaywith our friends at zillow rentals. my name is aimee miller and i'm the vice presidentof marketing here at appfolio. we provide web-based property management softwareand we also regularly host these free educational events that are designed for property managementprofessionals. i want to give you just a quick recap of gotowebinarso that you know how to communicate with us and send us questions so we can answer themfor you. on your right-hand side is the gotowebinarapplication.
you can feel free to chat into us, send usquestions that are questions for leonard. we will certainly save time to answer thosequestions at the end of today's presentation. one of the most common questions we get is,"are you recording this session? can we watch it later? how many notes should we take today?" so, we are recording it, which we always do. we will post a recap on our blog with a linkto the recorded version. we're also going to post the slides onto slideshareso you can take a look and review those after the fact.
probably tomorrow we'll send an email witha link to the blog post. we also post it on our facebook pages. so, we work really hard to make sure you canwatch this webinar again and again and again and again. so, leonard, could you click to the next slidebecause i want to tell a little bit about appfolio? we're super excited about today's topic andour speaker, leonard baron. leonard is a real estate professor. perfect.
and he's covering cash flow investment analysis. for us, like i said, our customers are alwaysinterested in better understanding investments. because we sell web-based property managementsoftware, our solution really touches all parts of a property management and owner-operatortype of business, from accounting to collecting rent online, tracking prospects as they flowthrough and enter in guest cards, marketing beautiful websites, posting vacancies--thisis why we also love working with zillow--processing payments, collecting online applications. and ultimately the educational events thatwe provide as well as our software our designed to help our customers run a more successfulbusiness.
so, if you are not in love with your propertymanagement software, today is the day you can decide to learn more. so, at the end of our session, we'll posta survey that lets you tell us your thoughts on the presentation as well as let us knowif you're interested in learning more about our great property management software. so, now i'm going to pass it over to my friendkyle from zillow and let him tell you a little more about zillow rentals. kyle: great. thank you, aimee.
so, if you're already using the excellenttools from appfolio, at zillow rentals, we have a relatively new offering called thefeatured listing, which will really help you turbo charge your marketing. so, the zillow rental network is the largestone on the web, comprised of over six million renters searching both hotpads, zillow.comas well as yahoo homes each month for their next home. featured listings receive over 11 times morevisibility than a standard listing, which will result in a lot more leads to get thesenew investment properties filled for you. it even comes with full lead reporting andcall tracking.
if you have any interest in this, you canjust head to zillowrentals.com/featured. i'm wondering, aimee maybe we can just dropthat into the chat box for everybody if they're interested after the webinar. aimee: yes. that's a great idea. kyle: terrific. so, without further ado, i'm going to kickit over to leonard baron. leonard, take it away. leonard: great.
thank you very much, kyle. thanks to appfolio for having me on todayand zillow rentals. my name is leonard baron. i'm a past instructor at san diego state universityand a long-term real estate investor. i'm the due diligence professor. what we're going to do today is learn abouthow to pencil out a real estate deal so we can help ourselves make better decisions whenwe're buying properties. now, this methodology that i'm teaching, iteach a very simple way to do it. but it applies to any real estate investmentthat you can make, from a five-unit apartment
building to a 500-unit apartment building. it's called cash on cash returns. the best way that i think and the reason thatmy information is good and useful for you today, is because i've learned many hard lessonson real estate and i hope to teach you those lessons without having the financial painthat i've experienced myself from learning those lessons. so, we're going to do a quick polling questionhere to get started. great. i'm going to go ahead and launch this andsend this out to everybody.
so, when investing in real estate, shouldyou target the properties with the best location, location, location in your area? you can choose one of the following choices,click it right into your polling question. yes, absolutely, that's the very best strategy. you can confess you're not sure. and then you can say no thanks, it's not agreat strategy. so, let's see what people say. i always love this one, leonard. i learned a lot reading through those slidesin advance.
so, i'm excited to see if everybody had thesame original thought that i did. leonard: we'll see how many people changetheir mind after the presentation. exactly. okay. so, i'm going to go ahead and post and sharethe results. so, look, it says 47% of our audience todaysays, "yes, absolutely, that's the best thing to do, target location, location, location." thirty-two percent of the people listeningtoday say they're not sure and 21% said no thanks.
so, leonard, tell us what the truth is. leonard: all right. well, we're going to find out the truth today. i don't want to spoil the surprise. but we're all going to know very quickly whatmy personal opinion is about prized properties and the best location, location, locationsand we'll see... i'll give you an eye-opener to think aboutand consider and then you can make the decision yourself as to what you think are the bestdeals, should you target those locations. are we back to me, aimee?
aimee: yes, you're on. leonard: okay. all right, everybody. what we're going to learn in this course today,you can see on the left side, is the whole task of due diligence stuff that i go through. we're only going to go through investor rentalcash flows today and we're going to do something called penciling out a cash on cash return. and that's on an investment property that'salready built and operating that we might buy to earn some money hopefully on.
remember, cash flows are one piece of duediligence, but all the due diligence steps are vitally important to do. you can't just do one and think that's goodenough. you've got to do all of them to better protectyourself and make good decisions. so, investment returns on real estate primarilycome from either appreciation in value--i would say that doesn't pay the bills and cannotbe counted upon--or what i think people should invest for, and that's positive cash flowand positive cash flow does pay the bills. as a long-term owner of rental propertiesand who bought properties years ago that i was hoping for appreciation in value, butthey didn't cash flow positive, i've learned
that positive cash flow properties are a muchbetter way to go, much less stress and much more profitable. so, we're going to pencil out or pro formaour deal cash flows with conservative estimates to calculate a cash on cash return. and once we figure out our cash on cash returns,we'll be able to determine, "hey, is this a good deal or not?" so, let's jump on another polling questionand see how people think properties actually do and how real estate investments do. aimee: okay.
so, this is a great question. it says, "what are the typical long-term ratesof return on real estate investment?" so, do you think it's zero percent, ten percent,negative percent or it depends. again, you can tell us if you're not sure. we've got everybody voting. i always love the polling questions. it's very exciting to see what the answersare. i'm going to go ahead and close the poll. we've got almost 75%, almost everybody's voted.
so, here we go. one percent of our audience said the typicallong-term rates of return on investments is zero percent. so, 38% of our audience said 10% is a typicallong-term rate of return. three percent of our audience thinks it'sa negative percent and 49% of our audience says it totally depends and about 10% of thepeople today said they're not sure. what do you think about that, leonard? leonard: well, returns can be all over themap on real estate, from negative returns to returns on 10, 12, 14%.
here's the thing--it really depends on whattype of investment that you make when you're buying property. there are really bad ones and there are reallygood ones. you need to understand how to figure out what'sgood and what's bad. so, let's first take a quick look here onmy slide and just take a look at types of returns that other assets would have. bank cds, 1.5%; bonds 4.5; diversified stocks,7.5; real estate, it really depends. it's very high-risk. here's the thing.
when you're going to invest in real estate,you want to make a smart decision. if you're taking your money out of financialassets, stocks, bonds, cds, which are low risk to high risk, those assets that you'retaking money from, they presumably earn interest dividends. they appreciate in value and hopefully earnwell. now, if you're going to take your money fromthose type of assets and put it into a real estate investment, which is high to extremelyhigh risk, are you going to earn a similar rate of return or are you going to do betteron your money over the same time that you're planning to invest?
so, let's get going. we'll go right to a spreadsheet right hereand let's talk real quickly. we haven't answered the questions yet aboutreturns nor whether you should by the best location, location, location, but we'll getto those in just a couple minutes. now, we're going to pro forma a deal here. i always call this a moderately priced property. so, it's not the fanciest property. it's not the best beach property or related. if you look on the screen, moderately pricedproperty, i might pay $125,000 for this.
and i need $40,000 to close escrow on thisinvestment, 25% down plus closing costs and rehab. that's the important number. that's the equity that you're taking out ofyour bank account, whether it's $40,000 for a single unit or a million bucks for a hugeproperty, you're taking cash out of your bank account. that's what we need to figure out our cashon cash return on. so, on this, i have rent. this is a single townhome unit like one i'vebought in the last couple of years.
rents are $1,200. gross operating income $1,140. i take out my operating expenses. i get my net operating income on the property. i take out my mortgage payment and a 510 andi come up with $205 of net monthly income. that's annual income of $2,460. i divide that by my $40,000 of equity at thetop and i get a 6.15% return on my money. so, that's adjusted cash on cash return. it doesn't include any appreciation in valueor amortization of my loan.
but i consider both of those the icing onthe cake. when we're investing, we want to go for cashflow first and make sure we're buying a nice cash flow positive property. so, let's take a look at a fancy prized property. this would be a downtown san diego condominium,where i'm from, san diego. i might pay $500,000 for this property. i'm going to put $150,000 down to close escrowon the property. now, what we find out in life is that fancyprized properties, the rents are low compared to the purchase price.
so, the monthly rent as a percentage of thepurchase price is very low compared to other moderately priced properties. so, let's look at these numbers. i paid $500,000. i put down $150,000. i've got market rents of $2,300 and i takeout a vacancy of $115. i get my gross operating income of $2,185and i take out my operating expenses of $1,200 to get net operating income of $985. now, that's before the mortgage.
i'm still positive. but then look, mortgage payment, $2,000 amonth on this property. so, my net monthly income on an investmentlike this is going to be $1,015 negative, $12,000 plus per year negative on my $150,000investment or a negative 8.12% return. does that make sense? do you guys see that? you might think, "how can that be possible?" one property is positive. another property is way negative.
but that is the realities of the marketplace. when you're going to go buy properties, whethera 5-unit apartment building or a 500-unit apartment building, you've got to take, "howmuch cash equity am i putting in and what are my rates of return on those properties?" so, the one that has positive, obviously,is an asset. the properties that are negative cash floware going to be liabilities. actually, when we're talking about apartmentbuildings, we're not actually going to be negative cash flow, just the bank is goingto make us put down 40, 50, 60% down payments. but regardless of how much money you put down,whether it's an all cash purchase or whatever
percentage you put down to buy the property,you can still calculate a cash on cash return with a formula like we have on the screenhere. and i say that because i hear people say allthe time, "i'll just pay cash and it will be cash flow positive." but the real question is, if i were buyingthe property on the right here and i put down $500,000 plus closing costs, what's my rateof return going to be on my money? on this particular one, if you invested $500,000,you might be at a positive one percent return. that's just not a really good way to invest. you've got to look at a better return thanthat.
so, in investing, there are three really vitalitems in projecting your returns. one, cash down payments. how much money am i taking out of the bankto buy this property? two, what are my cash flow and income percentreturns? am i positive cash flow? am i negative cash flow? i would say stick with the positive cash flowwith decent returns. and the third thing, which i haven't broughtup yet, is the risk. are the numbers good?
you know the saying, "garbage in, garbageout." so, if you put numbers in that are way highrents, way low expenses. you pencil out a great real estate deal butthen none of the numbers come true, unfortunately you're the one that has to learn the hardlesson on that. so, we want to always be conservative in thenumbers that we estimate and pro forma for how we're going to do. you can see on the bottom left there i put,"your instructor learned about fancy prized property the hard way." and i would say the fancy prized propertiesare generally the ones that people say, "location,
location, location. buy the best location." but i think if you pencil out your deal asthis methodology i'm showing and you of course can make your decision, what makes sense foryou as a buyer. but if you pencil out your deal, you're goingto find those best locations, the prices of them are bid up by all the other investorsand the rents relative to the cost are just way too low. you've got to find properties that are whati call boring, nondescript real estate, which is going to give you a much healthier cashflow return.
so, my question to you would be where do youwant to invest your hard-earned cash? prized properties are no prize. you've got to go for the locations of theproperties that pay positive cash flow. now, over here on the right, i just have somebasic numbers and percentage returns. so, we exclude deals, cash on cash prizedproperties like, for example, everybody's heard of la jolla and del mar and san diegoor manhattan beach in los angeles. if you go and buy properties in those prizeareas, they're going to be way negative cash flows. it's just the fact of the marketplace.
that's how they are. so, here you can see single family homes,a good deal, 2-5%return, town homes, 3-6% return, condos, 4-8% return. those are excluding the prizes, of course. and then there's always the 10%. and i always say if it's above 10%, if you'reprojecting out that you're going to earn more than 10%, it's probably one of those soundstoo good to be true deals. once you close escrow on the property, onceyou buy it, you're going to find out, "wow, it really was too good to be true."
now, one thing i'll say on that is, sometimespeople get lucky. there's always the guy who gets the unbelievabledeal and it really comes true. but everybody on this call doesn't have toworry because that person will never be you. it will never be you who's the lucky one whogets the great deal. so, when i asked before when we polled whattype of returns can you get on real estate, well, it all depends on the deal that youpurchase. if you buy a property that's going to havenegative cash flows like the downtown condo, you're going to find your returns are verylow. in fact, the time for that property to turnpositive--so, this is a downtown condo that
might be negative 12% or 12-15%, $1,000 amonth for the first year. it takes decades for you to get your firstdime of positive cash flow on that. we're going to show you that in just a coupleof minutes here. let's look here. if you want to listen in, what we're doinghere is i'm saying you've got $150,000 to invest in property. you can pick three moderately priced townhomesof about $150,000 per property and your total investment will be $500,000 up on the rightor you can pick one, let's say, ritzy downtown condo that's $500,000.
so, either way, on these two investment choices,you're going to invest $150,000 for about $500,000 worth of real estate. now, if we slide down underneath the years,we see the first one says nominal yearly cash as you can see, the three moderately pricedtownhomes produce about $8,000 per year of positive cash flow and the one fancy bestlocation, location, location property produces negative $12,000 a year of cash flow. so, you've got to think, "wow, that's a $20,000of cash flow difference. do i really want to hope that the propertywill go up in value enough to compensate for that cash flow?"
and i schedule those out for 10 years. you can see how they change over time. then we'll go down to the 10-year cumulativecash flows. what you can see on that is i've added upall the cash flows for 10 years including an opportunity cost of capital and on themoderately priced prop townhomes, i've got $113,000 of cash flow after 10 years. and on the fancy prize property, i've notonly bought that property and spent my $150,000, but i've taken out another $130,000 out ofmy bank account over the first 10years. so, on these two investments, the differencein cash flow, about a quarter million dollars.
hopefully that makes sense to everybody. you can see, prize properties mean negativecash flow. that means not a great investment deal inthis guy's opinion. of course, you make your own decision whatworks for you. but you've got to go and pencil out each dealyourself and see how it does and how you think that asset would perform in increasing yourwealth over time. aimee, how are we doing? we doing okay? aimee: yeah.
i think we're doing great. go ahead. aimee: i was just going to encourage if peopledo have questions, feel free to type them in and we'll have time at the end to go throughthem. aimee: oh, here's a question that just camein. maybe it's appropriate for right now. aimee: so, he asked, "what was the trendingrate on the cash flows used?" leonard: the trending rate? aimee: in that example.
leonard: what was the returns that would comein? aimee: maybe... leonard: i don't fully understand his question. well, let's let john... john, go ahead and type a little more detailinto your question. we'll let leonard keep going and then we'llcome back to it. so, let's talk about that prize property,the downtown condo and how long until that prize turns positive? so, as you can see, what you're seeing onthe screen here is i've done a detailed financial
analysis where i'm projecting out from theyear 1 numbers. if you look on the left side under year 1,you'll see on this particular property, we're negative about $11,000 per year. we're going to add up all those negativesbecause we want to find out how long is it going to take until it turns positive. so, at year 10, i still have negative $117,000on this downtown condo or any fancy prized property. so, i've spent $150,000 and i'm also in foranother $117,000 about $265,000-$270,000 at the end of year 10.
let's go to the next decade. we'll go all the way out to year 22. i just included a few lines of the financialsto make it a little clearer. so, year 22, we're finally nominally positive. we get our first dime of one year positivecash flow, $337. but our cumulative negative now is $270,000. if you think about it, you as an investor,you could have bought a property that was cash flow positive from day one. but on this particular investment, you'realready out 22 years and you invested in this
case $150,000 plus another $260,000. and in year 22, we're not even close to gettingto a positive cash flow. so, if we go to the third decade--let me goback one--if we go to the third decade, year 34 or year 31, our mortgage is paid off. so, we're finally getting some serious cashflow coming in. but we're still negative $300,000 on our overallcash flows. now, with that mortgage paid off and the healthycash flows coming in, finally in the fourth decade, year 44, will you be alive to celebratethis day where you finally got your first dime of positive cash flow?
so, the moral of the story here is that youcan't just buy property, any property and say to yourself, "oh, it's going to go upin value. i'm going to make this investment and it'sgoing to go up in value." you've got to look at the cash flows, conservativelyestimated that the properties can generate. if you don't, you're going to find out thatyou could have done much better by buying a property that pays for itself and providesyou a fair rate of return. i can tell you every city is different. you've got to pencil out your own deal. but what i think you'll find when you're pencilingthem out is the best corners, the prize properties,
the best locations, the nicest propertiesall have negative cash flow. it's the moderately priced properties in thelesser, but not bad, areas of town that will fill your bank account with money and cheer. when you retire, you'll realize that you maynot have been able to brag about owning the beach house like many people do, but you surecan afford to buy one for cash now if you so choose to do that to retire. you've got to stick with the positive cashflow properties. so, the important keys to remember in doinga cash on cash analysis is always in any investment analysis, you've got to pencil out your deal.
you've got to put pencil to paper. rent minus vacancy minus realistic expensesto come out and see, "if i buy this property, am i going to positive one and what's my cashon cash return?" and if you don't learn this now or in thenext decade or the following decade, you'll figure it out about the time that you retire. as you know, that will be too late. again, i've made these bad investments inthe past, 10-12 years ago. and thank goodness i've learned these lessonsthat, hey, it just doesn't make sense to buy those location, location, location properties,unless you're talking about the moderately
priced properties that pay you, the investor,a healthy cash flow. this is going to be for the cash on cash returns. it doesn't matter, again, if it's a five-unitapartment building or a 500-unit apartment building. the fancier the property, in general, theworse the returns that you're going to get. so, go for the boring stuff. so, to do your cash on cash returns and pencilthem out, you've got to figure out what the rents are. here are a couple of the variables that you'vegot to figure out.
you've can figure those on craigslist, apartmentbuilding surveys, call on signs, multiple listing service, real estate professionalsto figure out what the rents are. vacancy is a little bit tough to do. there are apartment building surveys in mostmetropolitan areas. but you've also got to drive to areas, callon listings and try to figure out what a vacancy percent is going to be for your property. be conservative. and then you've got maintenance and repairsexpenses. so, that would estimate at least one percentof the value per year.
apartment buildings are going to be a lowerpercentage than single-family homes, but condos are going to be, with hoaps, they may be alittle bit higher. so, depending on which property you buy, itcan really be all over the map. you've just got to do the hard work to tryto figure out, "hey, does this make sense? what are the numbers? i'm putting these numbers in to estimate howi'm going to do. are they realistic?" that's the most important thing and that'sthe toughest thing to do in real estate. are the numbers that you're putting into yourmodel accurate, valid and close to what will
actually occur once you take ownership ofthe property. aimee: leonard? leonard: let's take a quick polling questionhere, aimee. you know what, leonard? we actually have a couple questions relatedto that same topic, around how you actually estimate the operating and repair expenses. are there any tools? how do you get a good sense of that kind ofto your point that it's so important to get that piece of it at least somewhat accurate?
leonard: it is a very challenging thing todo. it really is. experience is going to give you the best goal. but you should talk to other real estate investors. you can never take the word of the personselling you the property or the broker who has a listing for the property because they'realways going to be overestimated in how much money you're going to make. so, if you're buying commercial property,they should come with financial statements and you've got to go to other investors andtalk to them and say, "hey, do these seem
realistic?" if it's a really large building, they mighthave audited financial statements, which would be a big plus. but nonetheless, it's very challenging tofigure out what the expenses are going to be until you buy and own the property. so, every property is different. older properties cost more. if you're the owner and you're paying forutilities that cost more, how much gardening is there related, how much maintenance isthere?
unfortunately, there's no easy answer forthat except be conservative on not only your expenses, but also on your rents and talkto other owners in the area to see how much they find operating properties costs. let me clarify. john actually wrote in and clarified his question. so, he was asking, "what was the trendingrate on cash flow used, the year to year trend rate changing the cash flow numbers from years1 until 10?" so, on your example. so, cash on cash return, i think, to answerhis question, you're trend that i estimate for increasing rents and expenses was about2.5% a year.
and then those net out to a certain amountof return that i'm going to earn. now, i calculate stuff based on my initialinvestment. so, i don't have a good trending rate overallfor real estate. you've got to figure that out for the specificproperty that you're going to buy. but if you buy a property that has five orsix percent return on your money, my guess--and it's only a guess because there's no long-termempirical data to support this--is that with cash flows, with amortization of your loanand with appreciation in value, you're probably going to be around 10% or more return on yourmoney. the trend is tough to determine, but the overallreturns, as long as you buy those cash flow
positive properties from day one, are goingto be pretty good. they're going to be higher up, which theyshould be because you're taking a lot of risk as a real estate buyer. let me ask you just one more question becausei think it's related to the worksheet. someone was curious and noticed that yourworksheet didn't include the anticipated general property price or the property values increasingover time and he's wondering why. is that just that the increases in propertyvalue tend to be offset by property tax increases or is it a factor that you can't really dependon that because things change so much over time?
leonard: right. i don't include... so, i think what the generalquestion wants to know is, "what about the return that i get from the appreciation invalue of my property?" and my answer is always the same on that. any appreciation is the icing on the cake. because i don't want someone to think, "well,i'll buy a deal and it's one percent return, but i'll make it up by the property goingup in value." i just would opine that's not a good way toinvest. we all hope our real estate goes up in value,whether it's a personal residence or an investment
i just don't include any of that because there'sno guarantees and i want to buy a good deal up from on a cash flow basis. cash pays the bills. appreciation in value does not pay the bills. i think any of us who have bought homes inthe last few years can probably relate to that. so, i think we're ready for a polling question. so, i'm going to go ahead and send it outto everybody. so, it says now that you know how to pencilout a real estate deal, what percentage of
investors do you think know how to calculatethis? do you think almost everyone does? seventy-five percent of investors do, 50%,less than 20% or, "i have no idea?" this will be an interesting one too. leonard: this will be interesting one. so, let's see. so, 68%, the majority of our audience thinkless than 20% of investors know how to calculate this kind of real estate deal. what do you think, leonard?
leonard: we should have put a less than fivepercent. i teach a couple thousand realtors a yearand i teach investors, nobody knows how to do this stuff. unfortunately, there's just not a lot of goodinformation about it and even myself, who's a pretty experienced real estate buyer, 8or 10 years ago i didn't know how to calculate this stuff. so, very few people do. but if you've listened and learned today,you can starkly see the differences on how you'll do in life depending on penciling outyour real estate deal.
my guess is less than five percent of peoplewould know how to do this. experience, people who are long-term commercialreal estate investors are going to have some idea. many of them know it very well. but there are also many very wealthy long-terminvestors who have no idea how to do this. they've bought property hoping it would goup in value and over time it has and great for them, but they probably could have donea lot better if they've known how to do this earlier on. almost all real estate and all the mistakesthat you could make doing due diligence probably
will be relatively well-compensated for overtime, if you hold real estate forever, which i advocate. but now you know, not all properties are createdthe same. some do much better than other propertiesand that's what you want to go for. so, a couple of last things to wrap up onpro formas and then i'm going to show you some simple spreadsheets that i have thatyou can just download from my website. how do you determine property taxes, mello-roosadd-on and that related information--this is, again, to put those good numbers intoyour pro forma. you get that from the county website or themls listing.
for insurance amounts, like how much insurancecosts, you've got to call insurance agents to get that. you can't just take an estimate or a guess. it can be all over the map. what type of property is it? where is it located? some properties have much more expensive insurancethan others, like on the west coast of florida where there are hurricanes coming in and onthe east coast of florida. so, do you need earthquake, do you need floodinsurance?
so, you're not putting garbage into your model. you want to put good numbers into your model. so, insurance, call your agent. and then to the mortgage and then privatemortgage insurance for smaller investments, you've got to talk to a lender about thoseand get all those numbers. again, the main point is, do the hard workto really verify what those numbers are. don't just guesstimate what they're goingto be and hope that things go well. so, the next three slides i'm going to showyou just a simple spreadsheet that you can download off my website.
you don't need to be signed in and it helpsyou pencil out a cash on cash real estate deal. my website is professorbaron.com. on the right side, you'll see chapter 3. if you click on it, you'll see informationabout appfolio and zillow and you can download that website, that spreadsheet and use it. this is the spreadsheet that i have. basically, you can see the blue numbers thatare in the spreadsheet. this is the same cash on cash analysis thatwe just did a few minutes ago.
it's just on an actual spreadsheet that youcan download and use. i break out a lot more of the costs so thatyou can put in actual costs that you think that the property will generate and rentsit will achieve. now, the nice thing about this spreadsheetis you can only put numbers into the blue numbers and everything else on it is locked. so, you can't mess up your calculations andanalysis. you can only put numbers in. so, like the total amount of the cost, thedown payment percentage. but if the number is black, you can't changeit.
at the bottom, you'll put in your acquisitioninformation in box one, property operation statement in box two, then your operatingexpenses and related down in box three, mortgage payment and cash flows and then at the lastat the bottom, it will calculate a rate of return for you on your property. i've also added onto this spreadsheet. there are a couple tabs in this spreadsheet. i'll show you how to get those in just a coupleof minutes, but let me show you the tabs first. it's going to take your year 1 numbers, thosenumbers we just showed you. it's going to grab all the year 1 numbersand project them out for 10 years so you can
see how the property will do over a 10-yearperiod. on this slide, you can see there are onlytwo blue numbers, only two things you can change and that's all of the property operationsand the only thing that is different is property taxes and that's only because california hasfunky property taxes different from the rest of the us. so i give californians an option to put inwhat their property taxes are. this 10-year statement, i also show one moretime just to illustrate one last time, this would be a prize property where you'd buythe $500,000 downtown condo but it could be la jolla or del mar, manhattan beach too.
probably new york city and san francisco andwashington d.c. are all going to be the same, the fancy properties. i just show you. will this knowledge help you save some moneyin life? you invested $150,000 to be negative $10,000-$14,000a year and 10 years later, you're still negative. as we saw, it could be 30 or 40 years whereyou're still negative. so, just something to keep in mind and belike, "wow, i've really got to pencil out my real estate deal to make sure i'm goingto be positive on this property. otherwise you get 15 years down the road andyou're still wondering why you're covering
negatives on your property. all that money that you could have had savedand earning money on in other types of financial assets or other real estate all gone rightout the door never to return. so, a couple of wrap up and recommendations. always pencil out your deal with conservativenumbers. it's really important to use conservativenumbers. you have to. otherwise you take the loss when you don't. pass on negative cash flow deals.
they just don't make financial sense. if you think a property is going to go upa lot in value and you're going to sell it a year later, maybe that would work. i'd say be very cautious about that. also, as you can see, prize properties areno prize. as i said before, you don't have to take myword on that. download my spreadsheet. go to the mls. go to loopnet.
put some properties in. put the numbers in. pencil out your real estate deal and see whatthe numbers look like. i'm also a fan of buy properties you planto keep for a lifetime. that's how you're going to earn the most moneyin real estate, by owning those properties forever. you earn equity in them. you get cash flows from the property. your tenants pay off your mortgage.
i don't know what could be a better deal. as long as you do your due diligence up front,the cash flow piece is one piece of this. so, number five, do your due diligence. all the work involved in due diligence, youcan take a look at my professor baron website and see what's involved. it's time consuming, but it's a lot less timeconsuming than unwinding a bad real estate do the hard work up front. it is hard work. it is time consuming.
but if you do it up front, there's a muchhigher likelihood you're going to get a nice solid cash flow property. you're going to take it all the way to thebank and hopefully you'll hold on to it forever and it will provide a nice retirement incomestream. we all want that and hopefully we'll all getthat over time. but that's cash flow. that's how to pencil out a cash on cash deal. grab the spreadsheet on my website. play with it.
we can take some questions now and you guyscan always click through on my website and send me emails. i post my zillow blog every week and sendme questions. i really enjoy doing this stuff. i'm always just trying to help people makebetter decisions because i've just seen too many people come back years afterward in financialand hurting pain because they didn't do the hard work up front to make better decisions. any questions over there, aimee? we've got some questions, leonard.
this has been great. so, here's one. "when you're looking to grow your portfolioand projecting the returns, are there any risks worth taking?" can you highlight anything that you thinkis a good risk to take? leonard: well, i think it's a good risk tobuy properties that are cash flow positive that pay five or six percent return. so, you have to buy decent quality properties. you want to avoid properties that... in aperfect world, you want to avoid properties
that need lots of work, that have bad creditquality tenants that are in bad areas. you also want to avoid properties that arethe fanciest properties in town because those have bad returns. so, the risks worth taking are do all thehard work, cordon down your risk and buy nice cash flow positive properties that you planto hold forever. that's a risk worth taking. i do it myself. i've got a number of properties and i'm hopeful,if things go well, i'll have a nice cash flow stream coming around retirement time.
so, someone else mentioned that, "i used theproperty appreciation to borrow the down payment for the next property. how does this affect your model, equity toclose?" it doesn't affect your model at all becauseif you're borrowing against your first property, you're still risking that capital. you're taking equity out of your propertythanks to a bank loan and you're still risking that capital. so, you can look at it many different ways. you can look at real estate investments manydifferent ways.
if you want to put that into your model, mymodel and have an all mortgage purchase price, great. you're going to be cash flow positive... you'regoing to have hopefully still cash flow positive. but you have to look at that money that you'reborrowing on one property. you're still spending equity. you're just spending equity you've alreadyearned. so, you still have the risk for it. you still owe that money. so, you can put it into the model howeveryou like to pop out a return.
but i like to just do them based on a 75 or80% down payment and see if it's positive cash flow with a decent return. again, anything better than that is the icingon the cake. this is a long one, but let's see if i cancommunicate this properly. this one says, "if and only if you can becertain that you will only negative cash flow in the first year and then you consider thatas additional equity, would you think that that's an instance where you might consideran initially negative cash flow a good deal?" i don't know how you would be certain. leonard: first of all, you can never be certainin real estate.
there's no risk free real estate. it does not exist. you always take significant risk in buyingreal estate because there are so many things that can go wrong. now, even if a property is one percent cashpositive, you're talking about negative. if it was one percent cash positive i wouldn'tbuy it. if it was two, i wouldn't. if it was three, i wouldn't. if it was four, i wouldn't.
that's just not, in my opinion, a good useof your money. why would you buy that if you can buy a propertythat's five, six or seven percent return? getting up to like four percent, then allof a sudden you're getting to a fair deal, especially depending on the risk characteristics. but if it's negative from day one, you canbuy whatever you want and it probably will appreciate in value and you'll probably makemoney over the long-term. but why wouldn't you buy a better deal thanthat, that pays three or four percent more return per year because that really adds upover time. so, you as a buyer can buy whatever you want,to answer your question.
if it's negative the first year, go for it. i wouldn't suggest doing that. i would suggest do the hard work to find propertiesthat make better financial sense. and one of the things that's always interestingfor us, for our customers who own multiple apartment buildings or a portfolio of properties,when they find ways to streamline their operations after the fact, they often find that increasein cash flow is really great. so, moving things online and not taking paperchecks, those kinds of things are hard to predict in a model, but it becomes a reallynice way to continue to take down some of those costs of managing and maintaining andworking through the property.
so, it's interesting to see that kind of flowthrough in these models as well. leonard: sure. to add on to that, aimee, there are many propertiesthat are gravely mismanaged and having some software in place to help you identify andlook at those numbers certainly helps investors do a better job than they're doing on manyproperties and many properties that someone is going to acquire, no question about that. aimee: perfect. and then we have one more question here. we're probably going to get a few more.
"do you account for depreciation in any way?" leonard: depreciation is a tax issue. yes. it helps your returns. i, again, consider the tax piece the icingon the cake. taxes are complicated. everybody has a different tax picture. so, you have to pencil out your deal withyour tax impacts including depreciation if you want to figure out how that will helpyour returns.
most likely, but not always, it will helpyour investment returns. but again, i consider that just another icingon the cake. let's do a simple, straightforward financialanalysis up front. if we can get five, six, seven percent return,that is a great deal and we should be the happiest person buying that irrespective ofany tax pieces, irrespective of any appreciation and irrespective of any pay down of our mortgage. so, let's wrap up with this final question. it says, "is there any model you use whenconsidering a multi-use building? will it be worth a negative cash flow if you'resaving on rent someplace else and subsidizing
your mortgage?" so, any thoughts around multi-use buildings? is it different, the same? leonard: the same simple analysis is whatyou should do. how much money are you taking out of yourbank account or stocks or bonds to buy the property and what's my cash on cash return? whether it's a multi-use property, whetherit's a single-family home, whether it's a $100 million office building, the analysisis still the same. what's my cash on cash return?
as a buyer, whoever asks that question, youas a buyer can buy whatever you want. i'm just trying to open your eyes to say,"hey, take a look at these returns." if you're buying negative cash flow properties,pencil them out for a few years and you should think, "wow, is there a better investmentout there that i could buy?" and if you're negative, there are better investmentsout there that people should be looking at. it doesn't matter what kind of operating propertyit is. how much am i taking from my bank accountand what are my investment returns on that property? well, this has been really excellent.
we're so thankful that you're letting theaudience download the excel spreadsheet for free. guys, it's at professorbaron.com. i want to thank you, leonard and thank you,kyle from zillow, and encourage everybody as you close out, please let us know how thiswebinar was for you. if you are looking to investigate new software,let us know as well. we will post the blog with the recorded versionas well as the slides very soon. that usually takes us just about a day andwe'll send them out to everybody on the call. thanks, everybody.
leonard: thanks for having me. i appreciate it. aimee: have a great day, everyone.
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