Relentlessly Decreasing DCR
I have been a landlord for 11 years. My properties have been doing well, but mostly by luck. I started out buying rental property on the theory that "rental property is good." Nothing more than that.
Things have been going well mostly by luck. My tenants have been very good, vacancy rates low, and appreciation has been running between 7 and 10 percent per year.
Now that I am learning more about the REI business, I have been calculating DCR's for my properties. What I am finding is that the rents are stabilizing and the market values have gone through the roof. As a result, the DCR on my properties has dropped to .6 and below.
Is it time to sell these properties. If so, can good rentals be found in the current market?
I am good at landlording, so I don't mind holding onto these properties forever, as long as it makes financial sense. They are also very well maintained, so no deferred maintenance problems.
There are good buys to be had, in fact there are a lot in your surrounding area. It sounds like you just need to raise the rents, or hire management consultant, to catch you up to speed, but I dont know the whole story. If values have increased then your rental amounts should as well, its the nature of the industry. If your vacancy rates are too low, you may be too cheap. Or alternatively you may be paying too much for expenses, what is comfortable for you may be high for the standard in the industry.
Also more importantly, You may want to join a local Real estate investors club, and find out what they are getting for there rentals, see what they are expensing out, etc etc. Worse case scenario you will find a buyer for your properties. Best case you will find out a real picture of the industry for your area.
Good Luck,
Kyle
Quote:Now that I am learning more about the REI business, I have been calculating DCR's for my properties. What I am finding is that the rents are stabilizing and the market values have gone through the roof. As a result, the DCR on my properties has dropped to .6 and below. curtbixel,
A DCR of 0.6 means that you have only $600 in net operating income to cover $1000 of debt service. A DCR of 1.0 is breakeven, and less is a negative cash flow situation.
If this is really the case, then you are in a serious negative cash flow situation. Sell all underperforming and non-producing properties immediately.
I am really hoping that you made an error in your calculations. Use this formula, then come back and tell us what your DCR really is DCR = (Net Operating Income) / (Debt Service)Please note that the Debt Service is principal and interest only. While you can calculate a DCR for each property, it would be better for our discussion if you do a composite calculation across all properties.[ Edited by DaveT on Date 04/15/2004 ]
Dave is right about what DCR means and I too am concerned if yours is really .6 but I suspect that you're defining the term differently or we'd be having a different discussion.
The Institute of Real Estate Management publishes an annual guide to average income and expense ratios for apartment buildings all over the country which not only gives national averages but local averages for selected cities as well. You might want to get the latest years and look at how your income and expense compare to others in your area.
woops, stop and give a pause. You may be doing the perfect thing for this market. If you are at a comfort level. Please continue.
Those that push the rents up and up also push their vacancy factors up and up and also they become involved in evictions etc. etc. Not the correct game.
Just check your area and see what the average income is and from that take a figure of 25 to 30 % that should be your correct rent. Democrats at 30% and Republicans at 25%. Conform and steady.
Just because we are experienceing a big up spike in real estate does not mean that you start increasing your rents. You smile politely observe the trend. Check to see if flutter has set in yet at the highest levels of the spike and if so look for a taper off and then a small little decline and who knows after that. Depends how smart Allan Greenspan and the rest of the leaders really are. Wjill they increase interest rates? Are they brave enough to push and twist the real estate market? Seems like it is the only thing truly at upper function. Will it be effected by the present small on going unbalance of trade? Is China slowly pulling up to dominance? Whatever. Just ride your properties and ignore the rest.
Of course if you want to sell and move to lower Slobovia and build a palace and impress the natives. Now is the time. Dump all on the ones whose experience level is only in present time. Wish them luck. These Spikes always break. We always have Little Evas dashing over the ice with dear Simon in fast pursuit. I always bet on the dogs. Speaking of dogs, can anyone explain Ryan Seacrest and his spike to leadership on daily TV? Is he a product of our times?
Cheers Lucius 8-)
I will get back to you soon after I recalculate. I do know that I did the calculations based on 100% financing at 6%, and this is not really the case. I have a relatively high level of equity in these properties so I am not in a precarius situation, but still feel it is important to keep track of their performance.
My first duplex I purchased in '93 for $96,000. At $500 per side, this gave me $1000 gross rent. The rents have gone up so now I have $1700 gross rent, while the value is now somwhere around $225,000.
Believe me, I am not complaining about my property doubling in value, but if the rents do not keep pace, I have to ask myself if it would not be better to take the money and run.
Perhaps there are better places in the real estate market to have my money invested than in a property worth $225,000 that produces only $1700 rent per month.
These properties are easy to manage because they are in very nice neighborhoods, No evictions, late rent, vandalism, etc.
At this point, you need to tell us your long term plan, your investment objectives, and goals. Why are you into landlording now, and where do you want to be in five, ten, fifteen years?
If you want to retire someday with sufficient cash flow to support your lifestyle, then your strategy might be long term retention of a few good properties with no debt. In this strategy, you don't sell unless you have a compelling reason to sell, and then only use a 1031 exchange to upgrade your portfolio.
If your short term objective is maximum return on investment, you can do return on equity calculations and say your ROE is only about 1%, but you also have to find places where you can put your money to better use. If you have somewhere to put your money, refinance to cash out your equity (keeping your DCR at 1.25 or better) and acquire more investments.
If you have a compelling reason to sell (neighborhood in decline, increasing overhead expenses are outpacing your rent increases, etc.) then exchange to upgrade your portfolio.
Originally, my plan was to buy and hold long term. Recently I have become interested in other possibilites.
My first duplex has done very well for me during the past 10 years. It has always had a positive cash flow and the appreciation has been great. This past year, I refinanced and took money out, thus raising my debt service. Now, even with 20% equity in the property, the DCR is .63.
Dave, I did the calculation as you suggested. I took my gross rents and subtracted repairs, utilities, and taxes. I then divided this number by the total principal and interest I paid during the year. The resulting number is .63.
If I take the tax benefits into account as well as the pay down of the mortgage. It gets me near even.
That being the case, appreciation has made this property profitable for me. Unfortunately, appreciation now seems to me to be in doubt.
Another property worked out at .57.
The other properties DCR's are more muddled. One I purchased last year and spent some time and money rehabbing. The loss of rent along with the repair expenses skew the DCR considerably. I would estimate that the DCR for this year will be right around .9 or 1.0.
The other property is a duplex in which I live in one side. I estimate the DCR for that property would be about .8 if both sides were rented.
My options at this point run anywhere from dumping some of these properties to holding them and waiting for rising rents to make them more profitable. This seems somewhat speculative. I wonder what the comming increases in inflation and interest rates will do to the rents. I also wonder what they will do to the market value of my rental properties.
It would make sense that the market value for a property would be right in line with the rents that it produces. I am not convinced that the current market value of investment properties is based on sense. It may be more like the stock market.
Finally, the DCR's for all of my properties is a bit depressed because last year I had 5 out of 9 units turn due to marriages, new out of town jobs, etc.
I truly value the time that you all are spending responding to my posts. Things have gone well for me as a landlord so far, but past performance does not guarantee future results. If it turns out that I should sell, I think the time is now.
Here is some additional information. The information in my previous post was for 2003. I have taken the time to run my numbers so far for 2004. Here is a summary.
Folkestone Property (4 family)
2003 DCR = .13 (low due to rehabbing costs and vacancies while rehabbing)
2004 DCR = 1.74 (high due to no vacancies or repairs so far this year)
Tibet Property - Duplex
2003 DCR = .63 (turned one apartment)
2004 DCR = 1.60 (high due to no vacancies or repairs so far this year)
Hibber Property - Duplex
2003 DCR = .57 (turned one apartment)
2004 DCR = 1.10 ( high due to no vacancies or repairs so far this year)
Quote:Originally, my plan was to buy and hold long term. Recently I have become interested in other possibilitesYou have a strategy in place. Now what is your goal, and how will you get there. When you define these, you will have a plan.
Based upon your latest information, it appears that you have a DCR of 1.47 across the board for all your properties. This high enough to consider keeping all your current properties, while you work on raising rents and reducing overhead in your Hibber property.
By the way, only calculate your DCR for the unit you rent in the duplex you occupy. The residence unit's share of the debt service, insurance, and property taxes do not factor into the DCR calculations.
With this DCR, you should have enough cash flow to meet nearly all your unplanned expenses and weather all normal vacancy turnover. At these numbers, I don't see any compelling reason to sell any of your properties.
Flesh out your plan, then come back. PM me if you would rather carry this discussion further privately.
Dear Lucius,
Thank you for your advice. Where is a good place to get my hands on the numbers for average income, and do I need to do some adjustments to these figures to account for the fact that many in the area are graduate students at the Ohio State University. Will this have an impact on the average monthly income that should be discounted because their parents who live someplace else probably are footing the bill?