Real Estate 032: Bookkeeping Tips for Rental Properties

If you are like most real estate investors, you may find joy in the "hunt", finding deals, networking, and growing your portfolio. A few handful will admit that they enjoy the administrative tasks that come with being an entrepreneur. Now that the initial tax filing deadline of 4/15 has passed, I wanted to share some best practices when it comes to bookkeeping and maintaining good records of your deals.

As much as we focus on the numbers and return on our investment. Not many talk about the money that may potentially be left on the table because of bad and/or inaccurate record keeping. Real estate investors have a distinct tax advantage when it comes to buy and hold rentals, and missing out on deductions directly correlate to a reduction on your bottom line. Below are 4 tips on bookkeeping and maintaining good records.

1. Use cloud storage to maintain your records

Nowadays, there are so many tools to help us keep accountable. Software such as Box, G-Drive, Dropbox, and others allow entrepreneurs to stay organized. Most have free basic accounts with 10-15 GB of storage that should be more than enough to store things such as receipts, purchase agreements, inspection reports, appraisal reports, warranty deeds, lease agreements, financial statements, and much more.

Good record keeping will help you defend yourself during an IRS audit, reduce CPA fees/costs, and ensure that you take all the deductions and credits you are entitled to as a real estate investor.

2. Utilize a checklist 

Apps like Google Keep, Trello, and Evernote have made it really easy for investors to create systems and processes to make sure that their business runs like a well oiled machine. With 15 deals under my belt, I still do not feel like I am good enough to "wing it". As such, I use buyer scripts, and purchasing checklists when I am making offers and closing deals.

I personally found that Trello is fantastic at creating checklists and notes for me to ensure that I cover all my basis as well as stay productive by prioritizing my to-do list. Below is an example of my "Real Estate Kanban Trello Board" that I use whenever I am closing on a new rental property.

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3. Prepare timely financial statements

In addition to learning about the basics of bookkeeping such as the balance sheet, profit and loss statements, and rent roll, its equally as important to make sure that these are prepared and reviewed timely. Many investors wait until the last minute before tax time, or update them every couple of months. By not staying on top of your income and expenses, you may be exposing yourself to increased losses. For example, you may have not realized that the utility bill on a vacant home has tripled in a couple months which may signal a leaky pipe not properly winterized.

Whether you are using an old fashioned excel spreadsheet, rental management software such as Quickbooks, Buildium or Stessa. As you grow your portfolio, you may want to consider outsourcing the bookkeeping function to a virtual assistant or CPA firm so that you can focus on the most important part of your business: marketing and raising capital. Regardless of which path you take, best practice is to review these transactions on a monthly basis.

4. Use a separate bank account/credit card

During my first year of real estate investing, I made the costly mistake of using my personal checking account and credit card for rental property related income and expenses. I did not have an LLC at the time, so I did not want to deal with the hassle of owning multiple cards and accounts, and also figured I would take advantage of maximizing the spend on my travel reward cards.

I quickly found this to be a time consuming mistake when combined with the fact that I did not review my statements on a monthly basis. This lead me to review over 1,000 rows of transactions online with only a couple weeks until the tax filing deadline. Even after going through the final list twice, I still couldn’t shake off the feeling that I may have missed hundreds of dollars worth of potential deductions simply because I lumped them in as a personal expense.

I have since created a separate business checking, saving, and debit/credit cards to handle all income and expenses related to my rental business. Furthermore, I created a separate Personal Capital account that aggregates these transactions on one excel form to be used during the bookkeeping process.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!

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Real Estate 031: Finding Private Lenders Script

As investors work towards building their portfolio, they often might run into an issue of finding capital to fund their deals. I have also run into this problem as I was taking down almost 1 deal a month in 2018, and needed to find a private lender (e.g. family, friends, coworkers, and other acquaintances that you have met/talked a couple times) that will help provide me with a short term loan while I execute the Buy, Rehab, Rent, Refinance, Repeat (BRRRR) strategy to force appreciation (build equity) in lieu of a 20-25% downpayment. I will share with you the steps that I took to raise capital and create win-win situations for myself and the lender.

My first private lender was an investor friend of mine, as such, we knew of each other's deals, experience, and goals prior to entering into a financial relationship. I knew that as I engage other potential lenders, I needed to be able to explain clearly what I do, my experience, and the potential returns on their investment.

My informational package included the following items:

  • Business name/contact information

  • Business mission and objective

  • Description of how my business operates (e.g. Market, Team, Investments)

  • Explanation of Private Money and how to fund a deal 

  • Business track record, including photos and videos

  • Referrals from previous investors or mentors

  • Expectations for both parties in the deal

  • Frequently asked questions

Remember that content, not format of the information is key. Be prepared to fully answer any and all questions that the potential lender may have as most private lenders do not do this on a daily basis and will need some education in the beginning

Once this was put together, I provided this information to the potential lender and walked them through the entire process. Remember that real estate is all about building relationships, so even though this potential investor may not pan out, there may be someone he/she knows that is interested or they may return in the future once they are comfortable with the concept. As much as they are interviewing you, you are interviewing them to make sure that they are not going to be a hindrance and obstacle in operating your business. Is this person a nervous individual who will be calling you every day for an update, or a pushy investor? Or will this investor be in it for the long haul and be with you on multiple deals? These are questions to carefully consider before entering any agreement with your lender.

Next, you want to learn about your potential private lender and their main concerns. During my experience, I learned that lenders mostly care about three things:

  1. Return on Investment

    1. What if the rehab goes over budget

  2. Securing their Investment

    1. What if the appraisal does not come in at ARV

  3. Timing of their Investment

    1. What if the economy changes

    2. What if the borrower goes bankrupt

These are all important questions that you should proactively address during your walkthrough and calls with the lender as follows (Investor Script taken from the BiggerPockets forums):

“As you know, these are ‘investments’ that we’re talking about, so there is no guarantee of success. There is risk involved with any kind of investment, but as our successful track record testifies, the way we invest in real estate seeks to minimize the risk at every turn. We offer a first lien position on any property we lend on, which means if I end up breaking any of the terms in our agreement, you could foreclose on me and take the property."

“Also, because of this lien, you will get all your money back, plus interest, before I ever see a dime. I only make money if you make money. Additionally, we will sign a promissory note that clearly and legally spells out all the terms and conditions of our arrangement. Finally, we only invest in amazing real estate deals that will have significant equity in right off the bat, so we are protected against a drop in the economy. Because we buy only good deals, there is significant monthly cash flow following conservative estimates, and we set aside money each month for future expenses. All these factors help limit risk and ensure that your investment is as solid as possible.”

Below is a sample rehab and FAQ sheet that I also share with my potential lenders as appropriate:

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By advising your potential lending partner on these concerns up front, you are able to build a stronger relationship and trust so that you are both on the same page. Show them different versions of a proforma on a sliding scale that show a best to worst case scenario. Although you do not want to scare off the lender, it shows that you have done your homework and will put them at ease when you run into roadblocks and have to make adjustments.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!

Real Estate 030: Cash on Cash Return vs. Overall Return

In my previous blog posts I discussed cash on cash return, debt service coverage ratio, net income and how these metrics are used by real estate investors to evaluate a potential acquisition and proforma over 5, 10, and maybe 30 years down the line. Other investors may look to buy all cash and consider comparing cap rates to make sure they are getting a healthy return when including other factors such as neighborhood class and type of property (e.g. single family rental vs duplex, etc.). While these metrics are valuable, they do not paint the entire picture, especially for savvy investors who are looking for value add opportunities.

By value add opportunities, I am talking about forcing appreciation on your deal by raising rents to market, rehabbing the property, and other things such as sub-metering individual units on a 2-4 unit and reducing your overall expenses. Value add opportunities allow investors to “force” appreciation in a short period of time.

To evaluate a value add deal, one must consider not only the cash flow, but appreciation, tax benefits, and loan paydown when financing your property. This is also known as the overall return. To calculate your overall return on a deal, you must add up the benefits realized in these profit centers and divide it by the number of years you held the property and total monies invested. 

Lets view an example below:

  • Purchase price: $150,000

  • Cash all-in (Downpayment, repairs, closing costs): $45,000

  • Loan amount: $112,500 (75% LTV), 30 year fixed at 5% interest

  • Annual Cash Flow: $3,000

Lets say that after 10 years, you decide to sell the property for $250,000, which reflect a gain of $85,000 after selling/closing costs of $15,000.

  • Cash flow: 10 years * $3,000 = $30,000

  • Appreciation: $85,000

  • Tax Benefits: $1,000 * 10 years = $10,000 ($3,636 depreciation per year * 28% tax bracket = $1,000 per year savings)

  • Loan Paydown: $21,500 ($112,500 - $91,000 Balance after 10 years)

Total return over 10 years = $30,000 + $85,000 + $10,000 + $21,500 = $146,500

Overall ROI: $146,500 / 10 years / $45,000 = 32.55% return

In this example, this means that your average return during the 10 year holding period was 32.55%. By using this simple formula, you will be able to better understand your overall return on the deal and compare it to others in your lead generation pipeline when having to choose one over the other.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!

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