The True Cost of Ownership

Jessilyn Persson: [00:00:49] Today’s topic, we’re going to be talking about underestimating the true cost of ownership. Many first-time investors focus solely on the purchase price only to be blindsided by a host of hidden expenses. So we’re going to talk through some of what those expenses are so you can avoid these when you decide to buy your real estate.

Brian Persson: [00:01:09] I can’t count the number of times I’ve been in a conference and meeting people who are investing in their first or second property, and they are still missing things in the budget. We’ll talk about what those things are, but effectively, their real estate portfolio is underperforming because it’s not really calculated properly.

Jessilyn Persson: [00:01:33] Yes, that is so true. We’re going to roll right into the takeaways. The first one is that hidden costs add up. Know what to watch for. I know many of us are familiar, when we want to buy real estate, that we have to figure out what the mortgage is going to be, and to have that you need a down payment. Then there are usually closing costs, which we know of course are legal, but there are a lot of costs which we learned as we were buying, such as appraisal fees, if needed, inspection fees. We’re fortunate not to have this here in Alberta yet, at least if ever, but our partners in Toronto have major land transfer fees. And of course, once you have your property, there are things like property taxes, insurance, vacancy periods, the list just goes on.

Brian Persson: [00:02:16] Goes on and on. Land transfer fees, Alberta is the only province in Canada that does not have them, so come buy in Alberta. A lot of people don’t calculate what you just mentioned. They, like you said, are looking at the purchase price. Even when they’re looking at the purchase price, all they’re really looking to do is find a deal that’s cheaper than the one next to it. Then all of a sudden their legal, appraisal, everything else that has to come into the picture, makes the property pretty well the same price. Especially if you have unexpected stuff. For example, your inspection takes more time because there’s more issues, like a crack in the basement. All these things start to add up and you end up not saving any money by trying to be cheap on the buy.

Jessilyn Persson: [00:03:07] I would highly recommend to always have an inspection done. They can save you thousands of dollars by finding hidden things, which homeowners do hide. They can be incredible costs. Like you said, a crack in the basement, a crack in the foundation essentially could cost you upwards of $50,000 or more if you have to get that foundation replaced. $50,000, if you can catch it in the inspection, you have a choice to decline buying that property if it’s just not going to work for you, or now you’ve got a large negotiating tool with the sellers. To be like, I need you to reduce the cost of the foundation fix. Then your buy will be cheaper so that in the end, even if you do decide to buy it and fix the foundation issue, your purchase price is still going to be the same because you got it back from the buyer before you bought it.

Brian Persson: [00:04:05] I can tell a story that has some good stuff and some bad stuff in it. When it comes to inspections, we use one of the top real estate investment focused inspectors here in our area. He came in and inspected one of the properties that we were purchasing, this was years ago. He was running his little camera down the pipe to see what was going on in the sewer lines. He came to this one point and he saw this little divot in the pipe, and he turned around and said, you haven’t put this property under contract yet, have you? I was like, oh crap. Because we had already put it under contract and we were just going through our diligence. We knew the builder and we knew he did good work, so we weren’t too terribly worried. But this problem was not in the building itself, it was actually out into the sewer line. Sure enough, this guy who warned me about maybe not purchasing this property, he was somewhat right in the fact that I have to have that sewer line augured every single year, and it cost me $300. But also, the property ended up being a total gem. We far made our money back on it, but I did have to spend extra time and costs in order to just keep that property maintained because of that little divot in that pipe that our inspector saw for us. Super important to have a really good inspector. You might not like the cost of a good inspector, because this guy that I’m talking about he’s quite expensive, but he will find everything for you in that property.

Jessilyn Persson: [00:05:43] Honestly, a few grand up front, I think in general, is the high end of a good inspector, but that is so worth your investment.

Brian Persson: [00:05:53] Not only that, he will come back with an investor-focused laundry list of deficiencies with that property, which you can then go back to the buyer and negotiate with. It is a hidden cost that the inspector is going to unfold for you, which you can then use to your advantage.

Jessilyn Persson: [00:06:13] And things like appraisal fees, sometimes you need them, sometimes you don’t. Sometimes it’s included with the bank, but if you have it budgeted it, at least if the bank comes back at an appraisal that doesn’t meet what your expectations were, now you have it in your budget to possibly go get a private appraisal done. Then that’s a comparison you can take back to the bank. You always want to have room in your budget for the negotiating side of what you need to make a deal land.

Brian Persson: [00:06:41] I’ve had to do that. I’ve had to go and get secondary appraisals just because the bank was trying to be cheap on what they thought property prices were in the area. It’s something that happens. A big killer, though, is property taxes. We have friends, there’s a neighborhood around our area that has very high property taxes. For whatever reason, people still buy real estate investments in that area. The exact same property will be $7,000 a year in taxes for our area, which is only $3,500 in taxes. Literally double the taxes. Imagine holding that property for 20 years, you do the math. How much extra have you just paid for that property, $60,000? You better make sure that property has an extra $60,000 built into it, so that you can make up for those taxes.

Jessilyn Persson: [00:07:34] Taxes, they can really get you.

Brian Persson: [00:07:37] Insurance when it comes to multifamily can be a deal killer. The realtors will give you their insurance numbers, but often they are old or perhaps haven’t been updated in a while. When you go to your insurance on a multifamily building, all of a sudden the insurance prices are way higher than you expected and the deal stops making sense to buy. Insurance can be a deal killer that people will just assume is going to be the same as whatever the current property is paying for, then they get their own insurance and they end up being underwater with that deal.

Jessilyn Persson: [00:08:15] And you don’t want to have properties without insurance because that will be a much bigger cost if something goes sideways.

Brian Persson: [00:08:21] Don’t do that. Let’s just scratch that from the record.

Jessilyn Persson: [00:08:28] That’s fair, but some people will try to do it.

Brian Persson: [00:08:31] This is on the flip side of things, tenants should have their own tenant insurance as well. That’s a hidden cost that can add up. More often than not, not for you, but sometimes there’s some implications for you as the property owner. To give you a quick story, a tenant that had tenant insurance when she moved into my property, at some point she canceled it. Then we had a flood in the basement and she ended up having to move out. I was working with her, walking her through everything that she can do to minimize her costs, get into another property as quickly as she can, etc. She was being very squirrely about my advice. Finally I said, you do have tenant insurance, right? She said, no I canceled it. It ended up costing her, my estimate, about $3000 extra, which at that time was pretty well two months of rent for her. So you can imagine the $15 or $20 a month that she could have been paying over those few years, turned into a $3,000 tab on her end. It could have turned into a liability on my end, depending on how she came about it. Super important for not only you to have the proper insurance, but your tenants to have the proper insurance.

Jessilyn Persson: [00:09:54] Absolutely. The second takeaway is that maintenance is a must. There is a lot of maintenance that can come down on any given property. Definitely over time, because we buy and hold. We don’t have a 2-5 year turnaround, we hold ours for 10, 20, 30 years. As with anything, there’s always wear and tear and there’s always going to be maintenance needed.

Brian Persson: [00:10:19] A lot of people don’t include maintenance into their budget. Ours is 5%, that seems to work for our property. Sometimes it’s 6%, but there’s never any ground shaking differences in how we budget our maintenance. But it’s critically important. You’re going to have appliances go, you’re going to have little things happen all the time that need paint, or a new door or whatever it comes down to. If you’re not budgeting that, your real estate, that deal might look like a disaster, depending on the year. We have a property right now that we went through a significant amount of maintenance. It’s part of the plan, we have a two year plan on this property to bring it to the end of its current mortgage, then we’re going to refinance it, pull out a whole bunch more money and buy another property with it, probably. This year looks disastrous when it comes to the maintenance, because we’ve been putting a lot of extra money into it purposely. I kind of freaked out when I saw the numbers when we were doing the budgeting. Then I went back through the last three years and I realized it was bang-on, right in the plan of that 5% that we had created. It’s really important to have that number in mind all the time and make sure that it’s nice and even across all the years. Not just aiming for zero one year and then 10% another year. If you’re going to do that, make sure you know what you’re doing.

Jessilyn Persson: [00:11:48] Like you mentioned, roofs leak, furnaces break, appliances go. If I look at our current home, we’ve been here for 14 years. Knock on wood, we have not had to replace an appliance in 14 years. But throughout our properties, we had a property last year where we had to replace three appliances. You can’t necessarily predict that. Sometimes it’s wear and tear, sometimes it’s just a faulty unit. But we know for sure appliances at some point will go.

Brian Persson: [00:12:24] This is where tenants are both your best friend and also your worst enemy. I find tenants do take okay care of the appliances, which is great. But what I find is that when you have tenant turnover, the property has a personality and a lifestyle of its own, and the tenant has a personality and a lifestyle of its own. Every single time we have tenant turnover, something goes on with one of the appliances simply because they’re just using it differently. They’re not abusing the dishwasher or anything like that, but they’re using that dishwasher differently. Sometimes the dishwasher will go. Pretty consistently, it is within a week or two of the tenant moving in. So keep that in mind when you’re looking at maintenance costs, because it could just be the fact that the tenant is turning over and not the fact that the dishwasher or whatever appliance is old.

Jessilyn Persson: [00:13:22] For sure. But statistically speaking, and I know you’ve shared this story before with one of your doctor buddies, and I’ll let you share it. If you have 25 properties, for example, and you don’t have a furnace go for five years..

Brian Persson: [00:13:37] You think you’re golden.

Jessilyn Persson: [00:13:38] You’re making money. But statistically speaking, what’s going to happen?

Brian Persson: [00:13:43] That’s where I say, make sure you got that maintenance budget locked solid into your plan. Because if you do have 25 properties, at some time during the ownership of those 25 properties, you’re going to have three furnaces go in the same month, it’s probably going to be the coldest month, and it’s going to be brutal.

Jessilyn Persson: [00:14:04] And that’s about $15,000.

Brian Persson: [00:14:06] If you don’t budget for that, and you’re not thinking about that on that scale, then you’re really gonna suffer some pain when it comes to those problems. Always have that in the plan, always have that in the budget. Keep your float nice and high where it should be, your float of money. So that if you do have a couple furnaces go across your properties, you have what you need to cover it. This property that I just mentioned where we had an unusual amount of maintenance on it, we replaced the windows, but I had planned for it, and the float in that property was able to cover the window costs. It wasn’t all of a sudden one month I’m $10,000 in the negative because I’m running my properties a little too lean. I had it all planned out and budgeted so that there was no hidden cost for those windows.

Jessilyn Persson: [00:14:58] Exactly, plan and budget. Then it won’t matter if something hits you offside because you’re prepared for it. That’s one of the things you really want to make sure of when you’re owning a real estate property. The third takeaway is remember that rent is your biggest expense, so manage your tenants well.

Brian Persson: [00:15:22] What do we mean by rent is your biggest expense? I don’t think most property owners think this way, but if you go a month without rent in a particular property, that is a huge hit to your underlying portfolio. The thing is, most people look at rent like an income, but it’s actually going to significantly deter you from having a good deal when you don’t have rent. I look at it like an expense, I can go a month empty in a property, or I can replace a water heater, given the prices around here. Which would I rather do? I would rather have a new water heater and work a little bit harder and make sure that property doesn’t go a month empty.

Jessilyn Persson: [00:16:11] I like an example you shared with me. This was quite a few years ago now, but just to give an example. If we were charging $2,000 a month for rent, and I was hesitant about us lowering the rent to fill the vacancy, your great explanation was, if we go one month empty, that’s going to cost me more than if I lowered the rent to $1,900 a month and rented it for the 12 months.

Brian Persson: [00:16:37] It’s actually lower than $1,900 a month.

Jessilyn Persson: [00:16:40] As an example. That’s when I went, reduce the rent if that’s what was our hang up for renting it. I don’t think many owners look at it from that perspective. They’re like, well no, I need to make $2000. They get so set on that amount that they realize with one month gone, they’ve already lost over that just for the year. That they could have been charging $1900 instead.

Brian Persson: [00:17:04] You said it perfectly, ‘I need to make this amount of rent’. They’re like, my expenses are $2,000 so I need to have rent of $2,000. Well, if you go one month empty, you’ve broken the bank right there. So take the $1,900 because at least you’re then only a little bit out and not a lot. You can always raise rents later on. One of our mentors, Don Campbell, I remember one of the first conferences we went to years ago, he said exactly that in the conference. He was like, people go buy a property and then they go look for the rents that they need for that property. Totally backwards. You need to know the rents for the properties in that area and then go buy a property that matches those rents. As compared to trying to backfill the rents into a property that, maybe you love, but maybe doesn’t work for you.

Jessilyn Persson: [00:18:01] I think that lends well into doing proper rent projections, not overestimating potential rental income. Do your research on what rent is going for in that area, in that neighborhood, and see if you’re in the ballpark. Because if you’re not, you might sit vacant for months trying to fill it if you’re not willing to lower that rent.

Brian Persson: [00:18:21] We know quite a number of investors that are more than willing to let their properties go vacant for a month or two, sometimes longer, depending on the market. To me, that doesn’t make any sense. Right now I have a tenant that’s only been in there for six months, and the reason she’s in there for six months is because I’m not going without rent for any of those six months. Whereas if I had to rent in the winter, I could have gone empty for a little bit, but I was also able to carry myself over into the spring. Now I’ve filled all my months with proper rent, in fact I got more rent out of her because it was a short term tenancy, and I’ve lined myself up for spring. Some people would just probably coast right on over the Christmas season and leave it empty, and that totally does not make sense for me. In fact, I’ve gone through some pretty extreme lengths. Most of our properties are suited properties, so we have a basement suite in them. The first time this happened, I actually didn’t conceptualize it when I put the plan in motion. What happened was, I had an upstairs tenant moving into the downstairs of the same property, then obviously a new tenant moving into the upstairs, and the current downstairs tenant moving out. Effectively, I had three moves in one property across two suites in one day. And guess what? I made it work. Because the alternative was that I’m $1600 or $2000 or more out of pocket. If both of those suites went empty, then I would be $3000 or $4000 out of pocket. That, to me, was way less acceptable than having a stressful 12 hour period and making sure that I got those properties filled.

Jessilyn Persson: [00:20:18] I agree, I do remember that day. One thing I don’t think a lot of owners are considering also when doing their rent projections and managing the expenses of rent is utilities. Some include them with the rent, some it’s on top of the rent. But regardless of how you choose to collect that, you need to be conscious of the fact that there are utilities, which are an expense, that you may get stuck paying if you don’t manage it correctly.

Brian Persson: [00:20:47] If you’re in a cold area over the winter like we are, make sure that you have a budget for the different seasons. Because you’re going to seem to underpay throughout the summer and then your bills for utilities are going to be crazy high over the winter. Some people don’t budget for that, they don’t average out the utilities across the year and understand what really should be in their bank account to manage those high utilities in the winter.

Jessilyn Persson: [00:21:17] It gets awfully cold here in the winter. I think the furnaces go up and stay on forever. I can’t blame them, I’m one of those people who do that here. While we talk about rent being one of your biggest expenses and to manage your tenants accordingly, if you are hiring out the property management, maybe you’re not directly managing your tenants, but you still need to manage your property managers. Because the cost for tenant turnover is going to eat at your profit.

Brian Persson: [00:21:53] Understand what your property managers are doing and have regular meetings with them. Don’t abdicate your responsibility with your property managers. It will take time to manage your property even when you have property managers, so don’t ignore that cost.

Jessilyn Persson: [00:22:11] When projecting the profit on a property that you’re looking to purchase, I know we’ve talked on quite a few costs that will come up when you’re buying a property. Make sure to include in your proforma when you’re creating them, as we mentioned, costs that are not necessarily so in your face or prominent, like you said, maintenance fees you always want to make sure, vacancy you want to include, property management if you’re not going to be the property manager yourself, how you’re going to pay yourself. I’m not sure if there’s anything I’m missing there.

Brian Persson: [00:22:44] You pretty well got it. If you manage your own property, it becomes extra important. If you’re a brand new real estate investor and you’re buying your first property, you don’t want property management, you want to do it yourself? Great, that’s fine. But put the 10% in for property management and make sure the deal works with that property management fee in the deal. Because if you decide that you’re going to manage it and the deal only works without that property management fee, five, ten years into the future when you don’t want to manage your property, and maybe you want to have a little bit more vacation time, now you have to put that 10% into the budget and the property might no longer work. I tend to run my numbers fairly conservatively. In the sense of, I probably put in more numbers than people think is necessary. That includes property management vacancy even though we are renting in a, pretty well, 0% vacancy neighborhood. Right now, the vacancy still goes in there. We talked a lot about repairs and maintenance. I actually put in, what I call, an asset management fee, which is an extra 10%. That’s the money for me and our family. Why are we in real estate? I need some way to measurably pay myself out of the real estate. The asset management fee is 10%, and if the deal doesn’t work with that asset management fee in there, then I don’t do it. It has to have enough money to pay us as well.

Jessilyn Persson: [00:24:23] Just doing quick math based on the 10% property management, the 10% asset management, your maintenance fee and your vacancy, say those are each 5%..

Brian Persson: [00:24:32] You should be at 30% or more.

Jessilyn Persson: [00:24:34] So just keep that in mind when you’re budgeting for your property, and whether it’s actually cash flowing in your favor or only cash flowing because you have excluded and now have risks.

Brian Persson: [00:24:45] I’ve seen so many proformas that don’t include any of these numbers, and as soon as you add them in, the property is underwater and it doesn’t make any sense. Which is probably part of the reason why over the last few years here, coming out of the pandemic and everything starting to stabilize, then having inflation and all this turmoil going on over the last four years, we’ve talked to a lot of investors where finally this year they’re like, my cash flow is back. Four years later. I’m like, where did it go? Why did your cash flow go anywhere? I think part of that is just the way we run our numbers. Our cash flow is so secure and the property is so well budgeted that there’s really not an opportunity, given all the turmoil, for the property to actually go into the red.

Jessilyn Persson: [00:25:37] That’s great. I’m going to recap our takeaways. The first one is, remember that hidden costs add up, know what to watch for. Number two, maintenance is a must. The third one is, rent is your biggest expense, manage your tenants well. In our next episode we will be talking about failing to plan for the unexpected. Which is one of the five mistakes we discuss in our free giveaway, ‘The 5 Fatal Mistakes When Buying Your First Investment Property’. Thanks so much for tuning in to this episode of the Life by Design podcast.

Brian Persson: [00:26:08] Before you go, don’t forget to visit discoverlifebydesign.ca and book your discovery call to build your customized wealth strategy with us. We release new episodes every two weeks, so be sure to hit that subscribe button on your favorite podcast app and join us on this journey to create your life by design.

Jessilyn Persson: [00:26:26] Thanks again for listening, it’s been a pleasure being with you today. We’re Jessilyn and Brian and we’ll see you next time.