How do you evaluate debt service
on a real estate investment? Let’s dive in. Hey, there. I’m Clayton Morris. I’m the founder of
Morris Invest, one of the largest turnkey
providers of rental properties in the country. And today, I want to talk
to you about debt service. It’s a question
we get a lot, how do you know if the terms
I’m getting on this loan or on this rental property,
does it all make sense. Does it work for me as
a real estate investor. So today, we’re going to talk
about evaluating debt service. And look, at the end of
the day, debt service is broken down into a
number of different areas. So let’s dive into
what those areas are. Number one, how much
money are you borrowing? So, how much money are
you borrowing at the time from the individual
you’re borrowing it from? How long are you
borrowing this money? Is it 30 years, is it 15 years? So you need to know that,
right, how much and how long. And what happens at
the end of that term, after the loan is paid off? Is it a balloon note,
like we used to have, and we got into so much
trouble in 2008 and 2009 where suddenly now you owe
the full amount of that note, or is it totally paid
off and you’re scot-free, and you own that rental
property free and clear? Also, what interest rate are you
paying on this particular loan? And is there a penalty for
paying it back too quickly? Now that we know all of
these different points that we’re working
with, we also need to figure out how much rent
the property can bring in. How profitable will
the property be? So, it’s great that we know the
terms of our note over here, and our mortgage, but
what about the rent? How much profit can we make,
and will one outweigh the other? That’s the overall
goal, of course. And there’s an easy way
to find the potential rent of your property that you’re
going to be purchasing. Now, let’s say you work with
a turnkey provider that’s going to be providing you
with a rental property. They’re going to
know specifically how much that property
is going to rent for, because the chances are they’ve
done hundreds of properties on those same streets. So they know very well. Also, you could use a
website like rentometer.com, rentometer.com. You just plug in the
property address, and it’ll spit out
a number for you. It’s a range, based on what
other properties are renting for in the neighborhood. Now, like with any
website, you may not get totally 100%
accurate information, but it is definitely a
good starting place for you to start running some
formulas and numbers. Now, the key with Rentometer is
it’s going to give you a range. And what I would do when you’re
figuring out your overall debt assessment on a property
is take the lowest number that they spit at you. Don’t take the highest, take
the most conservative number. The next big chunk
of this puzzle that you want to consider is
the expenses, the insurance, the taxes, and the
property management fee that you’re going to be paying. On all of our
properties, I always take monthly rent times
12– times 12 months– and I then multiply
that times 0.6. That takes out 40%. Now, I know that’s a
very conservative number. I probably go a little bit
too crazy in how much I account for. But that just makes me extra
happy at the end of the year when I look at my
spreadsheets and realize that we didn’t have to spend
that much on expenses and taxes and all of those things. Anyway, account for about 40%. If you can take out about
40% from your annual rent, that’s a good rule
of thumb for you to consider when looking to see
whether or not this property is going to be profitable for you. OK, so you’ve figured out your
rent, multiplied it times 12, and then you take out those
expenses, those taxes, insurance, property management
fees, and potential repairs on the property, and vacancies. You tie that all up
into that 40% bow, and that’s what
you’re left with. Now, we want to see,
am I going to cash flow above what I’m
going to be paying on that mortgage we talked
about earlier in this episode. There are a couple
of great websites you can visit to figure out
how profitable your property is going to be once you know
the terms of that loan. So for instance, you could visit
a website like bankrate.com. They’ll take you through one
of their loan calculators. You can also use an
amortized loan calculator. For my wife and I, we use a
simple calculator, an Excel spreadsheet that
we’ve built. In fact, we’re going to give it
away for you for free. If you want, the
link will be below in the description
of this video. You can click on it and download
it and use that worksheet. It’s free. It’s a spreadsheet. And you simply plug
in your numbers on that spreadsheet, and voila. You’ll be able to figure out
whether or not this property is profitable for you. OK, so once you’ve figured out
how much debt, the interest rate, all of those pieces we
talked about at the beginning, and you’ve figured out how
profitable your property will be minus your expenses,
your insurance, your taxes, your vacancy
rates, all of those things, it’s like two
different worlds here, right, now we’re going to
combine them on that worksheet that we’re giving away for free. Once you have those
things given away– once you have those
things all stuck together in that worksheet,
what is the number? Are you going to be cash flowing
$1 above the debt service you’re paying back
on this property? I’ve heard it said, Gary
Keller and others had said, as long as you’re cash
flowing $1 above everything you owe on this loan
after you account for all of your expenses,
then you’ve got a home run. And then in a few years,
when you have this paid off, then you get all
of your cash flow, including that extra dollar. I don’t stomach $1 as my cap. I would go as high as
$100, or even $200. If I can cash flow every
month from my tenants $200 above all of
the debt service that I’m paying
for it on a loan, that is an absolute
winner of a property. I would take it and run. There you go. That’s how to look
at debt service, and how to analyze debt service
on your rental property. It’s a good thing to
consider when you’re thinking about diving
in and picking up your first rental property. If you have any
questions, please feel free to leave some
comments in the thread below. Please don’t forget to
download the free cheat sheet and worksheet, which is below. The link is right there in the
description for this video. And don’t forget to
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