Don’t let a rental eat your seed corn:
Jimmy Napier is one of my teachers. He’s an old country boy from Chipley, Fl., and when you listen to his recorded classes, his accent and story telling reminds you of a young Andy Griffith. And just like Andy talking to Opie and Barney, Jimmy uses roundabout parables to teach you about investing.
One story he tells is about corn. It goes like this:
“Suppose you had only one seed of corn that you could plant. You till your dirt, make sure it’s fertilized well and then plant your seed. While the plant grows, you take great care to water and weed so the plant will do its best.
Suppose that one plant only produced one ear of corn. Man’s tendency is to eat that one ear, but you must resist. Those seeds are your seed corn for you to plant next year.
The next year you till your dirt, make sure it’s fertilized well and then plant your seed corn from last year. Suppose you got 15 seeds last year, and suppose this year each plant only produces one ear apiece. At 15 seeds per 15 ears, you end up with 225 seeds for the next year.
Man’s tendency is to eat an ear or two on this go-round. Don’t do it.
The next year you plant, you’ll have plenty of seed. And when it produces a crop, you can eat all the corn you want and still have enough seed to plant again.
This only works if you don’t eat your seed corn.”
The other day, I was talking to a young couple who are fairly new to investing. They’re highly motivated, positive as can be and ready to do whatever it takes to become financially free.
They were telling me about a property they’re buying that’s going to produce a cash flow of $200 a month. I thought to myself, “This is a great deal.”
As I asked them questions, they told me about the property. They let me know the house would rent for $1,000 a month. Then came the kicker – I asked what their mortgage payment would be. They told me it would be $800 a month.
There’s the downfall – this house is going to eat their seed corn. When you’re getting started, you may think you calculate cash flow by subtracting your mortgage payment from your rental income. That’s logical, because it’s your money coming in minus your money going out. So in this case, $1,000 minus $800 equals $200 in cash flow… right?
Wrong. This house will have a negative cashflow of around $150 a month.
What our young couple, like a lot of new landlords, didn’t account for was their expense factor.
Your expenses factor is all the business expenses associated with owning and operating a rental property. They include things like taxes, insurance, vacancy, repairs and even the cost of management. These are true costs that you’ll experience each year while you operate a rental.
Your expense factor on a single-family home normally runs around 35 percent of your rental income. So in our young couple’s case, they’d expect to pay $350 of their $1,000-a-month rent toward expenses. That leaves $650 to pay a mortgage and ostensibly make a profit. In this case, our young couple would have $650 to pay an $800 monthly payment. That means they’ll need to find $150 outside of this property to make their mortgage payment.
In Jimmy’s parable, your seed corn is the money you have to invest. With a negative cash flow of $150 per month, this rental can eat that seed up in a hurry. Applying the expense factor to your accounting ensures you’ll have enough seed to plant each year. And like Jimmy said, before long, you can eat all the corn you want.
Joe and Ashley English invest in real estate in Northwest Georgia. For more information or to ask a question, go to www.cashflowwithjoe.com or call Joe at 678-986-6813.