Real Estate Strategy for Long Term Wealth

“Bookkeeping is actually the core to a healthy rental property.” — Daniel Roccanti

For years, holding a rental property was almost enough on its own. In this episode of Your CPA’s Take on Real Estate, Daniel Roccanti sits down with Faith to talk about what changed, and why real estate investors now have to run their portfolios like a business instead of counting on the market to bail them out.

This is the first of a two-part conversation. Daniel covers the KPIs every owner should be tracking, the risks that get overlooked most often, and why bookkeeping might be the single most underrated investment in a rental portfolio. Part two continues the conversation on June 18th.

Resources

• Your CPA’s Take on Real Estate
• Your CPA’s Take on Real Estate YouTube playlist
• Watch this episode on YouTube

Full Transcript

[00:02] Faith: Hi everyone and welcome to the James Moore channel. I am here with Daniel Roccanti. Hi Daniel, how are you?

[00:02] Daniel Roccanti: Hey Faith, glad to be back.

[00:02] Faith: Good. Yes, so we’re actually doing a two-part series just because I think when it comes to real estate investments, everyone can have different opinions about things.

[00:22] Faith: So I think there’s a lot to cover here. We’re going to do the first part today and then we’ll be back with the second part June 18th at 3:00 p.m. So today we’re talking about running real estate like a business. The first question is, why are so many real estate investors still operating reactively instead of treating their portfolio like a real business?

[00:22] Daniel Roccanti: You know, I think this just happens to be, we all got trained over the last real estate cycle basically that real estate is a great investment and all you got to do is get in it and you’re going to be successful. So I think if you got into real estate somewhere around 2012 to now, you had basically success no matter what. It doesn’t matter, all you do is get into it.

[00:57] Daniel Roccanti: And so it really comes down to whether you were in real estate before the ’08 crash. If you were, you at least still have that in your mind, but a lot of us weren’t buying real estate in high school and things like that.

[01:27] Daniel Roccanti: So if you got into it afterwards, the reality is there’s just been a record of success. We all got trained over this last cycle that real estate always appreciates, there’s always low rates, rents always go up. So you could buy a property, be kind of sloppy with it and still have a good investment because the market bailed you out every time.

[01:54] Daniel Roccanti: And unfortunately that environment’s gone. We’ve gone back to a more skill based approach when it comes to real estate investing. As mortgage rates increase and expenses increase, that hot market we just had, that was always hot no matter what for many years, is unfortunately kind of gone away.

[02:12] Daniel Roccanti: And so now we’re getting back to a more income driven approach, where we really have to make sure the numbers work for our investment properties. We can’t just have appreciation bail us out. Anyone who bought a house or any kind of property before the pandemic, it’s almost doubled in value since. Yes, it slowed down since ’22, ’23, but that growth was ridiculous. It almost doubled every single property, and you didn’t do anything except hold it. So real estate’s all about timing sometimes. If you got that great timing, it played out in your favor, but now we don’t have that.

[02:55] Daniel Roccanti: So how are our rental properties doing in an environment where the market can’t bail us out anymore?

[02:55] Faith: I think that’s such an important thing. We could do an entire episode just on that alone, because it is so different. So what are the most important KPIs real estate owners should actually be tracking right now?

[03:22] Daniel Roccanti: So the core KPI for every real estate investor is net operating income. You really got to understand what your numbers are, what is my rent minus my expenses. Goes back to the basics. But once we turn into a more serious investor, we got to go beyond that. If we have multiple properties, we really should be doing an NOI by property.

[03:51] Daniel Roccanti: You’ll find out how successful your real estate really is varies by property, and you’ll realize, hey, I might have a dud or two here or there, and those are the ones I really need to focus on, or I might have superstars. Why are they superstar properties?

[04:18] Daniel Roccanti: Then I would probably look at my debt service coverage ratio. You really need to make sure you can support any kind of loan or debt comfortably. So if your debt service coverage ratio is high and you’re having a difficult time, that’s just an indication that property is not going to be as successful. You’re too leveraged on it.

[04:18] Daniel Roccanti: After that, I really want to make sure I understand my occupancy, and I want to look at what my break even occupancy is. What’s the occupancy where vacancy, basically, before my cash flow turns negative. Because if I know what my break even is, I can always be looking at what my actual occupancy is and judge based on that. If my break even occupancy is 70%, I need to make sure I’m never getting below 70%, and honestly I want to have quite a bit of buffer there.

[04:51] Daniel Roccanti: I can go on about KPIs all day, but a couple more I want to look at, always know what your turnover cost is per unit. That eats up all your profits when you have turnover. And also make sure you understand your CapEx reserves. A lot of people do not do a good job of saving for that.

[05:18] Daniel Roccanti: And then the last one I’ll leave you with is you should always be budgeting and looking at your actual results against the budget. You’re never going to be 100% on budget, but when something varies completely from budget, that’s a good indication of why, and why that property is different than what you think it should be doing.

[05:32] Faith: How important are cash reserves in today’s market, and where are investors underestimating risk?

[05:32] Daniel Roccanti: So I think with cash reserves, we got to a place where we almost thought it was optional, and that’s not the case. You need to have a cash reserve. This is just part of normal business in real estate.

[05:57] Daniel Roccanti: So when I’m looking at real estate portfolios, I’m looking at, how much cash is available, how fast am I burning through my cash, how fast am I going to burn through my cash if I have a stress event that comes up. Just like in your personal life, you need to have an emergency fund. It’s the same thing. I need to make sure I’m always holding enough operating costs to satisfy me three to six months, depending on how aggressive or conservative I need to be. And then I need to have an emergency fund when things come up. Make sure your rental properties are the same way.

[06:14] Daniel Roccanti: And you asked me also about risk. Some of the biggest risks right now are insurance and property taxes. These are things that are always going up, and substantially. You need to be looking at, if my insurance is going up, why. Talk to your policy holder. Is there a way I can save on it, or at least understand am I budgeting for this? I’m not expecting a 5 to 10 percent increase when insurance jumps up 25% in one year. People who don’t look at their policy every once in a while might not realize there are ways to cut out of this.

[06:44] Daniel Roccanti: There’s ways to make sure this premium isn’t increasing substantially. The next one is refinance and maturity risk. My debt is coming up, it’s maturing. So what am I doing? I’ve got to refinance, I’ve got to pay this back. How’s that going to look? I’m not going to get the same loan I got before. That’s a huge risk that I think a lot of people sometimes kick down the road. You really want to get out in front of that one, because you’re one refinance away from a property not being profitable anymore sometimes. And you don’t have the option, your loan comes up, you’ve got to get a new one.

[07:14] Daniel Roccanti: And the last risk is CapEx. CapEx is that sneaky one that gets everyone. Make sure you’re not deferring too much CapEx, because when it does come due, it’s usually very expensive. You need to make sure you’re saving, that you have a plan in place, so when CapEx comes and you have to put a new roof on, you have the money because you’ve been saving for years. That should be part of your plan, part of the budgeting you’re doing for your property.

[07:53] Faith: And this kind of ties into what you just spoke of, but why is forecasting becoming more important than ever in real estate investing?

[07:53] Daniel Roccanti: Forecasting is important because the margin for error is just smaller now. Before, I didn’t have a small margin of error, I just had to get into it and I would be successful for the most part. Now that’s not the case. You really need to be forecasting, because if the market turns, if it changes, if my property changes, my refinance comes up, one small thing can make a property go from profitable to unprofitable overnight. And if you have investors, it’s really important.

[09:00] Daniel Roccanti: So when you’re forecasting, it’s not all optimism. What happens if my rents can’t get increased? What happens if insurance does go up 25%? What happens if I refinance and I don’t even get anywhere near the loan I got before, so now my mortgage payment is much higher than it was. You really need to understand what happens in a worst case scenario, if the market turns, if my occupancy drops by 30%. What does that look like? So forecasting is not just hoping for optimism and that the market will bail you out. You’re really just catching yourself before the market turns, so you have enough time to react and salvage your properties and your investments, or at least have time to fix it, so you’re not just going with the flow.

[09:48] Faith: And this is like the next question, because I’m sure you see this a lot too. What financial blind spots do you see from investors who rely too heavily on gut instinct?

[09:48] Daniel Roccanti: With real estate, it’s really common to confuse cash with profits. I’ve got cash in the bank, property is good. But if you’re not really planning out your property, or you don’t understand what cash flow looks like, you’re not understanding, I have cash in the bank because I’ve been delaying all my repairs and my CapEx, I’ve been ignoring all this. The reality is I need this cash in the bank because I’m going to have a huge roof I have to replace. So you’re really just borrowing time, basically. You’ve got to understand what is profit and what is just cash in the bank.

[10:31] Daniel Roccanti: Some other ones we’ve talked about before is with properties, you don’t really understand depreciation recapture and things like that, and what capital improvements are, and how that affects your sales cycle. I come in and sell a property, and that gain is a whole lot bigger than I thought it was, because I didn’t understand depreciation recapture. In the year of the gain, that taxable gain is actually larger than what people think it is, because they’re just using high end numbers.

[11:13] Daniel Roccanti: A lot of where these blind spots come in is you’re spending your time too much at a high level, with a little too much optimism, and you really just need to get down into the details and understand, like I talked about, turnover costs. This is a huge one for a lot of people. They don’t realize every time you turn over a tenant, it costs a lot of money.

[11:32] Daniel Roccanti: So sometimes it’s more profitable to make sure that tenant stays, and I don’t have too much turnover. Maybe maximizing your rent is actually hurting your profits because you’re causing too much turnover. How can I prevent turnover? If I’m deferring maintenance, if I’m deferring capital improvements, my property is slowly deteriorating. People are less likely to want to stay there, they might move out.

[11:51] Daniel Roccanti: So really understanding the details can actually create a more profitable property, which then turns into a property that more people want. It helps you out when you turn around and sell it, because you get a much higher price.

[12:10] Faith: And don’t you think, because you touched on the real estate market pre-COVID, I’m sure there’s a learning curve for people who trusted their gut instinct then and made out very well, and now they’re starting to get back into real estate investing, and I’m sure there’s a learning curve because it is a different environment now than it was before.

[12:33] Daniel Roccanti: I would say anyone under 35 has a very optimistic view of real estate. Not that that’s a bad thing, I love real estate too. It’s just, you got into real estate at some of the best times possible. And now you’re finding out what the other side looks like, which is, it’s not all roses and rainbows and butterflies. Sometimes there actually needs to be real work done to make sure your properties are truly a business, and not just something you can put your money into that’s always going to go up.

[12:54] Faith: Absolutely. Okay, so our last question today is, why does bookkeeping matter so much more than people realize when it comes to long term profitability and tax strategy?

[13:23] Daniel Roccanti: Bookkeeping is probably one of the most overlooked things, because to you it just seems like a cost, and you don’t want to spend any money on it. But without good bookkeeping, it’s garbage in, garbage out. If I get garbage bookkeeping, you’re going to get garbage results, whether that’s your tax return, your financials, trying to get a loan, or just me looking at my properties trying to get good KPI numbers. I don’t have good bookkeeping, everything else is terrible. I can’t even rely on my KPIs. I go look at my net operating income, and that’s what it says, but if your bookkeeping is so bad, that’s not really the number.

[13:45] Daniel Roccanti: So bookkeeping is actually the core. When I go back and say, what’s the one thing you need, what’s the one area you should spend a little more money on, it’s actually your bookkeeping. But the general public is the complete opposite on this. They want to spend as little money on their bookkeeping as possible, because it doesn’t generate revenue to them directly. No one likes to spend money on things that don’t generate revenue directly, but what they don’t understand is how much it’s hurting them, because while it doesn’t do it directly, it means you’re making bad decisions, you don’t have correct information.

[14:08] Daniel Roccanti: And then your tax return is basically just taking your bookkeeping and putting it on a tax return. If I don’t have good bookkeeping, you’ve got terrible tax returns, which means you could be paying more taxes, you could be out of compliance. I can go on forever. So good bookkeeping is actually the core to a healthy rental property, because it helps owners truly decide how well their investments are doing, and that translates into better tax returns, better financial reporting, which turns into better loans and lending. Anything a third party requires on bookkeeping should actually be the number one priority when you’re thinking about what you can do right now to increase your rental property and your ROI. Invest in good bookkeeping, everything else can follow after that.

[15:04] Faith: Well, this was a great conversation, and I can’t wait for part two. Again, we’re doing that June 18th at 3:00 p.m., and it is a Thursday like today. It was great talking to you, Daniel. We’ll talk to you next time.

[15:26] Daniel Roccanti: Thanks. Take care.

Watch the Full Conversation

watch the full episode above or reach out to a James Moore professional to talk through how these KPIs apply to your own portfolio.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.