The Master Lease Option Series – Part 6: Managing for Cash Flow

Cash flow and equity are the two main reasons for doing a master lease option (MLO) deal. Both can be had using this creative technique to close real estate deals. Proper management will create both and make your next deal a cash cow!

Business is not about making money, it’s about keeping it. It doesn’t matter how much money you bring into your business if you lose it all in the expenses of running that same business. When discussing real estate keep this simple formula in mind.

Income – Expenses = Net Operating Income (NOI).

NOI – Mortgage Payment = Cash Flow

If we cut the cost of operations then we will increase cash flow.  The two main ways to do this with a MLO is to have the property create more income and less in expenses. In this article I will be focusing on managing the deal to cut down on operational expenses. Most people will hire a management company to take care of the daily operations of their real estate. If you are not managing the property yourself you will need to work closely with the manager/management company to achieve this. 

The first step in creating cash flow by cutting expenses is to be aware of what expenses are on the property and what they should be. I would suggest you start by surveying a few management companies in your area to see what they feel that a property like yours should operate at as far as expenses are concerned. Keep in mind to be clear about the size, age and area of your property when you first contact management companies. Age has a lot to do with expenses.  Usually the older the property, the higher the operating costs will be due to the needed repairs and maintenance. Ask the management company for several things:

1. Expense ratio per door. You will want to know how much this management company thinks they can run your property (or one like it) for per door in annual operating costs. For example I know I can run a C class asset in GA for about $3,300 a door in annual operating expenses.

2. Get the management company to give you an estimate for the major areas of operation. You will want to know what they think they can operate your property at in these general areas (in per door numbers).

   1. Repairs and Maintenance
   2. Contract Services (pest control, trash, landscape etc.)
   3. Payroll
   4. Utilities
   5. Taxes
   6. Insurance

The reason you get this info and get it in a per door format is so that you can start to compare that to what is already being done on the property you are looking at. Start by doing a quick analysis of your deal by taking its total annual expenses and dividing by the number of units. Now you know what their expense ratio is per door. You can compare this to the number your management gave you. If the deal you are looking at has a per door expense ratio much higher than what your managers told you they could run the same property for then you move on to a higher level of analysis. If the seller is already running the deal at a reasonable expense ratio, then this is probably not a good deal to do as a MLO.

If your subject property is running at higher expenses than what your team can run it for, we take a closer look. This is where you will want to compare the property’s financials line by line and compare each to what the new managers told you they could do in each category. Now you will be able to tell exactly where the current owner is over spending and exactly how you can cut those costs and profit the CASH FLOW.

This will help you to create a detailed plan for you and your management team going forward. You can now create a new budget for the property and work closely with your managers to get these expenses in line and to keep all that extra profit.

Now that you have a basic understanding of how to analyze your deals in a more detailed manner it’s just a function of analyzing more deals. Once you have some operational estimates from your managers, all you have to do is look at as many deals as you can. Find the deals that are operating at higher expenses than what your team can do it for and make lots of MLO offers. Once you get an offer accepted you manage the expenses better and cash flow all the way to the bank. It’s that easy!

Good Luck!

Bill Ham