my number can't be right... do you know where I'm overestimating?

Question

All,

Can someone please help me on my analysis? I feel like I put together conservative numbers (worried they're too conservative). I'm not sure how I'll ever find a deal if this is the financial model I use. Can someone please review and tell me if these are appropriate numbers to use, especially if you don't have the expense breakout of the property yet?

December is missing from the image.

Breakdown of expenses:

monthly expenses - 8%

utilities - tenants pay but $25 for grass mowing

Cap ex - 10%

PM - 10%

Jay Hinrichs · Answer

you can pencil whip it any way you want but reality is rentals are 5 to 10% return COC these days..

if its a quality building nothing wrong with your tenant paying off your property.. and your using max leverage.

and rents being that low I have to think there could be some upward movement over time.

although personally 600 dollar renters in my experience can be a lot of work with higher than normal turn over given the subsistence income the tenants make.

Anthony Wick · Answer

It's a 1% rents to purchase price property, with what appears to be $100 a door net cash flow. It is what it is. In many areas those numbers are worth purchasing at today's market rates. I'd call that a solid double, but certainly no home run. Depends on vacancy rates and projected future capex. How is the roof and HVAC? Can you get seller to buy 12 month home owners warranty to ward off large expenses in the first year? Tenants pay off property, you pocket a little money, gain some equity, and get a tax break. But I am wondering where the maintenance expense and vacancy rate projections are. And you need to address if those rents can be raised for a little extra revenue.

Jay Hinrichs · Answer

@Adam Philpot  keep in mind  market prices for Risk  and availability or product to buy..

the less risk the lower the returns Generally speaking..  when you have more money chasing too few deals values rise.

as you get the ( I don't want to be left out sentiment.)

John Teachout · Answer

As stated, this property's cost vs the rental income just isn't going to perform that well. It can be an equity builder or you can pay it down to "buy" some cash flow but it won't provide both. In other words, it's just not that good of a deal. If you can add value to raise rents or something like that, it may work better. If not, it's a marginal performer.

Clayton Mobley · Answer

Also, I know your primary goal seems to be cash flow, but remember the other thing that's happening is that your tenants are buying you 80% of this building, which is a huge benefit to you even if you don't see it in your bank account right now. Cash flow is king (at least for me) but be sure to always consider the benefits of tenant equity when looking at any investment.

For maximizing cash flow, try plugging in the P/I for a 30-year note if you're currently using a 15-year loan term.

Clayton Mobley · Answer

I'd say your back-of-the-napkin figures aren't bad, though I'd look for a way to boost rents. My primary point would be that these figures are just that - basics. We use these types of assumptions to see if the deal is even worth looking at further. In this case, you have positive flow for the year of about $230/month which is decent, not amazing - but assumptions are just used as a gatekeeper, to help you suss out which props warrant a closer look.

Since this prop passes this most baseline of tests (positive cash flow with conservative estimates), I'd say it's time to look at specifics. If the property needs a lot of work or is in a bad area, your real numbers will likely be worse than these estimates. If it's basically turnkey and has long-term tenants already in place, your real expenses will be lower and your cash flow higher. No investor pulls the trigger on a property based on their estimated expenses- estimates are just there to let you know when something is loser right from the start.

Clayton Mobley · Answer

@Adam Philpot Perhaps I am missing something, but what loan term and interest rate are you using? I agree, your P/I is eating up your cash flow. The general rule is that, if cash flow is your goal, stick to a 30 year term.

I also agree with @John Teachout that your rents at this value are only marginal - is there some cosmetic work that can be done to boost the rent numbers? I also see that you are accounting for vacancy by having one unit vacant for each of the first four months? Am I reading this right? If so, what is Monthly Expenses, is this maintenance?  If you are accounting for vacancy by omitting the rents from one unit each month for four months, then are you assuming this will happen each year? What are your minimum lease terms, how long have current tenants been in place, how does the PM in question handle turnover (speed?) and how successful are they at re-signing existing tenants? Bascially, with your current set up, you are assuming an 8% vacancy rate every year, which isn't the worst rate I've heard of, but with the right management you could do better. This is the kind of thing that is impacted by asset class, management track record, and current tenancy. You need these details to really assess this deal.

Also, most folks don't do the math quite like you have it - where the vacancy kills your cash flow for four straight months. Rather, put in your assumed rate (8%) as an expense and amortize it over the year. You'll have lower flow in months 5-12, but you won't be negative in months 1-4. The total flow for the year will remain the same, but since the vacancy allocation is more of a way to make sure you have a buffer for when there is vacancy rather than an assumption that someone will move every month, it's a more realistic way to look at that expense.

I would also consider your PM rate. While 10% isn't unheard of, it's the high end of the spectrum - usually 8-10% is normal. Unless you have a PM contracted already, in which case the rate is the rate.

Lastly, your Capex is 10% - what is this based on other than just conservative estimate? I'm not saying this is a bad figure to use, I'm saying you need more info on this property in order to determine it's value. How old are current capex items? Do tenants provide appliances or do you need to keep them in good repair? 10% is a good back-of-the-napkin figure, but depending on the state of the property, you could be looking at a lot more or a lot less. If it's turnkey (everything is new or just a couple years old) then your capex expenditure shouldn't come around for several years. If it's a C/D class prop where maintenance is deferred (another question for the PM) you could be looking at a lot more than 10% very quickly.

my number can't be right... do you know where I'm overestimating?

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