Help - useful rental property analysis?

Question

Hello,

I am interested in 1031 exchanging four of my duplexes in California into an apartment building in Idaho.  I am having a hard time running the numbers to determine if the apartment is a good investment.  I have all the 2018 income and expense worksheets, but they seem to make things more complicated and confusing to compare.  I would like to use a simple cash flow vs investment to make an apples to apples comparison.  It is reasonable to say:

Apartment Annual Income = $491k

Apartment Annual Expense = $188k

Apartment Annual Net Income = $303k

Apartment Cost = $4M

Apartment Downpayment = $3.2M

Apartment ROI = $303k/$3.2M = 9.5%

Then I can do the same thing with the duplexes but dividing my (Annual Net Income) / (Duplex Equity) to get the ROI on my current investment.

Is this simple approach a reasonable way to assess this purchase?

I didn't include the mortgage expense yet because I am not sure how to account for it.  Do I subtract out only the annual interest payment, or the entire payment including principal and interest?

Thank you for any input.

Franklyn Williams · Answer

@Fred A Baugh

Hey Fred, following up on great advice from @Charles Soper, you should, in comparing the ROI of both investments, add the mortgage debt service for the apartments (800K x rate factor of 0.6 = 48K annually), which would bring the apartment's ROI, based on your numbers, to 7.96875% (303K - 48K = 255K/3.2M). In addition, you may have self managed the duplexes and may not be doing so with the apartment; hence, you will also want to add a management fee to the duplexes expenses for the sake of an apples to apples comparison.  You also mentioned duplex equity though your ROI may be different from your return on equity (ROE). It may be preferable for your comparison to just calculate and compare the duplexes' ROI, that is, use only your rate of return on the funds you actually invested in the duplexes (duplexes NOI/funds invested in duplexes). You likely don't need to calculate the return on the duplexes' equity for your comparison and it may be a more involved calculation requiring you to consider not only your duplex-invested cash, but mortgage pay down, appreciation, etc.  Hope that helps.

Bjorn Ahlblad · Answer

@Fred A Baugh California dollars go a lot further in other states don't they?! Congrats on the find. First thing I would do is consult with a CPA, and an exchange expert, to make sure of numbers and don't screw up the 1031 transaction! Tax exposure if 1031x not done properly will have you in tears for a very long time.

When taking expenses it is anything you pay, plus anything you accrue for future expenses. So, all your expenses, including all loan payments plus a percentage for future capital expenditures (roof), vacancy, PM, etc.

I would make sure of the accuracy of the expenses-tax after sale, insurance after sale etc. then use percentages for CAPEX and vacancy, run that through a calculator-like the one on BP-and post that back on here, and you will get lots of help I'm sure.

It looks like you are on to something with this transaction, you need to run your due diligence process to make sure of the potential income and what your offer needs to be. All the best!

Charles Soper · Answer

Nice trade up!  I don't see many people putting up so much cash and having so little leverage, it's kind of refreshing.

What you are calling ROI should actually be NOI, which is pre-mortgage debt service.  So if you want ROI you should be subtracting out the payment (P+I) on the $800k you have left in a loan and that will allow you to do apples to apples as far as ROI vs. your duplexes.