Analyzing a Real Life “Rent & Flip” Deal

21

I picked up a new house last week…I call it “The Haggle House” due to the extensive negotiation it took to convince the bank to sell me this REO…

In this post, I want to walk through the analysis I did to determine whether this property would be a good candidate as a mid-term rental and flip, and the resulting financial metrics I came up with. My specific plan for this property is to rent it for 3-5 years, and then sell it; given the property’s location (near a freak flooding last year), I expect decent appreciation over the next 3-5 years as memories of the flood recede (forgive the pun).

First, here are the important numbers associated with the purchase and financing:

  • Purchase Price: $43,500
  • Closing Costs: $2,500 (only incurred at time of refinance)
  • Rehab Costs: $6,500
  • Financing: 65% LTV, 7.0% Interest, 15 Year Amortization, 3 Year Balloon

Overall, between the purchase and the rehab, I plan to put about $50,000 into the property of my own cash. My local bank is willing to do a cash-out refinance once the property is rented, which I anticipate should happen by the beginning of Month 2. Given their refinance terms above, I expect to be able to pull out $32,500, with $17,500 of my own cash remaining invested into the property. Add the $2500 in closing costs at the time of the refi, and my total out-of-pocket investment will be roughly $20,000.

My monthly income and expenses should break down as follows:

  • Income / Rental Rate: $900/month
  • Vacancy: 8.3% (1 month per year)
  • Property Taxes: $1400/year ($116/month)
  • Insurance: $400/year ($33/month)
  • Maintenance: $900/year ($75/month)
  • Property Management: $1200/year ($100/month)
  • Mortgage Payments: $292/month

Some additional notes:

  • The income is estimated, with actual rental rates between $850-950, and potentially going as high as $1050 with Section 8 tenants.
  • Maintenance is on the low side, but given that the property is only 6 years old and has been rehabbed, I don’t expect many maintenance costs.
  • I’ll be paying an employee $100/month to do all the property management, which should also keep my maintenance costs down, as he is my project manager for the rehabs as well.
  • I haven’t included any capital expenses, as I only expect to keep the property for 3-5 years, and there shouldn’t be any capital costs in that time frame.
  • The total expenses — including vacancy — are about 44% of income, which given that our capital expenditures should be low, given it’s a relatively new property and given that we’re doing our own property management, seems about right.

Given all that, our rental analysis breaks down as follows:

Rental Analysis

Ultimately, we’ll see cash flow of about $200/month, our cash-on-cash return will be somewhere around 12.5% and our total return will be about 19%.

While not a spectacular return, it’s enough to keep this property cash-flowing until my real exit strategy kicks in about 3-5 years from now. At that point, with a bit more rehab, I believe I should be able to resell the property for about $120K (these were 2008-2009 numbers in this area pre-flood).

Let’s assume that I hold this property for 3 years, with the purchase, refi and rental data determined above. After 3 years, let’s assume that I put another $15,000 into rehab (a good cosmetic overhaul on this property), and resell for a net of $110,000 (assuming $120,000 minus $10,000 in commissions/costs).

Based on that assumption, here is my expected compounded rate of return over those 3 years:

Return Analysis

So, given these assumptions, it appears my 3-year compounded return on my investment would be over 50%!

I’ll let you know how it goes…

About Author

J Scott runs a real estate company that invests in several parts of the country and that specializes in new construction, as well as purchasing, rehabbing and reselling distressed properties. J is the author of The Book on Flipping Houses and The Book on Estimating Rehab Costs, which you can get here on BiggerPockets.

21 Comments

  1. Jason –

    We’re hoping that we can use a number of free channels to get prospective tenants. First and foremost, Craigslist. Second, this house is located on a side street off a busy road — we’re hoping some strategically placed signs will generate some phone calls. Lastly, we get a lot of calls on our listed flips asking if we’re interested in renting or lease-option, so we have the potential to convert those to this rental as well.

    I’m really hoping to avoid paying for advertising for this property…

  2. This is one extensive analysis! I just have one question, though. Have you calculated the period when you are working to find renters on your property? It might throw off some of the calculations that you have plotted there. But anyway, good work. Thanks for posting it here. This kind of post makes me want to do something similar in the future.

    • Hi John,

      If you notice on the IRR calculation, I purchased the house in September, and don’t factor in receiving first rent until November. In this case, we purchased the property on September 10 and finished the rehab on September 15. The house is going on the market this weekend to find a renter, so we actually have 6 weeks to get someone in there based on the timeline above.

      As for the annual turnover, I have one month per year factored in for vacancy, so that assumes we have to find a new tenant every year and we have a month to do so.

  3. Great analysis, Jason. A couple of things that puzzle me:

    1. Why have you omitted the $32,675 from the total cost in the very first table on the top left?

    2. Why is your IRR calculation using a static cash flow instead of the cash flow that was earlier calculated based on 2% rent and expense growth?

    • Hey Vikram –

      Responses to your questions (both good questions :)):

      1. I had to reformat the spreadsheet to get all the data to fit into the correct sized graphic. Apparently, when I was cutting and pasting, I messed up the “Total Cost” cell. Indeed, the total cost should be $43,500 + $6,500 + $2,500 = $52,500. None of the other calculations should be affected, but good catch!

      2. That was half-laziness and half being conservative… 🙂 It was easier to drag the monthly results cells down 36 cells (three years worth) than to modify them for each year, and doing it this way gave me a very slightly more conservative result, as I really don’t know what the reasonable numbers are for revenue and expense increase. Combine those two rationales, and I just decided to assume a constant cash-flow over the 36 months. Again, good catch.

      Feels good to know that people are actually bother to read and check my work!

  4. I want to assert that guidelines for conventional cash-out refis on non-owner occupied investments are getting tighter and are becoming more difficult to fund, even when the property is owned free and clear.

    Although it seems you have tentively secured financing for this project, I would warn investors to carefully research the mortgage marekt in their geographic area before factoring a cash-out in any real estate investment analysis.

    Likewise, investors with multiple residential real estate holdings, investors who are self-employed, or investors who have a backend (DTI) ratio (including the proposed lien) of more than 45%, are at a higher risk of being declined for these types of loans regardless of the LTV or FICO.

  5. “extensive negotiation it took to convince the bank to sell me this REO”

    How did you go about in getting this property? Were you the only offeror? What was the asking price?

    That’s a nice deal.

    • Hey Mathew,

      The property was originally listed at $55K and I wasn’t willing to pay more than $44K. I was the only offer, but the bank refused to come down below about $50K. After a couple weeks of back and forth, I finally told the listing agent to call me when they dropped the price, and we could start our negotiations again.

      About two weeks later, the listing agent called to say they had lowered the price to $52K. We again went back and forth literally every few hours for three days, and again came to an impasse, with the bank wanting $44K and me not wanting to pay more than $43K.

      After a game of chicken, we ultimately agreed on $43.5K, but the bank dragged their feet on the approval process and ended up signing the contract only a week before it was scheduled to close. Luckily, I have a great closing attorney and he was able to get this REO turned around and ready to close in 3 days…

    • Robert –

      You are most likely talking to lenders who will be selling the loans to the large national lenders (Fannie, Freddie, and the big banks). When they do this, they have to play by the rules set forth by those banks, and these days, the rules generally state 12 months seasoning before a refi.

      That said, visit some small, local banks that lend their own money (“portfolio lenders”) and therefore make their own rules. Many portfolio lenders have seasoning closer to 3- or 6-months, and the lender I use has no seasoning whatsoever — they’re happy to do a cash-out refi for me the day after I purchase a property (we did two of these last week).

      So, my best suggestion is to start visiting all your local banks…if you’re persistent, you’ll find a bank who can do this…

  6. Sorry, real noob here. I understood everything except how you calculated the accrued equity. How is that calculation done, and why is it not just your mortgage amount? Appreciate your help and hopefully I don’t get flamed here.

    Thanks

    • Hey Jon –

      The accrued equity is only going to be a piece of the total mortgage. Remember, each month, you’re paying two things:

      1. Interest on your loan;
      2. Part of your equity.

      So, in this case, every month I’m paying about $300 in mortgage, which is actually $200 in interest (the bank’s profit) and $100 in equity (this is how much my mortgage gets reduced each month). The closer I get to the end of the loan, the less I owe, and therefore the less interest I’m paying — so more of the mortgage payment is actually going towards paying it off.

      In Excel, there’s a function called CUMPRINC that will calculate this for you…

  7. rachel zhang on

    Dear J Scott,

    I have read quite few of your articles, and every single one is as detailed, high quality and well-put as this one. Solute to you for your time and thoughts putting into all these articles. Every one will learn something new or understand some topics at a deeper level than before. You are the type of investors who make this community great. Thanks for your contribution. we appreciate you.

    Rachel Zhang , Fremont, Ca

  8. Hi, I’m new here, but the two articles I’ve read are really great. I’m a numbers guy, too. So before I buy my next rental property I want to get everything straight.

    Why did you bargain so hard for something that you predict would give you a 50%!!! IRR? Pardon me, but isn’t it nuts to possibly miss out on such a great return? If the bank didn’t come to your price you would miss this opportunity.

Leave A Reply

Pair a profile with your post!

Create a Free Account

Or,


Log In Here

css.php