The following numbers are not made up—this is an actual deal that came across my desk just recently, and you are going to help me analyze it!

(The address has been changed to protect the innocent!)

First, let me tell you a bit about 123 Main Street, as seen below.

## Step One: Figure Out Total Project Cost

The first step in analyzing this property is to find out our total project cost.

In other words, how much is this property going to cost to buy, fix up, and get rented?

Four values typically help us determine the total project cost:

This is pretty self explanatory, but the purchase price is the actual amount you will pay for the property. This is not necessarily the asking price or what it’s worth. This is what you will actually pay. In the case of 123 Main Street, I’ll use a value of $75,000. (They are asking $77,000, but it’s been on the market for 21 days, so I think they’ll go down a little.)**Purchase Price:**The purchase closing costs are all the costs associated with the purchase transaction. Included might be loan points, loan origination fees, prepaid insurance, prepaid property taxes, title and escrow fees, recording fees, attorney charges, and other fees custom to your area. In my experience, these purchase closing costs usually average around $1,500 for a $100,000 property, plus any fees added by your lender. In the case of 123 Main Street, it’s fairly inexpensive, but I know that I would likely be obtaining a loan, so I’m going to use $2,500 as my purchase closing costs.**Purchase Closing Costs:**In other words, how much will I need to pay monthly for this property before I can get it rented? Enough for two months? One month? Because you won’t likely have a renter the first day you buy it (especially if it needs a lot of repairs), you should be sure to account for any holding costs. These costs will likely be the mortgage, taxes, insurance, and utilities. For this property, I think it could be rented within two months, so I’m going to use a nice round number of $1,200 here.**Pre-Rent Holding Costs:**How much work does this property need before it’s rent ready? Let’s do a quick preliminary analysis of the repairs needed. Right now, you may not have even been to the property, so you might need to make some assumptions. Once you’ve walked through the property, you’ll be able to refine those assumptions to be much more accurate. Then, after the inspection and bids from contractors, you’ll be able to get even more specific.**Estimated Repairs:**

To help estimate the rehab budget, I recommend filling out the following form with your best estimates. These are the 24 main categories of repairs you’ll likely face when estimating the repairs. As you can see in this chart, I’ll use $17,250 as our total repairs needed.

At this point, we have everything we need to estimate the total cost of the project:

At this point, we can see the total amount we’ll have in this property and can compare this with other homes selling in the area. After all, a fixer-upper like this house doesn’t make sense if all the other homes that are already fixed up cost around the same price (after all, why go through the hassle of a rehab if you aren’t getting something for your work?). In this case, however, I can see numerous examples of similar fixed-up properties selling in the $110,000 to $130,000 range, so I actually expect the ARV (after repair value) for this property to be approximately $120,000. So far, so good.

**Related:** Case Study: A 7-Unit Multifamily Financial Statement Analysis [Real-Life Example!]

## Step Two: Figure Out the Financing and Total Cost Out of Pocket

Next, we want to determine how much the financing on this property will cost us each month. If you plan to pay 100% cash for the property, then you can skip this step. However, if you plan to use a loan, we’ll need to know how much it’s going to cost each month. Let’s just look at the underlying math.

Typically, a bank will require a 20% down payment on a rental property like this, with some banks requiring 25%. In addition, they will likely not cover the repairs, pre-rent holding costs, or the closing costs. Instead, they will base that 20% or 25% on the purchase price alone. In this case, the purchase price we are analyzing for is $75,000, so a 20% down payment would mean our loan is for 80% of the purchase price.

Our loan from the bank will therefore be for $60,000, and we will need to pay $15,000 for a down payment. Now, to determine the total amount of cash we’ll need to have to make this deal a reality, we simply need to subtract the loan amount from the total

project cost.

Total Project Cost – Loan Amount = Total Cash Needed

In the case of 123 Main Street, we know that the total project cost is $96,950, so $96,950 – $60,000 = $36,950

Therefore, to buy this property with a 20% down payment loan, and to cover repairing the property, closing costs, and pre-rent holding costs, we’ll need approximately $36,950 in cash. Before you start with Negative Nancy thoughts like “I don’t have $36,950!” continue reading. There are numerous ways to finance real estate, including a lot of creative methods that don’t require a full 20% down payment. There are also ways you can include the repairs in the cost of your loan.

## Step Three: Calculate the Monthly Mortgage Payment

To calculate the monthly mortgage payment, you’ll need to use a mortgage calculator; the calculation is impossible to do in your head but exceptionally

easy to do online through one of millions of online mortgage calculators. To calculate the mortgage, you’ll need three numbers:

- Loan Amount
- Loan Period (length)
- Interest Rate

The loan amount we have already determined, so we just need to know the length and the rate. Although mortgages come in all shapes and sizes, 30 years is the most common, though some people do choose 15. For our purposes, we’ll choose 30. As for the rate, it changes daily and depends on numerous factors, so your best bet is to call a few local banks and ask them where current rates are for non-owner-occupied properties. Today, those rates hover around 5%, so that’s the number we’ll use.

Now we simply need to plug our values into the mortgage calculator to determine our mortgage payment. Some mortgage calculators, such as the BiggerPockets Mortgage Calculator, allow you to include annual taxes and insurance with the payment, but we will include those items later in our discussion on expenses, so we’ll leave them blank here.

As you can see below, our expected mortgage payment will be $322.09.

Step Four: Determine Total Income

What do you think our 123 Main Street property will rent for?

That’s kind of a silly question, isn’t it? After all, you know nothing about the area! Remember, trying to determine the fair market rent depends on numerous factors, including location and characteristics of the property.

A quick scan of Craigslist and the local newspaper for this area shows us that prices for 3-bedroom homes in this neighborhood are renting for between $975 and $1,350 per month. The higher end of that spectrum seems to be nicer homes that have been rehabbed, whereas the lower end seems to be more in line with houses that need a ton of work. Since 123 Main Street will be rehabbed, you can expect it to get near the top of that range, but we also don’t want to price it too high in our estimates. So let’s shoot for a $1,200 per month price for fair market rent.

With this property, there are no obvious extra ways to make more money—no laundry machines, no storage buildings, etc. Therefore, we can move on.

Total monthly income: $1,200

## Step Five: Determine Total Expenses

Next, we need to nail down the expenses for 123 Main Street. To do this, let’s take another look at that list of all possible expenses and determine which ones we might need to pay as the landlord.

According to our graph, we can estimate $902.27 per month in expenses for 123 Main Street. Of course, we would also want to check to make sure there were no other special expenses unique to this location or this house, but we’ve done that homework and are comfortable with this number.

Our total expenses: $902.27

Step Six: Evaluate the Deal

We now have all the numbers needed to make a decision on this property.

Total Monthly Income: $1,200.00

Total Monthly Expenses: $902.27

To determine our cash flow, we subtract the expenses from the income:

$1,200.00 – $902.27 = $297.73

Therefore, we can estimate that per month, 123 Main Street will produce approximately $297.73 in cash flow, on average, over time. To get the annual cash flow, we simply multiply this number by 12:

$297.73 x 12 = $3,572.76

Now we want to determine what kind of ROI this cash flow represents.

To do this, we simply need to divide the annual cash flow by the total invested capital.

Annual Cash Flow / Total Invested Capital = CoCROI

We determined back in step two that the total invested capital on this project would be $36,950.00. We’ve also estimated the annual cash flow to

be $3,572 .76. Therefore,

$3,572.76 / $36,950.00 = 9.67% CoCROI

In this example, we could estimate that this property, with this cash invested, should return around 9.67% on our money. Remember, however, that this does not take into account the fact that the loan is being paid down each month, that the home has some incredible equity built in (since we did a slight rehab on it), and that there may be other tax benefits to go with it, or that would at least minimize the tax we would need to pay on the property.

Let’s take this one step further and try to determine our overall return (the ROI we’ll see when we combine the cash flow, equity growth, and loan paydown over time). A 9.67% CoCROI might be a good number to know, but let’s quickly compute the overall return on this property, assuming a few things.

**Related:** How I Analyzed a Deal in 5 Minutes (& Bought it Before Anyone Else Could)

First, let’s assume that we’ll hold this property for five years and then sell.

Let’s also assume that appreciation will increase the value of the property 2% per year over those five years. In other words, up in step one we determined that the property was worth $120,000. Therefore,

At the end of year five, our property is worth $132,490. Of course, if we were to sell it, doing so would cost us some money. Again, we’ll need to make a few assumptions. We know real estate agents will charge around 6% (roughly $8,000), and the other closing costs will likely run around $4,000. Plus, we’ll probably need to do some cleaning up of the property, such as a new paint job. So let’s add another $5,000 there. Our total sales expenses, at this point, would be $17,000.

Next, we simply need to determine how much the mortgage balance would be at the end of five years. Our initial mortgage, if you’ll recall, was

$60,000. However, we know that in five years, that loan will have been paid down some. To determine just how much, we need to use an “amortization calculator,” which you can find easily online on a site such as www.amortization-calc.com. By doing this, I can see that at the end of year five,

we’ll owe $55,004.72 on the loan.

We now have all the puzzle pieces needed to determine our overall return. To do this, we will want to find out exactly how much profit we made over those five years. This profit is spread among two categories: cash flow and equity. Let’s look at equity first. The equity is the profit we’ll get if we sell, not including any money we’ve paid for a down payment. To determine this, we simply start with the sales price and deduct everything that has ever been paid for the property, including sales expenses, the loan payoff, and the total invested capital.

For 123 Main Street, these figures are as follows:

Therefore, when we go to sell the property, we will have made a profit of $23,535.28. However, we are not quite done. We’ve also made some good cash flow over the previous five full years. A few moments ago, we estimated that this property would produce $3,572.76 in cash flow each year. Knowing that we held on to the property for five full years, we can multiply that by five to get our total received cash flow:

$3,572.76 x 5 = $17,863.80

So, we’ve made $17,863.80 in cash flow over those five years and another $23,535.28 in equity over the same time frame, for a total of $41,399.08 in five years. But we are still not quite done. What does this actually mean?

Remember, the total return is the ROI we’ll see when we combine the cash flow, equity growth, and loan paydown over time. It’s similar to cash-on-cash return, but it includes all the profit made, not just the cash flow.

To determine our total return, we need to use the following formula:

If this is confusing for you, let me try to explain in words what we are doing. Essentially, we are doing the same ROI calculation we’ve done in the past, just taking profit divided by investment. However, because we are spreading this out over a number of years, we need to divide by that figure to likewise spread the investment out over a number of years. So, let’s do this with 123 Main Street:

Total return = 22.4%

We determined earlier that our total CoCROI on this property would be 9.67%, and now we can see that if our rehab caused the value to increase

to $120,000, appreciation carried the value up 2% per year and we sold for full value in five years, after expenses we might expect a 22.4% overall ROI, on average, each year for the next five years. However, we’ve made a number of assumptions that could or could not be true. What if appreciation carried the property’s value up 5% per year? What if we received no appreciation?

What if we held on for ten years? Twenty years?

The point of this exercise is not to show you exactly what you will receive from a property, but to help you learn how to calculate these numbers.

If you want to get even more fancy, you can pull out the IRR (internal rate of return) or MIRR (modified internal rate of return), but those discus-

sions are far beyond the scope of this article.

Once you have a firm grasp of why the numbers work the way they do, and you are able to do these calculations by hand, I encourage you to check out the BiggerPockets Rental Property Calculator at www.BiggerPockets.com/analysis to help you save a lot of time doing these numbers. Everything we just went over can be done in just a few minutes on the calculator, and numbers can easily be adjusted and changed as needed. For example, if you wanted to know what would happen with a rehab budget of $30,000 instead of $17,250, you can simply edit the report and run the numbers again, rather than starting over at the beginning and going through the whole process. Online calculators, such as the BiggerPockets Rental Property Calculators, can help you out tremendously and save you a lot of time once you understand the basics of how they work.

*What do you think about this sample deal? Any questions about the analysis process?*

**Leave a comment!**

## 15 Comments

Great article, Brandon. Thanks for sharing. Very helpful to see the breakdown clearly.

One q: you calculated vacancy at 5% or $60/month. If you’re renting it as a 3-bedroom house, would vacancy either be 100% or 0%? Or if you’re renting it out at a total of $1200/month but each room individually, wouldn’t one vacant room equate to $400/month?

Emily, it is simply a method of recognizing that you will seldom experience full occupancy, and apply this assumed expense to the analysis. In this case, he is using 5% as his typical vacancy for this type of property, which could be thought of as .6 months per year). If, instead, he figured on a month a year vacancy, that would be 8.3% vacancy (=1/12).

Good article clearly explaining the thought process. I have a couple of thoughts that should be factored into your calculations.

First, your capes number is ridiculously low. Capex needs to include not only whatever improvements you need to add when getting the property ready to rent, but capex expenses that will happen during the 5 years you hold the property.

Research actual length of life of appliances these days, and you will find that, no matter the pricepoint or brand, some percentage of brand new appliances will need repair or replacement within 6 months of the end of the manufacturers warranty, whic is usually 1 year, two at most. Unless the seller has transferable extended warranties on the appliances, you will likely be buying new ones during the 5 years you hold the property. Fridge, stove dishwasher, washer, dryer. If you shop sales and/or buy an appliance package, you can get functional nice but not high end appliances for an average price of say $700 including an extended warranty of three years. That is $3,500 capex

Water heaters last on average 10 years. How old is this one, and how much will a new one, plus installation cost? Add to capex. What about anything else that has a short term lifespan? bathroom and stove fans? smoke and CO2 detectors? Heater?

I use 8% for capex to handle this stuff, and to gradually save for the big ticket stuff like a new roof. Or replacing the windows. If 8% is more than the actual costs, you win. If the costs are more than you allocated, your profits just got reduced.

I think your repairs number is also too low. You will probably be repainting the exterior at some point in the 5 years, probably within a year of selling. You are also responsible for “normal wear and tear”, which will result in funds spent to repair/replace stuff damaged by tenants. A good lease with checklist and pics will take care of assigning most wear and tear to tenant damage, and having them pay for it, but some things do just wear out. Carpets are likely to be trashed within 5 years, and you could plan to replace them with tile, and/or hardwood, increasing your sale price. Maybe this was alreadly figured into the initial repairs. I wasnt sure, so I thought I’d mention it.

I also think your property management cost are high at 11%. I pay 8% max.

Another thought is depreciation, and 25% depreciation recapture tax. On a $75,000 purchase price 5 years of depreciation is $13,636, reducing your taxable income from the property by $2727/year. how much benefit you get from this depends on your income, and your marginal tax rate. The depreciation recapture on $13,636 will cost you $3,409 in taxes when you sell. Depreciation recapture means the first $13,636 of your capital gain will be taxed at 25%, and the rest of the gain at the long term rate on 15%. Even if you decide to hold the property for longer, and live in it for two years to take advantage of the capital gains exclusion, you still pay 25% tax on depreciation recapture. At least, that is my understanding. I am not a CPA or financial advisor.

Or were you going to 1031 the property?

Hi Cindy I largely agree with you in all respects.. I do better rehabs on rentals and have gone 6 yrs on my current 38 rental portfolio without any major systems replacement. I think one condenser was replaced… I think 2 roofs… I buy 1970 and newer in Ga/Atlanta area so my houses are newer than some nationally so my CapEx is actually LOWER than Brandon’s model. I could see lots of capex if one does not thoroughtly rehab, OR if old houses that have more systems problems.

I’ve become very good at buying low all in cost rentals, yet high appreciation and ease of management, I wrote a paper capturing my tips/tricks off my profile 1st paragraph a URL to an uploaded file. So I would NEVER consider a deal if cap rate was not >10% and cash on cash >20%. I ignore principal pay down etc in cash on cash.

A way to reduce total cash trapped in a deal is buy with hard money which covers both purchase and rehab, then refi out at 75% of ARV (FANNIE REFI underwriting or most Portfolio lenders) probably will leave this deal with less than the $36k trapped in the deal (I suspect).

The good in this deal, $1200 rent (a better area), $360/mo positive cash flow, the real problem seems to be the too high cash stuck in the deal.

Cap rate math using short cuts (36% expense ratio) is 1200 x 7.5 = 9k NOI / 96k = 9.3% cap rate. This is ok for me. The problem is COC is a dog. Debt is supposed to double the cap rate. So something is wrong at 9.7 COC…. and loan amount 60k. I see the problem, I self manage (no PM fee) and I don’t take out that $150/mo capex, So my COC would be 18%. Almost a “yes” do the deal. But in metro Atlanta area 18% COC is a good deal, and I bet most other areas too.

Cindy, Brandon used 12.5% CAPEX (You said you use 8%) so I don’t get your point.

Also, you do not depreciate the land so not sure how you arrived at those numbers.

Hi Brandon. Have you guys considered letting plus members run a small amount of reports on a monthly basis; instead of just the 5 initial ones? Even one a month would great, allow us to continue practicing using the software and evaluating deals? It would add something needed and missing to make a difference between the entry level membership. When that first deal hits I don’t see why that wouldn’t lead to another membership upgrade.

There are some mistakes in the formulas and use of the terms such as cash flow and profit.

To calculate net income you would not deduct the mortgage payment because that includes principal which is balance sheet and cash flow transaction. not an income statement transaction You only deduct interest for GAAP and tax treatment in the income statement

Income

Less Operating expenses

= Net operating income or Earnings Before Taxes and Interest

Less interest (not annual debt service which is principal and interest)

Less depreciation

=Net Income and taxable income.

Net Operating Income

Less annual debt service (principal and interest)

= Cash flow

In the sale calculation it is not appropriate to call $23,535.28 “profit” because it is not profit. It has nothing to do with income or expenses in the income statement sense. Profit does not include payoff off the promissory note which is a balance sheet transaction and statement cash flows transaction. $23,535.28 is the sales proceeds from the disposition of the asset.

All ROI calculations involve discounting cash flows to derive the periodic compounded interest on the investment. It is called discounted cash flow analysis. That’s not possible in this example with the calculation errors for cash flow and the calculation for ROI in the example which is completely wrong because it fails to account for the time value of money or discounting the cash flows And, no its not a different way. Its plain wrong.

For sake of showing the correct ROI calculation using the discounted cash flow technique Internal Rate of Return with the example numbers:

Year

0 (36,950.00)

1 3,572.76

2 3,572.76

3 3,572.76

4 3,572.76

5 3,572.76 + 23,535.28

IRR 2.8%

the ROI or interest is 2.8% and not 22.4%.

Thank you,

Michael P. Lindekugel, MBA – Finance, CDPE

RE/MAX Metro Realty, Inc

2312 Eastlake Ave E | Seattle, WA 98102

P: 425.390.4197

Michael,

I think you forgot to include the recapture of the $36,950 in the year five sale. Deduct the transaction costs and the loan repayment from the sale price, and that’s the cash flow that goes into the IRR calculation. Doing that results in an 18.5% return, which is much closer to the 22.4% quoted in the article.

As the article mentioned, IRR (and therefore discounted cash flows) were beyond the scope of this article, but you’re right that IRR is more accurate.

Also, it sounds like you were looking at terminology solely from a strict perspective, while the article used the terms colloquially. In this case, I think most people would agree that profit is a reasonable word for “how much more money do I have now than when I started?” (not including taxes). You’re right, though, that technically you have to build in TVoM, taxes, depreciation, etc. into the calculation.

no, i didn’t forgot to include depreciation or the recapture because it is not part of the example data. i used the data from the article.

IRR is not more right. it is right. the formula in the article is completely bogus. if a CPA or a CFA used it they would lose their license.

I used terminology from a correct perspective. if we want to teach and help investors, then we need to do it the right way. telling them profit is cash flow doesn’t help. it needs to be explained. i run across supposed great deals that when property analyzed are not.

By recapture I did not mean recapture of depreciation. I should’ve been more clear knowing your preciseness. Let me put it another way: in the article, the property sold for $132,490. Out of that was paid $17,000 for sales expenses and about $55k to pay off the loan. That leaves $60,485.28 cash coming back to the investor. Why did you only use $23,535.28 (plus rent) in the IRR calculation?

I’m not sold on single family rentals in this market.

How about flipping it?

$120,000 Sales Price

($96,950) Purchase & Rehab Costs

($6,000) Commissions (5%)

($3,000) Seller Paid Closing Costs

($1.000) Closing Costs for Seller

=============================

$13,050 PROFIT (and you get your initial $36,950 back)

It would take you almost 44 months to make $13,050 with your monthly cash flow of $297.

Wash, rinse, repeat.

Great article Brandon, I enjoyed this walk through. Although I think you was conservative on expenses.

Excellent read!

Great article!

Great article. Just wanted to point out that there are some calculations errors in your numbers.

Repair costs should have been $25,850.

Even if you were to use the $17,250 estimate, the total cost of the project should have been $95,950.