Being Flexible
Posted on November 22, 2006 - Filed Under Business |
This will wrap up this week’s discussion on my analysis tools.
Today is running scenarios. This is the beauty of performing calculations on spreadsheets.
In the ad, the property has a positive cashflow of $95 and a Gross Rent Multiplier (GRM) of 7. This one warrants a second look.
A cashflow (PCF) $95 per month may not sound that attractive for the $19,300 down payment. Remember this is based on a "worst case scenario".
If some of the assumptions are changed, even a little, the cashflow can increase.
The property management fee was figured high (10%). This is always negotiable. Just changing this a few percentage points increases the monthly cashflow.
| Mgt % |
10%
|
9%
|
8%
|
| PCF |
$95
|
$121
|
$145
|
Next, take a look at the interest rate on the mortgage. The assumption was 7.5% when the rates today are 6.75%. This, of course, is dependent on how the property is treated by the bank, what the credit score of the borrower is, etc.
| Interest |
7.5%
|
7.25%
|
7%
|
| PCF |
$145
|
$175
|
$204
|
There is one more factor that comes into play. This, I recognize, is based purely on what the intentions of the investor are.
The loan assumption was based on a 30 year fixed rate mortgage. There is the school of thought that once you have a cashflowing property you keep it forever. This is actually in the minority. Investors typically sell properties after a certain period of time in order to move up to bigger properties (think Monopoly).
If the intention is to maximize cashflow and sell the property in five years, then the "Interest Only" (I/O) option could be entertained as well. The use of ARMs can secure a lower interest rate for the first 7 years. At year five, the investment could be sold.
| I/O |
7.5%
|
7.25%
|
7%
|
| PCF |
$274
|
$310
|
$346
|
Now the range of possibilities has been explored. The absolute minimum cashflow is $95 per month. The maximum obtainable is $346 per month. This deal is looking more attractive all the time. The good news is not a single dime has been spent to increase the
monthly cashflow. This is pure negotiation on the part of the investor.
In this analysis, there were a couple of factors not considered. First, the tax implications of the property. This includes (1) write-offs of the interest of the mortgage payment (2) depreciation of the property.
The second item not considered was the appreciation of the property over time. If the assumption can be made of a 3% appreciation rate over a 5 year period, this property increased in value from $193,000 to $223,740.
The reason why the two aforementioned items were not included was because these may not align with the original two objectives. The first objective was to have a property with positive cashflow. The second was for the GRM to be between 3 and 7. If positive cashflow does not exist on a property, I don’t care about the tax write-offs from depreciation nor from mortgage payments. Furthermore, I don’t care about the appreciation of the property if it has negative cashflow. Having another negative cashflow property is not feasible for me.
Let’s do a quick review based on the 5 year analysis.
Total CashFlow Range is between $5,700 and $20,760 (PCF x 12months/year x 5years).
Total equity range is between $50,000 and $56,000 (depending on if interest only).
Now it’s becoming clear why more people become millionaires in real estate than in any other industry. If you had ten properties doing this, you would be closing in on the million dollar mark awfully quick.
Have a great Thanksgiving weekend. I’ll see you next Monday.
By the by - this years Beaujolais Nouveau is excellent. *slurp*
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Great lesson!
Happy Thanksgiving Professor Clifford!!