Welcome to Chez Cliff!

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.

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.

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.

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*

Continued from yesterday.

My objective is two-fold.  First, make sure the property has a positive cashflow.  Second, the Gross Rent Multiplier (GRM) is between 3 and 7.  I’ll talk a bit more about the GRM later on.

Now that the givens and assumptions are known, the monthly expenses can be calculated.  Please keep in mind that all dollar figures below are rounded to the nearest dollar.  I don’t care about 27 cents.

Next is to calculate the Net Operating Income (NOI).  This is a fancy term for the total rent minus all the expenses.

NOI = Gross Rent – Expenses = $2400 – $1088 = $1312/month

Now the final step is to calculate the cashflow (negative or positive).  This calculation is performed by subtracting the monthly mortgage from the Net Operating Income (NOI).

CashFlow = NOI – Mortgage = $1312 – $1217 = $95/month

The first of my criteria is met.  It does have positive cashflow, albeit not that much.

Next, the Gross Rent Multiplier.  The GRM is nothing more than the purchase price of the property divided by the gross yearly rent.  This gives a whole number.  Typically GRM’s that are between 3 and 7 have no problem cashflowing positive.

GRM = Purchase Price/Gross Yearly Rental Income = $193,000/$28,800 = 7

The second of my criteria has been met.

The cashflow calculated here is the absolute minimum cashflow.  All the assumptions were taken at their maximum value.

More on this next time . . .

After the Texas property attempt, something was required to ensure that a similar mistake in the future didn’t happen.

I’m a recovering engineer.  Following instructions and checklist is something I do well.  Yes ladies, I have even learned that the toilet seat must remain down.

The best tool to use is a spreadsheet.  Not only would it be a checklist but it could give an indication of whether the deal warrants a phone call.

The first part in any analysis tool is to figure out what the "givens" are.  These are typically numbers that a seller places in their ad.  In addition, there are numbers that can easily be looked up, asking Lord Google.  These are called "assumptions".

Here’s my starter list.

Really, only three pieces of information are required:  Purchase Price, Gross Rent and Location.  How can I say that?

I’m glad you asked.

Let’s break down the other components on the list.

Down Payment:  This is typically 10 or 20% of the purchase price.  This is purely at my discretion.  Depending on the deal, I could find 10% or more for the down payment.

Interest Rate:  Whatever the banks are charging for loans.  I leave this at 7.5% which may be high.  I’d rather figure high than figure too low.

Loan Term:  I based this on a 30-year fixed rate.  I’ll explain why in a future post.

Property Tax Rate:  This is a question for Lord Google.  It’s typically between 1 and 2% of the purchase price.  It’s also dependent on location.

Insurance per year:  This one is tricky.  If an exact number can’t be found, I estimate it at $2000.

Vacancy rate:  This also depends on the area.  Typically it’s between 5% and 10% of the gross rent.  If the area has anything higher than 10% then I probably don’t want to buy there.

Management rate:  If the property is located in my neighborhood, this would obviously be zero.  But I’m looking to buy out of state.  Property management companies charge between 5 and 10% of the gross rent.  I figure this one high (10%).

Maintenance:  As I found out the hard way, money needs to be set aside for problems that may arise with the property. 

With that being said, data was pulled from a real an ad I found.

To be continued, yet again . . . .

In the meantime, watch this.

Prologue:  Every morning, I read 12 different REI blogs.  Thanks to them for saving my bacon.

This ad for a four-plex jumped up and bit me

Lease-Purchase Option Terms
$9500 down for  Lease-Purchase Option for Investors
$275,000 Purchase Option price (less your $9500)  makes this $265,500

3 years 5 months left on option

$2100 a month (of which $390 monthly applied toward purchase price)
Total rent received $2350 a month.

A Lease-Option.  This means I could take over the property, without having going through a mortgage company.  No applications to fill out, no credit checks, nada.  At the end of the lease, I could sell the property or purchase it for $249,000.

The only "out-of-pocket" expenses was $9500.  This was to get into the lease.

I thought to myself "I could get my hands on $9500 right now if I wanted too!" 

Simple math time.  Take the gross monthly rent and subtract the expenses:  $2350 – $2100 = $250 positive cashflow.

I thought to myself "Holy Cow!  $9500 gets me $250 monthly positive cashflow?  That’s an ROI of 30%!  I’m calling today!"

The owner of the property was really nice.  It was his first multi-unit property, back in the day.  Now he manages his own apartment buildings.  He doesn’t want to mess around with the 4-unit anymore.

The $9500 started coming together.  But something wasn’t right.

My fingers flew over the cell phone keypad.  "Does the $2100 include a property management company?  What about maintenance or vacancy rates?"

No, no and no.

When taken into consideration, the property management fees, maintenance fees, and vacancy rates kills the positive cashflow.  By my rough numbers, rents would have to be raised $550 just to break even.

The only way this deal makes sense is if I lived next to the property.  I’d have to manage it myself; cut the grass myself; plunge the toilets myself.  I’m sorry Texas but I must deny you of my presence at this time.

This experience made me step back.  This deal could have really bit me in the bum (or "patootie" if you prefer).  Reading all these REI blogs made me think of all the expenses involved with being a absentee-owner.

To prevent train-wrecking in the future, I entered the mad-scientist lab. 

To be continued . . .

The moment you’ve been waiting for all year has finally arrived.  Grab your "significant other" and rejoice!  Beaujolais Nouveau est arrivé!

I’m always happy to see this gem arrive on shelves at my local wine store.  Not because I’m a raging alcoholic nor because I’m a wine snob.  It is this wine that single handedly saves Thanksgiving from bone-dry turkey’s that are the specialty of so many households.

Host:  Cliff, would you like some more of my bone-dry turkey?  I made it myself!
Clifford:  Do you have anymore gravy?
Host:  No, you drank it all with your first helping of turkey.
Clifford:  That’s ok.  I have Beaujolais Nouveau!  Bring it on!

Or maybe after dinner it will help dull the pain of Uncle Larry’s "pull my finger" routine you’ve been tolerating for 30 plus years.

Uncle Larry:  Here Cliff, pull Uncle Larry’s finger.
Clifford:  Um I need another glass of wine.
Uncle Larry:  Uh-oh, too late.  Did you see that elephant under the table?

Beaujolais Nouveau is, as the name suggests, a French red wine.  On the third Thursday of every November, it is released to the world.  Wine-lovers anticipate this day much like children anticipate Christmas morning. 

It is amazing with a total processing time of three weeks that this wine becomes very, very fruity.

If you’re saying "But Cliff, this is a red wine!  You can’t serve red wine with Turkey!  You’ll burn in hell!"

Poppie cock!

If you insist on drinking that dry chardonnay with your dry turkey then knock yourself out.  This fruity beauty refreshens the mouth and the palette in between bites of this food laden with tryptophan.

A votre santé!