My previous post examined the components of a cashflow analysis by working backwards from the rent. In this post, I want to put all of those components together by using examples in order to help you understand the analysis process and determine cashflow.
The goal here is to and apply the cashflow analysis components to practical examples so you can do two things. One, determine if the asking price on a property is anywhere near your criteria for a good deal. Two, develop an offer price on a property that may not be listed. Both of these numbers will be arrived at by working backwards from the rent.
In order to develop these examples, I am going to “meld” several properties together from the area of Memphis, TN that I generally work in. This area has a strong rental market and is in a nicer part of town. So rents will be on the higher end, but so will prices. The numbers are however typical for the area. However, the analysis will work for any property anywhere.
Let’s Begin.
We will look at two duplexes. One currently on the market, listed in the MLS by a Realtor and being offered for $195,000. The other is an off market deal in which the owner has asked you to make an offer. Is $195,000 anywhere close to a deal? What should you offer to the owner of the second property?
The Market Listing
The first thing we have to know about any property is the potential gross rent. What is the amount of rental income the property will bring in each month? After doing some research, you find that each side of this duplex will could bring as much as $750 per month or $1,500 total gross monthly rent. This is the first number you need for the analysis.
Now Work Backwards
First, go to the Shelby County Property Assessor’s website to look up property tax information. Here you can enter an address and get both the appraised and assessed value. Understand that duplexes in Tennessee that are non-owner occupied are assessed at 40% of appraisal, rather than the 25% rate for owner occupied properties. The amount of tax will therefore be higher than it would for a single family home of similar appraised value. Keep quirks like this in mind when looking in your area.
On the Property Assessor’s website we can also calculate the yearly amount of taxes. Upon doing so we find that the total yearly tax bill for this property (which is appraised at $150,000) is about $4,200 or $350 per month. This is the second umber you write on your sheet.
The third is the monthly insurance premium. After talking with your insurance agent you find that your yearly insurance premium will be $480 or $40 per month .
The third, fourth and fifth numbers to write down are easy. Simply take out 10% from the gross monthly rental income for maintenance, vacancy and reserves. These numbers total $150 each.
So this is where we are at so far.
Property A – Listed Duplex – $199,000
Gross Monthly Rental Income $1,500
Less Property Taxes $350
Less Property Insurance $40
Less Maintenance $150
Less Vacancy $150
Less Reserves $150
Remaining Balance $660
Now we need to add in the cost of using other people’s money.
Most likely, you are not going to have a spare $199,000 laying around to pay for this duplex. You are going to need to borrow that money and there is a cost for that, which is interest. You have to pay the money back along with interest every single month. This principal and interest payment is the last number we need for the analysis.
Let’s assume you are looking at your first or second deal and can get very good terms from a local bank. Terms that are similar to terms anyone else would get if they were buying their own home. As of this writing, interest rates are around 4.7% for a 30 year fixed rate mortgage. If you put 20% of $199,000 down ($40,000 for ease) on this particular property and thus borrowed $159,999 your monthly payment would be $829.82. You can adjust the amounts you borrow and other terms and calculate your monthly payment here.
After subtracting all of the expenses from the rental income, this property has negative cashflow. There is no deal here for you. This scenario is often the case here. That is just where the market for these types of properties are. The owner is likely hoping to sell on the retail market to an owner occupant looking for a little income.
The Unlisted Duplex
What about the second property? The one you found and are dealing directly with the owner. What price can you offer? To find out, do the same analysis, but play with the principal and interest payment a bit.
On this second property, let’s assume it’s a little bigger, and the gross monthly income is $2,000. Let’s run the same analysis.
Property B – Unlisted Duplex – $???
Gross Monthly Rental Income $2,000
Less Property Taxes (Higher appraisal too) $400
Less Property Insurance $40
Less Maintenance $200
Less Vacancy $200
Less Reserves $200
Remaining Balance $960
This property is looking a little better than the first one as there is still almost $1,000 per month cashflow before we look at the cost of using other people’s money. Let’s keep in mind that we are looking for at least $100 of cashflow per unit or $200 per month. That means you can afford to have a principal and interest payment of around $750 and still achieve your cashflow goals
Using the same criteria I used for the first example and assuming you put 20% down, the most you can offer for this property is around $175,000 as the monthly payment on $140,000 is just under $750.
Will the owner take that offer? Maybe. But I would start out with a lower offer, perhaps around $150,000 or so and see what the owner does. If you never ask, you never get. Plus, the owner might just take it. If not, perhaps something creative can be worked out.
It Can Be Hard To Find A Good Deal
Both of these examples demonstrate an easy way to calculate cashflow. Sometimes it can be hard to find good cashflow, especially in strong markets. Be aware that I did not add any money for repairs and also assumed you would manage the property yourself, so no management fees either. Many times, to find good deals you really have to dig deep or go into marginal areas where there is more risk.
Despite the examples I used, Memphis is a strong cashflow town. What about your market? Please share with your comments.
