Deal Analysis Help

[Sara Conner]

Hi everyone,

I am brand new to all of this. Currently in the information gathering stage. I'm looking at properties with Rent to Retirement. The numbers on their properties look good. But when I check them against the bigger pockets calculator, I come up with negative returns. In fact, every property I look at comes up with negative returns on the BP Calculator. Am I doing something wrong?

[Sara Conner]

Thank you for that insight. I’m currently reading Dave Meyer’s book on deal analysis and Brandon Turner’s book on rental property investing. Hopefully I’m able to find something so I can pull the trigger on my first deal. 

[Zach Lemaster]

@Sara Conner Thanks for the interest.  I would help to know exactly what numbers you are inputing into the calculator and what deals you are evaluating.  I think the majority of the confusion likely comes from the fact that most all of the builders that have inventory on our marketplace are offering unique incentives like extensive rate buy downs, free PM & maintenance guarantees, up to 10% price reductions or up to 10% cash back, etc.  Things like that are often challenging to translate exactly to a rental calculator if you are not quite sure how to input these details.  So it would help to know the specific numbers and exact property you are considering so we can help you identify what numbers may be input incorrectly.  We are here to help however we can. 

[Sara Conner]

@Zach Lemaster okay here is an example of one that I just ran. It comes from the rent to retirement website. This particular property is in Indianapolis. They state there is a 16% ROI. Price is 153,000. 3 beds 1 bath. Class C neighborhood. Currently leased. 25% down. First year no PM cost. (After that I would factor in 8% so that is what I put in BP calculator for rental properties). Closing costs will vary. So for fun I put 5%. Rent is $1330. Annual property tax $451. No HOA. Annual insurance $850.

Bigger Pockets calculator asks the following:
Purchase Price: 153,000

closing costs 7650 (5%)

20% down 30600

Interest rate 6.5% 30 year loan

Rent $1330

Property Taxes 451/yr

Insurance 850/yr

CapEx 5% ($66/month)

Repairs 5% ($66/month)

Vacancy 3% ($39/month)

Management 8% ($106/month)

Leave utilities blank assuming the tenant puts them in their name, BP calculator gives me 5.33% CoC ROI, which is better than what I originally did. I changed some of the numbers, like putting 20% down instead of 25%. But where do they get a 16% return from?

[Zach Lemaster]

@Sara Conner This is very helpful. Thanks for sharing details. The pro forma the builder put on our page shows 11.5% CoC ROI (if you look at the bottom of the page where the ROI is broken out). The 16% ROI includes the loan pay down after year one coming from the amortization schedule along with breaking out other ROI considerations. I think the other discrepancies are likely from these inputs:

-closing costs at 5% would be too high for this type of home.  We are not seeing closings costs at the $8K range on a $150K home.  You are likely about half of that if (unless you pay points to buy the rate down).  Please note the builder on this is buying the rate down for you already some.

-20% down vs 25% down will affect ROI as well.

-Property management is 0 for first year since mngt is covering that, but you would want to increase it to 8% for year 2.  However, you would also need to increase rent by 4% for year 2 since the team builds in a 4% rent increase year two.  Don't forget to increase rents over time just as you would increase maintenance, etc.

-Insurance seems accurate.  You certainly could include 5% capex, but this seller has not as the home has been recently renovated or newly built, meaning you would not expect large capital expenditures within the first 5 years at least.  I think after that timeframe it would make since to include capex.  Completely up to you of course, but on a new construction home or renovated property, the first few years should limit capex unlike a home that is not new construction or renovated.  I assume that is where a good portion of the variance is coming from.

Great job diving into the numbers on the properties as that is always good practice and allows you to better understand what numbers you want to input on the various types of assets you explore investing in.  On the RTR website under education, then tools, we have a free portfolio calculator that I highly encourage you to play around with as well as that allows you to evaluate both individual properties, but also a portfolio as a whole.  Most importantly, it helps you future project anticipated equity, cash flow and net worth based on whatever variables you want to input for things like appreciation, rental increases, loan terms, etc.  We developed this out of necessity for our own investment planning as we simply could not find a portfolio calculator online that also allowed for this.  I'm sure that will be a very valuable tool.

Hope this all helps.  Don't hesitate to reach out with any questions at all.  We are here to assist you with any properties you are looking to invest in on our site or anywhere.

To your success, 

Zach

[Sara Conner]

@Zach Lemaster I have a phone call with Tommy tomorrow

[Zach Lemaster]

@Sara Conner Fantastic!  He will be able to give you absolute clarity on this and ensure you have a full understanding of all the different inputs/outputs for each specific deal as they all vary.  Having a call with the team to gain clarity and directly answer your questions is the best thing you can do!  We look forward to speaking with you.

[Jake Berlin]

Quote from @Zach Lemaster:

@Sara Conner This is very helpful. Thanks for sharing details. The pro forma the builder put on our page shows 11.5% CoC ROI (if you look at the bottom of the page where the ROI is broken out). The 16% ROI includes the loan pay down after year one coming from the amortization schedule along with breaking out other ROI considerations. I think the other discrepancies are likely from these inputs:

-closing costs at 5% would be too high for this type of home.  We are not seeing closings costs at the $8K range on a $150K home.  You are likely about half of that if (unless you pay points to buy the rate down).  Please note the builder on this is buying the rate down for you already some.

-20% down vs 25% down will affect ROI as well.

-Property management is 0 for first year since mngt is covering that, but you would want to increase it to 8% for year 2.  However, you would also need to increase rent by 4% for year 2 since the team builds in a 4% rent increase year two.  Don't forget to increase rents over time just as you would increase maintenance, etc.

-Insurance seems accurate.  You certainly could include 5% capex, but this seller has not as the home has been recently renovated or newly built, meaning you would not expect large capital expenditures within the first 5 years at least.  I think after that timeframe it would make since to include capex.  Completely up to you of course, but on a new construction home or renovated property, the first few years should limit capex unlike a home that is not new construction or renovated.  I assume that is where a good portion of the variance is coming from.

Great job diving into the numbers on the properties as that is always good practice and allows you to better understand what numbers you want to input on the various types of assets you explore investing in.  On the RTR website under education, then tools, we have a free portfolio calculator that I highly encourage you to play around with as well as that allows you to evaluate both individual properties, but also a portfolio as a whole.  Most importantly, it helps you future project anticipated equity, cash flow and net worth based on whatever variables you want to input for things like appreciation, rental increases, loan terms, etc.  We developed this out of necessity for our own investment planning as we simply could not find a portfolio calculator online that also allowed for this.  I'm sure that will be a very valuable tool.

Hope this all helps.  Don't hesitate to reach out with any questions at all.  We are here to assist you with any properties you are looking to invest in on our site or anywhere.

To your success, 

Zach

 Dear Sara, 

Congrats on looking to get into the real estate game. When buying your first rental property, or any, you probably should not bet on rents going up 4% per year. Though rents are likely to increase, market rents can also decrease. Betting on rents to increase overtime can be detrimental to your cash flow. Rents don't always increase, but expenses, such as property taxes and insurance do. 

Zach does bring up a few very good points about closing costs likely being too high and adding rent appreciation to your proforma. Just be very careful about betting on a 4% increase every year. 

[Dan H.]

Quote from @Zach Lemaster:

@Sara Conner This is very helpful. Thanks for sharing details. The pro forma the builder put on our page shows 11.5% CoC ROI (if you look at the bottom of the page where the ROI is broken out). The 16% ROI includes the loan pay down after year one coming from the amortization schedule along with breaking out other ROI considerations. I think the other discrepancies are likely from these inputs:

-closing costs at 5% would be too high for this type of home.  We are not seeing closings costs at the $8K range on a $150K home.  You are likely about half of that if (unless you pay points to buy the rate down).  Please note the builder on this is buying the rate down for you already some.

-20% down vs 25% down will affect ROI as well.

-Property management is 0 for first year since mngt is covering that, but you would want to increase it to 8% for year 2.  However, you would also need to increase rent by 4% for year 2 since the team builds in a 4% rent increase year two.  Don't forget to increase rents over time just as you would increase maintenance, etc.

-Insurance seems accurate.  You certainly could include 5% capex, but this seller has not as the home has been recently renovated or newly built, meaning you would not expect large capital expenditures within the first 5 years at least.  I think after that timeframe it would make since to include capex.  Completely up to you of course, but on a new construction home or renovated property, the first few years should limit capex unlike a home that is not new construction or renovated.  I assume that is where a good portion of the variance is coming from.

Great job diving into the numbers on the properties as that is always good practice and allows you to better understand what numbers you want to input on the various types of assets you explore investing in.  On the RTR website under education, then tools, we have a free portfolio calculator that I highly encourage you to play around with as well as that allows you to evaluate both individual properties, but also a portfolio as a whole.  Most importantly, it helps you future project anticipated equity, cash flow and net worth based on whatever variables you want to input for things like appreciation, rental increases, loan terms, etc.  We developed this out of necessity for our own investment planning as we simply could not find a portfolio calculator online that also allowed for this.  I'm sure that will be a very valuable tool.

Hope this all helps.  Don't hesitate to reach out with any questions at all.  We are here to assist you with any properties you are looking to invest in on our site or anywhere.

To your success, 

Zach

 >You certainly could include 5% capex, but this seller has not as the home has been recently renovated or newly built, meaning you would not expect large capital expenditures within the first 5 years at least. 

when a product is placed into service its lifespan has started. Not allocating cap ex and maintenance because an item is not expected to fail soon is simply providing a misleading return estimate.  

10% maintenance/cap ex ($132) is less than half of reality and maybe less than 1/3 of reality.  

cap ex/maintenance is not a function of rent and I dislike that BP represents it as such.   In fact it can be an inverse function of rent.  2 properties otherwise the same one in c- area the other in A- area.  Which will have higher rent?   The A- area.  Which will have higher maintenance/cap ex?  The c- area.  

I highly suspect maintenance/cap ex over long hold to be closer to $400/month than $132/month and it will in no way be $0/month and leaving it out to inflate the return for any reason including it has just been rehabbed or is new construction is absurd and misleading.    Class c area, calling it at near ~$400/month long term. 

My underwriting would show this property far worse than the PB calculator showed for the OP.  In addition, I do not believe there is a large market in the US with 3% vacancy/missed payment.   maybe 3% vacancy but add missed payments in and it is higher.  

I take less issue with equity pay down but this certainly has a cost to access.  Did you include that cost in the underwriting?

I am shocked that you actually wrote that seller did not include any maintenance/cap ex.  I would not believe any part of the pro forma provided by the seller on the basis of this alone and encourage the OP to go likewise.  

by the way nothing you indicated in your calculator except for potentially anything to support portfolio calculations is not in the BP calculator. 

best wishes.  

[Drew Sygit]

3% vacancy factor for a Class C rental?

What about tenant-nonperformance?

What FICO score range are the targeted renters expected to have?

The lower the expected FICO score range, the HIGHER the Vacancy/Nonperformance percentage should be!