My First Deal by the Numbers - Before We Bought

In November 2017, I bought my first rental property. This post outlines my thinking before I bought the property, and unlike other posts in this blog, it does not have the benefit of hindsight.

I plan to provide updates on this property after the property is rented, and then again after I refinance, so you can see my actual ROI.

THE PROPERTY

5270 Mount Pleasant Center St, Greenwood, Indiana

Zillow

THE STRATEGY

• Buy a distressed home in need of repairs well below market value. Most distressed homes must be purchased in cash up front without a mortgage.
• Repair home.
• Rent home.
• Refinance home. Purchase home with cash and get a mortgage after all repairs are complete, so the mortgage reflects the after repair value (ARV) of the home, not the purchase price.

THE NUMBERS

Below are all of the key financial assumptions to estimate:

• Cash on Cash Return - annual cash flow from rent net costs divided by cash left in home after refinance
• ROI - annual value gained in home from cash flow, paying down mortgage, and appreciation divided by cash left in home
• Equity Gained in Home - what I would earn if I immediately sold the home (not counting closing costs from sale)

Google Sheet with Detailed Metrics

The key points to understand are:

• After I refinance the home, I should get most of my money back. Only $20,000 is left in the home. Therefore, all ROI goals should assume this investment only cost $20,000.
• It’s important to distinguish what your return is with and without selling the home. Without selling the home, you only receive the rental income net costs. When you sell the home, you also capture gains from equity gained by paying down the mortgage, appreciation, and the discount from by below market price.

There are many other ways to evaluate the success of a real estate investment. You can get a lot more detailed. However, I think these are the most important for your typical single family home investor.

THE INTANGIBLES

These are the basic metrics I use to evaluate deal quality, but there are other “fuzzy factors” to consider. For example, this home is in a great school district, and there aren’t many good schools close enough from Mom and Dad to commute to downtown Indianapolis for work. Because these homes are scarce, their value is more likely to appreciate, and they’re less likely to be vacant.

In addition, this neighborhood is a very tight community, and the neighbors take care of their homes. There's also a new development being built next to this neighborhood with slightly nicer properties. When that happens, typically the adjacent neighborhood’s home values increase too.

Last but not least, this is the type of community where a tenant with a family is more likely to stay long term. It’s possible that the right tenant will even pay above market price to buy the home.

All of the above increase the likelihood I’ll beat the numbers, which are already strong, and mitigate downside risk.

FUTURE UPDATES

Or the rehab costs could blow up. The property could sit vacant for months. The actual rent price may be lower and the ongoing repairs may be higher than expected. Who knows!?...

That’s why I plan to do lookback posts after the property is rented and refinanced. Stay tuned.