In Depth Deal Analysis
I know a lot of people are turned onto Wholesaling by the Guru's and rightfully so if all you have to go off of is what they tell you.
For now lets look at how we might approach a duplex. A duplex has 2 units or 2 income streams. If you are purchasing an established duplex you need to look into the properties performance track record. If you went to the horse races you wouldn't bet on a horse you knew nothing about would you? So it makes sense that we need to ask for exact numbers. After all you are potentially going to buy the property and the books that come with it. So ask to have a look at:
- Property Taxes
- Operating Expenses
- Gross Scheduled Income
- Vacancy Rate
- Net Operating Income
- All Leases
We are looking to prove the numbers. For every number you prove with cold hard facts the chance of having something come back to bite you diminishes. The easy stuff is utilities, insurance, and taxes. If you need to manually look these things up you can.
- Call your local Utility company up and ask for the average cost of the target property.
- Call your local Insurance Provider and ask what insurance is costing in the area
- Look online at your city/county website for tax millage rate, assessment value, lot and structure dimensions, previous purchase price, who owns it
When looking at Operating Expenses do not include mortgage or Capital Additions. We are only looking for expenses that are necessary to keep the business/property running. I say business because this includes keeping the books, advertising, legal fees, etc. Operating Expenses include:
- Property Management
Everything above is pretty straight forward but what exactly is considered Property Management? Well it is more than just hiring a Property Management Company. Property Management is a term referred to the overall MRO (Maintenance, Repair, Operations) of your business. Anything the property needs in order to function, grounds keepers, CPA, Lawyer, Payroll, office supplies, etc.
When looking at operating expenses the more you can drill down into what exactly those expenses consist of the better. Each expense should have a category (like a ledger) that we can compare against our GOI. Such as: lawn care, maintenance, advertising, etc. (refer to Deal Analysis Overview)
Once you have your categories we can find just how big or small these expenses are by converting them to percent of GOI. To do this divide one of your expenses by the GOI. Now we can see whats really happening. Read on to find out what GOI is.
Gross Scheduled Income
GSI is the annual rents off of every unit you own no matter whether it is vacant or not. Put another way it is your potential annual rental income.
Gross Operating Income
GOI is your GSI or potential annual rental income minus your Vacancy. This gives you how much rent you actually collected. So this number is what you would actually use in finding the percent of GOI each expense is.
Net Operating Income
NOI is what you are left with after Operating Expenses. So take your GOI and subtract Operating expenses from it. Do not include Cap Ex or mortgage in this figure.
Unless you have an established rental you are buying that has history this figure is usually a guess. In my opinion if it is newly built and has not had much exposure, or you just want to be cautious, you could raise this number to 10%. Otherwise leave it around 5 or 6 percent.
Have a look at the lease agreements. Sometimes landlords haggle with people in return for a service. You need to know if Joe is getting free rent in exchange for maintaining the property.
Let's assume renters are liable to pay all utilities and mow grass. We are going to do the work unless professional services are needed. Click inside the frame below and use arrow keys to scroll.
Now what is our Cash Flow? Cash flow takes into account what is coming in and what is going out. So the formula is:
- minus Debt Service(Mortgage)
- minus Capital Additions
- plus Loan Proceeds
- plus Interest Earned
- = Cash Flow Before Taxes
- Cash Flow Before Taxes
- minus Income Tax
- = Cash Flow After Taxes
In the above example Capital Additions means major structural additions. Loan Proceeds means taking out a second mortgage or something of that nature. Interest Earned is money accruing interest in the bank account. Let's go over it:
- NOI = $11,610
- Debt Service is $150,000 @ 5% over 30 yrs = $9,660 annually
- We have no Capital Additions
- No Loan Proceeds
- No Interest Earned
- NOI - Debt Service = $1,947 Annual Cash Flow Before Taxes
- CFBT - Income Tax = Annual Cash Flow After Tax $1,558
Ask your CPA about your local Income Tax Rate for rent collected by a landlord.
This is an example of how a property sounds good but $1558 a year only equals $130 a month. We are still in the positive but this is no get rich quick scheme. If you would like to get more per month you will have to increase income or decrease expenditures.
References and Citations
- Gallinelli, Frank. What Every Real Estate Investor Needs To Know About Cash Flow. McGraw-Hill Education publishing, 2016.
Place ads here