Real Estate by the Numbers: a Complete Reference Guide to Deal Analysis by J Scott

Author:J Scott
Language: eng
Format: epub
Publisher: BiggerPockets Publishing

Scenario 1: Rehab

In Scenario 1, we’re going to hold off on renting out our new property for six months while we complete a rehab of the property. The cost of the rehab will be $120,000, and that money will be coming out of our pocket. But we expect that with this significant rehab, we’ll be able to raise rents from the current $2,200 per month to $3,600 per month. Furthermore, this renovation will help the property value and rent appreciate faster (3 percent each) than if we do not renovate (1 percent). Lastly, by upgrading the property, we’ll keep our expenses (which are heavily impacted by maintenance and repairs) down to $7,500 annually.

To summarize this option:

SCENARIO 1

Purchase Price $480,000

Financing 80%

Down Payment $96,000

Rehab & CapEx $120,000

Total Initial Investment $216,000

Rehab Time Frame 6 Months

Current Rent $2,200

Post-Rehab Rent $3,600

Rent Growth 3%

Property Appreciation 3%

Annual Expenses $7,500

Sale Price $645,079.86

Note that the anticipated sale price assumes 3 percent per year in property appreciation, but it doesn’t take into account any selling costs. If you were to do this analysis in the real world, you’d probably want to take those extra costs into consideration.

Scenario 2: No Rehab

In Scenario 2, we buy the house for the same price, but rather than taking six months and spending $120,000 to rehab the place, we rent the property immediately. We do need to invest $10,000 to replace the HVAC system and patch the roof, just as a precautionary measure. As a result, rents stay at $2,200 and the property value and rent only appreciate at 1 percent per year over the ten-year lifetime of our investment. Because we did not renovate the property, our annual expenses are a good bit higher, at $10,000 per year.

SCENARIO 2

Purchase Price $480,000

Financing 80%

Down Payment $96,000

Rehab & CapEx $10,000

Total Initial Investment $106,000

Rehab Time Frame N/A

Current Rent $2,200

Post-Rehab Rent $2,200

Rent Growth 1%

Property Appreciation 1%

Annual Expenses $10,000

Sale Price $530,218.62

Without doing any math, what does your gut tell you the better deal is? Scenario 1 requires an extra $110,000 in out-of-pocket expenses early in the project, but it also provides significantly more monthly income, and the extra $110,000 in rehab costs is more than recouped at sale.

Luckily, we don’t have to rely on our gut anymore. We have the perfect tool to answer the question of whether we should be doing the rehab: internal rate of return. Let’s look at the IRR analysis for each of these scenarios.

For Scenario 1, this is what our Excel model would look like. (Note that we’ve done the math for you for each year to take into account all the inflows and outflows from purchase, rent, expenses, etc.)

YEAR CASH FLOWS

Jan-22 0 -$201,900

Jan-23 1 $36,996

Jan-24 2 $38,331

Jan-25 3 $39,706

Jan-26 4 $41,122

Jan-27 5 $42,581

Jan-28 6 $44,083

Jan-29 7 $45,631

Jan-30 8 $47,224

Jan-31 9 $48,866

Jan-32 10 $645,080

IRR 25.85%

And this is what our Excel model would look like to calculate the IRR for Scenario 2:

YEAR CASH FLOWS

Jan-22 0 -$102,800

Jan-23 1 $17,192

Jan-24 2 $18,008

Jan-25 3 $18,848

Jan-26 4 $19,713

Jan-27 5 $20,605

Jan-28 6 $21,523

Jan-29 7 $22,469

Jan-30 8 $23,443

Jan-31 9 $24,446

Jan-32 10 $530,219

IRR 28.

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