A Closer Look At "The Numbers"

Show Me the Money – After Closing

Despite what a lot of overly aggressive Realtors in the industry and at seminars will tell you, it´s not enough just to look at the principal and interest and taxes expense of an investment property to realistically calculate cash flow. Here are the seven expenses you´ll need to budget for in your pro forma:

• Principal – the monthly expense to pay down your principal. The principal paid down on a 15 or 30 year note increases or "amortizes" over the course of loan period. The first few years, the majority of your payment goes towards interest (with the associated tax benefits), while later years more of the payment goes to the principal.
• Interest – interest is the fee the bank gets in exchange for loaning you the money to buyer the property. Though some investors swear by "interest only" loans, we´re not big fans of them, and don´t feel they should be necessary in order to justify a real estate investment. Matt and Martha´s principal and interest payment per the above example: $857/mo
• Taxes – taxes are higher in Texas than some other states and their calculation is not based on purchase price (see below for further explanation). Generally, the county appraises property less than actual market value, and with 2007 tax rates decreasing per legislation, one can use a factor of 1.9% times purchase price as a good estimator of annual taxes. Matt and Martha´s taxes: $292/mo
• Insurance – insurance rates range from $600/yr to $1000/yr depending on the carrier. (See section on insurance for more details and recommendations). Matt and Martha´s insurance: $58/mo
• Maintenance – it´s important that a thorough inspection be performed at the time of purchase to ensure any soon-to-be-expenses are addressed before they become expenses. Many months will go buy with no costs being incurred, but inevitably chaos theory reigns, and air conditioners and roofs will need to be replaced. We generally like to suggest a 5% (of rents) maintenance factor for projecting expenses: $75/mo
• Management – fees tend to range from 6% for "bare bones" management to as high as 8% or more for full service management. We do NOT recommend out of state investors avoid hiring a professional property manager to look after their asset. Monthly expense: $90/mo
• Vacancy – tenants can and do sometimes move out. With good management and pre-screening, vacancy should be kept at a minimum and rents do rise, but we like to assume a 5% vacancy rate to ensure our figures are conservative: $75/mo

Current Rental Income: $1500/mo

(Minus) Current Expenses (sum of above): $1447

Total Cash Flow: Positive $53/mo

Indeed this is not the "King´s Ransom" in monthly cash flow that some call us initially hoping it will be.

However, let´s take a similarly conservative look at Matt and Martha´s next five years of ownership of this property. Recall that we´ve already accounted for all expenses (including vacancy and repairs to the property). There is a fancy version of this cash flow spreadsheet further below that you may download and play "what if" scenarios all day long.

2007, Property Purchased

2008, 6% Property appreciation, 2% rental price appreciation
Market Value: $196,000 Year´s Positive Cash Flow: $1044

2009, 5% Appreciation, 3% rental appreciation
Market Value: $205,800 Year´s Positive Cash Flow: $1400

2010, 7% Appreciation, 0% rental appreciation
Market Value: $220,206 Year´s Positive Cash Flow: $1400

2011, 7% Appreciation, 2% rental appreciation
Market Value: $235,620 Year´s Positive Cash Flow: $1700

2012, 3% Appreciation, 4% rental appreciation
Market Value: $242,700 Year´s Positive Cash Flow: $2200

2013, 6% Appreciation, Property Sold
Market Value: $257,250 Year´s Positive Cash Flow: $2200

Cost of sale – 7% x $257,250 = $239,000

$239,000 net sale proceeds minus mortgage payoff of $135,000 (adjusted for 5 years principal paydown)

Total cash return is $104,000, profit is $54,000

5 year return on investment with 20% down – 146% (more if adjusting for pos cash flow)

5 year return on investment with 10% down – 234% (less if adjusting for neg cash flow)

Now – let´s see you compare this to your blue chip large cap indexed stock fund – I bet we beat it.

Next Page: Other Expenses