Wednesday, January 20, 2010

Arithmetic.

So. In trying to decide which property to pursue, and which ones to drop, I have been trying to figure out the final selling prices for these places. Since there are not many good comps (other properties that are similar and have sold lately) to look at, I have been leaning on a friend of mine for advice. He lives in Philadelphia and his job deals with huge buildings full of apartments. I have no idea what he does, but he's helpful.

That in mind, I asked him how I could go about finding a realistic final selling price for an apartment building. He told me about the Capitalization Rate, or Cap Rate. I could use the Cap Rate to figure out what a fair selling price would be, when finished. The Cap rate is the ratio between the Net Operating Blah Blah Blah...

Basically, it's how much the property will make you per year, divided by the cost.

A simple enough equation, even for people like me who are terrible at math (If I were any good at math, my SAT score would have blown away Dan's. Sadly, I stunk, and still do).

I tried my best, using some information from the owner of the property, to figure out the final selling price for the first property we visited on Sunday.

Here are some specifics:

The math is based upon renting out all four of the units.

The monthly income is $3,350. That number is based upon the actual rents the previous owner was charging, so I could probably get a little more per month, since the units would be pristine, plus I would add pay laundry in the basement.

The monthly expenses, not including the mortgage payment, but including taxes and insurance, are $1,371. These numbers are also straight from the current owner. I think I could get the expenses down a bit (no air conditioners, make tenants split gas/water/electric, etc), but I can't guarantee it, so I went with the numbers I was given.

With those numbers in mind, I attempted to figure out the monthly mortgage payment that would give the property a Cap Rate of about 10%, which is a decent return.

I crunched a bunch of different selling prices, but for the purposes of this post, I will only include the one I arrived upon.

Final Selling Price = $155,000

20% down payment from the potential buyer = $31,000

Total mortgage amount = $124,000

Estimated monthly payment with a 6% conventional mortgage = $744

Income ($3,350) minus expenses ($1,371 and $744) = $1,235 = Monthly Net Operating Income

Yearly Net Operating Income = $1,255 times 12 = $14,820

To get the Capitalization rate, I take the yearly Net Operating Income, and divide it by the cost, which is the purchase price.

$14,820 divided by $155,000 = .096 or roughly 10%.

Using a Cap Rate of 10%, I could feasibly sell this house at $155k. I have asked John McCann, Realtor, to provide me with what Cap Rates are selling in and around Providence, so I may have to adjust my number to accommodate.

That said, $155k looks pretty good to me. If I could shed some costs and charge more in rent per unit, that number could be even better.

Also, there is probably a much easier way of figuring all of this out, but since, again, I'm terrible at math, I don't know it.

Thanks Greg.

1 comment:

Robert said...

It may also help to create a proforma to see how different scenarios (rent changes, vacancy rates) will affect your bottom line. They're pretty straightforward and excel does most of the work for you.