Question by Lai L: “Investment property” – - in-laws are renting!?
I have a single family investment property that is rented out to my in-laws. They pay the mortgage and ANY and ALL maintenance/upgrades to the house. (I essentially purchased it for them-they will buy from my in 2 years!) — reminder – Currently it is my house, I’m on mortgage/deed, etc….
Issue – The mortgage payment is a direct withdrawal coming directly from their checking to bank. I do not pay out of my account. Also, maintenance and upgrades, utilities are all paid by them…Basically I used my income and credit to BUY them a house until they can get established.
FYI – they can afford the house no problem…
Question – Since I will be claiming mortgage and expenses, also reporting the rental income on Sch-E, if I were to get audited, will the IRS be looking for those receipts? The receipts I will have, as I’ve told them to keep all receipts for all purchases.
However, since all is paid by them and NO evidence of paid by me, would that be a problem for me?
Best answer:
Answer by robert w if they ask u may need representation.
contact quailified CPA with real knowledge of tax issues.
When toying with the idea of a property investment opportunity, you have to make sure you do all your homework right out of the gate. Hands up all those who just jumped straight in and lost cash because they “thought” they knew what they was doing and didn’t listen to a professional? Ok, I see a few hands, well, more than a few.
One of the biggest mistakes people make, is in the thinking that if they buy a “lemon”, that they can make “lemonade” for pennies in renovations. Think again! Real estate investment has to be structured just like any business. You have to keep track of your bills, in-comings and outgoings and you had better have the right tools in place before you start otherwise you’ll be back in the same boat as others in losing money, could be worse, you might end up being captain of the boat if you are not careful!
Be prepared.
Yes I know, an old scout cliché BUT being prepared will seriously cut your time and energy losses basically down to zero.
Do you have your plans laid out? Are you looking for a beachfront property investment or a condo property investment? Are you looking to renovate a “fixer-upper” or do you want something ready to go right out of the box. What is your budget? What contractors have you lined up for your projects that need some repair? Have you spoken to a tax investment property specialist? Have you thought on how to finance investment property? Do you know the fees for buying and selling a property within your local area? Is your investment going to finance commercial properties? If you can’t answer yes to a lot of these questions, then you are not ready for the property investment opportunity market. If your answer answer is “No BUT I want to know how”, then maybe, just maybe you are smart enough to realize that you can capture what you are missing financially by doing things smarter.
One thing people don’t do, which drives me crazy, is tell their friends that they are in the foreclosure property investment business. Why hide what you do from your friends when they can actually be networking for you? It’s insane to hide anything about your business from anyone. Be proud of the business you are in, or are going to get into. Just because someone else’s financial burden was too much, as in a property foreclosure, doesn’t make you the bad guy/gal. You never called their lien/note now did you? So stop acting like you are hiding national secrets and blurt it out from the highest tower,” I’m in business and it feels great”.
Whenever you look at a property, make sure you have a plan for it before signing any papers. If the property you are looking at doesn’t fall anywhere in any category you had in mind, you might want to do the following: Find someone else to which that property WILL fall into their category and ask for a possible finder’s fee. Who says you can’t make money at just doing that? Not me!
Lets cover one topic very quickly “How to finance investment property”. There are many MANY ways to go about this. One of these many ways is “seller financing.” What the heck does that mean? In a nutshell, the seller allows you, the borrower, to use a portion of the home equity to finance the purchase. That’s just one definition, another one would be: “An agreement in which the property seller also acts as the lender.”
There are oodles of ways to finance a property purchase and I just gave 2 definitions. You can also use Wikipedia to search for such terms such as “seller financing”, “creative-financing”, “real estate terms” to find the right terminology that’s easily understood by you, so….
I am not a professional within this business by any means but let me tell you one thing. Having all the right information is worth more gold than Solomon has! Dig that information up, its right in front of you. No you won’t find it on any porn pages, that’ll get you nowhere, part from blind! I would hate to think where I would be if I had just gone on a whim with my business and not listened and researched the information I wanted. Probably Captain of the aforementioned boat with an upgrade to Admiral looming large!
on that note, I won’t ramble anymore but what you have just read is my own opinion and experiences within the property investment opportunity business. I have defined a set of rules to which I abide by in this industry and it just plain works. Don’t try to overthink the whole process, because it is just that, a process of learning. Be a sponge on information that moves you ahead. Don’t stick your head in the sand if you get stuck. Find the right materials, study the materials, inhale them in fact. The more you know, the more you know, the more you know! As a heads up, the materials I use are from Charissa Cawley, which, in my honest opinion are second to none. Again, that’s my opinion and the materials I use, along with search engines of course. Happy house hunting and always remember, the key is YOU and how much time and effort you are willing to put into yourself!
Working as a self-employed Graphics artist, I had to expand my horizons because the market was being outsourced to different Countries too much for my liking and that’s when I found, well it found me, the investment property business. I haven’t looked back since!
Question by Princess: What is “Investment Property”?
I understand the concept of purchasing a piece of real estate simply to gain a profit. But I interviewed today for a Property Manager position for a rental property that is converting to condo. The owner kept referring to a percentage of the units that were “investment units” mandated by the village. The others were “rented” and “owned”. What was he referring to?
Best answer:
Answer by kella l He’s putting an investment into it to make a big chunk of change back out of it is all he’s referring to. Fixing up a house or apartments or any real estate property is considered an investment property because they are investing more into it to make more out of it. Hope this helps….Good luck on the job!
Question by Deke: Are the words “great investment property” on a private residence listing a red flag?
I found a home listing in near my office yesterday that is in a good neighborhood, has a great price, and without having seen the inside of the house, seems like a great deal. The listing, however, reads “Great investment property”. This makes me wonder if it needs a LOT of work, or if there are other issues for which I should avoid the place altogether.
Thoughts?
Best answer:
Answer by C W I’ve been looking for houses and I’ve observed that this either means:
1. The house is in a horrible neighborhood – and the investment is that you clean it up and rent it to someone who doesn’t have a lot of money. Other code words for this is (“great cash-flow property” or “convenient location”)
or
2. It needs work (another code word sentence in the listing is “it needs a little tlc”).
The amount of work that the place needs might be minimal. It could be mostly cosmetic – or perhaps there is a major problem. There is no way to tell.
If you are truly interested, go and take a look at it. Look for stuff like visible evidence of mold, termites, water leaks. Look at how old the appliances are, particularly the heat pump, water heater – look at the roof – what type is it? Does it need a lot of work? Look at the condition of the house. If you think it looks ok and you want it, when you make an offer, do it so that it is contingent upon your right to inspect the property. Hire a professional to inspect it (should cost you a couple of hundred bucks). They should inspect all major systems in the house and give you a report of the findings. If they find problems, then you can back out of the contract for the house. Simple!
www.MountaintopMTG.net Using Pay Option ARMs can turn an under performing investment property into a cash machine. You need to take a few things into consideration first. . . Video Rating: 2 / 5
PositiveCashFlowInvesting.com – Buy turnkey residential investment property with your 401k or IRA. Did you know you can buy a 000 house that has a 0 positive cash flow without having to become a landlord? Buy turnkey real estate the way the big dogs do. Do you really think Donald Trump is unclogging tenants’ toilets at 3 in the morning?
Building financial models is an art. The only way to improve your craft is to build a variety of financial models across a number of industries. Let’s try a model for an investment that is not beyond the reach of most individuals — an investment property.
Before we jump into building a financial model, we should ask ourselves what drives the business that we are exploring. The answer will have significant implications for how we construct the model.
For example, a financial institution such as a bank is driven by its assets (investments, loans, mortgages, etc.), therefore we would probably be better off forecasting the growth of the company’s balance sheet. A retail store, on the other hand, is driven by the sales of its products. Therefore, we should focus on forecasting revenues and the income statement.
Other questions to ask are who will be using this model and what will they be using it for? A company may have a new product for which they need to calculate an optimal price. Or an investor may want to map out a project to see what kind of investment return he or she can expect.
Depending on these scenarios, the end result of what the model will calculate may be very different. Unless you know exactly what decision the user of your model needs to make, you may find yourself starting over several times until you find an approach that uses the right inputs to find the appropriate outputs.
In our scenario, we want to find out what kind of financial return we can expect from an investment property given certain information about the investment. This information would include variables such as the purchase price, rate of appreciation, the price at which we can rent it out, the financing terms available fore the property, etc.
Our return on this investment will be driven by two primary factors: our rental income and the appreciation of the property value. Therefore, we should begin by forecasting rental income and the appreciation of the property in consideration.
Once we have built out that portion of the model, we can use the information we have calculated to figure out how we will finance the purchase of the property and what financial expenses we can expect to incur as a result.
The next section we can tackle is forecasting the property management expenses. We will need to use the property value that we forecasted in order to be able to calculate property taxes, so it is important that we build the model in a certain order.
Once we have these projections in place, we can begin to piece together the income statement and the balance sheet. As we put these in place, we may spot items that we haven’t yet calculated and we may have to go back and add them in the appropriate places.
Finally, we can use these financials to project the cash flow to the investor and calculate our return on investment.
Since we are about to build a somewhat complicated model, we should think about how we want to lay it out so we keep our workspace clean. In Excel, one of the best ways to organize financial models is to separate certain sections of the model on different worksheets.
By putting calculations and projections that are closely related in the same worksheet and separating other calculations that are more relevant to other sections of the model on separate tabs (worksheets), we keep our model organized.
We can give each tab a name that describes the information contained in it. This way, other users of the model can better understand where data is calculated in the model and how it flows.
In our investment property model, let’s use four tabs: property, financing, expenses and financials. Property, financing and expenses will be the tabs on which we input assumption and make projections for our model. The financials tab will be our results page where we will display the output of our model in a way that’s easily understood (in the form of financial statements).
First Things first, let’s start with the property tab by renaming the tab “Property” and adding this title in cell A1 of the worksheet. By taking care of some of these formatting issuing on the front end, we’ll have an easier time keeping the model clean.
Next, let’s set up our assumptions box. A few rows below the title, type “Assumptions” and make a vertical list of the following inputs:
Purchase Price
Initial Monthly Rent
Occupancy Rate
Annual Appreciation
Annual Rent Increase
Broker Fee
Investment Period
In the cells to the right of each input label, we’ll set up an input field by adding a realistic placeholder for each value. We will format each of these values to be blue in color. This is a common modeling convention to indicate that these are input values. This formatting will make it easier for us and others to understand how the model flows. Here are some corresponding values to start with:
0,000.00
,550.00
95.00%
3.50%
1.00%
6.00%
4 years
The purchase price will be the price we expect to pay for a particular property. The initial monthly rent will be the price for which we expect to rent out the property. The occupancy rate will measure how well we keep the property rented out (95% occupancy will mean that there will only be about 18 days that the property will go un-rented between tenants each year).
Annual appreciation will determine the rate that the value of our property increases (or decreases) each year. Annual rent increase will determine how much we will increase the rent each year. The broker fee measures what percentage of the sale price of the property we will have to pay a broker when we sell the property.
The investment period is how long we will hold the property for before we sell it. Now that we have a good set of property assumptions down, we can begin to make calculations based on these assumptions.
There are many ways to begin forecasting out values across time. You could project financials monthly, quarterly, annually or some combination of the three. For most models, you should consider forecasting the financials monthly during the first couple years.
By doing so, you allow users of the model to see some of the cyclicality of the business (if there is any). It also allows you to spot certain problems with the business model that may not show up in annual projections (such as cash balance deficiencies). After the first couple of years, you can then forecast the financials on an annual basis.
For our purposes, annual projections will cut down on the complexity of the model. One side effect of this choice is that when we begin amortizing mortgages later, we will wind up incurring more interest expense than we would if we were making monthly principal payments (which is what happens in reality).
Another modeling choice you may want to consider is whether to use actual date headings for your projection columns (12/31/2010, 12/31/2011, …). Doing so can help with performing more complex function later, but again, for our purposes, we will simply use 1, 2, 3, etc. to measure out our years. In Excel, we can play with the formatting of these numbers a bit to read:
Year 1 Year 2 Year 3 Year 4 …
These numbers should be entered below our assumptions box with the first year starting in at least column B. We will carry these values out to year ten. Projections made beyond ten years do not have much credibility so most financial models do not exceed ten years.
Now that we have set up our time labels on the “Property” worksheet, we are ready to begin our projections. Here are the initial values we want to project for the next ten years in our model:
Property Value
Annual Rent
Property Sale
Broker Fee
Mortgage Bal.
Equity Line Bal.
Net Proceeds
Owned Property Value
Add these line items in column A just below and to the left of where we added the year labels.
The property value line will simply project the value of the property over time. The value in year one will be equal to our purchase price assumption and the formula for it will simply reference that assumption. The formula for each year to the right of the first year will be as follows:
=B14*(1+$ B)
Where B14 is the cell directly to the left of the year in which we are currently calculating the property value and $ B is an absolute reference to our “Annual Appreciation” assumption. This formula can be dragged across the row to calculate the remaining years for the property value.
The annual rent line will calculate the annual rental income from the property each year. The formula for the first year appears as follows:
=IF(B12>=$ B,0,B5*12*$ B)
B12 should be the “1″ in the year labels we created. $ B should be an absolute reference to our investment period assumption (the data in our assumption cell should be an integer even if it is formatted to read “years,” otherwise the formula will not work). B5 should be a reference to our monthly rent assumption, and $ B should be an absolute reference to the occupancy rate.
What this function says is that if our investment period is less than the year in which this value is to be calculated, then the result must be zero (we will no longer own the property after it is sold, so we can’t collect rent). Otherwise, the formula will calculate the annual rent, which is the monthly rent multiplied by twelve and then multiplied by the occupancy rate.
For subsequent years, the formula will look similar to:
=IF(C12>=$ B,0,B16*(1+$ B))
Again, if the investment period is less than the year in which this value is to be calculated, then the result will be zero. Otherwise we simply take the value of last years rental income and increase it by our annual rent increase assumption in cell $ B.
Now that we have forecasted property values and rental income, we can now forecast the proceeds from the eventual sale of the property. In order to calculate the net proceeds from the sale of our property, we will need to forecast the values mentioned above: property sale price, broker fee, mortgage balance and equity line balance.
The formula for forecasting the sale price is as follows:
=IF(B12=$ B,B14,0)
This formula states that if the current year (B12) is equal to our investment period ($ B) then our sale price will be equal to our projected property value in that particular year (B14). Otherwise, if the year is not the year we’re planning to sell the property, then there is no sale and the sale price is zero.
The formula to calculate broker fees takes a similar approach:
=IF(B18=0,0,B18*$ B)
This formula states that if the sale price for a particular year (B18) is equal to zero, then broker fees are zero. If there’s no sale, there’s no broker fees. If there is a sale then broker fees are equal to the sale price (B18) multiplied by our assumption for broker fees ($ B).
Our mortgage balance and our equity line balance we will calculate on the next worksheet, so for now we will leave two blank lines as placeholders for these values. Our net proceeds from the property sale will simply be the sale price less broker fees less the mortgage balance, less the home equity line balance.
Let’s add one more line called “Owned Property Value.” This line will show the value of the property we own, so it will reflect a value of zero once we have sold it. The formula will simply be:
=IF(B12>=$ B,0,B14)
B12 refers to the current year in our year label row. $ B refers to our investment period assumption, and B14 refers to the current years value in the property value line we calculated. All this line does is represent our property value line, but it will show zero for the property value after we sell the property.
Now let’s model how we will finance the property acquisition. Let’s name a new tab “Financing” and add the title “Financing” at the top of the worksheet. The first thing we need to know is how much we need to finance.
To start, let’s type “Purchase Price” a few lines below the title. To the right of this cell make a reference to our purchase price assumption from the “Property” tab (=Property!B4). We will format the text of this cell to be green because we are linking to information on a different worksheet. Formatting text in green is a common financial modeling convention to help keep track of where information is flowing from.
Below this line, let’s type “Working Capital.” To the right of this cell, let’s enter an assumption of ,000.00 (formatted in blue text to indicate an input). Our working capital assumption represents additional capital we think we’ll need in order to cover the day-to-day management of the investment property. We may have certain expenses that aren’t fully covered by our rental income and our working capital will help make sure we don’t run into cash flow problems.
Below the working capital line, let’s type “Total Capital Needed” and to the right of this cell sum the values of our purchase price and working capital assumption. This sum will be the total amount of capital we will need to raise.
A couple lines below our “Total Capital Needed,” let’s create a capital sources box. This box will have six columns with the headings: source, amount, % purchase price, rate, term and annual payment. Two typical sources of capital for acquiring a property are a mortgage and an equity line of credit (or loan). Our final source of capital (for this model anyway) will be our own cash or equity.
In the sources column, let’s add “First Mortgage,” “Equity Line of Credit,” and “Equity” in the three cells below our sources heading. For a typical mortgage, a bank will usually lend up to 80% of the value of the property on a first mortgage, so let’s enter 80% in the line for the first mortgage under the % purchase price heading (again, formatted in blue to indicate an input value).
We can now calculate the amount of our first mortgage in the amount column with the following formula:
=B5*C11
B5 is a reference to our purchase price and C11 is a reference to our % purchase price assumption.
In the current market, banks are reluctant to offer equity lines of credit if there is less than 25% equity invested in the property, but let’s pretend that they are willing to lend a bit. Let’s assume that they will lend us another 5% of the property value in the form of an equity line. Enter 5% (in blue) in the equity line of credit line under the % purchase price heading.
We can use a similar formula to calculate the equity line amount in the amount column:
=B5*C12
Now that we have the amount of bank financing available for our purchase, we can calculate how much equity we will need. Under the amount heading in the row for equity, enter the following formula:
=B7-B11-B12
B7 is our total financing needed. B11 is the financing available from the first mortgage and B12 is the financing available from the equity line of credit. Again, we’re assuming that we’ll have to cough up the cash for anything we cannot finance through the bank.
Now let’s figure out what this financing is going to cost us. For interests rates, let’s assume 5% on the first mortgage and 7% on the equity line. Enter both of these values in blue in our rate column. For terms, a typical mortgage is 30 years and an equity line might be 10 years. Let’s enter those values in blue under the term heading.
The annual payment column will be a calculation of the annual payment we will have to make to fully pay off each loan by the end of its term inclusive of interest. We will use an Excel function to do this:
=-PMT(D11,E11,B11,0)
The PMT function will give us the value of the fixed payment we will make given a certain rate (D11), a certain number of periods (E11), a present value (B11) and a future value (which we want to be zero in order to fully repay the loan). We can then use the same formula in the cell below to calculate the payment for the equity line.
Now we’re ready to map out our projections. Let’s start by copying column headings from the property tab (Year 1, Year 2, etc.) and paste them on the finance tab below our capital sources box. Let’s also pull the owned property value line from the property tab (marking the values in green to show that they come from a different sheet).
Now let’s forecast some balances related to our first mortgage. Let’s label this section of the worksheet “First Mortgage” and below it add the following line items in the first column:
Beginning Balance
Interest PMT
Principal PMT
Ending Balance
Post Sale Balance
For year one of our beginning balance, we will just reference our first mortgage amount (=B11). For years two and later, we will simply reference the previous years ending balance (=B25).
To calculate the interest payment for each year, we simply multiply the beginning balance by our assumed interest rate (=B22*$ D). B22 would be the current year’s beginning balance and $ D would be our assumed interest rate.
To calculate each year’s principal payment, we simply subtract the current year’s interest payment from our annual payment (=$ F-B23). $ F is the annual payment we calculated before, and B23 is the current year’s interest payment.
Our ending balance is simply our beginning balance minus our principal payment (=B22-B24).
Finally, our post sale balance is simply our ending balance for each year or zero if we have already sold the property (=IF(B19=0,0,B25)). This line will make it easy for us to represent our debt when we go to construct our balance sheet later on.
We now repeat the same lines and calculations for projecting our equity line of credit balances. Once we are done with these two sources, we have completed our financing worksheet.
We can now drop in our mortgage and equity line balances back on the property tab in order to calculate our net proceeds. For the mortgage balance we use the formula:
=IF(B18=0,0,Financing!B22)
B18 refers to the current year’s property sale value. If the value is zero, then we want the mortgage balance to be zero, because we are not selling the property in that particular year and don’t need to show a mortgage balance. If the value is not zero, then we want to show the mortgage balance for that particular year which can be found on the financing tab (Financing!B22).
We use the same formula for calculating the equity line balance.
Let’s label our expenses tab “Expenses” and add the same title to the top of the worksheet. This worksheet will be simple and straightforward. First, let’s create an assumptions table with the following input labels:
Tax Rate
Annual Home Repairs
Annual Rental Broker Fees
Other Expenses
Inflation
Next to each of these cells, let’s enter the following assumption values in blue:
1.10%
0.00
0.00
.00
1.50%
Each of these assumptions represents some component of the ongoing costs of managing a property. Below our assumptions box, let’s again paste our year headings from one of our other worksheets (Year 1, Year 2, etc.).
Let’s drop in a line that shows our owned property value that we calculated earlier and format these values in green. We will need these values in order to calculate our tax expense, so it’ll be easier to have it on the same worksheet.
Below this line, let’s add a few line items that we’ll be forecasting:
Home Repairs
Rental Broker Fees
Other Expenses
Taxes
Our first year of home repairs will simply be equal to our annual assumption (=B5). For subsequent years, though, we will need to check to see if we still own the property. If not, our cost will be zero. If so, we want to grow our home repairs expense by the inflation rate. Here’s what the function for subsequent years should look like:
=IF(C=0,0,B15*(1+$ B))
In this case, C is the current year’s property value, B15 is the previous year’s home repair expense, and $ B refers to the inflation rate. For rental broker fees and other expenses, we can use the same methodology to forecast these expenses.
For taxes, we will need to use a different calculation. Property taxes hinge on the value of the property, which is why we have used a percentage to represent the tax assumption. Our formula to calculate taxes will be as follows:
=B13*$ B
Since our taxes will be zero when our property value is zero, we can simply multiply our property value (B13) by our assumed tax rate ($ B). And now we have forecasted our expenses.
Now comes the fun part. We need to put all of our projections into presentable financial statements. Since this will be the part of the model that gets passed around, we’ll want to make it especially clean and well formatted.
Let’s label the tab “Financials” and enter the same title at the top of the worksheet. A couple lines below, we’ll start our balance sheet by adding a “Balance Sheet” label in the first column. Just below this line, we’ll drop in our standard year headings, only this time we want to include a Year 0 before the Year 1 column.
Along the left side of the worksheet just below the year headings, we’ll layout the balance sheet as follows:
Cash
Property
Total Assets
First Mortgage
Equity Line of Credit
Total Debt
Paid-In Capital
Retained Earnings
Total Equity
Total Liabilities & Equity
Check
Our cash value in year zero will be equal to the amount of equity we plan to invest, so we will reference our equity value from the finance worksheet (=Financing!B13) and format the value in green.
Property, first mortgage, equity line and retained earnings will all be zero in year zero because we haven’t invested anything yet. We can go ahead and add in the formulas for total assets (cash plus property), total debt (first mortgage plus equity line), total equity (paid-in capital plus retained earnings) and total liabilities and equity (total debt plus total equity). These formulas will remain the same for all years of the balance sheet.
For the year zero balance for paid-in capital, we’ll use the same formula as cash for year zero (=Financing!B13).
Returning to cash, we will use this line as our plug for the balance sheet since cash is the most liquid item on the balance sheet. To make cash a plug, we make cash equal to total liabilities and equity minus property. This should ensure that the balance sheet always balances. We still need to watch to see if our cash is ever negative, which could present a problem.
On a balance sheet, property is usually represented at its historical value (our purchase price), so we will use the following formula to show our property value and format it in green:
=IF(C5>=Property!$ B,0,Property!$ B)
C5 represents the current year. Property!$ B is a reference to our investment period assumption and $ B is a reference to the purchase price. The value of the property will be either zero (after we have sold it) or equal to our purchase price.
Our first mortgage and equity line balances we can simply pull from the post sale balance on the finance tab. We format each line in green to show that it is being pulled from another worksheet.
Paid-in capital, will be equal to either our original investment (since we won’t be making additional investments) or zero after we have sold the property. The formula is as follows:
=IF(C5>=Property!$ B,0,$ B)
C5 represents the current year. Property!$ B is a reference to our investment period assumption and $ B is a reference to the year zero value of our paid-in capital.
We will have to skip the retained earnings line until after we have projected our income statement as it hinges on net income.
The check line is a quick way of telling if your balance sheet is in balance. It is simply equal to total assets minus total liabilities and equity. If the value is not equal to zero, then you know there’s a problem. As an extra bell and whistle, You can use conditional formatting to highlight any problems.
Below the check line, let’s set up our income statement in the same way we set up our balance sheet — with an “Income Statement” label followed by our year column headings. We will layout our income statement as follows:
Rental Income
Proceeds from Sale
Total Revenue
Home Repairs
Rental Broker Fees
Other Expenses
Total Operating Expenses
Operating Income
Interest Expense
Taxes
Net Income
Rental income, proceeds from sale, home repairs, rental broker fees, other expenses and taxes can simply be pulled from the other worksheets where we have calculated them (and formatted in green of course). Interest expense is simply the sum of the interest payments for both the first mortgage and the equity line on the financing tab.
The other line items are simple calculations. Total revenue is the sum of rental income and proceeds from sale. Total operating expenses is the sum of home repairs, rental broker fees and other expenses. Operating income is total revenue minus total operating expenses. Net income is operating income minus interest expense and taxes.
Now that we have our net income figure, we can jump back up to our retained earnings line in our balance sheet to finish that up. The formula for retained earnings starting in the first year and going forward should be as follows:
=IF(C5>=Property!$ B,0,B17+C43)
Again, the IF function looks at the current year (C5) and compares it to our investment period (Property!$ B). If it is greater than or equal to the investment period, then we have closed our our investment and the value is zero. Otherwise, the formula for retained earnings is the previous year’s retained earnings balance (B17) plus the current year’s net income.
To answer our original question of what our return on this particular investment is going to be, we need to project the cash flow to the investor. To do so, let’s create another section below the income statement called “Investment Cash Flow,” which also has our year column headings. We’ll also want to add the following lines:
Initial Investment
Net Income
Cash Flow
Our initial investment line will only have a value in the first year zero cell, and it will be equal to our paid in capital only negative (=-B16). Our initial cash flow is negative because we make the equity investment to finance the project.
The rest of our cash flow comes in the form of net income. Since we have the net proceeds from the sale of the property flowing through net income as well, we can simply set the net income line equal to net income from our income statement. To maximize our potential return, we will assume that net income is paid out each year rather than being retained (this could result in some negative cash balances, but for simplicity’s sake, we’ll make this assumption).
Cash flow is simply the sum of the initial investment and net income for each year. The result should be a negative cell followed by some negative or positive net income figures (depending on our model’s assumptions). Now we’re ready to calculate our return.
A couple lines below the cash flow line, we’ll label a line “IRR” or internal rate of return. The internal rate of return is basically the discount rate at which your future cash flow is equal to your initial cash outflow. In other words, it’s the discount rate that gives the project a present value of zero. The formula we will enter to the right of this label is as follows:
=IF(ISERROR(IRR(B51:L51)),”N/A”,IRR(B51:L51))
We’re adding some fancy formatting to the formula to make sure that if the IRR function can’t calculate the return, it shows up as “N/A.” The basic function for IRR will simply reference our cash flow cells (B51:L51).
We can now play around with our model inputs to see if our assumptions and our project make sense. If you have data from a similar project, you may want to input those values to see if your model closely follows the actual results of the project. This test will help you determine if your model is working properly.
Remember, a model is only as good as the assumptions you put into it, so even with a detailed working model of a project, you will still need to invest a lot of time researching appropriate assumptions.
Take some time to format your model as best as possible. Set up each page so that it can print properly. Make sure that other users of the model can clearly follow it to see what you have done.
This is just one example of a financial model. Other models may be more simple or much more detailed. In order to be a great modeler, you have to practice. Good luck!
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Question by jamie: How do I know if my loan is non-recourse / recourse?
I live in california, but made a bad investment in Arizona. I will keep my house in California, but the lender will foreclose on the Arizona investment property.
I have THOUGHT for the past few weeks that my loan for the Arizona property, which was taken out to buy that property (“purchase money”) and has never been financed, I thought it was non-recourse….
But now I am hearing that in California non-recourse is just on the first mortgage.. Is this true? I have talked to two lawyers Ca/Az and neither one mentioned this to me… How can I tell for sure without tipping off the banks.
I tried calling the bank a couple of weeks ago and gererally asked how I would know if my loan was non-recorse. The woman I talked to didn’t even know what that mean. Nice!
Help!
Best answer:
Answer by real estate guy you are screwed. First, nonrecourse mortgages are ONLY!! on 1st mortgages (purchase money, not refinanced) on RESIDENTAL PROPERTY ONLY. This is an investment property. It’s a recourse AND!!!! in this case the IRS will tax you as income for the bank’s lose – again, for the reasons above. You may be able to work a deal out with the lender (short sale, etc), but the IRS will still hit you and there’s no way out, EVEN BK will not resolve this problem.
I would talk with a real estate/tax lawyer ASAP. YOu can’t just walk away.
