Let's break down a real estate investment deal

As I embark into this brave new world of real estate investing, something that has always stumped me was the financials of it all. As with all investing – at least good, logical investing – it heavily relies on numbers and financial formulas. Thankfully, much of the math in real estate investing isn’t very complicated. But it’s heavily reliant on a strong grasp of the industry idiosyncrasies, which thus makes it challenging.

Breaking down the numbers behind a real estate deal is one of the scariest parts of RE investing to me: properly and thoroughly vetting potential homes via financial analysis. But, what better way to understand something than to try to attempt to explain it to others! Wise folks have always said you learn best through teaching, so this is what I’m attempting here.

As a newbie to this industry, please don’t take my numbers as anything more than a thought exercise. The more I read about real estate investing and practice financial calculations, the more I learn.

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I will use the BRRRR methodology in this example. BRRRR – which stands for Buy, Rehab, Rent, Refinance, Repeat – is an extremely popular financial strategy of real estate investing wherein the goal is to “reuse” most of the money used to purchase a home. Ideally, an investor purchases a home in cash, rehabs (fixes it up) in cash, finds a renter, refinances the new value of the house with a bank, and then uses that money from the refinance to repeat this process in another property. Most people cannot finance every aspect of a home purchase and rehab in cash, so using borrowed money is also common. Nevertheless, the goal is to use as little of the borrowed money as possible.

For this example, I found a potential investment property in my city. It’s list price is $70,000. I won’t show pictures, but the home needs a lot of work including new flooring, updated countertops, new cabinetry, and a backyard overhaul. Without having visited the property in person and lacking more knowledge about rehabbing, I’m estimating it needs about $25,000 worth of work done. How was the $25,000 of rehab estimated? I searched online for financial calculators and found a home rehabilitation spreadsheet that used estimations of common costs. I downloaded an Excel doc from this company, House Flipping Spreadsheet. There are other companies/websites/books that have this information as well, I just chose this one for this quick exercise.

Some of what made the $25,000 are guesstimates of what I thought needed to be done to the home to get it in renter-ready condition. I mentioned above the backyard needed an overhaul and the spreadsheet estimated a tree removal to be $500/tree, so I plugged that into the calculator. Another area of improvement could be the flooring. I estimated the home needed 1,000 sq ft of new carpet; I chose economy grade carpet at $1.25/per sq ft with labor and taxes included. This estimate came out to be a little over $2,000.

Okay, now that we have an idea of how the calculator estimates rehab costs, let's put everything into perspective:

*** Items not included in this analysis: A) Realtor fees since I will get my license this year. B) Closing costs on the mortgage loan and refinance loan from the bank.

Here’s a line-by-line breakdown of what the above numbers mean:

1. List price: what the home is being sold for

2. Purchase price: good deals are always made on offering the lowest purchase price available. Unless the list price is a steal, never offer full list price

3. Repair aggregate: based on the aforementioned spreadsheet

4. After resale value: I did a quick calculation that averaged the price according to the Tax Assessor’s website. This could also be achieved by performing a comparative analysis that Real Estate agents do

5. 70% rule: this states that an investor should pay 70 percent of the ARV of a property minus the repairs needed

6. Mortgage: same as the offer price

7. 6 months holding costs: I estimated the rehab and time to find a renter would be six months

   1. Mortgage: 6 months’ mortgage payment (principal and interest only)

   2. Insurance and taxes: 6 months’ mortgage payment (insurance and taxes only; I found estimates of these online)

   3. Maintenance: 2 x month lawn maintenance ($50*6 months)

   4. Utilities: $200*6 months

8. Out of pocket costs: what it’ll cost me (loans plus cash) to buy the house and get it renter-ready

9. Profit after refinance: this is based on the estimated After Resale Value. Since I was smart, I put far less into this house that the bank would consider it post-rehab. $117,000 - $85,837 = $31,63. I highlight this number to show just how much money can be made if this home were to be flipped (sold immediately)

10. Cash out refinance: I’m not flipping this house, but rather holding it (aka buy and hold). And here’s where the real money is made. If I held onto this home and refinanced it at the new value of $117,000, a bank will give me on average 80% of that value to do with as I please.

In summation, the goal is to have the largest profit as possible after refinancing. This is important for several reasons, the main being that a larger refinance amount is essentially “free money.” Yes, I had to borrow some money from the bank and throw in some of my own money to make this deal happen. But my all in amount was about $85,000, meaning nearly $10,000 of this refinance amount is from the bank. Now, here’s where the beauty of BRRRR comes into play: I will now throw the $93,600 I got as a fat check into the next real estate deal. This is why the BRRRR method is so popular, it really increases the velocity of money. After all, I work hard for my coins. Shouldn’t they equally work hard for me?

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Resources:

• What Is The 70 Percent Rule When Flipping Houses?

• Learn How to Analyze a House Flip

• Buy, Rehab, Rent, Refinance, Repeat