Deal Analysis Basics: Buying Cash Flow

Some real estate investors buy properties to fix up and immediately resell. Some real estate investors buy properties to rent out and ultimately make a monthly income from their rents.

When you are wholesaling properties, you may come across both types of investors and in this article I will be discussing how to analyze deals from the perspective of a buy, rent and hold investor. By understanding how they look at their deals, you can buy your deals better and also make your best presentation when trying to sell your deals to these types of investors.

Net Operating Income

When you take the rent you are receiving from a property and subtract out all the expenses except the mortgage payment, the remaining value is the Net Operating Income.

Investors use Net Operating Income (or NOI) to determine how much debt a property can afford to support and as a gauge of what they can afford to pay to purchase a new rental property.

While I have done literally thousands of examples of this type of analysis on various websites over the years, here is a quick run down of an over-simplified deal.

Example

If you have a property that brings in $1,000 per month in rent and you assume that for 1 month out of every 20 the property will be vacant, we can subtract off a vacancy allowance of 5% (1 out of 20 months = 5%).

So, $1,000 per month is actually really only $950 per month when you figure that for one month out of every twenty you will have no income from the property. That’s what the vacancy allowance takes into account.

Now, from the $950 per month left over, we can subtract the rest of the expenses including management, maintenance, taxes, insurance, utilities (if the landlord needs to pay them) and any HOA fee.

In this example, here are our expenses:

• Management: 10%
• Maintenance: $50 per month
• Taxes: $105 per month
• Insurance: $50 per month
• Utilities: None – Tenant pays
• HOA: No HOA

So, from the $950 we subtract $95 for management (that’s 10%), $50 for maintenance, $105 for taxes and $50 for insurance. This leaves us with $650 per month in Net Operating Income (NOI).

So, $650 per month is the amount of debt, in the form of a monthly payment, that the house can afford to support.

If we plug into a financial calculator a payment of $650 per month, an interest rate (whatever the current rate is…we’ll use 7% here), and a 360 month term (30 year loan), then we can solve for what amount of money could be borrowed.

As it turns out, when you plug these numbers into a financial calculator, you get $97,604.12.

This number is for break-even cash flow. What if the investors you have on your wholesale list want to see $100 per month in cash flow?

Well, we take the $650 per month NOI and subtract out $100 so they can actually collect $100 per month as income. If we redo the calculations with our financial calculator with $550 per month, then the most you can afford to pay for the house is $82,573.37.

If you wanted to collect a $10,000 wholesale fee for finding that deal, then the most you can put that house under contract for is $72,573.37 ($10,000 less than what your investor buyer would need to buy it for to get their $100 per month cash flow).

I strongly encourage you to run your own examples on dozens of properties so that you can see how this calculation works. If you run into trouble, I have many examples for you to review as well.

Until my next post,

James

P.S. Need help with deal analysis from someone that has analyzed thousands of real estate deals for investors? Sign up for our Real Estate Investor Bronze Membership and get the support and training you need.

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