Watch part 1 of 2 of a detailed example of a residential rental income property analysis. A detailed financial analysis model is included.
- [Instructor] Okay, in this lecture, we're going to go over the rental example that we're going to actually analyze with the model. So, at a high level, this is what we're going to be doing. We're going to be buying a recently built single family home in an up and coming community targeting young families. There's very little to no renovations to do. It's going to be a long term hold. We're going to look at it for a seven-year hold, and we're going to compare just like in the fix and flip case, what it looks like for the investment if it's done all cash versus with some debt, and we're going to collect some rents from this investment and hopefully it makes a good investment return, okay.
So, now let's look at the actual economics of the example we're going to be doing. We're buying a 122,000 Short Sale home. It's a four-bedroom home built in 2003. The home owner bought it at the peak in 2006, have been struggling, and finally is underwater, has negotiated something with the bank to do a short sale. And we're going to put some very light renovations on this, two and a half thousand paint job, some stuff to the front lawn, give it some curve appeal, but otherwise really nothing major.
And the neighborhood has rental rates around the 1,300 to 1,600 asking so we're going to test what the returns are going to be like by looking at rents in that range. Again, we're going to hold this for seven years so let's see what that looks like in the model. Okay, so, let's start with this model. We're going to go to the main assumptions worksheet here and then let's start with some assumptions. All right. For the purchase price, it's 122,000 so we put in 122,000 here.
Again, we're going to leave some for closing cost, maybe 2%. Oops. So, you go times the purchase price and it's about 2,400. What I like to do is I like to calculate it and then just round up to something that will account for that cost, okay. So, 2,500 for closing cost is reasonable assumption here. All right. This one, remember, we're doing very light renovations, okay, and it's going to just take us one month, but you know what, when we're selling it, I want to spend a little bit more when we're selling it.
I'm going to spend 10,000 when we're actually selling it to see what that would look like, okay. Now, rents is, let's start with 1,500 first a month, okay. And for the financing assumptions, we're going to assume that if it is done with debt, we're going to do 35% down, borrow the rest at 25-year term, and the interest rate right now is pretty low, let's say 4.5%.
We're going to hold it for seven years. I'm not going to assume that much appreciation here. Maybe, maybe not, but let's say, you know what, let's keep it at that, let's keep it at 7.5%. This will account for the value so in seven years, going from 120,000 to 200,000ish, and this is an up and coming neighborhood so maybe it's doable. So, let's see what that is and then we'll play with it later. Assume 6% sales cost for broker's commissions.
Now, for the other assumptions because this is a hot market, we're going to keep it at four weeks. The rental growth rate, sure, let it grow at 3% a year. Repair allowance, we're going to set aside 1,200 for a year for repair. Sounds reasonable, about 100 bucks a month. If it's a new home, probably won't even need that much, maybe less, let's make it 5% so 900 bucks a year for the allowance. Property taxes is going to be just a little over 1% so I'll leave it at 1,500.
Insurance, I think it's about 400 bucks there, and I will give $40 of utility allowance to the tenants so it's going to cost me 600 a year. And sorry, that is for the property manager. Let's go zero, I'm going to manage it myself. We're going to do $40 a month for the utilities and then I'll keep the discount rate at 7.5%. So, that's it.
When you have all your core assumptions, you can run analysis really, really quick. So, now with all of these numbers in there, and here we can see a breakdown of sources and uses, and what it does is it's basically saying, Hey, where are your sources coming from? I'm assuming 35% is coming from cash and then the rest is borrowing so we have debt. And here's how we're using it. There's purchase price, there's closing cost, there's initial rehab, and then there's the final rehab, and then that breaks down sources and uses need to add up to match each other, okay.
So, with all that, we can look at what the returns are going to look like now. So, on a all-cash basis, unleveraged, we see that, hey, the IOR is going to be about 16%, which actually on unleveraged basis is very, very good for a rental income property, and it looks like over seven years, you're going to be more than doubling your money. For every dollar you're putting in, you're getting $2.14 back, a full $1.14 of profit here. And we see that net present value is clearly positive at 7.5% discount rate.
Now, if we did it with some debt as in this case where we had 35% debt, we see how the debt really, really improves the returns here, right, because you're getting a long-term loan at 4.5% interest rate, which is very low. You're in a good investment so it really improves your returns. And in fact, your IOR nearly doubles, your cash multiple is now 3.67x so for every dollar that you put in here, you're getting $3.67 back.
And what it's saying is the debt here is actually not very costly so you get to keep most of that money from this investment for the rents. So, there you go. If you have assumptions for the rent, for how much you're paying for it to get the property, any assumptions around renovations, whether you're getting financing or not, and what the financing terms are, the length of the whole and how much you're selling it for plus assumptions that affect your rent.
You got all those in place, you can make an analysis for a rental income property extremely easy especially when you have this investment model in front of you. You can put in these things, save a file for a different income property, then you can save all your assumptions, and you can have separate files for each income property you're evaluating, then you can kind of compare them against each other for evaluations. Now, on the next lecture, let's look at what happens when we play with some of these numbers and see how it affects your analysis.
- Conducting market research
- The seven-stage investment process
- Due diligence: Validating and verifying your investment
- Financing and closing
- Exiting: Selling your investment
- Investment considerations and strategies
- Measuring returns
- How debt impacts your return
- Real estate analysis case studies