Analyzing Properties for Cash Flow
To make the right decisions, you need reliable tools.
On March 9, 2022, Empire Investment Club Members were invited to attend a Club Conversations entitled “Analyzing Properties for Cash Flow.” During this event, Jennifer de Jesus walked Members through her process for assessing properties for their propensity to provide reliable cash flow.
Jennifer also provided her own spreadsheet with built-in formulas for calculating these values. You can download it here:
Download Jennifer’s Cash Flow Analysis Excel spreadsheet, complete with formulas.
Key takeaways from the event:
Here are key points and considerations Jennifer talked about at the event:
Define your hold period. Ask yourself, “What is the property going to do in a specific amount of time as an investment?” For example, if your holding for a short period of time, you wouldn’t do any major renovations. For long-term holds, however, you want to do value-add improvements. When you analyze the cash flow, build in the improvements you plan to make.
How much cash do you have on hand? Cash flow analysis has to go beyond the basics. What is going to be required for improvements for that property?
Do you intend to use the equity in the property for future investments and how quickly will you need that equity? In a value-add scenario, you’ll force appreciation because of those improvements whether they are capital expenditures or increased rents. Think about the equity that you’re pulling out of it. You’re going to want to buy a property that you can improve quickly so you can pull the equity out.
Fix and flips are typically done in six months. When you’re doing a value add where a renovation could take six months to a year, the likelihood of you refinancing in that year is low.
You need cash flow for fix and flips. Start at the actual deal itself and how you analyze the cash flow. It’s critical that you buy fix-and-flip properties far below market value. You must buy them at a minimum of a 30% discount off market value for the property to be a good avenue for a fix and flip. Jennifer suggested having a net income goal of $50K or more after renovations to make the flip worthwhile.
There’s a general rule of thumb in the industry to buy properties at 70% of the after repair value. However, when analyzing properties for a flip, people focus on costs and they don’t count the cost of time. Never forget to consider the hold period as a lot can happen during that time. Depending on how you finance the property, interest can be high and there may be delays in construction which makes the project take longer than expected. You may have hold expenses like grounds care, utilities, etc. Think about the loss of income during the renovation period and that you’re shelling out a lot of money while there’s no money coming in.
You can get the historical 12-month average of utility bills on a property and you can build that into your actual costs. But you also need to factor in closing costs, hold period costs, insurance, taxes, mortgage and interest, utilities, grounds keeping, general property upkeep plus renovation costs—and always factor in extra for the surprises!
When you’re looking at your contractor’s bids, mark them up 10% to cover those surprises. Make it all-inclusive. Contractors will only look at what you ask them to look at. When you go through the entire property—roof to basement—make sure everything is checked. Look into right-to-know requests at the local municipality for past issues such as floods at the property. Account for the time it takes to sell as well as if you need a certificate of occupancy and if so, add those and other fees to your cost analysis.
Add a due-diligence period so you can walk away if that deal doesn’t come to fruition.
Some people analyze too much. Over-analyzing can not only slow the process but also blindside you to potential income on the back end.
In the spreadsheet, as Jennifer’s personal rule of thumb (line 49) the equity has to be at least 25% or better.
Analyze your cash flow at least once a year, many do it quarterly. Whether you have a management company or not, you need to understand your cash flow. You have to know if your money is working for you or not. What worked, what didn’t work, what should you do differently. A good time of year to do your analysis is January after you have all your historical records for the previous year.
Reassess your property’s value after there’s a major market shift. Ask yourself if you should you hold or sell. Some people miss the changes in the market. You should always look to be able to pull the trigger and sell. The market may have shifted, and that is in your favor. Reinvest it into a larger, smarter property. Also, the market can shift in a non-favorable way which will make you hold the property longer.
People also make mistakes when they’re buying value-add properties. When you’re looking at a cash flow statement, it’s stagnant. You’re making assumptions on what you can see. We’re not analyzing the work or the time that it takes to get the property improved and the cost associated with those improvements. The “J curve” is how real estate functions in a value-add world. Sometimes when investors are buying properties in markets where the value of the property could be so much more significant than it is today, they forget that the property income has to go down before it goes up. You never buy anybody’s best investment. There’s always something that comes up.
When Jennifer buys value add, she is committing to a year of no income. Most buildings will not cash flow in the first year no matter how pretty the spreadsheet is. There are many unforeseen factors that are part of the reality. Economy. Pandemic. Working with old buildings. Collapsed sewer lines. These cannot be foreseen. Sometimes there are bad storms that cause roof damage. These issues have an impact on tenants, and sometimes they get displaced. Loss of rent coverage on your insurance is critical for those emergencies where the tenant may be displaced. You need to have enough cash flow to make the improvements, but also pay the bills in the event of no rent coming in. If you can do that, inside a year that property will turn around with the right strategic moves. Make calculated decisions and take calculated risks.
When calculating how much to spend on an investment you’re turning over, consider this: If a hold period is 2 or more years and you can make that value of the improvements back in the first year then the investment likely makes sense. You will want to scale back your renovations unless you can increase rent enough to offset the cost of the renovations.
Capital improvements (roof, windows, siding, foundation, heating systems, etc.) Hold the property for at least 2 -2.5 years after the improvement to realize the gain unless your capital improvement will increase your ability to recover when you sell that property. When deciding to do or not to do the improvement consider what it will cost you to lose a tenant. It is not always just about the cost of the capital improvement. If your capital improvements impact your tenants, for example, it affects their heating costs, you are likely to lose them if you do not make the improvement. What would be the cost of that compared to the cost of the improvement? You don’t need to make capital improvements all at the same time. Consider only changing out one apartment worth of windows during each turnover versus a whole building at one time to help spread out the cost of the capital improvement over time.
Join other EIC Members at a future Club Conversations event to learn first-hand the insider secrets to being a successful investor and making smart decisions regarding your properties, renovations and cash flow.