Real Estate Deal Analysis

Real Estate Deal Analysis

Deal Analysis: Rehab and Lender Options

Deal Analysis:

I am now going to walk you through how I analyze deals, with an actual example that I had my realtor look at today. If you are new to real estate investing and not sure how to look at deals requiring rehab, then you are in the right place! When I was starting out, buying properties that needed rehab seemed like a daunting task. Hopefully this analysis will help you in your real estate investing journey!

This particular deal is an off-market deal, which is where most of my deals come from. The property owner currently wants $55,000 for a 4/1. It is 1,150 square foot and in a decent area. Comps are in the $95,000 – $130,000 range. Obviously the comps are all over the place but even at the low end the house is $40,000 less. The rent range is roughly $850 as is, or between $950-$1,050 once the rehab is complete.

The roof, windows, and furnace are all about 20 years old, which means they are nearing the end of their useful life and should be replaced. The AC condenser unit is new.

After looking at the pictures and talking with my realtor the property will need a rehab budget somewhere between $20,000 and $29,000. Here is the work that would need to be completed:

  • Roof
  • Exterior paint in SF or siding
  • Windows in units
  • doors in units
  • Garage door in units
  • Garage roof in SF
  • Garage paint in SF
  • Garage structural repairs in Levels 1-5
  • Yard cleanup in levels 1-5
  • Landscaping in levels 1-5
  • HVAC
  • Water heater
  • Plumbing repairs in units or per drain
  • Light fixtures in units
  • Interior Paint in SF
  • Flooring in SF
    • Carpet
    • Hardwood
    • Vinyl
    • Tile
  • New doors interior
  • Kitchen
    • Cabinets: clean and paint
    • Counter top formica in 8ft units
  • Kitchen fixtures
  • Bathroom Remodel
  • Drywall repair in SF
  • Framing in Linear Ft
  • Dumpsters needed
    • 40yd in units (x2)
    • 20yd in units (x1)

I always assume worst case scenarios when analyzing properties (see post on “rehab cost estimates”) and then even from there add another 5% or so. So, for this property, the high end of the rehab cost is $29,000. If I multiply $29,000 by 5% I get $1,450. Adding those 2 numbers together I get a rehab cost of $30,450. This is the number I will use in my analysis.

Once I know the extent of rehab required (if any), I can then easily decide whether I would be using a hard money lender or traditional bank financing. My objective is simply to get into properties with as little money out of my own pocket as possible. Since I am not going to use $30,450 of money out of my own pocket for the rehab, I would have to use a hard money lender with this deal.

The next stage is determining whether the purchase price makes sense, given how much the rehab would cost. To figure this out, you now need to assume an ARV. My realtor told me that this property would have an ARV between $95,000 – $130,000. I am not just conservative when calculating rehab costs, but with every part of the deal. I always assume a safety margin of 5% or so and always to my disadvantage. In other words, I would take the low ARV number of $95,000 and multiply by .95 for safety. This gets me an ARV of $90,250, which I will round down to a flat $90,000.

 Everyone has their strategies and sweet spots for determining what percent of ARV they do not want to exceed when they add their purchase price and rehab cost together. Mine is 70% if I am going to refinance with a commercial lender that loans up to 80% of the ARV. If I am going to refinance with a lender that loans up to 75% of the ARV, then I would prefer to be at 65%. Note: generally, if you use the 70% number and end up using a lender that only loans up to 75% to value, you will likely not be able to do a cash out refinance and get all of your money back, but you should still lower how much you have into the deal. As such, your cash on cash return should still be fairly good. If not, run away.

Given that, regardless of which refinance loan option I would choose, I already know without even calculating anything that this property will not work with the current purchase price of $55,000, given a rehab cost of about $30,000. This is because with those 2 numbers added together I am already at $85,000. My assumed ARV is $90,000, which quick calculations tell me I would need the total to be at $50,000 – $60,000.

This does not mean, though, that I give up on the deal. I continue forward by figuring out at what price this property would have to be purchased at in order to make financial sense with my goals and objectives.

Word of caution: In your real estate investing career you will interact with owners and investors of all kinds. There are unfortunately some owners who are simply ignorant and don’t care what the facts tell them their property is actually worth. A lot of people (perhaps all to some degree) operate out of emotion. People can get emotionally tired to their properties. So, even if they think their property is worth $55,000, while the rest of the world sees its true value at $30,000 as-is, some owners cannot be moved to lower how they see and value their property.

On the flip side, you will have investors that see this property listed at $55,000 and want it really bad. Maybe they just want to get into real estate investing immediately or they think they will just cut their rehab budget accordingly. Or they simply do not due their due diligence.

In either of these situations, the word of caution is to look at properties through the lens of logic. Do not get tied to a property emotionally. You have to love the deal, sure. But, not to the extent of it making no logical sense. You want to make money, not lose money. The act of creating future money trees depends entirely on your ability to remain logical and emotionally detached.

Going back to the actual example above, since I know my conservative ARV number of $90,000, I then just multiply that by 70% to come up with the number that I do not want to exceed when I add the purchase and rehab numbers together.

Here I get $63,000. The rehab cost is likely not going to be negotiable whereas the purchase price is always negotiable. So, I subtract my rehab cost of $30,450 from the $63,000 and get an offer price of $32,550.

For the most part, I always look at rehab costs as a fixed number. In other words, a number that is what it is and not to be changed or tampered with. The danger in thinking that rehab numbers are negotiable or changeable is that you could start reducing the rehab cost by taking items off of the scope of work that needs completed. If you start doing this to just make a deal work, you may enter into a deal that costs you a lot more money down the road.

Now that I have my ideal purchase price, I do not simply make an offer to the property owner at $32,550. I want to see how the deal looks long term by plugging in numbers into my excel calculator just to be sure I like the end result of the deal.

The only other number I will need is the rent that I will be using. My realtor told me that the rent range of this property once rehabbed is between $950-$1,050. I do think I could get $1,100 from this property once rehabbed, but for the calculations I will assume the $950 rent. If the deal makes sense at $950 and I later find out that I can rent at $1,100 then it becomes an even better deal (See property #8).

Here is what my calculator spits out.

First, option A (“80% (20 year – 3 month hold)) assumes I will be refinancing out of hard money with a commercial lender at 80% LTV where I do not have to hold the property for any set amount of time. I always use 3 months to be conservative. Generally, I will try and refinance as quickly as possible once rehab is complete.

Second, option B (75% (30 year – 6 month hold)) assumes I will be refinancing out of hard money with a residential lender at 75% LTV where I have to hold the property for at least 6 months. Lastly, let me explain what each of the terms above mean:

  • Purchase Price: My ideal offer price
  • Rehab cost estimate: My conservative rehab cost estimate
  • HML down payment: My hard money charges 10% down payment on the purchase price, with a $5,000 minimum.
  • HML closing costs: A close estimate of how much it costs to close on a property with my hard money lender
  • HML Total Loan: ((Purchase price – HML Down Payment )+ Rehab Cost Estimate)
  • HML Interest: My hard money lender charges 10.25% simple interest for the “HML total loan”
    • Here I just take the “HML total loan” and multiply by .1025 and then multiply by the amount of months I will be holding the property.
  • HML End Loan Fee: This is the end fee of 2% that I have to pay at the refinance closing. It is 2% of the “HML Total Loan”
  • HML Total Payback Amount: This is the total amount that I will need to pay off at the refinance closing. To find this amount you add the following together: HML Total Loan + HML Interest + HML End Loan Fee
  • ARV: After-Repair-Value which is the amount that the property will be worth after the rehab work is complete
  • Refinance Amount: The amount that the lender will loan on your property.
  • Refi Owe (+)/Refi Cash Back (-): This is the amount that I will get back after the refinance process is complete. It takes the refinance amount and subtracts the refinance cost and HML total payback amount.
  • Money in: This is the amount that I paid to get into the property initially which is the down payment plus the closing costs.
  • Total money in deal: This takes the “refi owe..” and subtracts the money in. Here we will see our true costs and what our cash basis in the property will be after the refinance process.

With all of that being said, we can see that the two options are all basically the same, except the HML interest hold time and the total refinance amount. Obviously changing these amounts affect all the numbers below it, but these are the two numbers that are the catalyst for the change.

What we can see from this analysis is that if I refinance with the commercial lender under option A, I will end up making a profit of $2,353.75. If I refinance with the residential lender under option B, I will still end up having about $4,932.50 in the deal.

This is information that is needed, but does not tell the entire story. We need to see what the cash flows look like compared to the money profited or money left still in the deal, in order to figure out how the deal actually looks long term.

Here is what the cash flow statement looks like for refinancing with the commercial lender under option A:

Since most of the information listed above should be self-explanatory, I will just talk about what the numbers are and tie it all together.

If I purchase this property and refinance with the commercial lender, I will profit $2,353.75 and after all is said and done cash flow $61.15 per month or $733.76 per year. So, in essence, I will make $733.76 per year, and will have $2,177.05 in equity per year as the mortgage gets paid down and have zero of my own money in the deal. This is basically an infinite return. All while actually having a property that profited me after all was said and done at $2,353.75. The property will also be completely rehabbed with all major capital expenditures like windows, roof, furnace, and AC all being brand new. This can be summed as followed:

  • Profit $2,353.75
  • Cash flow $733.76 per year
  • Debt paydown of $2,177.05 per year
  • Total return of $2,910.81 per year
  • Property is fresh and new and all major expenses should be low for next 10-15 years

Here is what the cash flow statement looks like for refinancing with the residential lender under option B:

If I purchase this property and refinance with the residential lender, I will still have $4,932.50 left in the deal and be cash flowing $171.81 per month or $2,061.68 per year. This equates to a 41.80% cash on cash return on that money. When considering equity through debt paydown of $921.76 per year, it equates to a 60.49% total return.

The property will again still be completely rehabbed with all major capital expenditures like windows, roof, furnace, and AC all being brand new. This can be summed as followed:

  • Money left in deal: $4,932.50
  • Cash flow $2,061.68 per year
  • Debt paydown of $921.76 per year
  • Total return of $2,983.441 per year
  • Property is fresh and new and all major expenses should be low for next 10-15 years

As you can probably tell, the true difference between these two scenarios has to do with the first option producing less cash flow each month but more debt paydown. This occurs due to the higher loan to value mortgage amount and shorter loan amortization. Put simply, you will have a loan amount that is higher AND spread out over fewer payments. This is why your monthly payments are higher and cash flow lower.

Since the loan has fewer payments, your monthly mortgage payment is paying more towards the principal right away, which increases your debt paydown. With the debt being paid down quicker, your equity increases quicker as well.

The second option has a lower loan to value mortgage amount and longer amortization. In other words, your loan amount is lower AND spread out over more payments, so your monthly payments are altogether lower. As a result, your cash flow is higher.  

While more cash flow each month is great, the loan has more total payments than the first option. This means that you are paying less towards the principal right away so your debt paydown happens much slower. In turn, this means you will not be gaining equity as fast as the first option.

The last and perhaps most important difference is that the first option is a 5/20 mortgage where it is amortized out over 20 years but has only a fixed interest rate for 5 years. So, every 5 years the interest rate resets to wherever the market is at. The other option is a 30 year fixed rate mortgage so the rate stays the same for the entire length of the loan.

This is where the decision on which option you choose depends on the individual and their goals and objectives. For me, I would choose the 2nd option because I prefer more cash in hand each month versus equity paydown since that only becomes realized once you actually exit the property. I do not plan on exiting my properties for a long time, so the equity is sort of trapped (only being said in this example, since you can get money out of properties).

I also believe interest rates will rise in the future, so would rather get a loan now that has the same interest rate for the entire length of the loan. Though I would still have cash in the deal, it is still a 41.80% cash on cash return, and that would be hard to beat outside of real estate.

With all that being said:

  • The rehab process could end up costing more than you originally anticipated
  • The property will sit vacant for months not producing any income
  • Some of the variable numbers such as holding costs, ARV, future rent, etc. could change to your disadvantage
  • Since the rehab process can take months, there could be a lot of mental stress and anxiety in the process that should not be overlooked

“Well, great, but what is the alternative to getting those kind of returns?” One possibility is finding something more rent-ready. Could we get the same returns by just purchasing something off the MLS without having to go through the trouble of hard money, refinancing, rehab, etc?

I ran some numbers to see what a similar rent-ready deal would need to be purchased at in order to get the same cash on cash return.

The question: what would a property have to be purchased at in order to put 20% down on a traditional 30-year mortgage and the property rents at $950?

The answer: $45,000! You would have to purchase a property at $45,000 that you put 20% down ($9,000) and so have a mortgage amount of $36,000 and rents at $950 in order to get 40% COC on your $9,000.

However, the likelihood that you could find a property that you could purchase at $45,000 that is rent ready at $950 is very slim. It is not impossible, just very unlikely.

When you do find such a property, it is best to put in an offer right away on those. As an example, while writing this blog entry, I decided I was going to pass on this specific property altogether. There were a few main reasons.

First, I still have a few properties that I need to refinance out of hard money. I only want to have 2-3 at a time with hard money, since the more you have with those high interest rates at a time the “riskier” your entire holdings are.

Second, I just didn’t feel the deal. I didn’t love it. After analyzing it, there is just not much rent growth possible. There is a lot of room in the comps to possibly flip the property, but for now I am staying away from those types of deals. In the future, I will likely try and do 3-4 flips a year, but for now my main focus is on stabilizing my portfolio with rent-ready cash flow properties.

Interestingly enough, after I decided to pass on this deal, I went to Zillow to see what properties were available. Any real estate investor knows that once you start purchasing properties, it is all you can think about. As months go by without a purchase, you start getting antsy! Well, I was getting antsy! Obviously ensure you don’t let the ants in your pants get you into a deal that doesn’t work!

After looking for an hour or so, I found a property that is listed for $59,000 and is tenant occupied at $700 per month. It is in the same area that (list property numbers and pages) are located. It is the same bed/bath and square foot count as those as well. I know, then, that I could rent it at $1,000.

The same owner was retiring and had 5 other properties he was trying to sell. I wanted to see what those properties were. To find those properties, I simply go to the property tax search website for the county. You can search by address to find the owner, or search by the owner to find all the addresses that a particular owner has.

So, I enter the address and it tells me the owner. In this case, it is a company. I then copy the company name, go back to the search by owner field, and can then see all the properties that this company owns. I then search for those properties listed.

A lot of the 5 have already been sold, except for 3 with 1 being the property I already found. Of the 2 remaining, one is in a less desirable part of town. The other, though, is in a decent location. It is listed for $55,000 and is also tenant occupied at $700 per month. This property also could be listed around $950-$1,000 based off other properties I own in that area.

One way to get better deals is to buy in bulk, similar to Costco. If I purchased both at current list prices, it would total $114,000 and $1,400 a month in rental income. Not terrible, but not great.

It is also best to start lower and hope the owner is willing to negotiate. Both properties have been on the market for 90 days and have had price drops of $5,000 – $10,000 already. Two of the five properties that this owner already sold ended up closing for about a 20% discount off list price. Tip: to find this, you just go to Zillow’s “price/tax history” after a property closes.

This could take 30-45 days depending on who ended up lending on the sale. The “sold” price tells you what the buyer paid to close on the deal. If you view the rest of the price history you can see what they originally listed the property at, along with any price drops, and then the final sale price. From this I was able to come up with the 20% number, by seeing what the property was originally listed for and the closing price of the property.

So, I decided to have my realtor put a package deal together at a 20% discount. 20% off of the total list price for those properties gets me to an offer price of $90,000. Or, $45,000 per property. Last night we submitted that offer.

The Plan

If I put 20% down to get into both properties with traditional financing, even with the current rent of $700 per property, I would get a 17% cash on cash return. Not bad.

If the owner accepts or we negotiate to a price that still works, during the 7 day inspection window I would determine what would be needed in the property to be able to get $1,000 in monthly rent.

The plan would be to keep rented for 1 year and save the 15% reserves for each property in addition to monthly cash flow. This would equate to 15% of $700, or $105 per month. In a year this would total $1,260.

The monthly cash flow after all expenses and reserves is $178 per month, or $2,136 per year. If I add the $1,260 reserves plus the $2,136 cash flow for the year I get roughly $3,400. This number would be the same for both properties since they would both be purchased at the same price and are both currently rented at the same price.

This would mean if I held the property for 1 year I would have about $7,000 sitting in my account. During the initial 7 day inspection period, I would have my realtor pay close attention to how much it would cost to get each property to rent for $1,000. The hope would be that it would only cost about $4,000 per property. If this is the case, I purchase, hold for 1 year, save the reserves and cash flow, and then spend $4,000 to rehab each property. From there, I either change current renter to $1,000 or find a new tenant at $1,000. At that point, my cash on cash return would be close to 40%!

In Summary

The above is how I do my deal analysis when properties require rehab. While rehabbing has its drawbacks, it is a really good way to get properties to newer condition, have less headaches down the road by simply taking care of most items in the rehab process, and can get you some really good returns on your money. It is much harder to find similar returns off the MLS that are rent-ready, though buying in bulk is a good way to accomplish this. Or simply staying vigilant by searching the MLS daily to try and find deals that meet your criteria. Generally this means properties that have been on the market a long time and have significant price drops already.

I hope this helped. Let me know in the comments section if anything further needs better explained. Also, stay tuned to see if my recent 2 property offer goes through!


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