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12 Cash-Flow Assumptions You Haven’t Thought of Yet

Last weekend Brent and I attended one of the Real Estate Investment Networks’ ACRES weekends. It’s always a good refresher weekend and the people I meet there always amaze and inspire me.

We often take out a booth to share our listings and our services as REALTORS®. However, since Brent joined me this July, we’ve been quite busy on the multi-family side of the business.  To help promote a few listings I did up 20″x30″ posters of a couple apartment buildings which are available. There’s always lots of discussion on what information goes into a proforma (financial summary) for a property and what investors can/should plug into REIN’s Property Analyzer for cash flow analysis. Here’s some assumptions you should consider, and some you should be aware of.

Inflation – Remember, the Bank of Canada aims to have inflation running between 2-2.2%, so for any costs that change, that’s my baseline.

Purchase Price – you should know your local market (or work with a buyers’ agent who does) well enough to know what the value of a property is before you look at the list (asking) price. Getting a discount with respect to list price does nothing but feed your ego. Know what properties have sold for, and be able to explain that to the sellers, personally, through your agent or in a cover letter. For some areas in Edmonton, I know the ballpark, so for quick analysis I just take 1-2% off the list price because for properly listed prices, that’s what things sell for. Again, there’s no substute for good data on sold properties and an agent who knows the area and the history.

Repairs and Renovations – I always assume at least $2,000 will be spend in the first few months. That’s both spent tidying up little things they sellers just did a quick fix for and also for normalizing the properties or making tenants happy. I usually get asked what I mean by ‘normalizing’. Ideally, all my properties have the same faucets, appliances, flooring, locks/door knobs, light fixtures, etc. That makes it faster, easier and cheaper to repair things when they break.

Current Rent – If you’re buying something that already has tenants in it, either single family or multi-family then this number comes from the vendor and should be confirmed before going unconditional and buying the property. If it’s vacant then you need to know what it’ll rent for today. Again, market knowledge is king and part of the reason I’m a fan of buying several units in a complex which you already know. To help make things easier for Edmonton investors, I’ve surveyed several property managers and investors to create a rental market survey that you can download for free.

Projected Rent – The projected rent comes in two flavours. First, this is how much you can rent it for or raise the rent to when you are next raising the rent or filling a vacancy. The second is where rents will go in the next few years. CMHC publishes some information and limited projections. For example, spring 2011 has the average 2-bedroom at $1030, with a projected 2012 price at $1060, or a 3% increase. If nothing else, I use a 2-2.2% increase, which is the Bank of Canada’s mandated range of inflation.

VacancyCMHC publishes lots of stats, but I also use my own historical vacancy because I have better than average property management. For apartments I use 4% and for single-family I use 5%.

Utilities – For all my single family properties I have the tenants pay the utilities. If I’m on the hook I look for actual historical amounts from the vendors, while for multi-family that’ll be included in the financial information provided during the due diligence period.

Property Management – As a rule I use 10% for single family through to 4-plexes. For multi family I use ~6% up to 8 doors, and 4-5% beyond that.

Financing – I use prime plus 1%. That’ll put us somewhere between the VRM and fixed costs. I also use a 30 year amortization, since that’s what I look for myself.

Multi-Family Specific Assumptions

Expenses – CMHC will use ~$3,600/suite/year in their projections unless you can prove that the real costs are lower than that. It’s still a good ballpark. Costs will be higher on older buildings, higher on concrete/steel construction that wood frame, and higher on poorly maintained buildings.

CAP Rate – Capitalization rates are always tough to figure out and one of the reasons we pay for private sources of sold commercial data. Today (Fall 2011) in Edmonton sellers are asking 4.5-6%, while CMHC is financing a maximum of ~7%.

Ownership and Tax – For multi-family buildings in Edmonton I always assume that the property is held in a company and will be subject to the top tax rate, which in Alberta is 17%. I also assume that the goal of the investor is long term buy and hold unless we’ve discussed otherwise. That way we have a base to determine how to handle slightly more complex items like maximizing the use of terminal losses if you decide to tear the building down and rebuild after several years.

There’s a projection for everything, but be sure to use realistic numbers. Also, it’s always a good idea to do a 5-year cash-flow model to get an idea of the impact of time on your investment.

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    { 1 comment… add one }
    • Jeff Gunther October 24, 2011, 11:41 am

      Once again Chris, thanks for sharing your extensive expertise. Under property management, investors may also want to consider lease-up fees, advertising expense, and other incidentals associated with inevitable turnover. In this post I especially appreciated your rules-of-thumb re: Inflation, and “the first few months”. Please post more on multi-family.
      -Jeff

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