Deal or No Deal? (with spreadsheet)

While many deals come through my inbox every day, there are only a handful that make it into my underwriting spreadsheet for review. Here is an example of a deal that came across today, and how I analyzed it:

Email:

I just got a very clean opportunity in Philadelphia that we are selling for 120k. The property is 1,216sqft on a 16x73 lot with 3 bedrooms and one and a half bathrooms. The property needs cosmetics throughout, a finished basement, and added AC. That will get you to our 245k comps all day long- 25 S 53rd sold for 230k after 15 days on market 5328 Locust sold for 240k after 7 days on market (No central air, partially finished basement) 34 S 53rd sold for 250k after 12 days on market 132 S 53rd sold for 260k after 40 days on market. If you want to rent this one out you will get at least $1,100 a month no problem and it will only require a very minimal rehab. Get with me ASAP for more info or access

Analysis

First off, note the urgency of the email and the feeling of scarcity that it provides (that "once in a lifetime opportunity" type of feeling). This is how many wholesalers come across. It's not necessarily a bad thing. They are trying to sell houses, so I understand the sales pitch style. Just make sure you don't get too caught up in it and remember to step back and analyze the deal objectively.

From first look, there could be a solid flip play here, and possibly a buy and hold rental as well. After getting a rehab estimate it looks like it will be close to 75k in repairs. The wholesaler also may provide a pro forma that usually consists of a spreadsheet that shows the financial projections of the property for various scenarios such as flipping vs buy and hold. After looking at the estimates, it is still looking like a decent deal with an estimated return on investment of close to 18% on a flip, and around $150 cash flow after refinancing for a buy and hold.

At this point, it is easy to get caught up in excitement over the deal and want to dive right in. That's where it is important to take a closer look at the assumptions and calculations for various metrics. I've simplified this process by creating my own underwriting spreadsheet for Philadelphia properties. There are a few inputs that I enter into the spreadsheet (usually easy to pick out from the provided pro forma), and then I let the numbers speak for themselves. The metrics are then defined in a manner that is most useful for me to compare with other deals and investments.

For me personally, the ultimate metric is the return on investment (ROI). For a given amount that is invested into the property (after moving into long term financing on a buy and hold or selling the property in a flip scenario), what is the annualized rate of return? This metric can be compared across assets and ultimately lets me know how well I am doing in my investment strategy. In my opinion, if I am an "active" real estate investor and am unable to beat 10%+ in annualized returns, then I really should move into passive solutions such as the stock market or better yet passive multi-family syndications (ask me more about how to get into multi-family investments if interested).

Back to the example. After digging a bit into the calculations, it was clear to see that the metrics in the pro forma were not aligned with what I actually cared about. There were also missing expenses that I knew of based on my previous experience owning property in Philly (property management, city utility, etc). Another item that was overlooked was the fact that when purchasing through an LLC, you are no longer eligible for conventional financing, so you need to underwrite a higher longer term loan rate than you normally would (for example, the commercial long term rate is closer to 7% instead of the conventional rate which is around 5.7%). When you add in realistic expenses and loan data, it is easy for a deal to go from good to just mediocre, so it is important that you don't shrug off these details in order to justify the deal!

I’ve included my spreadsheet below. As you can see, this deal ended up looking pretty mediocre in the end, so I passed on it. Better to have a few quality deals than a bunch of mediocre ones, especially in a hot market like we are currently in. The cash flow turned from +$200 to -$500 after the analysis, and the flip play actually turned out a bit better (30% ROI) than originally projected*.



To summarize the sheet, make sure you include the following in your analysis:

• Your actual financing costs if using private money (sometimes you have to ask several times to get all the various fees down, but make sure you do it)
• If buy and hold, make sure you are using a realistic rate (usually 1.5% higher than the conventional investment property financing rate) and using the appropriate LTV (75% for SFH, 70% for small MF)
• Inspection costs
• City specific costs (e.g. $300 garbage fee in Philadelphia for an investment property with 2+ units)
• Include all of the above costs in your calculation for ROI
• Take a much closer look at comps. It is very easy to group a couple of properties and say they are comps, so make sure you validate the assumptions and do your own due diligence there. Making a large mistake on ARV can completely destroy a deal and can make a deal much more risky than you thought it was.

*This has been a general trend I’ve been seeing lately when any type of private financing is involved; the buy and hold deals just really have not been looking good in terms of cash flowing and the flip play seems to be the best option right now.