The 2% rule states that, to make a good profit on a single family investment property, the gross monthly rents should be at least 2% of the total purchase price of the property. For example, if you could charge $1200/month in rent on an investment house that costs $60,000, you would make a good profit.

It’s important to understand that the 2% rule is a very conservative rule. I prefer to look at this rule as a “sufficient, but not necessary condition” to make an investment, meaning that if you find a property that meets the 2% rule, you likely will want to buy it, but just because a property doesn’t meet the 2% rule doesn’t mean that you don’t want to buy it. In fact, in many parts of the country, it can be very difficult — if not impossible — to find properties that will generate rents that are 2% of the purchase price of the property. But this certainly doesn’t mean that you can’t make money in these parts of the country…you just need to work harder to evaluate deals.

Let’s look at an example of the 2% rule in action, and see why it works:

Say you find a single family investment property for sale for $25,000. Additionally, let’s say that based on your research of the local market, you believe you can rent that property for $500. As you can see, this property meets the 2% rule — monthly rents are 2% of the total cost of the property.

With a gross rent of $500/month, using the 50% rule, your monthly NOI (amount remaining for mortgage and profit) would be $250:

NOI = Gross Rents * 50% = $500 * .5 = $250

Assuming a 100% fixed interest loan at 6% for 30 years, your monthly mortgage payment would be exactly $150, leaving exactly $100/month in profit:

Profit = NOI – Mortgage = $250 – $150 = $100

Most SFH investors consider $100/month to be minimum acceptable return per month, and any property that meets the 2% rule will generally return at least $100 per month. Also notice that in this example, the investment generated a good return on property that was 100% financed. If you were to put 20% down on this property, the cash flow would be even higher.

Remember, the 2% is great, conservative financial estimation tool, but it may not work in your local market or for the properties you’re considering. Just because the 2% doesn’t work in your area doesn’t mean you can’t make money; but if it does work (or you can make it work), you’re sure to find some great investments!

I knew that the big banks likely wouldn’t be able to help me much, considering I didn’t have any income, so I decided to start with the smaller, local banks. Surprisingly, a number of them were very receptive to my business plan and my investing approach, and said that they would consider providing some type of financing for my investments. While that was good, what they proposed wasn’t going to go far enough based on my investment goals (at least 6-10 houses in Year 1).

Late last week I made the decision to ask a friend of mine (who currently has a couple rental houses and a good income) if he’d be willing to partner with me on my investments. Basically, the deal was that if he’d co-sign the loans with me, I’d give him a percentage of the profits from my investments. The risk on his side was obviously his credit (if I ever default on any of the loans, it will hurt both of our credit); and the upside is that he will get part of the profits from all the investments I make without ever lifting a finger.

I went back to a couple of the banks I had been speaking with to see if having a co-signer with income would help me with my financing. The answer was that it would help tremendously, and I decide to move forward with one of the banks to submit preliminary loan applications (for both my partner and myself) to find out what the terms of loans we requested would be.

Essentially, the bank offered us two types of loans. The first — Purchase Loans — will be used to purchase properties. Once a properties is purchased using a Purchase Loan from the bank, I will use my own cash to rehab the property. Once the property is rehabbed and I get a tenant into the property, I use the second type of loan — a Refinance Loan — to refinance the property to pull out some or all of cash that I used to pay the down payment and the rehab costs. If I can get properties cheaply enough, I should be able to refinance to take out all the money I have invested, and still make a profit each month from the rental income, even after paying the mortgage. This would allow me to keep buying property after property withot investing much (if any) of my own money, but still turning a profit every month. Then, when I sell the property, I would pay off the loan, and keep the difference as my profit.

Financing my real estate investments have been my biggest challenge to-date (as I have no provable income), so getting past this hurdle is quite relieving!

Here’s an example of how the 50% rule can be used:

Let’s say you find a single family property for sale for $100,000. Additionally, let’s say that based on your research of the local market, you believe you can rent the property for $1000/month. Using the 50% rule for a first-pass financial analysis, we find that all operating expenses would total about $500/month:

Expenses = Gross Rents * 50% = $1000 * .5 = $500

So, the amount you have left over at the end of the month to pay your mortgage and your profit (also known as you Net Operating Income, or NOI) is $500:

NOI = Gross Rents – Expenses = $1000 – $500 = $500

Now, let’s assume you would get 20% down, 30-year fixed interest mortgage at 6% on this property. Your monthly mortgage payment would be $480, leaving you $20/month in profit:

Profit = NOI – Mortgage = $500 – $480 = $20

So, your very preliminary analysis indicates that you can get a small positive cash flow from the property with a 20% down payment. $20 per month isn’t much to get excited about, but consider that if you can negotiate the price down (thereby lowering your monthly payment), this might be a worthwhile deal. For example, if you can negotiate the price down to $85,000, your monthly payment drops to $408/month, leaving you nearly $100/month in profit.

Also, remember that property management costs are factored into the 50% expenses, so if you plan to manage the property yourself, all fees that otherwise would have gone for property management will now go to you.

As always, don’t trust rules of thumb to make your decisions for you, but don’t hesitate to use them for “back-of-the-napkin” assessments of whether a property might be worth looking into further. The 50% rule is great for that!

I figured I’d post some of that here, so if any other agents I’m working with read my blog, they’ll get an idea of how I think:

1. Why do you figure property management into your expenses? You should just be managing the properties yourself!

My ultimate goal is to own hundreds of units (mix of apartments, houses, and other commercial). While I could definitely property manage 10-20 units myself, once I have more than that, I’ll need to either hire a PM company or start one myself. Either way, I’m going to have to pay between 5-8% for that expense. So, even if I choose not to use a PM company now, I want to know that if I start using one later (if I leave the area, have too many units, etc), that I know each of my properties can still cash flow. I’d hate to be in a situation where I had 30 houses, needed to hire a PM company because I was moving, and then found out that all 30 would start to be cash flow negative because I needed a PM.

2. Why are you assuming $100/month for maintenance when the place is newly renovated and likely won’t require much maintenance at all?

A lot of people might think $100/month is a lot for maintenance on a newly renovated house. Those people probably haven’t owned any long-term rentals; remember that while maintenance might be $10/month this year, at some point in the next 10-15 years the house is going to need a new roof ($4000), new HVAC ($3000), likely to have at least one major plumbing/electrical problem ($2000), etc. Most long-term landlords budget about $1000/year for deferred maintenance and capital expense reserves. While I could make good money on this house for 10 years, eventually there would come a year where I’d have to spend $5000-10,000 to keep the house updated, and if I hadn’t planned for that expense, it could wipe out all my profits from those 10 years! A lot of landlords don’t think about this, and that’s why they end up desperate to sell, because after several years of ownership they have a place that needs $10K in deferred maintenance expenses and don’t have the cash.

3. Why do you assume such high expenses in your projections?

If you do some research (IREM, National Apartment Association, etc) you’ll find that the national average for expenses on a single unit – across hundreds of thousands of units nationwide – is about 45-50% of gross income. Based on that, I will generally assume that for any new property I purchase, I will likely be spending 45-50% of income per year on expenses. If the property turns out to be good (and so do my management skills), my expenses may come in lower, and that’s more money in my pocket. But, I don’t want to assume they’ll be lower, and then lose money. This is why so many landlords lose money, because they *assume* that their management skills will allow them to cut expenses below the national average…I like to assume my expenses will be in line with the national average, and not take any risks. One day when I own a lot of rentals, I’ll be able to project my average expenses (and benefit from economies of scale), but I’m not there yet.

4. This is the cheapest duplex on the block! You really should be looking at the comps when you make your buying decision…

I agree that looking at comps is important when buying a single family home, because resale value will be related to the comps. But, that’s because you are more likely to sell a single family home to someone who will live in it as opposed to an investor. As for a multi-unit residence (duplex, triplex, apartment building, etc), your buyer is going to be an investor. Generally, that investor isn’t going to buy based on emotion or sentiment, he/she is going to buy based on how much money the property will make him/her. So, whenever I deal with a multi-family property, I assume that I will eventually need to sell it to an investor, and I will need to ensure that the investor I sell it to can make money on it (otherwise I may not be able to sell it). If I can’t make money on it, I assume the next person won’t be able to either, and then I’m taking the risk of not being able to sell the place, regardless of the comps. If your duplex were sitting next to million dollar mansions, it doesn’t make your duplex worth millions of dollars, because you can still only rent it for a total of $1700-$2000 month.

5. Why do you care about cap rates?

When assessing multi-family residences (not so much duplexes, but it still applies to a degree), I always figure out the cap rate I’d be getting. If the cap rate is less than 7%, I run into two issues: 1) my cost of capital (the interest rate on the loan I’ll get to pay for the place) is about 7%, so I’ll be breaking even just on the interest I’m paying on my loan, and 2) I can get a 5% interest rate by putting the money in a high-yield savings account, why would I want the headache of managing a rental for basically the same return? So, I like to see a cap rate of at least 8%, which also happens to be the average in this area for small apartment buildings.

• I got a call from the agent/wholesaler who is negotiating this offer on my behalf, saying that the bank’s agent has multiple offers and wants a best/final offer from us (this may or may not be true, who knows);
• I *hate* the best/final offer negotiating tactic, and refuse to play that game (unless it’s a great deal, or I’m highly motivated for other reasons). If the agent really has multiple offers, I’m probably not going to get the property with my low bid; and if the agent doesn’t have any other offers (and is using that tactic to get my highest offer), he won’t be happy that I pulled my bid, and if I ever deal with him again, I’m expecting he’ll remember that and think twice before trying it again.
• I’ve spent the better part of my adult life negotiating professionally, and it’s important to me that anyone I will possibly be negotiating with on a recurring basis understands that I will only negotiate in good faith (I don’t consider, “Give me your best and final offer” good-faith negotiating); I’m willing to lose a deal today to ensure that the other side understands that I’m perfectly willing to take my offer off the table if I don’t like their tactics. I may lose a good deal here or there, but in the end, knowing that the other side won’t put deals at risk by trying to screw me is worth it.
• So, based on both the fact that I hate that negotiating tactic (again if it’s a great deal or I’m highly motivated, I can look past it ), and the fact that I now realize that this deal isn’t overly exciting (and may not even be decent), I’ve asked to have my offer pulled.

I’m guessing there’s a reasonable chance that my agent will come back tomorrow and tell me that they’ll accept my last offer (or he’ll leave the offer on the table on his own behalf), and if that’s the case, I’ll probably just try to negotiate a better price.

Btw, I know a lot of people will say, “You better get used to that tactic from selling agents, and learn to play along with it.” And again, if it’s a great deal, I will. But my suggestion to anyone who would say that, is that by playing that game with an agent you’ll be dealing with on a regular basis, you’re going to end up on the losing end long-term.

Just my opinion based on my experience…I could certainly be wrong…

Here are some of the questions/concerns that were raised that I need to address:

1. What are the rental comps? The most concerning part about this deal is that I have very little information about what my specific exit strategy could look like, because I have very few sale or rental comps in the area. Actually, I do have some rental comps, but because there are a lot of rentals in the area, I also have a lot of competition. New houses in the neighborhood are fetching between $900 and $1500 per month in rent (these are 3/1 to 4/2 sized properties), and the one old house I was able to comp was asking $850. So, on the low side, I believe the rental rates would be about $850, and on the high side, probably around $1000 for a rehabbed 3/2. Unfortunately, that range doesn’t give me enough info, as I would need about $925/month in rent to make this deal worthwhile. So, I would need to nail down rental comps before proceeding with that exit strategy.

2. What are the sale comps? This is where I really need to do my due diligence, and talk to some local agents. This area hasn’t had much transaction velocity in the past year, so it’s very difficult to tell how much this rehabbed property could sell for. My all-in rehab costs would be around $105K, and with smaller places currently listed at around $135, it seems reasonable that I could fetch enough to at least break even on this, but I can’t get into this business making assumptions. I need to find better comps and good local realtor advice on what the ARV of the property would be and whether it would even be possible to sell this place in the current market.

3. What is my exit strategy? Yesterday, I listed three potential exits. But, that’s not good enough. I need to decide an exit strategy before rehab starts, as that strategy will likely guide a lot of decisions that need to be made. A good example is that by adding 2/1 in the basement on a rental (thereby making the property a 5/3), I’m encouraging renters to bring in more than one family to the house, which would create enormous wear-and-tear, and much higher maintenance costs. So, as just one example, I need to know if I plan to rent or sell before deciding what to do with the basement.

4. What are my hidden costs? My potential partner assessed the property, and his estimates of rehab were in line with mine (though a bit higher). This is a good sign, but neither of us have the expertise to assess the electrical, plumbing, HVAC and foundation — each of which could add tremendous cost the rehab. So, before closing on this deal, I need to get a slew of inspectors/contractors out to review the job, make sure there are no hidden costs, and give estimates on the work we’ll hire out.

5. What the big price drop on this place? As I mentioned, the bank dropped the listing price on this property by $50K overnight. Why did they do this? Perhaps it’s not a huge issue, but in general, this should be a red flag, and I should dig into this a bit more.

6. What is my financing strategy? If we move forward with this project, and decide to rent, I need a strategy to get this property refinanced so I can get a good portion of my cash back out for the next few deals. I don’t have that strategy yet, and waiting until the property is ready to rent isn’t the best option.

7. Am I okay with my return? As mentioned, my ROI on the rental is probably 5% or less. While ultimately I hope to sell for a decent profit, I shouldn’t be counting on appreciation and ignoring ROI until sale. It’s possible that I won’t be able to sell for several years (or for much of a profit), so I need to ensure my ROI and cash flow is reasonable in the meantime.

Okay, I’m still waiting to hear about whether the offer was accepted…until then, I’m going to push forward on these tasks, and continue to gather information in the case I need to make a decision on this one…

Stay tuned.

First, here are a few details about the property:

• Single Family Home, built in 1964
• All brick
• .5 acres lot size
• 1250 sq ft main level
• 3 bedroom, 1.75 bathrooms (stand-up shower in master bath)
• Unfinished basement (almost the same size as main level)
• Most houses in the neighborhood are very similar in design/size/layout, and most still have unfinished basements
• The neighborhood is lower middle-class out past the suburbs, in the “path of progress”

The property is an REO, on the bank’s books for several months now. Just the other day, the bank dropped the price from $127K to $70,500 (no idea why so much at one time).

Potential Exit Strategies

In this area/neighborhood/market, houses aren’t selling. Unless you have by-far the nicest house for sale in the neighborhood at by-far the cheapest price, you can expect it to sit for many months. That said, if I were to buy this house, I would have one of three exit strategies:

Option #1: Buy, Rehab, Sell
If I did this, I’d likely need to sell well-below market to ensure a reasonably quick sale. A couple things I’d have going for me are that if I finished the basement, the house would be a 5/3, somewhat unique in this area; additionally, the area has a relatively large Hispanic community, where more bedrooms tend to be appealing to buyers.

Option #2: Buy, Rehab (including finishing the basement), Rent
Doing this would create a somewhat unique rental property in this neighborhood. The property would be newly renovated, and would appeal to larger families that didn’t have many other options for rentals (everything else is smaller). Additional benefit is that the basement investment would be worthwhile when I sold; additional downside is that the basement would no-longer be new when I sold.

Option #3: Buy, rehab (without finishing the basement), Rent
This option would allow me to put in the least amount of capital to finish the remodel, but also has the downside of commanding lower rent and having to compete with many similar houses in the neighborhood for renters. The nice thing about this option (vs. #2 above) is that I could decide *later* whether I wanted to finish the basement before selling or not. This option would obviously save some time as well.

Those are my options. Here’s the financial data that goes along with each:

Rehab Costs

1. This would be the most expensive option, with costs between $35-40K

2. This option would be somewhat cheaper, as I’d hold off on some of the cosmetic work that I would do when I sold (have stumps removed from yard, improve tool shed, re-finish the deck, put in cheaper fixtures, etc). The cost to renovate would be about $30-35K

3. This would be the cheapest option, and would likely cost about $18-20K to rehab

So, assuming I could negotiate the purchase price down to $65K (I believe I can), the all-in costs for the three scenarios are: 1. $105K, 2. $100K, 3. $85K

Sales/Rental Comps

The comps I’ve found for each of the scenarios above are as follows:

1. There have been very few sales in this neighborhood in the past 12 months (and few for sale currently), so finding comps is difficult. The best numbers I have indicate that the houses with unfinished basements are selling for $125-135K, but I have no comps for those with finished basements. And I have no idea if the lack transaction velocity around that area is more a function of lack of buyers or lack of sellers.

2. Because there are few of these houses in the neighborhood, I don’t have good rent comps. The houses with unfinished basements (the 3/2 layout) are comping out at about $925/month, so I’m going to just make a guess that a 5/3 layout could fetch about $1100/month. One anomaly is that a house up the street is 2 years old, a 4/2 with a finished basement, and the guy is asking $1600. Going to see if he actually rents it or not.

3. As noted above, I believe the rent comps are about $925/month.

Analysis of Options

Now, using that data, here’s what I figure my returns could be in each scenario:

1. To sell quickly, I’m going to assume (though I could be wrong) that I’d have to list this 5/3 for the same price as the 3/2 houses, or perhaps a tad bit higher (I will consult with a RE agent to get their opinion on this as well, as I could be way off). Based on that assumption, my profit in this scenario would be about $25-40K (I’m paying all cash, so there aren’t many holding costs to account for). This doesn’t include agent fees.

2. Assuming I refi 80% of my costs back out, I’m left with an $80K loan, and rental income of about $1100/month. Using the 50% rule (which I will discuss later in the week), my cash flow would be about $750/year, plus another $1000/year if I property managed myself.

3. Assuming I refi 80% of my costs back out, I’m left with an $68K loan, and rental income of about $925/month. Using the 50% rule, my cash flow would be about $600/year, plus another $800/year if I property managed myself.

Keep in mind that while neither option #2 or #3 are that exciting in terms of cash flow (my COC for each is less than 5%), the goal here would be to sell the house at what I believe is market value when the credit crunch loosens and people start buying again. That said, I don’t know when that will be, or exactly how much I could sell for.

As I’ve mentioned in various posts over the past week or so, my fiancee has always wanted to do a rehab on a SFH. Talking about it more recently, we have been considering actually starting a business around rehabbing and selling/renting SFH in the Atlanta area. It’s currently a great market to find deals, and I imagine contractors are pretty motivated to find work. But, unfortunately, we have absolutely no experience with flipping houses!

With that in mind, we decided that before we decide to launch a major venture around rehabbing houses, we should probably get at least one under our belt, figure out the process, the intricacies, and just plain learn-the-ropes. Also, with much of the work finished on our own home, and with another four weeks until our wedding, we were looking for a new project. So, we set out to find our first SFH investment property, and after looking at hundreds online, dozens of drive-bys, and twenty or so walk-throughs, today we might have finally found our first property.

And — for good or bad — it’s not your basic cosmetic-repairs-only type property. While there’s likely no major issues with the house, the issues in general run the gamut. Most concerning for us is the fact that there is mold in many of the areas where moisture is most prevalent (bathroom ceilings, around the window frames, basement, etc). While I’m going to ensure that I do my due diligence around the mold problem (and the steps to rectify it) before closing on the property, hopefully this won’t be a show-stopper. Contrary to popular belief, most types of mold aren’t overly dangerous, and unless the problem is quite advanced, clean-up is generally pretty straight-forward.

In addition to that, we’ll likely have to gut the kitchen, do some major bathroom demo, fix some grading problems around the exterior, do some roof work, and to top it all off, finish the basement to add another couple bedrooms and bathroom. All-in-all, a pretty ambitious first project…

Anyway, the guy who found us the deal (an agent, investor, consultant and part-time wholesaler) is going to be putting in an offer on the property tomorrow, and hopefully he can get it under contract for the price we discussed. The property is an REO, so it’s sold “as-is,” but if the offer is accepted, I’ll have a 7-day inspection period, where I’ll be sure to get a thorough inspection from a certified inspector and also get a mold specialist in to assess the extent of that problem.

While I’ve ball-parked the numbers and it seems like a good deal, I have a feeling I’ll be spending much of the next 24 hours putting together a detailed rehab plan and making sure the numbers really work. Unfortunately, I have very little experience in rehab costs, so I’m expecting the Internet will be my friend for much of the day…

As indicated by the projections, depending on the ability of the company to scale acquisition, rehab, and sales efforts, the company would likely show a profit of somewhere between $500,000 and $1.8M over 5 years, with total return on investment of between 34-140% per year. This does not include the salaries paid to the employees/partners.

Additionally, as can be seen from each of the Net Cash Flow projections, a $300,000 initial investment in the venture should fully support the annual cash flow expectations, for either scenario. Based on this pro-forma, at no time during the 5 year investment period should the company require additional capital or financial investment. It’s also worth noting that in both scenarios the business is net cash flow positive by the third year, with the more aggressive scenario showing decent income by Year 5 and beyond.

In addition to the returns indicated above, there is additional potential upside as well:

• As mentioned previously, there is also an aggressive scenario that is not unrealistic. While this scenario was not modeled, I believe the financial returns could be even greater than either of the two scenarios defined, given the right circumstances
• In the first five years, between $260,000 and $360,000 is spent on realtor commissions; by having one of the company’s employees earn their real estate license, 50% (or more!) of those fees can be returned to the company
• The assumptions used to calculate both future cash flow increases and property value increases are very conservative. As the real estate market picks up again in the next 5 years, both rental rates and property values may increase much more quickly than what is projected in this model
• Active participation in the real estate markets during this time of market recession would provide the operating team the necessary experience and networking to generate much larger investment returns on future real estate business investments

Given all that, this seems like a potentially lucrative venture, and I’m definitely considering funding it and seeing where it goes. Currently, I’m working with a potential partner to see if I can raise 50% of the investment capital (I don’t want to fund the entire venture myself), and most importantly, I still need a partner who can — along with me — qualify for the necessary loans. As I’ve mentioned in previous posts, my current lack of recurring income precludes me from getting traditional financing in these credit markets.

I’m going to continue to investigate for a bit longer, and hopefully will have more info in the coming weeks…

Anyway, in those posts, I put together a very conservative financial model to determine approximately what I could expect cash flow and profits to look like if we had three people working on the idea part-time. The results were encouraging, but not staggering. On a $250K investment, the idea looks to be slightly cash flow positive in Year 5 and beyond, with a total 5-year profit of about $500K. That would make a decent passive investment (which was my original intent with this idea), but if we were going to commit a good deal of time to the effort, I’m not I’d be interested in pursuing something this small.

A couple readers of this blog picked up on that (one sent me an email, and another posted comments), and mentioned that the business financials seemed a bit thin. And I certainly agree. But, given that the original financial projections were very conservative (I wanted to see what a near “worst case” scenario would look like), I thought it would be worthwhile to do another analysis using more aggressive assumptions, and see if — and by how much — the financials improved.

Below is the revised analysis, taken directly from the business plan I am putting together for this potential venture…

SFH INVESTMENT BUSINESS PLAN

5-Year Acquisition Plan

Based on the current experience of the active participants on the investment team, it is expected that the company could, in the first year, execute on 6 acquisitions and rehabs – one every two months – of a similar nature to the property acquisition example above. After Year 2, as the company is able to put systems and processes in place to optimize our acquisition and rehab efforts, it is expected that additional houses could be purchased each year. Further, the company expects that, as the real estate market improves over the next several years, it will be possible to start selling off property investments, allowing the company to generate short-term cash flow and to maintain liquidity.

In order to get a realistic idea of what we could expect both cash flow and profits to look like, we have put together two 5-year scenarios – one that we expect is overly conservative and one that is more aggressive (and have also considered a very aggressive scenario as well). Various factors will contribute to which scenario is more likely to play out, including such things as our ability to find suitable acquisition candidates, real estate trends over the next 5 years, our ability to scale our processes, etc.

Below, we lay out both the conservative and the more aggressive scenarios (as well as comment on a very aggressive scenario), and in the following section we define the financial projections behind each of the scenarios.

Conservative Scenario

In a conservative scenario, the company expects that while no properties will be sold in Year 1, at least two properties will be sold in Year 2, with more following each subsequent year. It is expected that after Year 5, the company will still retain ownership of 18-20 properties, all of which will be sold after Year 5 to provide investment returns to the original investors. Additionally, the company would expect never to acquire more than 8 properties in a single year, thereby allowing – for the most part – the team to fully focus on one project at a time.

Here is an overview of the number of houses the company currently expects to be able to buy, sell, and hold/rent in each year, based on conservative estimates:

More Aggressive Scenario

In a more aggressive scenario, the company still expects that no properties will be sold in Year 1, but that starting in Year 2 – once processes have been put in place to scale the business – at least eight properties will be acquired and four properties will be sold. In subsequent years, the company will continue to scale, with houses being acquired and rehabbed at least once per month. In the more aggressive scenario, it is expected that after Year 5, the company will still retain ownership at least 20 properties, all of which will be sold after Year 5 to provide investment returns to the original investors.

Here is an overview of the number of houses the company currently expects to be able to buy, sell, and hold/rent in each year, based on more aggressive estimated:

Very Aggressive Scenario

We could very well imagine a scenario where the success of the team and the buyer’s real estate market would dovetail to provide an opportunity to scale the business quickly and effectively. In this scenario, the business may hire additional project managers, employee contractors/workers, a real estate agent, etc. Other successful businesses of this nature have been known to acquire and rehab many houses simultaneously – up to many dozens per year or more.

Because this scenario is difficult to model without making many additional assumptions, we have decided not to perform 5-year projection for this scenario. That said, it should be considered that the income and profit potential of the business may be much greater than either of the scenarios presented above and below.

5-Year Financial Projections

Below, we have created two 5-year financial projections (cash flow and profit), each based upon the one of the two scenarios defined above. Again, the conservative projections assume acquisition of up to 8 properties per year, and the more aggressive projections assume acquisition of up to 12 properties per year. While it is not unrealistic that the company would scale to acquire even greater number of properties, those projections are not included in this proposal.

In order to create the 5-year financial projections, we have made the following economic assumptions on the sold and held properties (each of which we believe is realistic and in alignment with current trends):

• 2% annual increase in rental revenues
• 2% annual increase in expenses
• 2.5% annual increase in property values
• 6% sales commission on each property

Further, we assume that after Year 5, all remaining inventory will be sold off.

Conservative Scenario

Given the acquisition and sales volume/ratios defined above for the conservative scenario, the 5-year financial projections would look as follows:

As indicated above, the total profit given the conservative scenario would be $498,374, on an initial investment of $300,000 (it would actually only require an initial investment of $250,000, but I’m basing the returns on a $300,000 investment to provide an apples-to-apples comparison with the more aggressive scenario below):

• The total return over 5 years would be greater than 170%
• The simple return on investment would be 34% per year
• The compounded annualized return on investment for five years would be 11.25%

More Aggressive Scenario

Given the acquisition and sales volume/ratios defined above for the conservative scenario, the 5-year financial projections would look as follows (notice that in this scenario, the total salary for the three employees has been increased; as we believe this would be a full-time venture for at least 2 people to achieve these results, it’s reasonable that salaries are increased accordingly for the 5 years):

As indicated above, the total profit given the more aggressive scenario would be $1,810,751, on an initial investment of $300,000:

• The total return over 5 years would be nearly 700%
• The simple return on investment would be nearly 140% per year
• The compounded annualized return on investment for five years would be 47.5%

Tomorrow, I’ll go through a quick analysis of these results, and let you know what I’m currently thinking in regards to this venture…