SFH Investment Analysis (Part 1)

June 25, 2008 · 4 comments

As long as I’ve now sidetracked into discussing the possibilities of helping my fiancee start a single family home (SFH) investing business, and now that I’ve laid out what a typical investment scenario might look like in this market, I might as well take the analysis to the next level, and determine whether the financials would support a full-blown venture. For anyone working on a real estate business plan, perhaps this will give you some insight into how I approach the financial plans for mine…

In this case, let’s build a 5-year financial model for our business, given the example investment scenario presented previously and all the following (reasonable) assumptions:

  • The business would employ one full-time person, one “most-time” person, and one half-time person. I would be the half-time person, my fiancee would be the most-time person, and a contractor friend of ours would potentially be the third person, likely working full-time;
  • The roles and responsibilities would be as follows: I would focus on finding/acquiring property and ensuring that the financial plan was followed and on-track, as well as some of the back-end property management tasks. My fiancee would assist in the finding/acquisition, the rehab design, and some of the back-end property management tasks. Our third partner would be responsible for acquisition consulting (helping figure out the rehab costs prior to purchase), project management of the rehab, and some of the back-end property management tasks;
  • Given that division of labor above, I believe it’s reasonable that this venture would be able to acquire and rehab approximately one house every other month, or about six houses per year;
  • Given the current real estate market, it’s unlikely that we’d be able to sell any of the houses this year, but starting next year, we may be able to sell one or two, and from there, hopefully the market will pick up and we’ll be able to sell more and more of our houses in years three through five;
  • The three employees would likely want to draw at least a small salary to support themselves while the business reinvests income and capital gains for the first several years. Let’s assume each employee needs to draw $30,000 per year in salary.

Give the assumptions above, the company would have a number of recurring income and expense line items, which could be analyzed on an annual basis. Here are the major income and expense items:

  • Acquisition Costs: Per our acquisition analysis from a previous post, typical after-refi acquisition prices will average about $12,000 (this includes closing costs on the refi loan)
  • Sale Proceeds: Again, per our previous analysis, we expect to generate about $40,000 in equity for each property after refinancing. Let’s assume that these properties are sold without an additional appreciation, so, our total proceeds on each sale would be $40,000
  • Sales Commission: Of course, each property sold (through an agent) will cost us a sales commission of up to 6%. Given the $120,000 selling price of each place, that’s a $7,200 expense on each property sold
  • Cash Flow: Each property held for rental (i.e., not sold) will generate cash flow for the company. As per our previous analysis, typical cash flow in Year 1 will be about $862. This increases annually, as rent/expenses keep up with inflation. So, cash flow will increase in each year and with each additional property acquired/held
  • Salaries: As discussed above, the three employees would draw an average annual salary of $90,000
  • Final Sale of Inventory: To appropriately model the financials, it will be much easier to assume that all remaining properties are sold at the end of analysis period (they may or may not be). For this exercise, let’s assume that all remaining properties are sold in/after Year 5. Further, let’s assume that the remaining properties were bought equally across the 5 years, and that each saw 2.5% market value appreciation per year (again, per our previous analysis). Modeling this in a separate spreadsheet, each of the remaining properties would sell for an average of $52,239 in profit, and generate a sales commission of $7,758, for a net profit of $44,481

So, now we have the assumptions about how the business model will look and the income flow for each component of that business model. In order to create a financial model, we just need to determine specifically how many houses we will buy/sell in each of the years we’re modeling for. We already know that we’re going to build a 5-year model, and we also know that we’re planning to acquire 6 houses per year over each of those five years. Now, let’s make a reasonable guess at how many houses we’ll be able to sell in that time period. Keep in mind that we don’t have to sell any houses, but by selling, we free up the equity we’ve created during rehab, and can use that new-found cash to buy additional properties and mitigate any liquidity risks (i.e., ensure that we don’t run out of money).

Here are guesses about the number of houses we’ll be able to sell each year:

SFH Business Model Assumptions

We should now have enough information about how we plan to execute on our business model that we should be able to put together a 5-year pro-forma financial plan, including cash flow data (for proper liquidity planning) and income/profit estimates.

I’ll finish this analysis in my next post…


4 responses to “SFH Investment Analysis (Part 1)”

  1. El Guapo says:

    First you said $30k salaries, but then later you said $90k. Not sure which it is.

  2. J Scott says:

    I guess I wasn’t very clear on that… my expectation is that both my fiancee and myself, along with our full-time employee, would each be earning $30K/year in salary. Since this would likely be a full-time responsibility for us, drawing at least a small salary would be a requirement.

  3. Shane Johnson says:

    You ever look back at these and laugh, and go Wow. I was way off! Great job J. You have sold double your goal of houses, two years faster than anticipated. You and your wife are truly an inspiration.

  4. J Scott says:

    Shane –

    That’s awesome! I don’t generally look back at old posts, but these are really making me laugh…thanks for pointing this out!!!

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