How to Analyze a Proforma Sheet (1)

The Ultimate Beginners Guide to Scrutinizing a Proforma Sheet on Turnkey Real Estate

How to Analyze Proforma SheetYou’re wishing for a boost in monthly income in the simplest way possible.

You have strong desires to invest in real estate on the side, without the hassle of being a landlord.

You enjoy the freedom passive incomes provides you and you’re not interested in working in the trenches for your investments.

You’re thinking that there must be more affordable markets than the one you’re located in and you want to buy a rental property in those markets even if they are thousands of miles away.

You’re feeling overwhelmed when you start to look at turn key investment properties because it is hard to figure out which are good, which are bad, or which are down right scammy.

You’re afraid of making a mistake in crunching the numbers while scrutinizing the real estate proforma sheets.

Well, fear not; for here is a great guest post from Alexander, an experienced turn key investor on how to pull back the curtain and look behind the scene at these seemingly perfect proforma sheets.

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Screen Shot 2016-03-15 at 12.19.18 AMBecause this post is a unique guide, I created a Free Rental Income and Mortgage Calculator for you to crunch your numbers – you can download it here:

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Purchasing turnkey rental properties are becoming increasingly popular. With the ease of having a team built into the rental investment (property manager, handyman, and tenant), it is getting easy to buy them and get an instant return on your investment – when done right!

It is important that you know how to properly analyze a turnkey property so that you minimize risk and build a successful portfolio of rental properties.

Today, we will be doing a case study on how to analyze a turnkey rental property. When you find a turnkey rental property that you are interested in, many times the seller will give you a pro forma document that conveniently has all the numbers and calculations built in for you.

This makes it very easy to analyze a property right? Well, not so fast! Just like any other investment, it is up to you to make sure you conduct your due diligence, including validating that the numbers are accurate and complete.

If you do not properly analyze these numbers, then you increase your chances of failure. And you don’t want to do that now, do you?

Here is an example of a typical pro forma document you will see when searching for good cash flowing turnkey properties. (Take notice of all the highlighted fields.)

proforma

The highlighted fields above are all assumed numbers by the turnkey provider and every single one of these amounts can be different after properly analyzing and verifying these numbers.

There are a lot of fields highlighted above which we will dive into below. What this means is that the numbers provided on this typical pro forma sheet can vastly differ from what your actual numbers will be. This is why it is so important to properly analyze and verify your numbers prior to purchasing.

Now let’s dip into each category to see why or how these numbers can differ for you:

Purchase Price

When buying real estate, you must know many items are negotiable. This does not mean that you will get what you want; however, it is highly advisable that you try and negotiate your purchase price. By even dropping the purchase price a few thousand dollars, you can significantly improve your overall returns.

Key Tips from Financial Nirvana Mama: Ask for comparable sales and conduct your own search as well. Use at least three comparables to negotiate on the price. The person sending you comparables may deliberately show ones that are aligned with the list price. Use tools like Zillow, Craigslist, and Kijji to conduct your search as well.

Down Payment

This pro forma is assuming you are doing a 20% down payment. Chances are high that you probably will do a 20% down payment; however, in some cases the lender will need you to put a higher down payment. For conventional lenders, once you get past 4 mortgages, they do require a minimum of 25% down payment. Contact your lender and confirm what your down payment should be.

Key Tips from Financial Nirvana Mama: When you are new to the real estate investing game, best to use cash as a down payment or other people’s money (i.e., joint ventures). Using lines of credit adds risk (interest rates fluctuate), and you don’t want to be stretched too far paying a line of credit down too.

Buying Costs

In this example, there is a random number thrown in and it does not indicate what these buying costs include. Are they talking about mortgage fees?  You don’t know. You will want to verify with your seller exactly where they got this number. In many cases, a typical buying cost would be that of an inspection report. An inspection report is not usually required by a lender and it would be up to you to order one and confirm your property is in adequate condition. Once you know the actual “buying costs”, you will want to input the correct number to run your analysis.

Key Tips from Financial Nirvana Mama: Additional buying costs include legal fees, land transfer fees, inspection reports, and an appraisal (if needed). Many of these costs are not part of the ‘buying costs’, so please budget these expenses accordingly as part of your consideration.

Initial Cash Invested

This number will also change based on what your down payment and total buying costs will be and it is important that you input the correct number. If you are purchasing a turnkey rental property in a different location and you decide to travel there to check it out first hand, this would increase your buying cost and it would be wise to include this cost in your “Initial cash invested”.

Key Tips from Financial Nirvana Mama: It is wise to budget for two months of expenses up front (2 months of mortgage payments, property taxes, and insurance, as a minimum) to start your investment off on the right foot. This will cover unexpected vacancies or larger repairs.

Term

This pro forma is also assuming your mortgage has a 30-year amortization. There are many types of mortgages out there and amortizations can vary. Typically, they are in the range of 25 to 30 years. It is best you contact your lender and confirm what kind of mortgage you are approved for. Once you have your correct term, you will want to update this in your analysis.

Key Tips from Financial Nirvana Mama: If you’re looking for a boost in your monthly cashflow, try for a longer amortization. If you’re looking for a “forced savings plan” type investment, try for a shorter amortization.

Interest Rate

This number can also vastly differ for each individual. Your credit score and downpayment can change what your interest rate will be. Not to mention, interest rates are constantly changing in the mortgage world. You will want to confirm what the rate will be with your lender and update your analysis accordingly.

Key Tips from Financial Nirvana Mama: Stress test your analysis by putting in today’s interest rate as well as a higher interest rate. Check that it still cashflows with a higher interest rate.

Payment

Confirming your purchase price, down payment, term, interest rate, taxes and insurance will allow you to get an actual payment. See below for confirming taxes and insurance. It is very important you know exactly how much your real mortgage payment will be when running your analysis as this will affect your monthly cash flow.

Key Tips from Financial Nirvana Mama: There are many professionals to go to for advice (real estate agents, lawyers, accountants) to help you make an informed decision. However, it is still your responsibility to conduct your own due diligence. Do your own analysis, crunch out the numbers and figure out if this property generates enough income to be worth it.

Gross Rent

Just because the turnkey seller tells you the property will rent for X amount, does not mean your property will actually rent at X amount. In some cases, a scrupulous turnkey seller will inflate this number to make the deal seem better. This is why it is important to conduct your own rent market analysis to determine what the market rent should be on a property of that nature.

Key Tips from Financial Nirvana Mama: Look at kijiji, rentometer and other similar resources to get a gauge on market rent. Stress test your numbers by putting in a rental range starting from a mid range rental price to a lower number. Figure out what the minimum rent this property needs to collect to bring you income. If the market can easily support this based on past market rents, then you are in good shape.

Vacancy Loss

Vacancy loss is a projection of future vacancies you will have with the property. Every market is different and it is important you analyze what type of vacancy is common in your market. Some cities have very low vacancy meaning it is possible to fill a vacant property in just a few weeks. In some cases, it could take months to fill your vacancy.

Key Tips from Financial Nirvana Mama: Contact multiple local property managers in the area and ask them how long it takes to fill a rental property. Protect yourself – budget for at least one month of vacancy as part of your buying costs rather than relying on a vacancy percentage. If you stay aggressive with your rental rates, vacancies will eventually happen, it is just a matter of when.  

Cleaning and Maintenance

In this example, the turnkey seller is assuming a 5% monthly cleaning and maintenance cost. This number is very low and it is best to be on the conservative side and estimate 10% in your analysis. The age of the working mechanicals in the house, including roof/HVAC/water heater and other appliances, can help determine what this number should be. If you have a freshly rehabbed property with all new components, this will help keep this cost lower; however, at the end of the day, it is the quality of your tenant which will determine this. Good tenants can prolong the life of your appliances and keep your property clean.

Key Tips from Financial Nirvana Mama: Budget for two months of expenses for every rental property you own. Alternatively, you can also buy insurance to cover wear and tear on appliances and mechanical parts rather than coming up with a huge chunk of money up front to cover repairs.

Insurance

Contact multiple insurance companies and get actual quotes of a property you are interested in. Get the correct insurance payment and crunch out the numbers. It is important to put actual numbers in your analysis when running your numbers.

Key Tips from Financial Nirvana Mama: A less expensive way of getting insurance is adding a rider to your home insurance and/or being part of a professional association that gets you discounts on insurance.

Management Fees

One thing about buying a turnkey property is that they usually come with a property management team in place. Property management costs are also negotiable and it could be possible for you to change what this monthly payment will be. It is also possible for you to choose a different property manager with lower fees if you choose to do so.

Key Tips from Financial Nirvana Mama: Choose your property manager wisely. Conduct a background check to see how good and diligent the property manager is. There are a lot of scam artists out there, who will charge you for false repairs. Look into the property management fees and see what it includes – a lower flat rate could translate to higher service charges for repairs. Also, be weary of rental pools, which are essentially a guaranteed source of monthly income that fluctuates month to month. Guaranteed rent is nice, but getting dragged down month after month by other people’s vacancies is draining on your pocket.

Taxes

Your monthly tax payment can differ depending on where you buy your property. It is possible to get accurate tax expenses by researching your local tax and assessor sites. In some cases, if you purchase an out of state rental property, there are additional costs and it is important you find this info.

Key Tips from Financial Nirvana Mama: be conservative with your tax estimates because it is possible for these to increase over time.

Cash Flow

Cash flow is the whole reason you are buying a turnkey rental property.  This is one of the most important numbers. If your cash flow requirements are not met, then it is best to move on to a different property.

Key Tips from Financial Nirvana Mama: Is the cashflow enough to justify buying a turnkey rental property? Double check that the cashflow is aligned with your personal cashflow goals. If the cashflow is low, maybe it is time to move on to another property.

Buying a turnkey rental property can be a great way to setup your financial freedom; however, it is not always easy to find a good cash flowing property. It is very important you assess all your numbers when analyzing a potential rental property as a first step.


Alexander Aguilar is an entrepreneur/real estate investor/blogger dedicated to reaching financial freedom and retiring early by generating passive income. He is highly motivated and has a deep passion for helping others achieve greater success. He is the founder of Cash Flow Diaries – a blog dedicated to tracking his journey to financial independence and sharing intimate financial details for the world to see.

You can follow Alex on Social Media here: Twitter,Facebook, LinkedIn, Pinterest


Investors: What are your experiences with turn key real estate?  Any questions about this form of real estate investing? Leave all your comments and questions below.


 

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5 Comments

  • Investment Hunting
    Twitter:

    Reply Reply March 15, 2016

    I’m wondering if annual tax savings should be included somewhere on this sheet. Potential write-offs could make a break even turnkey property worth it in the long-run. Thoughts?
    Investment Hunting recently posted…Good Reads – 36,000 Feet EditionMy Profile

    • Hi Investment hunting, My thoughts – investing in real estate always includes tax write offs so if you were to compare a property that cashflows vs not cashflows, the one that cashflows always wins. Having a cashflowing property makes you happy in your real estate journey. Having a ‘breakeven’ turnkey property is never worth it in the long run. Along in the journey in turnkey real estate,there will be wear and tear, costly repairs, broken faucets, leaky roofs etc, which makes a larger dent in your pocket (especially if you have no income coming in for this property). A key financial factor for investing in turnkey is for income, not for building wealth. Also, these properties tend to be harder to sell as they tend to attract mostly investor buyers – so in order to sell it to another investor, you need to demonstrate that it cashflows – otherwise you could be stuck with this property for a long time. Buy turnkey real estate only for cashflow. Have you seen a turnkey property that doesn’t cashflow?
      Financial Nirvana Mama recently posted…A Simple Formula to Make you WealthyMy Profile

    • Alexander
      Twitter:

      Reply Reply March 16, 2016

      I dont include those kinds of savings on my calculations mainly for these two reasons:

      1) it is not easy knowing exactly how much you will save each year from taxes. you will be speculating at best.

      2) it is not ideal to consider tax savings as part of your returns from these investments, you should consider it as a bonus or icing on the cake.

      I agree with what Tracy says, if the tax benefits is what makes it a good deal than it its actually not a good deal at all and you should find a different property with better returns.

      🙂
      Alexander recently posted…Selling With Amazon FBA – My Private Label ExperimentMy Profile

  • Alexander, great guest post! Understanding the proforma is the first step, then being able to adjust it for your own beliefs (like thinking vacancy might be a little more or rent a little less).

    To chime in to the previous discussion, I think it is worth knowing the tax benefits even though it shouldn’t make a difference in deciding if the property is a good investment. A rough estimate is 1% of the property value per year.

    Also wanted to call out – Alexander I’m not sure if you want to remove your last name from the author line.
    Brian – Rental Mindset recently posted…Embrace the Mindset of a BeginnerMy Profile

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