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Pro Forma

Wednesday, March 25, 2020   /   by AJ Shepard

Pro Forma



Speaker 1:

So this is a pro forma from 68th that we did. I don't know exactly what version it is, but just quickly go over. We cut this down to a five-year projection, which is why this is highlighted. Ultimately the way the deal ended up working out, we had to do two pro formas, one for the first year before we refinance, and then one after that just because it gets complicated when you do a refinance. So, but to give you an idea, the red numbers are the numbers that are inputs. So we had the purchase price of 1.315 capital improvements in the 150K repaired enum of minus 63,000. Listing out current rents, those are get ins, inputs, and then listing out what we expect, the renovated rents or what we can get it up to.

Speaker 1:

So, well yeah. So going through, you can assume different numbers, assume annual rent increase of 2% or 5% and you can check out how that changes out the overall percentages. You see here this return on investment goes way up when you do a higher increase. But yeah, when you're doing a pro forma, what you want to make sure is you have all of your expenses in there. So the reason we highlight these numbers in red is that they're generally assumptions. In the first year we put in a 15% vacancy rate just because we know that we're kicking people out. We've got people transitioning out of a bad unit, renovating it, it's going to be vacant for the construction and then getting them back in. So it's just the typical higher vacancy.

Speaker 1:

Whenever you're doing a pro forma, the best thing to do is be conservative and start really conservative. Then as you look at the deal more and you get more comfortable with it, that's when you start sharpening your pencil and dialing stuff in. So starting out with an expansive list and then narrowing it down is always pretty good. So, I've seen some other pro formas that have some stuff in here, but the last thing you want to do is forget about something and then you get the deal and you're like, "Oh shit. I forgot about $20,000 worth of siding."

Speaker 1:

Or something else, I don't know. So the main thing is making sure that you get everything in there. From this particular one, we don't have any payroll. We assumed after we got it up and going we're going to have less maintenance and repairs because we're fixing a lot of the problems up front. There's a capital cost, not necessarily maintenance costs. That's just lawn care, making some other ones ready, it's going to be $1,500 presumably after we fixed the units up. We have good units and good repair, so the tenant's security deposit should cover most of the turns.

Speaker 1:

We did knock down our management fee to 6% for this to help out. Taxes are a given insurance, you can get quotes on that. I think we actually might be pretty, we might be higher with that. Then lender reserves and then we did do an asset management fee of 1%. Then here on the cashflow area is where you can put in the terms of the loan. This is when we were looking at just a straight finance that did not work for us. We had to actually go do a semi-hard money loan and then the plan is to refinance out. So these numbers don't really or do not reflect reality, so you can move them around and see what happens. But if the loaned value goes up, you can see the percentages go up because you just have less cash in the deal.

Speaker 1:

So it's interesting to see how the numbers actually move when you change them. Obviously, if the interest rate goes up, the cash return goes down. But moving some numbers and even extending out instead of 25 that helps too. So we have a preferred return for our investors, which is 7% and then the LP split after a preferred return is 80, 20. So that means that if we had a return of... what is going on. That's what I wanted. We had a return of 9% in a quarter, let's see where is, yeah. So this cash ROI is our cash-on-cash. So the first year we expect to have 7% but the subsequent years we're looking at higher percentages for cash-on-cash return.

Speaker 1:

So the first 7% goes directly to the LP investors, and then the 3.7% will be split 80% going to the LPs and 20% going to the general partners and upturn syndication would be the general partner. Over on this sheet, we have the IRR and return on investment entirely. So IRR, we're shooting for a 20% we're hoping that we can beat this. I believe that if we unhide this, this is the L... this is the general partnership IRR. Then this is the LP, and the reason those are different is that, does anybody know why they're different?

Speaker 2:

You've invested less cash.

Speaker 1:

No. It's because the general partnership takes that extra on the preferred return. So the limited partners and also the general partnership at the end of the deal take 20% so their return is just inherently going to be higher and they do have less cash in the deal. We're acting as limited partners and general partners in the deal, but overall the general partner has no, essentially no money in the deal. But I think this is a calculation is if the deal was straight up. So the investors can expect to see at the end of five years approximately 77.5% increase on the money. So if they put in 100 grand, they would have seen over the course of disbursements and the return of the money, the sales and the profits, they would see 177,000.

Speaker 2:

What's the difference between the IRR and the normal ROI?

Speaker 1:

ROI is an initial investment and then return, doesn't take into account time. So IRR takes into account time. So over the course of five years, you're making about 18% per year is what this says. So if you have started out with $100,000 and we ended up cashing out at year three, the ROI would most likely only be 140%, 150% because you'd be making 20% on your money the first year, which should be 120 grand. Then 20% of your money the second year which should be 142 grand. Then sometime in there, between two and three you'd cash out.

Speaker 1:

So IRR takes into account the time value of money. Because likewise you could put in the way... Some people can say, "Oh, my ROI is going to be 250%." But if you put in 100 grand and it takes 50 years to make 250% that's not that good of a deal. So it's you always, whenever you hear ROI, you have to think in the back of your head, well what sort of timeframe is that actually happening over and that helps you get more to the IRR calculation.

Speaker 2:

Okay. Is that discounted cashflows essentially or is that not really being taken into account at all? If an interest a bond is I don't know, 3% or whatever it is. Is the IRR taking into account the discount rate or is it just a straight-up internal rate of return averaged out per year roughly 18%.

Speaker 1:

That is a good question. So we give a preferred return of 7% and the IRR typically takes into account what your expected return is. I don't know that this calculates that.

Speaker 3:

Yeah.

Speaker 1:

When you're looking at IRRs, if you know that you can, and this is when you're analyzing deals, right? If you know that you can get a 15% return over at another investment, but you can get a 20% return on this investment, but there's only an 80% chance that you get a 20% return.

Speaker 3:

Right.

Speaker 1:

It's well, what's the other 20% chance? Is that going to be 10% or is it going to be 2%? That's where it's the bottom rate of what you can get on your money, and most people set that at that. That's one of the reasons that are our main right, is 7%. We can't say that we guarantee it, but it's pretty much guaranteed. Before any profit is taken from the company other than the management fees that the property management company is doing and what else, the investor is going to get their money back before any GP takes the profit. So that's where the expected return on the IRR calculation is about seven, is 7% for those.

Well, you did say after you start conservative and then as you become more familiar with the deal, as you do more research then you start to sharpen your pencil, what kind of things are you looking for that give you more confidence, putting in more accurate or more precise numbers?

Speaker 1:

Giving hard quotes on insurance. Getting hard quotes on your construction budgets. When you start getting quotes for roofs, you know you can budget I think we budgeted 22,000 or 25,000 in this. Then we started drilling that down and I think you can make small adjustments here and there. Hopefully, when you're doing that budget and estimate you want to be high and then you want to start like, we looked into mold, and we got into the place and got to see more and then we realized it's not that big of a deal. We just need to fix the leaks and we need to clean up the attic a little bit and get some dehumidifiers. It's not a full-on cut out the drywall and do everything.

Speaker 1:

When you're doing the repair addendum too, if you get it under contract, you want to paint the picture that it's about to fall down. That's how you're going to get the best price on your repair addendum. You can almost have two sets of numbers one that's the, what your original budget was, which is super conservative and then you have your other budget of this is what I really think I can get it down to. What I will say too is with construction, my dad, who I'm here visiting right now, always says it takes longer and it costs more. There's some absolute truth to that. So you definitely want to have some contingency in there in your budget as well. Really just try to think of everything and put a number to it.

Speaker 1:

Then as you sharpen your pencil and you find out what those numbers actually are and again, try to start high and then come down. I know that can be hard too because then you're like, every deal you look at you're like, "Oh man, this is a dog. This is a dog." But yeah, if I sharpen my pencil on it, it starts to get a little bit better and a little bit better. But you'll thank yourself in the end if you have 100% of your projects and your deals are profitable. There's a reason that you start high and you look at a lot of deals, it's a time-consuming thing. As you get better at it, you recognize what's going to be a good deal and what's not a lot easier, which I'm sure you guys are starting to do too.

Speaker 1:

All right. You guys have access to this on Dropbox under the syndication folder. Please don't change it, but you can take a copy of it. I've sent it out to all of you too. For some of my, some really rudimentary one, this is another one that I made up when we first started going, first started doing deals. I think I even got 6817 Oak here in Longhorn. Then a couple, then I did 2600 Lombard too. So maybe not that old. But these are just, it's a cash flow calculator and this is where you can... You guys are welcome.

Speaker 1:

I can send this out to you too, but this is the type of thing that I would share with my clients. That first performer, when someone looks at that for the first time, that's one it's just like, "Whoa, this is so much information and this is for multiple units." I think had one that was just super financial model. Sometimes it doesn't need to be that hard. Sometimes it just needs to be like, is this going to make you guys, is this going to make a lot of money? Does this make sense? So as you can see, some of them make more sense than others. But the problem is this one was bought five, six years ago.

Speaker 1:

So every year that goes by and your rent increases more than your assumed 2% or 3%, the cap is at 10% now with the state CPI is three that's why, our assumption on here three is super conservative.

Speaker 2:

I mean annual revenue increase is going to be what? 5% to 6%?

Speaker 1:

Yeah. If you look at it over the last 10 years, you're going to see 8% or 9% in rents. Just because we had that huge jump between 2012 and 2015 so yeah. If you look at it over the course of 100 years, I think it's more along that 3% to 4% range. I'd have to look at it. I don't know exactly off the top of my head, but I know that there's very few drops. Well yeah, like I said, this is something that it's a good way to say that these are a couple of the deals that we... If I put these deals up, these are a couple of deals that we did and this is what they look like now.

Speaker 1:

Then this is one that we're looking at so that you can compare whatever newest deal that you're looking at with your client and understand what's going to be good, what's going to be bad. So when we put this one in, even if it's a negative cash flow, a small amount for the entire year, you got to know that their principal, they're going to be getting $1,200 in principal a year. So it's still going to make money. I think that's what I was doing down here is first payment principals, $800 so net they're actually making $800 a month. So that's why it's getting people into the first one and they start to understand after a couple of years they get the heat lock and it just, it starts to compound.

Speaker 2:

So for that Rock Creek deal, if a client is looking at that, they're going to say, "I'm technically losing $8 per month before the rest of it?"

Speaker 1:

Yeah.

Speaker 2:

So for eight bucks a month, you could have a deal?

Speaker 1:

Yeah.

Speaker 2:

Okay.

Speaker 1:

For the most part, most people when they price real estate do a pro forma too. With the financing that's out there, it's generally a zero cash flow. That's how they try to price it. Then what's interesting, I'm sure you guys, I mean in the residential market, the zero to one, four... Zero to four-bedroom market, a lot of brokers don't know what they're doing. So you may find some that are mispriced, which if you look at the stats, I think Taylor, when you were going over the stats in the win meeting the zero... The two to four-bedroom, time on the market was 12 days or something. It was something ridiculous it's because what happens is if someone puts something on the market and it's actually a good deal, it goes away really quickly. But then if it's not a good deal, it stays on the market forever because everyone that is looking in that market knows how to analyze a deal. They realize what the income is and what's not. So there's a fine threshold on what becomes a good deal and what doesn't in the multifamily market.

Speaker 3:

Yeah.

Speaker 1:

A little bit different than the residential, where you have the first time home buyer an emotional, like this is the perfect place for me in a great location and-

Speaker 3:

My kids will run around in the backyard.

Speaker 1:

Exactly. My kids friends live next door.

Speaker 3:

Yeah. I'll take it and love it.

Uptown Properties
Chris Shepard
3526 SW Troy
Portland, OR 97219
503-941-0276
Fairway Independent Mortgage Corporation
Mike Maier
5410 SW Macadam Ave, Ste 100
Portland, OR 97239
503-545-9879

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