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URL:  https://boards.fool.com/lets-look-at-this-a-different-way-first-of-all-15436482.aspx

Subject:  Re: Possible first buy Date:  7/24/2001  8:23 PM
Author:  jiml8 Number:  587 of 14356

Let's look at this a different way.

First of all, when I do that computation, I come up with a PI of $959.71 per month (300 months, 7.5%, 125K mortgaged). You will pardon me if I use my number rather than yours.

If you put down $45K and have a positive cash flow of $300/month, then you are getting a pretax ROI of 8% on your money. You will have a straight line depreciation of 27 1/2 years on the building (not the land...you can't depreciate land). Probably the land value will be taken as about 25% of the purchase price, so you will be depreciating $125K at a rate of 378.78/month. So you will have an excess depreciation of $78.78/month which will protect other income of yours, saving you about $22.06 in federal tax per month (presuming you are in the 28% bracket. This $22.06 adds an additional $264.72 to your annual income, adding another 0.6% to your yield, for an effective 8.6%.

Now, you will have a payment on principal out of that money. In the first 12 months (using your assumptions), you will pay $2,216.74 in principal. This represents a yield of 4.9%, giving you a total yield of 13.5%.

Let us assume that your building appreciates in value at 1% per year. We would normally assume appreciation at the rate of inflation, but you have already indicated that the economy in the area is bad. So, we will say 1%. That is an appreciation of $1700 in the first year, which is added to your effective yield (though you don't see it until you sell, if then). This 1700 is a 3.78% bump in your effective yield, giving you a gross effective yield on your $45K investment of 17.28% per year.

Pretty good, huh? ;-)

But, you forgot a couple things which we have to consider. First, your specified $300/month cash flow is based on your payment of PI. But you are going to have property taxes and insurance. Taxes vary widely from area to area; I have no clue what yours might be. But you need to find out. Similarly, insurance varies quite a lot; again I have no clue.

I would expect your property taxes to run at least $2000/yr on a building with that valuation, and your insurance to run about a grand. So you are looking at - let us say - $3000/yr in taxes and insurance. This comes out to $250/month, leaving a net positive cash flow of $50/month, and reducing your effective yield from cash flow to 1.3%. OTOH, your excess depreciation allowance is increased by that $250/month which saves you an additional (at 28%) $70/month in federal tax, increasing your effective yield by 1.87%.

So, after factoring in the taxes and insurance, your effective yield is 12.45%, of which $50/mo is cash, and $70/mo is tax savings.

Now, let us look at your risk. Commercial clients tend to remain in place for a long time (plus) but when they move, your property tends to sit empty for a long time (minus). If your property sits empty for an extended period, its value will drop, wiping out your paper gains while also neatly eliminating your REAL gains (you gotta pay the mortgage, and it takes a lot of months of $50 cash to make up for one month of $959.71 PI. How much minus are you willing to accept for your 12.45%?)

I'll give you a hint. I wouldn't touch it. No return and more risk than I want. Your $45K would make close to 8% with basically little risk in junk bonds, and would make better than 5% with no risk in treasuries.

When I do the computation I just went through here, I expect to see an effective annual yield of better than 50%, with something on the order of 15% cash (AT LEAST!!) yield for my money invested.

So, you either need a much lower selling price, or substantially higher rents.
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