Apartment #2 – Real Estate Analysis PART 2

In the second part of the real estate analysis I am going to dig deeper into the numbers. As promised, I am going to show you how my actual calculations look like. I do this using a 10 year forecast Excel based model. The model is developed all by myself and it is a work in progress kind of thing. It is by far not complete model, nor is it correct in each and every bit. But if you are interested to hear more about it, I might make a post dedicated to it or share the model with you.

In the first part of the real estate analysis I already showed you the results of my analysis. Here, I am going to talk more about the different assumptions and input parameters that I chose.

Before we start with the inputs, let’s just recap what our entry inputs were.

Entry assumptions apartment 2
Entry assumptions apartment 2

We assume to buy the asset for the price that the broker states on his memo, € 69,000. In addition we have some ancillary costs that amount to c. € 8,400 in total and include real estate transfer tax (RETT), notary & land registry costs, broker fees and financing costs.

Assumptions…or “guesstimates”?

Now, let’s start with the top line, the net cold rent. I received a couple of documents from the broker including the current lease contract. It is interesting to see that the contract does not distinguish between a cold and warm rent, or between a cold rent and ancillary (recoverable) costs. That is quite weird because it is a common practice. I would even assume that this is statutory.

Operating assumptions apartment 2
Operating assumptions apartment 2

The contract tells us a warm rent of € 340 per month. In a next step I we have to find out what we should deduct as recoverable costs. This is actually easier than expected. Based on the utility statement issued by the property management some € 100 per month can be allocated to recoverables. As a result, the actual net cold rent amounts to c. € 240 per month (€ 7.5 per sqm). Let’s have a quick thought about whether this is a fair reflection of the current market. Remember that we are not located in the city centre, but in a suburb. A quick Google search reveals the following:

It is crystal clear that the actual net cold rent of € 7.5 per sqm is way below the current market rent. The problem that now occurs is that we cannot just increase the rent to a market rent. This is not a legal move in Germany. In fact, we are only allowed to increase the rent by 20% within 3 years. Assuming that there were no rent increases during the past years, the highest achievable net cold rent immediately would be 20% more than the € 240 per month = € 288 per month (€ 9.0 per sqm).

Our next point to consider are non-recoverable operating costs. Again, this can be more or less read from the utility statement. This statement mandatorily prepared by the property management company for every owner of an apartment. Usually the property companies already split all costs according to whether they are recoverable or non-recoverable. This makes life much easier ;-).

In our case and after adding all expenses, the non-recoverable costs amount to c. € 55 per month (€ 660 each year). Just the number however, does not really tell us anything. It will become more interesting once we calculate how much “NOI leakage” we have. This is done via the following calculation

1 – NOI / Net cold rent

In my model I named these figures “NOI yield”. It is exactly the same as the above expect for the “1 – “ part. During the first year we have a 80% NOI yield. That means approximately 20% of our income is attributable to costs. This figure is quite normal. Usually I would expect to see a range of 10% to 30%. Costs are higher when the apartment is older (e.g. worse insulation). However, that doesn’t necessarily mean that newly built apartments have automatically less operating costs. Think of high maintenance things such as elevators etc that often drive up operating expenses.

Although we calculated the non-recoverable costs to be c. € 660 per year, the model takes a slightly more conservative view and comes up with € 688 during the first year.

The next part is the financing. Of course we want to take advantage of the leverage effect. If you don’t know what the leverage effect is, I made a short post about the leverage effect that you can check out.

In relation to the purchase price of € 69.000 I assumed a financing of c. 79%. This ratio is what you call the loan to value (LTV) and which is a very, if not the most, important ratio for banks.

Although I have not checked with any bank what kind of debt service I could expect for such a financing, I think that a 2.0% interest p.a. and a 2.0% amortization p.a. are feasible. All in all, the debt service amounts to almost € 2,170 each year. Wow, that eats up quite a chunk of your cash flow. What a bummer…

Financing assumptions apartment 2
Financing assumptions apartment 2

If you are going to ask yourself why I chose such an odd number for my LTV, let me explain. In this case my goal is to generate at least a little bit of positive cash flow. In fact I would like to earn roundabout € 50 each month (€ 600 per year). I then used the goal seek function in Excel to see how much leverage I can take in order to get my € 600 at the end of the operating costs and the debt service. That is the reason why I came up with 79% LTV.

As you can see in line “Cash flow II” the surplus is exactly € 600 in year 1.

Now that we discussed almost all inputs, let me add that I also assumed a 1.0% p.a. inflation. That means income and expenses grow by 1% each year. I assume not to have any Capex. This is actually a very bold statement and in reality I would probably much more cautious.

In order to calculate my returns I assume to exit this investment by year 10 for an amount of c. € 75,500 (this number equals the purchase price plus the inflation).

The Cash Flow

Here is the complete 10 year cash flow. From top to bottom you can see all line items, although we didn’t talk about each line. One side note about the tax line. I regularly struggle to assess the correct tax. Reason is that I am not 100% sure what costs can be deducted etc to calculate the yearly tax expenses. It might be better to just ignore it 😉

Cash flow apartment 2
Cash flow apartment 2

Go? No go?

In summary, this was my second analysis of a potential real estate investment. Now that we looked at the numbers, would you pursure this deal and ask for more information/site visit etc?

I can only talk about myself, but I am not going to go any further with this apartment. In fact the IRR of just over 6.0% for almost 80% leverage is just not enough for me personally. Not only the numbers are not convincing enough, the apartment (and the house that the apartment is in) is just too old. I can already “feel” that there will be costly renovations. Remember that we didn’t include any Capex in our calculation.

What are your thoughts about my analysis? What mistakes did I do? Where do you think differently?

I highly welcome a healthy discussion with different opinions and point of views!


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