College Town Rental - Renting Out Individual Rooms

Symon He
A free video tutorial from Symon He
Author | Investor | Entrepreneur | Stanford MBA
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Lecture description

Example showing the purchase and lease up of a college town condominium where each room is leased separately to individual students.

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Fundamentals of Analyzing Real Estate Investments

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18:34:48 of on-demand video • Updated December 2020

  • Confidently Evaluate the Return Potential of Any Real Estate Investment Opportunity
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English High in this example we're going to look at a deal where you're purchasing a single unit can be a home or a condominium or an apartment where you're renting out each of the rooms individually to a separate tenant. For example we're going to look at the purchase of a three bedroom two bath condominium in a college town and we're going to rent out each of the rooms individually. There's going to be some minor renovations involved to Why didn't some of the rooms. And the goal of this investment is for stable cash yields during the whole. And this is targeting a private investor. Now the economics of the sample deal we know look at we're looking at three hundred twenty five thousand purchase price. There's going to be a 15000 investment to widen to other rooms and expand the living room while reducing an oversized garage that's under utilized by the college demographic. And the attendance there so the rents for individual rooms in the area go from anywhere from 700 to over a little over a thousand dollars for those studio apartments and the for this deal you're looking at 65 percent debt. And the investment term is for 20 years. All right now let's see how this deal looks like in the model. We're going to be using the multi-unit for your waterfall model here to evaluate this deal. Now you'll see these old values here we're going to right over them given the New Deal assumptions so . So as you're doing this the numbers you're going to look really weird and maybe even go undefine or no number because it won't make sense until you're done with all of this. OK. So we'll start at the very top. Now recall that this unit was going to be going to be for 300 25000 that's keep the purchase the same cause and costs let's assume maybe 2 percent of the purchase price. And now here let's look at the the different floor plans. Now we know there's three rooms so we're going to say let's clear out the bottom ones first make sure that they're all zeroed out right here. OK. Now let's let's name the rooms. Let's use the floor plan. Here's the name the rooms that we're going to be renting. Now recall that there's three bedrooms and two baths one of them one of the rooms is the master room with the master bathroom so this is let's call this the master bed private bath and then let's call the second one the shared bath large. One of them is a little bit bigger than the other one third room is a shared bath. Small and the number of units of each of those rooms. We only got one. So now you see here up top the returns are zero because you've got so got some big numbers down here but we'll get there. Now this market we recall that individual rooms or studios were renting it cost a thousand dollars. The three bedroom itself may be renting for 800 but if you rent them individually you're going to get a little bit better rate. So let's say let's see the big one with a massive room rents for seven seventy five the large room with the shared baths rents for seven hundred and the smaller rooms that rents for 650. Now typically for these kinds of student housing if you think about it for private student housing as a student I don't ever remember the landlord offering utilities credit so we're not going to give them any of that either. These students are going to have to pay for their own water and trash and an Internet and video and everything so. And also for repairs you know let's put in something modest here. What we see for these kinds of deals usually is the landlords will take either a whole month or at least two weeks worth of rent as collateral. So if there's any kind of damage usually the collateral will more than cover that. Some places will call a security deposit collateral same thing. So we don't need to assume too much for the repairs here because that's usually covered. So now we've got the economics of the each of the rooms figured out. Let's look at some vacancy assumption. So right now let's say when you buy it you're buying it just you know a few weeks before this. The school's about to open. Students are already reaching out to you. But you know you want to do some work to do that unit's first in terms of some renovations so let's just say you're going to get four weeks of vacancy initially but then afterwards you're really looking at almost no vacancy so we'll just assume two weeks of vacancy maybe just as transition's because you know students movie and now between summer the start of summer and then the summer there might be a week of know vacancies there. So no no no real vacancy. We'll just say that other than the initial four weeks after that you're really just looking at two weeks vacancy you know for the rest of the hole. Now let's go to the property management assumptions down here. It's a single unit. You're not going to need a property manager there so make make that a zero. Now for the rental growth rate per year it really depends on the market that you're in but if you know if you're in a place that's quite popular the student population is going to be continuing to grow. For instance one of the schools that I went to for undergrad when I went there there was under 30000 students. But over the course of the years that I was there they began some massive constructions and now the campus can actually Howze assumed body of probably about 60000 so there was tremendous growth. And yes the rents for all the units near and around the university got more and more expensive as well . Even even though they were also building new student housing it was still hard to come by. So for something decent like that you're looking at probably at least 3 percent growth. So we're going to leave it at three and a half right now. Now I recall from the discussion earlier we're going to assume a $15000 hundred fifty or fifteen thousand initial renovation assumption and let's say it just takes about a month to do that. And really all this was is getting some contractors to kind of widened the rooms a little bit spaced it out you know that there's a huge garage that is not being used for instance. So you know the students want as much space as possible so this where you're making your units a bit more appealing for a minor cost. You're just basically demises one of the walls and shifting it out now investment. Let's see you're going to invest 30 35 percent of the investment here. So just a little over 120000 you're going to do a 30 year loan and so you've got a good deal on your loan at four point to five percent. Now we're going to assume that you're going to hold it for 20 years. And let's assume that this area because it's growing you're going to get pretty decent appreciation as well for residential asset let's assume 6 percent cost of sales when you do sell it in 20 years. Now for property taxes let's put in something more reasonable let's put in 1.5 percent times the purchase price up top. Whoops. You'll need to use you know do some research for whichever area that you're looking at to make a good guess for what the property taxes are now for for insurance if you're not sure a good way to estimate is just use to use the purchase price. The value of the home divided by one thousand times three point five dollars you know it may be a little bit different but that's just a good kind of a starting point to guess at what the insurance costs may be. And for the discount rate let's let's make it 6 percent for this one. So now you have everything in here as part of the deal. Now let's see what it looks like in terms of your returns. So on unleveraged basis you're still looking at a pretty good return of 9.2 percent return year to yield at 5.8 percent in overed because you're holding it for 20 years with the appreciation of three and a half percent a year. You're making a big profit at the end because most of your debts can be paid off and you know it can be a pretty big difference between what you paid. What would you all still and what you're going to get in terms of profits when you sell in 20 years . So that's why there's going to be a pretty big cash multiple here. Now we look at the BCR racial unleveraged Bass's still looks great. So looks very very good. So for every dollar getting a dollar thirty seven cents back in terms of profits in today's value. So that's a very good return here. Of course you're taking on some leverage. So in this case we see that leverage definitely is helping the returns overall. It didn't help your yields as much but didn't hurt it too much either. So what this is saying is the cost of the debt is just a little bit more expensive such that part of having to pay for the service to service the debt it lower the return that you've got on your cash investment during the hold. But you were able to capture a much bigger percentage of the profit at the end for what you put in. So since you're only putting 35 percent in for your 35 percent investment you're getting it eight times return on the cash multiple for every dollar you're putting in you're getting $8 back. Now in terms of today's value for every dollar you're getting putting in you're getting $3 profit back in today's value. So you know on a leverage basis it actually looks really attractive as well and it doesn't hurt your yield during the whole. So let's see what that looks like in terms of the deal summary here. Now we see that the difference between the leverage and the leverage. You know it's cash flow positive for for both of the cases that yield here. This right here divided by what you invest that is slightly lower than the yield on the unleveraged basis as we've discussed. And you can see that going through to year 20 but what you see here in year 20 is that there isn't that much of a difference in the profits that come at the end. Right. So on the unleveraged basis you don't owe anything so that's you get to keep the entire sales price . But on the leverage basis there was still some debt that was left. So it's it was a 30 year loan so that 10 years left there's some principle that was left on there so after paying that off you get to keep the rest. So that's the difference right there. Now let's look at the breakdown between the different floor plans. So since the. Now let us look at the breakdown of the rental income by the different rooms that we have. Recall that we have three rooms. We've got the master bed with the private bath the shared bath large and the shared bath. Small now because the rental rates for each of the room aren't that far apart you'll see that the distribution across the 3s pretty evenly split and almost one third. But you know obviously more to the master bed with a private bath. And if we look at the revenue from those rooms by year this is what they would look like because we're assuming the same growth rate for all of them they're going to have kind of the same trend here. But the values are going to be a little bit different because the total rents that's collected are are different here and at the very top of the deal grafs that's where you see the graphs on the leverage as well as the leverage basis here. And if we were to end if we were to look at the investment across different investors let's say the same structure as our example previously with the five investors. And the same kind of breakdowns. But let's have Alice be the manager and then we're going to use the for tier structure that's set up here with a present pref 19:10 until there is a 10 percent are at a one point so five cash multiple than a 100 percent catch up to the manager. And then finally a 65 20 35 split here. So in this case Alice gets a really good return on her 5 percent investments you'll see that she's going to get phenomenal cash multiple as well as the BCR ratio. Now the IRR isn't all it's high but it's not super high and that's because you know the deal itself it's a pretty low IRR deal. So even with the incentives her Arar's not going to be 10x what the other investors are going to get . And if we keep it here like this and take a look at how the investors cash flows look you see that for Alex she's investing very little so she's not getting a whole lot and all this here is assuming a leverage basis right. So she's not getting a whole lot of cash flow. You know during the year but in terms of relative to what she put in it's not bad. She's looking at over 10 percent yields starting in Year 6. And so then but she gets this huge bump in year 20 due to the waterfall incentives that she's going to get to. Now for the other investors they'll have something similar but they are they are investing more. Are they going to get more cash for long years. And they have a little bit less of a windfall year 20. Now let's go back to the main assumptions page. Let's see what happens if you know your your purchase price is a little bit higher now. Where I went to college. That was in Southern California. It's tough to get a three bedroom two bath condominium for this price near a college town. It was usually closer to kind of the mid 400 at the time. So for the mid-fall hundreds with these rents you see that the returns are going to be as good. You're still looking at a decent hour are assuming the the this the appreciation that we've assumed here but you'll see that in the leverage basis we're we're looking at now a negative year to year. That means the debt is the debt services more than the income you're collecting. So if we take a look at the deal graphs here the leverage basis we see that it's negative for negative Cashell for the first five years and then it's cash flow positive after that. So that's not not very appealing if your purchase price was that that amount. So again just like the other deals you got to get comfortable with your rental assumptions about what you can achieve in this market and your other expenses then then use that to drive what is the maximum purchase price and renovation. So basically your total project cost what is the maximum total project cost that you can manage to have and still make a good return given your rental assumptions. So let's say on a levers basis we want to be able to achieve a 5 percent return given these rental assumptions as well as the renovation assumptions and repairs What purchase price what's the maximum purchase price we can do here. So let's take a look. We're going to use the Goal Seek tool here. So it's under Tools Goal Seek and then what we're going to do is we're going to take that year to year there set it to 5 percent. Now this has to be a decimal number by changing the purchase price so Cetin. And then we're going to click OK. So it's going to crank through and we see that it's around 330000 with all of the other assumptions that you have. That's the maximum you can pay for the property and still be able to achieve a 5 percent yield in year 2