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Looking to buy a building
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THE SCENARIO
This week, I helped a friend look over some numbers on an 8-unit apartment building she's thinking of buying. I've changed the numbers a bit for simplicity, but the concept is sound.
The building pulls in about $45,000 per year in rental income, and the expenses last year (a 'typical year' according to the seller) were about $17,000. Insurance will cost about $2,000 for a year, and taxes are likely to cost another $4,000 based on the selling price of $375,000. I know of a bank that would lend money on this building at a rate of 7% with 30-year fully-amortizing financing.
The question: If my friend wants to make at least $500 per month in net income after purchasing the building, how big of a down payment does she need to have?
THE SOLUTION
First off, let's figure out what the monthly net income before debt service will be.
The gross rents are $45,000, and annual expenses are $17,000. That leaves $28,000. Taxes and insurance are $2,000 + $4,000 = $6,000. That leaves $28,000 - $6,000 = $22,000 for debt service and cash flow.
My friend wants to make at least $500 per month, which is $500 x 12 = $6,000 per year. That means that she can afford $22,000 - $6,000 = $16,000 in annual payments on the mortgage.
$16,000 per year is $16,000 / 12 = $1,333.33 per month in payments.
Now that we know my friend's maximum payment, we can determine how much she can borrow when buying the property.
First things first, make sure the calculator is using 12 Payments per Year.
N: 360 (The loan will be for 30 years, which is 360 months)
I/YR: 7 (The loan will be at a 7% interest rate)
PV: (This is what I'm trying to find)
PMT: -1,333.33 (This is my friend's maximum mortgage payment, as calculated above)
FV: 0 (The loan amortizes fully)
If my friend wants to make at least $500 per month on this building, she can borrow no more than $200,410.09* when buying it. That means she'll need to bring about $175,000 as a down payment.
What do you think? Would owning a small apartment building like this one appeal to you? If so, what do you think of these numbers? As a bonus question, figure out what my friend's return on her $175,000 would be if she bought the building. Does looking at that return make the building more attractive to you, or less? Why? Let us know in the comments!
* Note that if you typed in -1,333.33 rather than using the division result, your answer will be about $0.50 different. When we're talking about hundreds of thousands of dollars, minor variations like this can safely be considered to be insignificant.
