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Author Topic: Help me understand my analysis  (Read 3125 times)

Offline duke_of_hazard

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Help me understand my analysis
« on: July 27, 2004, 11:38:07 pm »
I am interested in purchasing a condo to rent out for investment purposes. I wrote my own online calculator to look at the whole picture over ten years. I am confused on the following results:

1) The sooner I pay off the loan, the lower my internal rate of return at the end of ten years

I suppose this is offset by my increased net worth after 10 years. But what is more important, my net worth or IRR?

2) If I decrease the purchase price, my IRR goes up.  Can I use that information to iterate a purchase price that gives me a 7% IRR after ten years. Is that reasonable?

Doing that I find I need to offer 30k, but the seller is asking 37k. Is there a bug in my program/ assumptions or is the seller asking too much?

You can click here to see the calculator and the report it generates.

Thanks!


Offline Dave T

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Re:Help me understand my analysis
« Reply #1 on: July 28, 2004, 02:27:13 am »
duke,

Your internal rate of return is affected by the amount of your initial down payment, your annual cash flow during your holding period, and your profit when you sell.   Changing any of these parameters will change your IRR result.  For example, a lower initial down payment will raise your IRR, as will a higher cash flow.  However, a higher cash flow usually means a larger down payment.

If you want to compare your results to mine, download a copy of my Cash Flow Analysis spreadsheet.  It only takes you out eight years and I don't do any sensitivity analysis, but you may get some feedback from just experimenting with a different tool.


Offline duke_of_hazard

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Re:Help me understand my analysis
« Reply #2 on: July 28, 2004, 08:48:24 pm »
I checked out the spreadsheet but could not get my numbers to add up to yours. One thing I noticed is you calculate tax benefit as:

 "depreciation dediuction" * tax bracket

In my program I calculate it as:

$tax_deduction= ($expenses + $depreciation + $interest - $income ) * tax_bracket

Let me know which is right,

Thanks!


Offline Dave T

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Re:Help me understand my analysis
« Reply #3 on: July 28, 2004, 09:44:17 pm »
duke,

Take another look at my calculations.  The "Tax Benefit(Liability)" is (Taxable income/loss) * (Tax Bracket)

The sum of (depreciation expense, interest expense, and total operating expense) is subtracted from the effective rental income to determine taxable income.

Let's modify your calculations:  $income - ($expenses + $depreciation + $interest) = taxable income(loss) -- what I think you mean to call your tax deduction.
  • If the result is positive, then taxable income * tax bracket = tax liability.  That is, the actual income tax you will pay solely as a result of your rental operations.  
  • If the result is negative, then taxable loss * tax bracket = tax benefit.  In other words, tax benefit is the amount by which your tax bill went down as a result of your rental operations.
Subtract the tax benefit/liability from your cash flow before taxes to determine your Net After Tax Cash Flow.  Of course, these calculations assume that you do not have suspended passive losses that have to be carried forward.  If the $25K cap on net passive loss allowance applies to you, then some further calculations are needed to determine your true tax liability/benefit.

Does this answer the question?
« Last Edit: July 28, 2004, 10:00:49 pm by Dave T »

Offline duke_of_hazard

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Re:Help me understand my analysis
« Reply #4 on: July 29, 2004, 08:02:43 pm »
makes, sense . sounds like we are both calculating it the same way. Still not sure why my IRR numbers are quite different from yours though. Maybe it's the inflation.

Offline Bud Branstetter

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Re:Help me understand my analysis
« Reply #5 on: July 29, 2004, 09:31:29 pm »
If I were buying a piece of commercial property for a million or two I might be concerned about IRR. Even do a present worth of annual charges.   For a little condo it should be about discount from value from a motivated seller.   That way I am guranteed a profit and a positive cash flow. I know my IRR and CAP rate will be fine that way.

Offline Dave T

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Re:Help me understand my analysis
« Reply #6 on: August 02, 2004, 11:57:16 pm »
makes, sense . sounds like we are both calculating it the same way. Still not sure why my IRR numbers are quite different from yours though. Maybe it's the inflation.
duke,

I can't answer that question for you until I see the calculations behind your number.  IRR is really the discount rate that must be applied to a series of future income streams such that the Net Present Value of all income streams is equal to zero.  Are you doing any Present Value calculations?

Generally, IRR is meaningless for a single family rental property.  You will note the comment in my spreadsheet that I provide an IRR for information purposes only.  The cash flow should be your determinant calculation in a rental property cash flow analysis for a single family property.


 




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