Ocean Reef Absolute Auction Results

[Matt J]

The point I was making, lets try to encourage potential buyers to look today with the idea in time it will cash flow. In the meantime the use of the property has value. Would it not be nice to try to have some postive forward thinking to the market, as I believe the opportunities are a lot more realistic for affordable beach property. This is not the bottom, I don't believe, however more people should be doing due diligence for a purchase, and when they feel comfortable with the deal, pull the trigger. People love to rent SoWal properties, and properties close to the beach will always have renatal premium.

I read your post and used it as an opprtunity to show what time can do for your beach investment. Do you not agree with anything I stated.

Shelly:

Ok, I'll take a stab at it.

Question: Is it possible to cash flow at recent auction prices?



Assumptions:

• Purchase Price $359,500 (for 4BR as stated earlier in the thread)
• 20% down with a 30 YR FXD at 6.5%
• Annual Mortgage Payment = $21,828 ($18,600 Int. + $3,228 Prin.)
• Annual Maintenance = $6,300 (HOA Fee of $400 plus additional exp.)
• 1st YR. Rents = $30,000
• 30% Marginal Bracket
• 1st YR. Depreciation Expense = $11,983 (Straight line)

The Formula:



Earnings Before Tax = Rents - (DEPR + MAINT + INT. EXP)

• EBT = $30,000 - ($11,983 + $6,300 + $18,600) = ($6,883)

Tax = 30% Marginal Bracket * EBT = .30* ($6,883) = ($2,065)

Net Earnings = Earnings Before Tax - Tax = ($6,883) - ($2,065) = ($4,818)



CASH FLOW = Net Earnings + DEPR - Principal Repayment

• ($4,818) + $11,983 - $3,228 = $3,937 A POSITIVE NUMBER

Can you believe it?

Little Fish

Once again the assumption that you're going to rent this thing year round is the key factor. Anyone going into the purchase of investment property needs to be under the assumption that it's going to COST them money not make it for them. The reason we are in our current financial crisis is due to people listening to Carlton Sheets and his ilke. If you can't afford it without rentals then you can't afford it with rentals. Is it really that hard to understand that it could be additional income and not a source of income?

 

[skyking]

Wow, way to go Little Fish, your example exemplifies that realestate at the beach, at these levels, arn't toxic waste after all. If the numbers work out like this today, just think what they will look like in 5 years. Of coarse it does appear these #'s seem to appear as napkin math once again. I think we need to feed these examples into a wallstreet super computer to get the true outcomes to the equations, you know the ones they fed the subprime, alt-a, option arms, and 100% ltv loans into to create the toxic waste that is affecting the world economy today. It was interesting to see both of the examples did envolve equity.

 

[Matt J]

Again the issue boils down to the fact that one variant is completely unknown and unpredictable. Will someone book and rent the unit. You also have the unknown's of vandalism, whether accidental or intentional.

 

[YoungFT]

In Little Fish's math you added the entire amount of Year 1 depreciation back to After-tax earnings to get Cash Flow. The only cash flow benefit that depreciation offers is the tax benefit, or the tax savings of 30% of depreciation.

So instead of adding back the entire amount of depreciation you should have only added back the taxes saved from being able to deduct it. Had you used an accelerated depreciation method would your cash flow have increased? Yes but only because of a larger tax deduction.

Only taking the tax benefit portion of depreciation, turns the cash flow number negative. But that's not to say it's a bad investment.

Any cash flow analysis is only meaningful when you take into account two additional things:

1. The opportunity cost of the money you're investing. In this case the down payment and the principal repayments. Could you have invested that amount in an insured CD and earned more? In this case yes, because your annual flow is negative.

2. The terminal value of the investment is important. In Little Fish's case, you can't get the numbers to work unless you include in the analysis a level of appreciation in the 5% - 7% per year range to make this a viable investment accounting for taxes, transaction costs on any sale and the opportunity cost of the cash you're putting out.

So if you're thinking of investing you need to make sure you manage the property to keep it rented @ 30,000 per year (I assume that's net of any property management fees) and you can see 5-7% appreciation in the value of the house.

This is how I'm looking at investment options - if I'm mistaken I would value any knowledgeable comments.

 

[Little Fish]

YoungFT:

"In Little Fish's math you added the entire amount of Year 1 depreciation back to After-tax earnings to get Cash Flow. The only cash flow benefit that depreciation offers is the tax benefit, or the tax savings of 30% of depreciation."

Sorry, but this is an incorrect statement. Operating income includes the full amount of depreciation and later when calculating cash flow, it is fully added back. If you google it, I'm sure you will find this to be the case.

Also, Shelly originally challenged me on my gut feeling that it was possible to cash flow at these prices. I used an example to show that at the end of one year, you could cash flow the property that was mentioned earlier.

That said, I was not analyzing the investment relative to any alternatives, nor did I do discounted cash flow analysis to determine whether or not it is an acceptable investment over the long term.

Little Fish

 

[SHELLY]

1. The opportunity cost of the money you're investing. In this case the down payment and the principal repayments. Could you have invested that amount in an insured CD and earned more? In this case yes, because your annual flow is negative.

This is how I'm looking at investment options - if I'm mistaken I would value any knowledgeable comments.

Bingo! Opportunity costs are what folks tend to forget when figuring cashflow. In this case it's $71,900 (20% down) and $38,738 in principle for the first year. Over $110K is too much pocket change to "discount."

Additionally the assumption that one can keep a 4 bedroom condo in PCB rented out year-round for $2500 per month is quite a stretch.

Moreover, the illiquidity of Florida condoz is a HUGE risk. If one has a few hundred thousand dollars collecting dust in their sock drawer, this type of purchase should be considered a "hobby" at these prices, but certainly not an investment.

 

[SHELLY]

Also, Shelly originally challenged me on my gut feeling that it was possible to cash flow at these prices. I used an example to show that at the end of one year, you could cash flow the property that was mentioned earlier.

I applaud your efforts, but anyone can concoct a positive cashflow by figuring backwards through the process (start with a positive outcome and make up the numbers that would make that outcome work). Developers, investment bankers and annuity salesmen use this all the time.

That said, I was not analyzing the investment relative to any alternatives, nor did I do discounted cash flow analysis to determine whether or not it is an acceptable investment over the long term.
Little Fish

Which is exactly why people who didn't do their homework are pretty much screwed today.

.

 

[YoungFT]

YoungFT:

Sorry, but this is an incorrect statement. Operating income includes the full amount of depreciation and later when calculating cash flow, it is fully added back. If you google it, I'm sure you will find this to be the case.

Little Fish

Thanks Little Fish. But I'm still not convinced you should be adding the full amount back. If at the end of the day, you're defining "cash flow" as money in pocket, coin in the bank, funds to re-invest - or any of the other basic terms I would use to define "cash flow" as an investor, you don't add it all back, just the amount it helps you save in taxes. You may be referring to the accounting term - which is really only meaningful to accountants. I'm referring to the term an investor would care about.

I took your suggestion, thank you by the way , and did Google it, and found this description that might help clarify:

"Depreciation does not involve any cash flow. This is clearest in the simple case of an asset acquired entirely by cash payment. Although the initial purchase is a cash flow, the subsequent allocation of part of the cost as a period expense involves only an accounting entry. Depreciation is not intended as a mechanism to provide for replacement of the asset. There are no cash flows associated with depreciation, and there is no connection with any cash accumulated for replacement of the asset...Because depreciation is an expense but has no associated cash flow, it is sometimes described as being "added back" to arrive at cash flow for the firm. This gives the impression that depreciation is somehow a source of cash flow. The "adding back," however, is simply a recognition that no cash flow occurred, and depreciation cannot supply cash."


http://www.answers.com/topic/depreciation


Interestingly, you can find the text above under "Misconceptions About Depreciation" so you're not alone.



Hope it helps the collective wisdom.

 

[SR2608]

Hi,

Don't post often but this one raises a question. Don't property/wind insurance and property taxes need to count as expenses? Utilities, power, water, trash, pest control, etc? Surely these would turn the positive negative quickly. Thoughts? Thx.

 

[Matt J]

Hi,

Don't post often but this one raises a question. Don't property/wind insurance and property taxes need to count as expenses? Utilities, power, water, trash, pest control, etc? Surely these would turn the positive negative quickly. Thoughts? Thx.

Generally in a condo you are going to have COA dues that will cover water, trash, pest control, and in most cases cable. However power is always metered seperately unless your in an oldy like Pinnacle Port.