Final – Real Estate Model
MBA 623, Spring 2012, Blk 1
Due 5:00PM, March 3rd, 2012
Since 2003, I have invested in rental properties by acquiring some median income type houses in some prime locations in Fortaleza, Brazil. The business has been profitable but with home prices exploding at unjustifiable levels in Brazil now I feel forced to look for other markets to invest. The recent real estate crisis in the U.S. created a favorable economic environment by reducing acquisition costs and increasing rental demand. So last year, I purchased my first rental property in Draper. I am now looking at the possibility to expand my rental business, but first I would like to develop a model that could answers couple questions. First, the model needs to be robust enough to tell me how long it will take replace my current salary, so I can have a comfortable retirement. Also, I would like to find out whether this investment is offering me a good return by calculating the Return on Investment of this endeavor and how to enhance my ROI. Last but not least, I am trying to assess what variable would impact the rental income the most. For instance, according to the ARA Equimark report, some areas in Salt Lake have a lower vacancy rate compared with others. I would like to see how I could maximize the net present value of future cash flows by purchasing properties in different areas besides Draper.
The Real Estate Investment Model provides a clear picture of cash flows generated by investing my savings in real estate. It takes in consideration the following variables and assumptions: Inflation will play a key role to help me to justify raising the rents annually. As part of my rental contract and for simplicity, I stipulated that I will adjust the rent payments and cost of life at least by the U.S. inflation rate. Salary growth rate will be used to adjust my salary annually since I want to assess how long it will take to replace my salary at any given point in the future. Current salary is a given and the starting point for the model. Cost of life is used to in the model to allow me to have an idea of how much I can really save per year. Down payment requirement is another important variable to the model given that mortgage companies currently require a minimum down payment to be willing lent money to buy a house. The down payment will also affect the amount of savings at the end of each period. Maintenance cost and improvements will impact the initial investment value to put the house in habitable condition. Interest rate will impact the cost of financing the purchase of each house. It is another component to determine the monthly free cash flow. Rent per Home Value ratio is a simple way to determine how much I will change per rent and clearly an important variable that should impact the amount of positive cash flow. Taxes and insurance is a component of cost therefore also considered as part of the model. Vacancy rate will impact my ability to have a steady flow of cash from rentals. It is important to consider that rate if I want to have a realistic analysis of the investments made.
The Real Estate Investment Model relies on Excel to calculate my annual savings amount and cash flow from my rental operation by inserting variables and assumptions about the market and economic indicators in the model. Note that the model it is mathematically complex and relies heavily in simulations running Crystal Ball. The description of the model is shown below: Inflation and Increase in salary rates are variables calculated based on historical levels in the U.S. according to the U.S. Department of Labor. I decided to use 4% as salary increase rate even after arriving at a historical average of approximately 4.7%. By using Crystal Ball’s Predictor tool (please see the graph below), I noticed that the salary increase trend was negative, therefore not justifying to keep at historical...
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