SFH Investment Analysis (Part 3)

In some previous posts, I laid out a quick-and-dirty business and financial model for a real estate company that bought, rehabbed, and sold/rented single family homes full-time. My goal was to determine whether this could be a potentially lucrative undertaking, as my fiancee would love to get into the “house flipping” game (she’d be happy doing it in her spare time as a hobby, but if it’s lucrative, why not do it as a business).

Anyway, in those posts, I put together a very conservative financial model to determine approximately what I could expect cash flow and profits to look like if we had three people working on the idea part-time. The results were encouraging, but not staggering. On a $250K investment, the idea looks to be slightly cash flow positive in Year 5 and beyond, with a total 5-year profit of about $500K. That would make a decent passive investment (which was my original intent with this idea), but if we were going to commit a good deal of time to the effort, I’m not I’d be interested in pursuing something this small.

A couple readers of this blog picked up on that (one sent me an email, and another posted comments), and mentioned that the business financials seemed a bit thin. And I certainly agree. But, given that the original financial projections were very conservative (I wanted to see what a near “worst case” scenario would look like), I thought it would be worthwhile to do another analysis using more aggressive assumptions, and see if — and by how much — the financials improved.

Below is the revised analysis, taken directly from the business plan I am putting together for this potential venture…

SFH INVESTMENT BUSINESS PLAN

5-Year Acquisition Plan

Based on the current experience of the active participants on the investment team, it is expected that the company could, in the first year, execute on 6 acquisitions and rehabs â€“ one every two months â€“ of a similar nature to the property acquisition example above. After Year 2, as the company is able to put systems and processes in place to optimize our acquisition and rehab efforts, it is expected that additional houses could be purchased each year. Further, the company expects that, as the real estate market improves over the next several years, it will be possible to start selling off property investments, allowing the company to generate short-term cash flow and to maintain liquidity.

In order to get a realistic idea of what we could expect both cash flow and profits to look like, we have put together two 5-year scenarios â€“ one that we expect is overly conservative and one that is more aggressive (and have also considered a very aggressive scenario as well). Various factors will contribute to which scenario is more likely to play out, including such things as our ability to find suitable acquisition candidates, real estate trends over the next 5 years, our ability to scale our processes, etc.

Below, we lay out both the conservative and the more aggressive scenarios (as well as comment on a very aggressive scenario), and in the following section we define the financial projections behind each of the scenarios.

Conservative Scenario

In a conservative scenario, the company expects that while no properties will be sold in Year 1, at least two properties will be sold in Year 2, with more following each subsequent year. It is expected that after Year 5, the company will still retain ownership of 18-20 properties, all of which will be sold after Year 5 to provide investment returns to the original investors. Additionally, the company would expect never to acquire more than 8 properties in a single year, thereby allowing â€“ for the most part â€“ the team to fully focus on one project at a time.

Here is an overview of the number of houses the company currently expects to be able to buy, sell, and hold/rent in each year, based on conservative estimates:

More Aggressive Scenario

In a more aggressive scenario, the company still expects that no properties will be sold in Year 1, but that starting in Year 2 â€“ once processes have been put in place to scale the business â€“ at least eight properties will be acquired and four properties will be sold. In subsequent years, the company will continue to scale, with houses being acquired and rehabbed at least once per month. In the more aggressive scenario, it is expected that after Year 5, the company will still retain ownership at least 20 properties, all of which will be sold after Year 5 to provide investment returns to the original investors.

Here is an overview of the number of houses the company currently expects to be able to buy, sell, and hold/rent in each year, based on more aggressive estimated:

Very Aggressive Scenario

We could very well imagine a scenario where the success of the team and the buyerâ€™s real estate market would dovetail to provide an opportunity to scale the business quickly and effectively. In this scenario, the business may hire additional project managers, employee contractors/workers, a real estate agent, etc. Other successful businesses of this nature have been known to acquire and rehab many houses simultaneously â€“ up to many dozens per year or more.

Because this scenario is difficult to model without making many additional assumptions, we have decided not to perform 5-year projection for this scenario. That said, it should be considered that the income and profit potential of the business may be much greater than either of the scenarios presented above and below.

5-Year Financial Projections

Below, we have created two 5-year financial projections (cash flow and profit), each based upon the one of the two scenarios defined above. Again, the conservative projections assume acquisition of up to 8 properties per year, and the more aggressive projections assume acquisition of up to 12 properties per year. While it is not unrealistic that the company would scale to acquire even greater number of properties, those projections are not included in this proposal.

In order to create the 5-year financial projections, we have made the following economic assumptions on the sold and held properties (each of which we believe is realistic and in alignment with current trends):

2% annual increase in rental revenues

2% annual increase in expenses

2.5% annual increase in property values

6% sales commission on each property

Further, we assume that after Year 5, all remaining inventory will be sold off.

Conservative Scenario

Given the acquisition and sales volume/ratios defined above for the conservative scenario, the 5-year financial projections would look as follows:

As indicated above, the total profit given the conservative scenario would be $498,374, on an initial investment of $300,000 (it would actually only require an initial investment of $250,000, but I’m basing the returns on a $300,000 investment to provide an apples-to-apples comparison with the more aggressive scenario below):

The total return over 5 years would be greater than 170%

The simple return on investment would be 34% per year

The compounded annualized return on investment for five years would be 11.25%

More Aggressive Scenario

Given the acquisition and sales volume/ratios defined above for the conservative scenario, the 5-year financial projections would look as follows (notice that in this scenario, the total salary for the three employees has been increased; as we believe this would be a full-time venture for at least 2 people to achieve these results, it’s reasonable that salaries are increased accordingly for the 5 years):

As indicated above, the total profit given the more aggressive scenario would be $1,810,751, on an initial investment of $300,000:

The total return over 5 years would be nearly 700%

The simple return on investment would be nearly 140% per year

The compounded annualized return on investment for five years would be 47.5%