Question

You are a professional real estate investor, and you are considering the acquisition of a “distressed property’’ which is on Covina Bank’s REO list. The property is available for purchase for $500,000 and you believe that you can take a $400,000 interest-only loanat 9 percent interest requiring monthly payments. You also estimate that the property will require $20,000 total for maintenance, landscaping, and renovations during the next year, spread out evenly over the months. Future selling expenses for the property are estimated to equal $10,000. Title search and inspection would cost a total of 1,000 upon the purchase.

Case 1:

If you plan to sell the property 1 year from today, and if you require an 18% annual return (in nominal not effective terms), how much would you need to sell it for?

Case 2:

What will be the required selling price if you sell the house not 1 year, but 2 years from today? Assume you will need to keep paying for the loan, maintenance, landscaping, and renovations expenses throughout the additional year.

Case 3:

What will be the required selling price if you sell the house not 1 year, but 2 years from today? This time, unlike Case 2, assume you will need to just keep paying for the loan throughout the additional year.

Answer 1

Property Price	500,000
Loan	400,000
Interest	9%
Payment Structure	Monthly
Capital Expenditure- Monthly	1,667
Sellling Expenses	10,000
Title inspection	1,000

Case 1) Sell after 1 year with 18% nominal return

Costs at Time 0
Property Price	500,000
Title inspection	1,000
Total Costs	501,000
Value at Year 1 at 18% return	591,180

Value at Year 1 (FV) = PV * (1+int%)^n = 501,000(1.18)^1 = 591,180

Monthly Costs
Capital Expenditure	1,667
Interest Costs (400,000*9%/12)	3000
Total Monthly Costs	4,667

Months Remaining	Monthly Payout	Value at Year 1 at 1.5% monthly return = 4667*(1.015)^T remaining
11	4,667	5497.10
10	4,667	5415.86
9	4,667	5335.82
8	4,667	5256.97
7	4,667	5179.28
6	4,667	5102.74
5	4,667	5027.33
4	4,667	4953.03
3	4,667	4879.83
2	4,667	4807.72
1	4,667	4736.67
0	4,667	4666.67
	Value -->	60858.99

Costs at Time 1
Sellling Expenses	10,000

Selling Price to Earn 18% nominal return = 591,180 + 60,858.99 + 10,000 = 662,038.99

Case 2) In this case we will keep on paying all the expenses for an additional year and sell at year end 2 but not with 18% annual return . This means selling price must cover all costs

Costs at Time 0
Property Price	500,000
Title inspection	1,000
Total Costs	501,000

Monthly Costs
Capital Expenditure	1,667
Interest Costs (400,000*9%/12)	3,000
Total Monthly Costs	4,667
Total Costs over 24 months	112,000

Costs at Time 2
Sellling Expenses	10,000

Selling Price = 501,000 + 112,000 + 10,000 = 623,000

Case 3) In this case we will keep on paying loan expenses for an additional year and sell at year end 2 but not with 18% annual return . This means selling price must cover all costs for 1st year and loan expenses for 2nd year.

Costs at Time 0
Property Price	500,000
Title inspection	1,000
Total	501,000

Monthly Costs
Capital Expenditure	1,667
Interest Costs (400,000*9%/12)	3,000
Total Monthly Costs	4,667
Total Costs over 1st Year	56,000
Additional Loan expenses for 2nd Year	36,000
Total Costs over 2 years	92,000

Costs at Time 2
Sellling Expenses	10,000

Selling Price = 501,000 + 92,000 + 10,000 = 603,000