PRODUCCIÓN

means that you have a much greater likelihood of experiencing negative cash flow. Instead of reaching into your pocket one time to ante up the down payment, you may be reaching in every month to make up the difference between cash inflow and cash outflow.

2. The cost of this additional financing is likely to be high. Loaning the “down payment” component is a high-risk proposition. A third-party lender would expect a high rate and a short repay- ment term, both of which would be likely to suck the life out of your cash flow.

3. Why would a seller take back all the secondary financing if you don’t put in your own cash? Maybe the property is difficult to sell; that won’t change after you buy it, except that now it will be your problem. Maybe the seller has convinced you to agree to an inflated price, so the proceeds from the secondary financing is just gravy. Study this book and that won’t happen to you. If all the stars are lined up just right, a no-money-down deal can work out beneficially, but don’t expect that to happen routinely.

20

Calculation 15:

Sale Proceeds

What It Means

When you sell your investment property you hope to leave the closing with a check in your pocket. The money you take home is called sale proceeds. To be more precise, it is called before-tax sale proceeds because Uncle Sam is waiting outside for his cut.

Most of our discussion in this book has focused on purchasing and oper- ating an income-producing property, but for many investors, it is the sale of the property that makes the greatest impact. If all has gone according to plan, you are probably recovering your original investment plus the property’s apprecia- tion in value, plus the paydown (amortization) of your mortgage. When it does come time to settle up on your taxes, much of your profit from this venture may be taxed at capital gain rates, lower than the rate on ordinary income.

How to Calculate

Keep in mind that when you forecast the future sale of your investment prop- erty, your purpose is not to fulfill your childhood dream of mastering double- entry bookkeeping. Rather, it is to complete the final projections you need in order to judge the overall success of your investment. For simplicity, it’s cus-

tomary to make these projections in full-year increments. In real life you may sell your property on November 7, and the attorney who closes this transaction will have to make adjustments for mid-month loan payoffs, per diem interest due, property taxes paid in advance, rent collected in advance, and security deposits, to name the most common. For your purposes, and for those of most investors, it is just as useful and far less complicated to assume that in whatev- er year you sell, you will do so just before the stroke of midnight on December 31. Please do not wear funny hats or bring noisemakers to the closing.

Given that you decide to forecast an end-of-year sale, the calculation becomes straightforward:

Selling Price less Costs of Sale less Mortgage Payoff

Sale Proceeds Before Taxes less Tax on Sale

Sale Proceeds After Taxes

In Chapter 4 and in the chapters on Capitalization Rate and on Net Income Multiplier, we’ve discussed how to estimate value by capitalizing net operating income (NOI). You can put that technique to work here to esti- mate the value of your property in the future.

You will then estimate the costs of sale. These costs usually include legal fees and brokerage commissions. Most investors estimate costs of sale as a percentage of the selling price.

Mortgage payoff amounts can be calculated in a number of ways (see Part I, Chapter 3 and Part II, Calculation 34). You can use one of the Excel models shown in Chapter 3, or you can download the RealData Calculator from www.realdata.com.

For more information on the calculation of the tax liability, see Part I, Chapter 4 and also Gain on Sale in Part II, Calculation 40.

You can use the following form to help you calculate sale proceeds.

Example

You estimate that you will sell your property for $500,000. You also esti- mate that you will pay 5% of the selling price for the services of a broker

and 2% for an attorney. At the time of sale, you’ll have a first mortgage with an outstanding balance of $200,000. What are your before-tax sale pro- ceeds?

If you pay 5% to a broker and 2% to an attorney, your total costs of sale will be 7% of the selling price.

Costs of Sale
500,000  0.07
35,000

Now you can take the formula or the preceding form and fill in the values:

Selling Price 500,000

less Costs of Sale 35,000

less Mortgage Payoff 200,000

Sale Proceeds Before Taxes 265,000

Rule of Thumb: Whenever you obtain a mortgage loan, print out

an amortization schedule for that loan. It used to be necessary to order (and pay for) a schedule from a financial services provider. Use the free RealData Calculator program or download a basic Excel template we provide for readers of this book. You can also create such a schedule online with your Web browser at www.realdata.com.

An amortization schedule will not only allow you to keep track of the outstanding balance of your mortgage loan, but it will also let you monitor the amount of interest paid and verify the information you receive from your bank on IRS form 1099 at the end of the year.