How To Avoid Inaccurate Estimates Of Cashflow, Income And Net Worth Computation In Real Estate Investing Financial Plan Forecasting

This is an impromptu article that I find necessary to write because of the urgent need to get it across to as many investors as possible. I hope and believe this might help thousands if not million of real estate investors out there who struggle to compute their financial plan forecast which makes it difficult for them securing mortgage loan facility from financial institutions to finance real estate property.

Many investors ignore the use of professionals in computing their financial plan forecast section of their feasibility study, they often time prepare their business plan by themselves and in the process mess up the whole proforma and balance sheet with inaccurate figures.

This dreadful mistake in the process of computing the estimates is due to ineptitude of investors in handling financial accounting. They inaccurately compute the cashflow, income, cash balance and net worth estimates in their real estate investing (REI) financial plan forecast mostly due to wrong or inaccurate mortgage loan or debt repayment calculation which consist the principal repayment and interest expense.

The need to address this issue and shed more light on how to calculate monthly mortgage debt repayment is what prompt this article.

A client, name withheld who wanted to finance purchase of a real estate property through mortgage walked up to me for some advice on how to go about it. He complained bitterly about how badly structured the mortgage system is and the high mortgage interest rate most financial institutions are offering investors.

In addition, he said, after he computed his cashflow and income estimates factoring in all costs associated with mortgage such as origination, underwriting and processing fees; and also all costs of acquiring, rehabbing, escrow and other expenses into his financial plan forecast projection. He discovered that in the third year his net cashflow is negative, the cash balance is very low and the net worth is not encouraging and he was frustrated and discouraged about the entire plan of securing a mortgage facility.

In other words he calculated and computed his real estate investing financial plan forecast by himself and in the third year he was getting unfavourable figures that suggest the investment won’t be a success.

However, based on my previous experience in real estate investing financial plan forecast projection in preparing a business plan. I know most investors or newbies don’t understand how mortgage principal repayment and interest expense are calculated and instead of seeking the services of professionals or someone who understand the intricacies of mortgage financing, who can explain or walk them through this process of mortgage debt repayment calculation.

They opt to do it by themselves, thinking they understand the steps involved in calculating or preparing real estate investing financial plan forecast for their investment. After he finished his story, i was forced to ask if he was right about the figures on the financial plan forecast? He said yes. I then further asked how he arrived at the some of the figures especially mortgage principal repayment and interest expense and to my surprise he said he used the normal simple interest calculation to determine what he would pay annually for a period of 30years.

Although, i was not that surprise he got it all wrong because i know there are many real estate investors out there whom at some point make similar mistake right from the on set prior to their real estate investing adventures due to inaccurate cashflow and net income estimates analysis and misjudgment of other costs, expenses, utilities, maintenance and management fees.

In the case of this client, he calculated his mortgage repayment the same way simple interest is calculated and am sure those of us who had a class or two in simple interest while in college will understand this formular

S I = ( P *R * T) / 100 

Where

S I = Simple Interest

P  = Principal Amount

R  = Rate

T  = Time

This is what the client used in computing his real estate investing financial plan forecast projection which gave him unpleasant outcome in the third year. I would love to use this opportunity to address this issue in order to help many investors get through with this important part of real estate investing by walking you through a practical step by step approach on how monthly mortgage repayment are calculated. 

I will try to simplify the process as much as possible for you to easily grasp the method used. Let us assume an investor meets mortgage prequalification and approval and purchase a property through mortgage financing facilitated by the National Housing Fund who granted the investor a sum of #15,000,000 at 6% mortgage interest rate for a period of 30years.

Let us quickly see where this client got it wrong using the simple interest method in computing the mortgage repayment.

Applying S I = ( P *R *T ) / 100

= ( #15,000,000 * 6 * 30) / 100

=# 27,000,000 represents the total interest to be paid on the mortgage loan

30 years will add up to 360 months

If we add the principal amount to the total mortgage interest to be paid we have

#15,000,000 +# 27,000,000 = # 42,000,000

#42,000,000 represents the total mortgage debt

Let us now determine monthly mortgage repayment

Monthly mortgage repayment = #42,000,000 / 360

= # 116,666.67

Monthly principal repayment will be = #15,000,000 / 360

= # 41,666.67

And monthly interest expense will be = # 27,000,000 /360

= # 75,000

 

In contrast to what we have above, the right way or accurate method used in calculating monthly mortgage principal repayment and interest expense using the same example as  above will clearly show the difference and wide discrepancy in both methods.

Before we do anything we must first identify, know and understand some important mortgage terms used in calculating and arriving at the monthly mortgage loan repayment.

Here are the common terms used in mortgage calculation and what they represent.

M = Month mortgage payment

P = Principal Amount

I = Monthly interest rate

T= Term of the loan

n = Number of payment

i = Interest rate in decimal

PF= Payment frequency

L= Length of loan

APR = Annual percentage rate

After getting acquainted with these mortgage terms we can now proceed to the first step in the calculation. 

1.  You have to convert the mortgage loan interest rate to decimal using

i = APR / 100

= 6/100

= 0.06

 

2. Here is where you calculate the monthly mortgage interest rate using

I = i / PF

= 0.06 / 12

= 0.005

 

3. You are to now find the number of mortgage payment you must make using

n = L * PF

= 30 * 12

= 360 payments

 

4. At this point you have to calculate the term of the mortgage loan using

T = ( 1 + I ) ^ n

= ( 1 + 0.005 )^ 360

= ( 1.005 )^ 360

= 6.023

 

5. Finally you can now calculate the monthly mortgage loan repayment using

M = P [ ( I *T) / ( T – 1)]

= #15,000,000 [ ( 0.005 * 6.023) / ( 6.023 – 1) ]

= #15,000,000 [ 0.030 / 5.023]

= #15,000,000 [ 0.006]

= # 90,000

We should now determine the overall interest by multiplying the monthly repayment by the number of payments and then subtract from the principal 

Then we have 

Total mortgage repayment will be

#90,000 * 360 = #32,400,000

We can now subtract to principal amount to get the total interest to be paid on the loan.

Hence we have

# 32,400,000 – # 15, 000,000 = #17,400,000

 

Monthly principal repayment will be = #15,000,000 / 360

= #41,666.67

Monthly interest expense will be   = # 17,400,000 / 360

= # 48,333.33

Let us have a closer look at both methods, we can see that using both methods give us the same mortgage principal repayment amount of #41,666.67 but there is a great discrepancy of # 26,666.67 in the mortgage interest expense if we subtract #75,000 we got from using the first method from # 48,333.33 of the second method.

This discrepancy account for about 29.6% more of the actual each month mortgage loan repayment on the client’s financial plan forecast which resulted in wrong and inaccurate computation of estimates analysis of cashflow, net income, cash balance, profit and net worth in the third year of the financial forecast in his feasibility study.

In conclusion, i hope i have been able to clearly show you how monthly mortgage repayment is calculated and computed, this article will go a long way to assist real estate investors in accurately calculating and computing their financial plan forecast projection especially if it involves mortgage principal repayment and interest expense.

For more information, assistance, enquiries and suggestion you can leave a message on the comment box and we shall respond swiftly to your needs 

To help promote excellent initiatives in real estate investing

Be sure to comment, like, follow or share this article

Sharing is Caring

Thanks 

Olatunbosun Idowu

For Ordiez Resources

 

 

 

 

 

Advertisements

One thought on “How To Avoid Inaccurate Estimates Of Cashflow, Income And Net Worth Computation In Real Estate Investing Financial Plan Forecasting

Feel like sharing anything? leave a comment!

Please log in using one of these methods to post your comment:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

w

Connecting to %s