Inner Circle Trashflow Evaluation System Explained

Of all the systems in my comprehensive Real Estate Goddess’s Guide to Real Estate course, the Trashflow Analysis® is the one that I use most often, and the one that causes the most consternation among students.

In brief, the Trashflow Analysis® is a way figuring out what a property is worth when there are no comparable sales in after-repaired condition (which, as you know if you know enough to be making offers, are the ONLY kinds of sales we can really put any weight on). It uses a mathematical formula based on rents and expenses—sort of like a stripped-down cap rate evaluation used on commercial properties—to guess at a value of a given property.

Before we look at the system itself, there are a few things to understand about WHEN and HOW it’s used.

  1. It only really works on single family properties. Anything bigger than a 3 unit is valued based on a full-blown income analysis by tradition; 2 and 3 families often have more expenses (owner-paid utilities, garbage pickup) than the Trashflow Analysis® accounts for, and as a result the Analysis gives a value for these properties that’s too high.
  1. You’d only use it in a situation where there weren’t enough sales of properties in after-repaired condition to determine a value that way. What other buyers are paying for similar properties in after repaired condition is THE best way to determine market value. The Trashflow Analysis is what you use when there are no such comparable sales, or there are too few to be useful.
  1. Because it’s basically an evaluation of what a property is worth based on the INCOME it will generate, it’s only applicable to properties in rental areas. You wouldn’t use it to try to find the value of a property in a homeowner/retail area, because a) in those areas, there should be PLENTY of after-repaired condition sales to choose from and b) property values in areas primarily occupied by homeowners aren’t valued for their income, but for their sale price

So, to summarize, the Trashflow Analysis® is used:

  1. For single family properties
  2. In rental areas
  3. When there are no, or too few, after-repaired value comparable sale to establish a value using the comparable method

Information you’ll need to gather to do an accurate Trashflow Analysis®

To use the system, you need to gather several pieces of data beforehand:

  • RENT Comps. In other words, what do fully stabilized rental homes with similar amenities (same number of rooms, bedrooms, baths, with or without a garage, with or without a fenced yard, etc.). Craigslist is a good source for these, as is
  • The adjusted real estate taxes on the property. I say ‘adjusted’, because if the property is selling for a great deal more or less than the current tax appraisal, the real estate taxes will go up or down, accordingly. In most areas, you can come up with adjusted taxes either by calling the county tax collector and asking them what the adjusted taxes would be at a new appraisal, or by calculating that yourself by dividing the current annual taxes by the current tax appraisal, and multiplying the resulting fraction by the new tax appraisal you expect after the property is purchased.
  • The probable monthly insurance bill. This varies drastically by the part of the country, but within any given region can usually be calculated based on the value of the house. A $200,000 house in Ft. Meyers Florida will cost a lot more to insure than a $200,000 house in Kansas City, but a knowledgeable insurer who regularly covers investment properties (try can give you a general idea of what a $50,000 house, a $100,000 house, or a $200,000 house should cost to insure in either area
  • The minimum net monthly cash flow that a reasonably savvy landlord wants to make on a single-family rental in your area. Believe it or not, this will be the hardest number for you to get, because most landlords don’t know how to calculate net monthly cash flow. This number is normally between $50 and $200 a month on a leveraged property—but they’ll say numbers like $500/month, because they’re calculating their profit as rent minus principal, interest, taxes and insurance, completely leaving out maintenance, vacancy, and other irregular expenses. Absent any other data, use $50 in an expensive, hot market and $150 in an average market

Doing the Math

The idea of the Trashflow Analysis® is that landlords, consciously or subconsciously, value properties based on their potential to cash flow. Thus, the formula takes this and other expenses into account, then takes what’s left over and assumes that amount is what’s available for a mortgage payment. The question then is, “How much mortgage will that monthly payment support?”.

The basic trash flow analysis formula is this:

Gross expected monthly rent (get from Craigslist for similar rental properties in the area)

  • 20% of gross rent (this accounts for vacancies, maintenance etc.)
  • Monthly taxes
  • Monthly insurance
  • Any other expenses that would be paid by the owner of the property—utilities, trash etc.
  • The typical landlord’s expected monthly cash flow in your area

= the amount of monthly rent left for mortgage payment

In my area, the numbers on a real type 2 property might look like this:

Gross rent                           $900
-20% of gross                     $180
-monthly taxes                  $80
-monthly insurance         $40
– other expenses              $0 (in my area, tenants in single families pay all utilities etc.)
– desired cash flow          $150

=$450 left over for mortgage payment

That $450 represents the monthly payment that a landlord could make on this property and still pay all his expenses plus get his desired cash flow. So, the question is, how much mortgage will a $450 payment pay?

And there we run into another problem because not every landlord qualifies for the same financing. One might be able to get a conventional loan at 4%, another a portfolio loan at 5%, and $450 will support less of a mortgage balance at 5% interest than at 4. Heck, another landlord might pay cash, which messes up the whole deal, right?

That’s where the Trashflow Analysis® makes a big (but generally accurate) assumption: that the buyer would get a private loan at 8% fixed interest amortized over 30 years. While this may not be true of any GIVEN buyer, it’s true of ENOUGH buyers to be useful

Doing the Math

The easiest way to set up this calculation is on an excel spreadsheet like the one attached, where the final calculation of the “value” is done with the excel formula  @PV(yearly interest rate expressed as a decimal/12,months over which the loan will be amortized, monthly payment as a negative number, 0,1). You can also input the interest rate, payment, term, and future value (which is $0) into any financial calculator to get the result.

In the case of the example above, what you’d enter into Excel is @pv(.08/12, 360,-450,0,1) and the result would be $61,736.42

Analyzing the Result

If you care what that number actually represents, it’s how much your buyer could borrow against the property at 8% interest for 30 years, and still pay all his other expenses and get $200 a month in cash flow.

In other words, the result is what a landlord could pay for the property IF it needed no further investment of money to be stabilized.  It’s not what we’d pay for a property that’s not in after-repaired condition, though, so to get to the sale price, you’d need to do one more step:

Mortgage balance
-repair costs
=sale price to the landlord

You might logically ask, “Wait, where’s the ARV x .7 formula I’m used to? Shouldn’t I multiply the result by .7, the subtract repair costs? But the answer is no—if the landlord buys at this price, then does this amount of work, and borrows the whole amount, the deal should reach his income goal.

There’s one more thing you should do before deciding to pay the resulting price, or sell at that price, if you’re a wholesaler, and that is to cross check the result you got with any sales that might have occurred in the area, whether they were after-repaired condition sales or not.

This is simply a “gut check” to compare your proposed price with the (perhaps not great, but still there) comps that a buyer will see if he bothers to look at local sale prices.

If your price is slightly above or below the price at which distressed properties in the area are selling, your price is a good one unless you have some reason to believe that your property needs a lot MORE work or is in much BETTER shape than the other sales.

On the other hand, if your proposed sale price is $20,000 less than the lowest distressed sale and you have no special reason to think that it’s a lot different or in a lot poorer condition, what this tells you is either that your rent or one of your expenses is off, OR that landlords in the area are willing to buy at prices that return them LESS cash flow than the number you’ve plugged in for them. Double check your math, and if the income and expenses are all accounted for, you can probably raise your price some and still sell the deal, since it will still be lower than the lowest sale price in the area—a figure buyers love to see.

If your proposed sale price is far ABOVE the price of properties in similar condition, the same logic applies; either you’ve underestimated the expenses, or buyers in the area consider it a higher-hassle management area and want to make more for owning it.

In most cases, though, you’ll see that this system turns out a result that matches up pretty well with the prices that landlords are paying in these rental areas.

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