If you want to be a successful real estate investor, you have to find the right deals. You don’t want to spend a lot of time analyzing every real estate deal presented to you. Instead, you can analyze a deal quickly with a high-level overview to see if it meets your investment criteria. If so, you can then move it to the second round of analysis. This way you can analyze more deals in less time and find that perfect investment opportunity.
The old adage that the three most important things in real estate are location, location, location still holds true. Look into local services that make the property attractive. For residential properties, renters appreciate conveniences like shopping, restaurants, good schools, high-quality medical services, parks with recreational facilities, and transportation within walking distance. Make sure to get figures on the vacancy rate of the area. Find out if there are any environmental risks associated with the property, such as flooding, earthquakes, mold, or termites. Research the area surrounding your property to check if the population and/or jobs are stable, increasing, or decreasing.
Examine the property inside and out to see if it is in need of extensive renovations, or if some easy fixes will improve the appearance. Remember that the building does not exist in a vacuum, so you need to look at the other properties in the area to see if they appear well-maintained.
The fact that a property may need some renovation is not necessarily a deterrent. A Value Add investment property that requires some improvements is ideal for investors who are willing to fix up the property in return for a discounted price and the expectation of a greater return.
There are a host of easy formulas you can apply to make a fast assessment of the property. The Cash-on-Cash (CoC) return is a simple calculation showing your rate of return relative to your down payment and the annual pre-tax cash flow. While the CoC does not give the total picture, it is often used to compare real estate investment opportunities. The Price-to-Rent ratio compares the price of the property with the median rent you can anticipate annually. Real estate with a high Price-to-Rent ratio is not considered a decent investment.
Keep in mind that the NOI and Cap Rate do not take your debt service into consideration.
Here are the formulas you can use to do the math:
Cash-on-Cash = Annual Pre -Tax Cash Flow/Total Cash Invested
Price-to-Rent Ratio = Value of the Property/Annual Rent
Net Operating Income = Annual Gross Income – Annual Expenses (Debt Service is not included)
Cap Rate = Net Operating Income/Purchase Price
Cash Flow = Net Operating Income – Debt Service
If you determine that the property is attractive, think about financing. Lenders often look for a debt-to-income ratio of 45% comparing your gross monthly income with your debt payments each month. They may factor in other elements as well, such as your cash reserves and credit score.
A down payment of 25% or 30% is common, and some lenders require up to a hefty 40% of the purchase price. How much of a down payment is required will be based on the price of the property, NOI of the property, your credit profile, and other factors. Lenders may look for a track record of two years in managing investment properties to consider the rent as income.
When you consider adding a property to your investment portfolio, use easy formulas to perform a fast, high-level overview. You might want to set up a preliminary investment criterion and use a process to check if the deal is meeting your core requirements. Having a process will save you time and give you data to benchmark your progress.
Real estate is a popular investment choice because it can offer a stable asset that produces an immediate cash flow. You can leverage the capital investment to build wealth faster…
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