Ratios

[Justin Przybylski]

What would be a beginner's guide to the criteria and ratios that I would need to analyze an investment property? My goal would be to have the property produce positive cash flow even if its $1 a month. I just want to get my first deal under my belt. Obviously the selling price is important. I heard about the 50% ratio. How do I even begin my due diligence to know if a property would be profitable or not? If I was analyzing a restaurant I would easily just look at the financial statements and be able to quickly judge if it profitable or not. With real estate it seems it's not as simple. So what criteria and/or ratios do I need to analyze?

[Brandon Hall]

You look at the area and determine how many homes are being rented vs. owner occupied. You look at what the going rental rate is in the area, compare your house to comps, then determine a worst case/ best case rental rate. You estimate all of your operating expenses, capital expenditures, financing costs, and other fixed costs. You create a spreadsheet that will allow you to easily input numbers to show you the expected return over 10, 20, and 30 years. After you do all of that, you can play with the purchase price to determine what purchase price you need to meet your expected return.

As ratios go, everyone will say something different. I will want to know the cap rate, the year-over-year return (which includes your built up equity), and your total return (which includes previous year's returns).

Also, while you make think a positive cash flow is good no matter how small, you need to understand that your time is going to be your biggest constraint, and in most cases, you do not want to work for $1 per month in cash flow. Also, what happens if there is a storm and you need a new roof? What happens if you need to evict your tenants? What happens if you have to replace appliances or other equipment? $1/ mo won't cut it.

Keep reading BP. Read books and soak in as much knowledge as you can. Pick houses, do your deal analysis, and post it here on BP for feedback. You can jump right in if you want, but after reading BP, you'll realize that the people who jump right in tend to get burned on their first few deals.