@Steven B.,
Welcome to the site, lurker!
I hope you can read faster than me. Thanks for giving me a prompt and papyrus to throw down some thought to paper and sharpen the gray matter! I hope it's not more than you bargained for:
I'm not going to bother with actual numbers and data, because they'll only add to your analysis paralysis. You have to accept there are some things that will come up that you won't be able to account for down to the dollar.
I know that's not what you wanted to hear, so here are some general trends or traps that I've fallen into as a more green investor:
First, a little background:
I started in 2002? The internet wasn't as useful as it is now, and finding reliable information was difficult. I didn't do any super detailed analysis on my first 3 properties. I know this sounds crazy, and looking back it was a little nuts. I did all 3 prior to 2007 and I was doing 0% down, so I didn't have much skin in the game short of sweat equity.
However, I did what I dubbed "the basic math" and took:
RENT - MORTGAGE - INSURANCE - TAXES = POSITIVE NUMBER!!!,
and pressed the GO button. I didn't even use a spreadsheet, at best it was pencil on a pizza box and at worst it was just mental math that my brain could handle. I don't have the brain cells or the pizza boxes to prove what I actually did.
I have since plugged all those numbers into my light-years more advanced, but still relatively simple, analysis tools and realized that before I refinanced to lower the mortgage costs I was actually set up for a negative net on those properties.
(I digress, but it's worth the read) Time heals almost all wounds in real estate. I've come to settle on the idea that if a deal works for the next 5 years (usually what I can get loans out to now), then it should be good for the life of the investment. Principle pay-down is the simple answer that heals all wounds. After 5 years an argument can easily be made to refinance (without taking money out) to a lower mortgage payment. Even if rates rise a little over time, you'll still have some principle paid off and it will likely reduce the actual debt service expense number in your equation. And, oh by the way, rent generally increases over time further extending your net.
Here are some big lessons learned:
1.) Not accounting for the closing costs in your purchase equation.
If you can convince the seller to pay all closing costs that's great, but some won't get on board. If not, you're looking at around 3% of the purchase price as a rough guess for the closing costs you'll have to cough up in cash if you don't have it bankrolled by your lender.
2.) Not sticking to the maint/repair costs reserve.
I fell prey to this trend in my early investing career (10+ years ago). I have been blessed to have never had to come out of pocket to cover maint costs, but it was mostly due to lower than anticipated vacancy rates. This is a great testimonial to the ability to heal over time. If I hadn't been able to refinance later I would have started to come out of pocket when bigger items hit. You could say I was lucky not to get hit with those costs before I was able to change the equation with a refi, but I'll say I was blessed. Either way, I didn't understand the math on the front end of the purchase well enough to execute it on the back end.
3.) Learn what metrics really matter.
$/Sqft? CAP rate? 1% rule? COC (Cash on Cash) return? How far is the property from the nearest Walmart? These are all numbers I look at, but maybe don't use, during some phase of a detailed analysis now that I know what I'm doing. However, most of them don't matter after they've served their purpose.
Here's something that took me a really long time, about 30 years, to boil down:
CAP rate vs. Cash on Cash Return (COC)
CAP rate is useful for comparing properties in a market to other properties from the eyes of a universal (meaning faceless or interchangeable) investor.
COC return is a very personal metric that tells me (based on my financing assumptions) how much cash is being returned to me in cash flow (after all expenses including debt service)
In other words, CAP rate doesn't take into consideration my individual financing assumptions. It also doesn't take into consideration transaction costs (closing costs). It is singularly based on continuous operations.
Therefore, COC return is my #1 metric I use to compare the opportunities that I have available to me.
"Fortune favors the bold". Move forward and make offers. Experience will come with experience, but do the simple math.
I hope this helps!
Good luck! Keep us posted.
-Sam
