It’s a numbers game.
Calculating the profitability of a real estate investment is critical to the success of your real estate investing career. Most investors think they know how to calculate the number. Most do not as they will not calculate all the expenses, forget to add the profit that they need, bank on appreciation when there is none, calculate profit before debt service and end up losing money after debt service. There are a lot of ways to go wrong here. In order to calculate if an investment is worth while there are a few different ways to do it, this is how I do it. I first take the property that I am looking at and research it. I look up how much the taxes are, get a estimate of insurance costs, drive the neighborhood during the day and at night, find out what current rents are, compare current rents to market rents. After that I perform my “cash-flow” analysis, notice I do this before I schedule a time to view the property.
This is an example of what my calculations look like when analyzing a property that rents for $700 and $750 per unit and costs $134,500 (assumptions 20% down with a 30 year conventional mortgage):
This is not a “cash-flow” that I would be interested in buying at that price. I look at it as if I am buying a cash-flow because that’s really what you are doing. For my down payment of $26,900 plus closing costs I would be getting a $245 per month cash-flow. A 10.9% return on cash ($2,940 first year return / $26,900 down payment= 10.9%) in the first year is nothing to laugh at, it beats most markets, but there are even better deals out there for my money. This is how I analyze every property that I am interested in. Maybe the previous example is a great deal if I could get the seller to reduce their price or maybe even hold the note at very agreeable terms with little money down. This is where a true investor shows his or her colors by being able to “create” deals. Take the previous example; let’s say we are able to convince the seller to carry a note on the house. We negotiate that we will give the seller $5,000 down and make payments of $500 per month till the note is paid off or we refinance. Because the seller agreed to carry the note they wanted a higher price for the house so we agreed to pay $145,000 for the investment. This is not an issue because we are more focused on the monthly cash-flow and return.
Our new return becomes $323.33 per month or $3,880 annually. The new return on cash for the first year is a whopping 77.5% ($3,880 annual return / $5,000 down payment = 77.5%)!!!I would much rather purchase a $323 per month cash-flow for $5,000 than a $245 cash-flow for $26,900.
You can see how deals can be “created” from what seems to be a bad deal. No matter what the fundamentals must remain. You need to calculate all of your expenses including debt service to see if the deal is worthwhile. You must determine the level of risk you feel comfortable with and how much you are willing to “pay” for a cash-flow. Some people will pay more for certain cash-flows because they find the property to be much safer than another. Sometimes you would pay a lot less for a cash-flow because the investment is not appealing as others. This is where personal preference comes in but in no instance (except vacation rentals in some cases) should you be willing to lose money per month on your investment.
