A quick formula/guideline for those of your looking at deals.
Many people who get into investing or look at deals often don’t calculate the “real” cost of expenses.
My guideline is always OVERESTIMATE because things always cost more than you think.
The quick formula I use to evaluate a deal is is 18% to 28% NOE (net operating expenses). This includes all costs except for your mortgage loan (principle/interest).
Keep in mind this is just used to quickly evaluate a deal but you’ll need to go through all of the numbers once you have it under contract or make an offer.
Example:
Duplex for sale at $400,000
Current gross rents $1500/month. (Could potentially be raised to $1600, but start with the lower number to be safe).
$1500 income x 23% = $345 expenses.
- Property management - 9% @ $150
- Capital expenses (improvements and repairs to set aside in a savings account) - 5% @ $75
- Utilities, landlord licenses, city fees, etc. - 4% @ $60
- Vacancy rate - 5% @ $75
- Insurance and taxes - 7% @ $105
Now take your mortgage at 4% interest over 30 years (assuming you’re putting 25% down which would be $100,000) and your principal and interest payment will be $1433 per month.
$1500 gross income - $345 NOE - $1433 mortgage = -$278.
This math doesn’t work so don’t do the deal!… Unless you can figure out how to drop the purchase price, lower the interest rate etc.
Otherwise your cash on cash return would be negative (always a terrible idea):
-$278 x 12 months = -$3,336
-$3,336/$100,000 = -33.4% return.
Case in point don’t just buy something because it’s a “good investment “tip by someone else. If the math doesn’t work nothing else will.
Hope this helps and happy investing!
