By Matt Andrews — I hear it all the time from bird-dogs that bring me properties. “Matt, this property is a great deal. It will make you a lot of money. It will be easy to fix up and flip. It will be a great rental return.” I always laugh to myself when someone attempts to qualify the investment value of a property by using descriptive terms like “great deal“, “a lot of money“, or “easy to flip“. These terms are totally subjective. They tell me nothing about the property and let me know that you have no idea what you are talking about.
Look at those inadequate descriptive terms above and ask yourself, “Would I put my hard-earned money into a property described like that?” I seriously doubt it. Here is what I would want to hear from a trusted real estate partner:
“Matt, I have a property that I think will meet your buying criteria. This property can be bought and renovated for around 65-70% of its after-rehab value. I calculated the ARV using real comps of similar homes sold within the last 90 days. You are looking at a 20-25% ROI.”
Or if it’s a rental investment I would want to hear:
“Matt, this rental property will yield a cap rate of 13% after all expenses, which include insurance, taxes, property management, vacancy and maintenance reserves.”
Do you see the difference between the first examples and these last two? The last two clearly show a knowledge of the real estate investments that you are attempting to sell. You are saying to your prospect, “I am not just hawking properties. I analyze and qualify true investment potential.” This kind of knowledge and understanding of real estate fundamentals will separate you from the crowd and bring real value to your investors.
This next section will be a little challenging, especially for those of you who are as mathematically challenged as I am. But trust me, if I can get it, anyone can! At the end of the section, I will give you some tools and some short cuts, so don’t worry. Okay, put on your analytical hat, because here we go!
ROI – Running The Numbers
Sometimes known just as RETURN, ROI (Return on Investment) is the ratio of money gained or lost on an investment relative to the amount of money invested. ROI is a measure of investment profitability, not a measure of investment size. The amount of money gained or lost may be referred to as interest, profit/loss, gain/loss, or net income/loss.
The money invested may be referred to as the asset, capital, principal, or the cost basis of the investment. ROI is usually expressed as a percentage and indicates cash flow from an investment to the investor over a specified period of time, usually a year. If someone says that they made a 20% return, they usually mean that the investment made them a 20% gain that year.
In general, the higher the investment risk, the greater the potential investment return, and the greater the potential investment loss.
So, what is a good return on investment for a property that you will buy, fix, and flip? You will get many different answers depending on whom you ask, but here is my general rule of thumb: After renovations, I want to be into a property for 65-70% of its current value.
For example, if a property is worth $100K, then I do not want to have any more than $70k invested in that property. Assuming I pay Realtor fees, buyer concessions, and closing costs totaling $10K, my profit will be $20K — roughly a 30% return on investment. I arrived at that percentage by dividing 20 (my profit) by 70 (my invested capital). Make sense? Good. Now you should be able to use the same process to quickly calculate the investment return for any flipped property you are selling. Your investor buyers will love you for being able to explain how this is done and they will value your input greatly.
CAP RATE – Running the Numbers
When someone says that a property is a 10 cap, what they mean is the property will produce 10% return. Basically, cap Rate is the ratio between the net operating income produced by an asset and its capital cost (the original in- vestment amount). commit this simple formula to memory.
Generally, NOI, (New Operating Income) is defined as the yearly gross income less operating expenses.
For example, if you bought a house for $100,000 and it produces $10,000 in annual net operating income, then:
The asset’s capitalization rate is ten percent; one-tenth of the property’s cost is paid by the year’s net proceeds.
Run the Real Estate Numbers
New Investors tend to avoid true, objective evaluation of property deals. In doing so, you are avoiding the one thing that can separate you from “dime a dozen” Realtors and “wanna-be investors.” Don’t be that guy!