As you become a seasoned investor sometimes you need to make a decision on a property very quickly. So here are three ways to quickly analyze and evaluate a property to decide if you should pull the trigger on it or not. These principles can really help beginner investors as well.
Principle #1: The 1% rule:
You might have heard of the 2% rule, but where I live and invest in that is nearly impossible or at least it is right now. So I try to follow the 1% rule. Basically does the monthly rent equal 1% of the purchase price (your all in price including repairs).
Example:
Purchase price $100,000 and the monthly rents are $1,000
If the property meets or almost meets this 1% rule I will continue to consider it. If not I move on.
I mentioned the 2% rule or 1.5% rule earlier. This can be done, but remember there is a trade off between risk and reward. There are classifications of properties (A, B, C, or “War Zone”).
Class A: High quality tenants, Safe neighborhoods, low turnover, New construction or recently remodeled, etc.
Class B: Mid quality tenants, Moderate neighborhoods, some turnover, older properties in decent condition, etc.
Class C: Low quality tenants. Crime neighborhoods, high turnover, older properties that needs repairs, etc.
War Zone: Terrifying
So I guess what I am saying is yeah you might be able to get that 2%,but is it worth the C class property and headaches that can come with it? Verses the 1% rule on a Class A property?
Based off the 1% rule your property will gross 12% annually (which are pretty good returns). Typically 50% of that goes towards operating overhead (6%). That means you net 6%, but there is also another way to create returns and that is appreciation. We know that real estate typically rises at the level of inflation which is around 3%. So your total return is 9% annually (not to shabby).
Principle #2: The Cap Rate:
Cap Rate (Capitalization Rate) is the ratio of your NOI (net operating income) to the property value. A simple example would be a property sold for $100,000 and the NOI was $10,000 then the cap rate would be $100,000/$10,000 or 10%.
You can read more on Cap Rate and how to find our NOI here.
Principle #3: Cash on Cash Return:
They last formula or example is called the the cash on cash return. You do this by cash flow (money after paying all bills and financing) divided by the cash out of pocket.
Example:
Lets say I buy a house for $100,000 and put 20% down ($20,000 (this is my cash out of pocket)). After all bills and financing I make $250 a month / $3000 a year.
$3,000/ $20,000 = 0.15 or 15%
Pretty sweet
For me real estate is a stable asset and investment where a small investment can get you 10-20% cash on cash return.
Good Luck with your investing!
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