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How To Pick A Great Real Estate Investment Property
Real estate can be an excellent investment – if you know what you're doing.
But how do you know if you're getting a good deal? Will you make money on your investment? Will your estimate for expenses and income work out?
This real estate calculator will help you answer these questions… and more.
Related: 5 Rookie Financial Planning Mistakes That Cost You Big-Time (and what to do instead!) Explained in 5 Free Video Lessons
The reality is your investment property profits are driven by the math behind the deal, which can be complicated. There are a lot of numbers and ratios to consider. This investment property calculator makes the math easy so you can focus on negotiating and operating your property portfolio, rather than analyzing it.
Below is more information about how real estate investment works so you can maximize your results.
The Goal Of Investment Properties
When you start acquiring properties for investment purposes, your ultimate goal is to earn a profit – both through cash flow and appreciation. These are the two main components of your return on investment equation (tax considerations being a third).
The number to focus on is positive cash flow because it makes investment property ownership a joy to get paid at the same time you grow equity; whereas, it is a pain when you have to feed your real estate due to negative cash flow.
Ultimately, your ROI equation will be dominated by the gain or loss from the changing value of your real estate, but your peace of mind while owning the real estate will be determined by whether it is positive or negative cash flow.
Additionally, you should try to pick investment properties that don't require much maintenance. The reason is because you have only two resources – money and time – and the only one that is truly limited is time. You can't make more of it.
What that means is the last thing you want is to spend all your valuable time improving and maintaining properties. Even if the property doesn't require much money, remember: time is ultimately more valuable because it is limited – you can't make more of it.
In summary, always keep in mind the reality of ownership before buying. There is much more to real estate than just numbers. For example, positive cash flow gives you an infinite holding period and makes ownership a joy, but that number will be overshadowed by gain or loss in market value dominating your return on investment equation even thought it has little effect on how you feel about ownership month to month.
Similarly, maintenance problems might not seem a problem when you are excited to gain control over a property, but the ongoing headaches can severely impact how you feel about ownership.
How To Make Money From Investing In Real Estate
So how do you build wealth through real estate investing?
Let's look closer at the various sources of return that will be revealed when working with this real estate calculator.
- Real estate investments generate income through rent – Some people invest in properties such as buildings, commercial complexes, or houses for the purpose of renting them out. Income generating properties include warehouse units, apartments, office buildings, rental houses and more.
- Real estate can appreciate quickly – Growth in valuation is usually the biggest factor impacting your investment return equation. If the properties around your area are scarce or the area experiences rapid economic growth then you can expect real property values to increase. Conduct careful research and know the development plans in your city before investing.
- Make money from business operations – Engage in business services that could generate additional income, like setting up a vending machine, offering laundry, or food-catering services in apartments. If your property includes vacant land consider adding storage units for additional rental revenue.
How To Buy Real Estate Properties
There are several ways to finance your real estate purchase. You can take loans against your existing property or take a regular mortgage loan.
For those who are already experts in real estate investing, they can consider hard money loans. Hard money loans are easier to get because they are not based on the credit worthiness of the borrower. Instead, they are based on the value of the property. But beware – hard money loans can be expensive turning a marginal property into a loser.
Begin your investment process by considering the following steps:
- Start saving for the down payment – Review your budget and check which expenses you can cut to increase your savings.
- Set a goal and start with small investments – It is important to set a goal for yourself in writing stating when you will be able to buy your first investment. Be specific using an exact date.
- Control Risk – Complete a thorough due diligence before closing escrow. Make sure to carry proper insurance and consider purchasing within a legal entity other than yourself to control lawsuit risk. Manage the property tightly with careful control over cash flows and investigate any irregularities immediately. It is amazing how much money can be saved in expenses with proper care and a little creativity.
- Get some help – There are lots of self-help books available. But it is also important that you consult the experts in this field. Learn from the mistakes of those who are one or two steps ahead of you.
Investing in real estate is not for everyone. It is part business and part investment.
Your investment return is a function of buying it right and financing it right. Your business return is a function of managing it right.
Real estate investing is not a get-rich-quick scheme and it can take decades before you see results. Educate yourself, invest wisely, and design a strategic plan of action that includes real estate as part of your overall wealth plan here.
Real Estate Calculator Terms & Definitions
- Real Estate – Property consisting of land or buildings.
- Purchase Price – The price of the real property.
- Down Payment – An initial payment made when something is bought on credit.
- Loan Term – The period you need to pay the loan.
- Interest Rate – The proportion of a loan that is charged as interest to the borrower, usually expressed as an annual percentage of the loan outstanding.
- P&I – Principal and interest.
- Principal – Denoting an original sum invested or lent.
- Interest – Money paid regularly at a particular rate for the use of money lent, or for delaying the repayment of a debt.
- Closing Costs – Fees paid at the closing of a real estate transaction.
- Vacancy Rate – A value calculated as the percentage of all available units in a rental property that are vacant or unoccupied at a particular time.
- Gross Scheduled Income – The maximum possible annual income generated by rent collections.
- Other Income – All the other income generated from the property.
- Property Management Expense – The total expenses for maintaining the property.
- Capitalization Rate – The ratio between the net operating income produced by an asset and its capital cost (the original price paid to buy the asset); or, its current market value.
- Cash on Cash – The return on investment. It is equal to the Before Tax Cash Flow (BTCF) divided by the sum of all out-of-pocket acquisition costs (down payment, closing costs, etc.).
- Gross Rent Multiplier – Purchase price divided by the Gross Scheduled Income (GSI). The lower the number the better.
- Net Income Multiplier – Purchase price divided by the Net Operating Income (NOI). The lower the number the better.
- Debt Coverage Ratio – The Net Operating Income (NOI) divided by the Annual Debt Service. The higher the number the better.
- Expense Ratio – Total Operating Expense divided by Gross Operating Income (GOI), expressed as a percentage. A percentage below 35 is considered good.
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