How to RUN NUMBERS for a real estate deal and when to pull the trigger…Sep 17, 2020
When you are looking to buy a rental investment property, its crucial to know how to “run the numbers”. This is the foundation of analyzing any investment deal, rental or not, and the end result should align with your goals – for example, a decent goal would be to hit a CoC (cash on cash return) between 8-10%. This is basically just expressing annual cash flow from your rental (after all expenses are deducted) as a percentage of your initial cash investment (down payment and closing costs). Depending on your market and aptitude, this number could be as low as 5% or as high as 15% before you consider the deal noteworthy. Knowing the numbers also means that you could then work backwards, arriving at an offer that may be much lower than asking, but one that allows you to hit your CoC goal… So let’s dive right in…
COC = (Annual net cash flow/Initial investment) x 100 expressed as a percentage
Cash flow = Income – expenses…
So the real trick then is to be able to estimate accurately rental income for the property you are analyzing and potential annual expenses for the property. An easy rule of thumb is to calculate PITI (Principal and Interest + property Taxes + Insurance)+ 5% possible vacancy + 10% allowance for Maintenance (including Capital expenditures) + HOA and Property management fees if applicable. In some circumstances, including Utilities (particularly with Multi Family Units) and Pool Maintenance may be necessary if these expenses cannot be billed back to tenants, but for the most part in Single Family rentals these expenses need not be factored in. It’s also important to remember that rent estimates on Zillow or Redfin may not be accurate, checking with your agent is important. Also current property taxes may not be an accurate estimate as these taxes are reassessed upon sale of the property.
For example, a Single Family Home (SFH) you are eyeing is listed for 235,000$. Current tenant pays 1995$. This is your gross income per month. Let’s calculate monthly expenses assuming 20% cash down ie 47,000$, 3.625% interest rate for 30 years (yes, rates are higher for investment properties, please factor that into your calculation), 3000$ in closing costs, property tax rate of 1.9% and no property management fees (self managed)…
Initial investment is 47,000$ + 3000$ (down payment + closing costs)
PITI (Principal + Interest + Property taxes + Insurance) = (828.2+370.3+115.7$) = 1314$
Vacancy + Maintenance = 15% of rent = 299.25$
HOA = 75$
This leaves you with a monthly cash flow of (1995-1314-299.25-75) 307$. So your annual cash flow is 3684$. And your Cash on Cash return is (3684/50,000) x 100 = 7.4%. And if you remember from my previous post, this is all TAX FREE income thanks to Depreciation.
This may or may not be aligned with your goals… You may choose to put an offer in at 225,000$ that would be more aligned with your goal for CoC. But your decision is informed …
Now while assessing Short Term Rentals STRs, you will have to factor in a much higher vacancy which may even be seasonal depending on the property location, per night rates, hiring maintenance crews etc. In a High Cost Of Living HCOL market, the numbers may only work with a much higher down payment. Or you may need to tweak the numbers based on Forced Appreciation, ie if you plan to rehab the property after purchasing it (which will likely also increase rental potential), you will need to factor those costs into your initial investment. But the basic principle remains the same.
Now, go ahead and run those numbers …..
Just remember, Rome wasn’t built in a day… the more numbers you run, the better you get at spotting a great deal; the more offers you put in, the more likely you are to close on your next property. Best wishes…
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