I have said, time and time again, how great real estate investing is. Real estate investing is one of the best ways to grow wealth without as much volatility as the stock market. If you haven’t started your real estate investing adventure or haven’t been doing it for more than a few years, I have some great real estate investing tips for you. All the tips involve math. But, it’s the math that will make you wealthy and not the kind that makes you want to bang your head on a wall.

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7 Real Estate Investing Tips

  1. Net Operating Income (NOI)
    1. This is the profit from a monthly or annual basis you get from a property. However, this does not include debt service.
    2. total revenue – (taxes + reserves + hard costs)= NOI
      1. Hard costs are things like: insurance, utilities, third-party management company etc.
      2. Reserves are capital expenditure account for a new roof, a water boiler, vacancy, the big costs that happen in a rental
    3. This information is good to have if you think you are going to purchase a real estate property with cash.
  2. Cash on Cash Return
    1. This is, basically, your return on investment. You are looking at how much the property is bringing you in cashflow versus the amount of cash you invested into the property.
    2. For a cash purchase:
      1. Look at annual income
      2. NOI/(purchase price of property+repairs or cosmetic money)
        1. NOI is $6,000.00
        2. Purchase price is $60,000.00
        3. Math: 6,000.00/60,000.00= 0.1 or 10%
        4. Your return on investment is 10%
    3. If you are looking at mortgages and bank money:
      1. NOI-principal + interest payment= return
        1. 2,400.00/12,000.00= .2 or 20% return
    4. Bank money is not always going to produce a better return. This is why doing the calculations matter!
  3. Cap Rate
    1. This is something that happens more often in commercial real estate, but you can use it for single-family and residential properties if you really, really want to.
    2. The cap rate is important because the cap rate almost always stays the same. But you can change the NOI and therefore know how much a building’s value has gone up.
      1. Cap rates are calculated by taking the NOI and dividing it by the purchase price.
      2. Cap rates and cash on cash returns are the same calculations if you are buying a building in cash.
    3. Math time:
      1. Everything in the area has a 10 cap. (10% rate)
      2. You find a building, you divide the NOI by the Purchase Price and the cap rate comes back at 8%.
      3. This building is over-priced. That doesn’t make it a bad deal, but it’s going to make banks hesitant to give you the money for the loan. They will give you the value of the building.
    4. You should not buy a building based on its potential cashflow. You need to buy it at the value of what the building is making when you look at it. If the building has 12 offices and only 8 offices are rented, you don’t pay for what the building would be making if it had all 12 offices rented out. You buy it for the cashflow that the 8 tenants are already paying.
    5. So, what if you calculate the cap rate for a building in a 10 cap area and you come up with a 12% cap rate?
      1. Means you found yourself a good deal!
      2. Also means that if you have the ability to raise the rent or cut some costs, you can change the NOI and the bottom line of the building.
  4. Rent to Cost Ratio
    1. This is an easy calculation and a great rule of thumb.
      1. I use Rentometer because it tells me the going rate of rent for a single-family home, with three bedrooms, and in a specific zip code.
      2. You can see the average rent, but also the specific rent in areas for each property.
    2. Use the monthly rent for the area and you divide in by the sale price of the property
      1. Example
      2. Rent: $1000
      3. Property: $100,000.00
      4. Rent to cost: 1000/100,000=.01 or 1%
      5. I personally never buy a property with less than a 1% rent to cost ratio. Less than 1% can give you some low cashflow or issues with cashflow
      6. I aim for a 1.5% ratio
    3. There are people out there saying you shouldn’t use a ration with less than a 2%. Here’s the thing, CNBC said in 2018 that Cleveland is the best area for rentals. We are a hot market and you will be extremely hard pressed to find a 2% ratio. I know, I live here and do deals here.
      1. If you love the 2% rule, you might be waiting years for a deal to hit that mark.
  5. The 50% rule
    1. A guideline, if you will, to give you a quick look at what the potential net operating income of a place could be.
      1. You will have a 50% expense ratio to rent.
      2. If a property rents at $1000 a month, 50% will go to costs and 50% will be cashflow.
      3. So, say the cashflow is $500 a month, you multiply it by 12. $6000 a year.
        1. 6000/purchase price=cap rate or cash on cash return
      4. If the return sucks with the 50% rule, then you can be pretty sure that the deal is bad and walk away without spending hours finding the real taxes and expenses.
      5. If the cash on cash return is still better than the average ROI for an index fund or something to that effect, then you should definitely spend the time looking into the actual expenses.
  6. 70% rule
    1. This rule is mostly for those looking to flip or wholesale a property.
    2. Take the ARV (After Rehab Value) multiply it by 70% and that is the price point you want to start at before subtracting expenses and everything else. After subtracting all the expenses for rehab, you use that number as what the house is worth to you to buy from the seller.
    3. The 70% rule helps you decide what kind of offer you should give the buyer to ensure you can still make a profit or the wholesale fee you think you should get.

Therefore…

These are the calculations that will help you in your real estate investor journey. They can save you time, energy, and keep you from making a bad deal.

Don’t Forget!

If you love the returns of real estate investing, but don’t want to deal with any people, you have the option to be the bank. You can be part of a trust or a fund. Right now, I have a fund set up for accredited investors with over $5 million in assets. The fund has preferred interest and 70% profit sharing. Visit me at investwithdrmatt.com to find out if you have the opportunity to invest with us.

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