Hi I was wondering if any investors have formula’s when they are looking at investment properties? I’m looking to buy homes and have them as rentals. So I was wondering if there is a formula to make it easier to determine if the house is a good deal or not. Something that covers property taxes, home owner insurance, maintence, monthly mortgage, etc…
Any information or ideas would be great, Thanks
I’ve posted this elsewhere, and it’s not really geared for single family investment, but it has what you need to analyze any deal.
jaypalmquist.com/real-esate-analysis-form.png
It’s impossible to answer your question regarding one single ‘formula’ for buying, without knowing what your objective(s) for investing is/are; whether you’re speculating, or not; buying for long term, or short term holding; and the market conditions where you’re looking to invest.
For example, the formula you would use for a short-term, cash-flowing rental will be different than an ‘appreciation play,’ as it were.
In some areas, there aren’t many naturally cash-flowing investments that don’t require enormous down payments and/or a extraordinarily long term holding. In that case, maybe any deal that cash flows with 20%, or less down, is “OK.”
Or perhaps a gross rent multiplier would be part of your measure. GRM’s are calcuated by dividing the sale price by the annual rent. So a $100,000 sale price divided by the annual rents of $12,000 would be 8.3, etc.
In other areas, you can pay full price, get 100% financing (in theory) and still experience cash flow.
The lowest priced houses are usually the target for cash flow buyers. Drilling down a bit, there is a rent/price ratio that many investors look for, to evaluate a given property.
For example some investors want the market rents to be at least 1% of the purchase price to be considered “good.” Others want the market rents to be at least 2% of the purchase price, to be acceptable.
For instance, using the 1% ratio, if the market rent was $600/mo, the maximum, after repaired value, would be $60,000. Of course, anything less than $60,000 paid, would reflect more of a bargain price.
Same thing goes for a 2% ratio/price requirement. Assuming $600/mo market rent, the maximum price would be $30,000.
So, are you looking for cash-flow? Appreciation? A combination of both? Are you looking for value-added investments that might include zoning changes, extra land, ?? All these objectives require a different valuation measure.
Hope that helps, more than confuses.
Several years ago, I posted my rental cash flow analysis spreadsheet. You can download it from this site at this link Cash Flow Analysis Spreadsheet
There are only two metrics I use: Debt Coverage Ratio must be greater than 1.25, and, the Internal Rate of Return must be acceptably high.
Thanks, I was thinking more along the lines of the GRM. I heard some people say that 12-15% is good and if your getting 20% or higher your knocking it out of the park. I’m looking for cashflow, but something to hold to as well. Thanks for all the information!
DaveT, I have to say a Big Thanks for the spread sheet! I was fooling around last night creating a spread sheet to figure out a return and the one you provided has everything and more! I will go over it a couple of times to wrap my head around it. I haven’t spent much time reviewing it yet, but on box O, line 9 how did you come up with that percentage? Thanks again!
Thanks, I was thinking more along the lines of the GRM. I heard some people say that 12-15% is good and if your getting 20% or higher your knocking it out of the park. I'm looking for cashflow, but something to hold to as well. Thanks for all the information!
20% is a good what? GRM’s are not percentage-based measurements.
Sorry, I thought they were?
From your previous post
Or perhaps a gross rent multiplier would be part of your measure. GRM’s are calcuated by dividing the sale price by the annual rent. So a $100,000 sale price divided by the annual rents of $12,000 would be 8.3, etc.
From me
20% being excellent cashflow
The spread sheet I developed last night was a simple one. I took the sale price of home, minus all the deductions and came up with the annually net profit. Then figured out the annually percentage…
Am I wrong? Thanks
A GRM is expressed as a multiplier, not as a percentage.
Price / annual rent = GRM
If you had a GRM of 20, this would reflect a horrible price, with negative cash flow …in any case I can think of.
So, the lower the GRM multiplier, the better.
For example, if the annual rents were $12,000 and the price was $50,000 this would represent a GRM multiplier of 4.1. That would surely be a ‘cash cow’ of an investment.
GRM is a figure that is used by both investors and real estate appraisers to turn rent into market value. The inherent problem with GRM is that it reflects the GROSS rent. It does not account for any expenses.
Additionally GRM is very market specific. What may be acceptable in Phoenix may be way to high compared to New Jersey or Chicago. You may want to talk to a commercial real estate agent or a local appraiser to find out what the rate is in your market area.
Another way to judge the cash flow of a property - and one that I believe is more accurate - is to use the 50% rule. Take 50% of the gross rents and set that aside to cover your expenses including vacancy, taxes, insurance, owner utilities, repairs, maintenance and capital reserves (it does not include mortgage payments or property management). The remaining 50% will be used to pay the mortgage, if any, and to provide your profit.
If you can find an income property that provides $100 per month/per unit of profit per month, then the property will cash flow. Anything over that is good.
I love this thread!
This post is more geared to multifamily evaluations and not single family.
Appraising single family residential is fairly straightforward. Value is based on what retail end/users are currently paying.
So, it’s just a matter of knowing market rents and assuming a self-managed, 40% overhead. If the house will break even against those assumptions, then it’s investment worthy (long term).
Anything else, and it’s a speculation, and in another category of investing.
Meantime, for multifamily, where the GRM’s are actually useful, there is another weaknesses in relying on them, or even static expense ratios, and that is, every property is different.
If the rents are substantially lower on a given property, the GRM may seem abnormally higher, especially if the seller is basing his price on newer, remodeled, or just better-performing properties that have sold.
Also, a 70-year old building with a boiler, common hot water and heat, will have higher overhead than a building that’s fifty years newer. It’s not unusual for a depression-era project to have expenses that run more than 70% of the gross scheduled income.
That’s why we need to compare apples only to apples, regardless of what valuation method we use.
The most important thing in evaluating income property is to use actual comps to compare data. And part of that is knowing:
This goes for single family investing, too. Except that single family investors never use CAP rates in their evaluations.
Those figures are too susceptible to hiccups.
One stolen air conditioning compressor can skew the CAP rate on a rental for more than two years. One stolen compressor in an apartment complex is ‘business as usual.’
Meantime, everything else falls from one’s knowledge of the market.
For example, not knowing market rents, and the GRMs only expose gross ranges in value, but hardly a precise valuation.
Also, a high GRM could mean the rents are say, “$200/unit/mo below market,” but if we didn’t know that, the high GRM would scare us away (or help us negotiate a better ‘steal’… It works both ways here!!!).
That’s an extreme example, of course.
The only way to know these things is to actually know what similar units, in similar conditions, with a similar age and construction have in common, and what ‘should’ be happening, etc.
I think a fantastic way to really become an expert at making evaluations of property, is to deliberately analyze 100 property data sheets. It makes little difference what we analyze.
Half way through this process, and we’ll begin to spot the clues to the hidden bargains, just by recognizing the spreads between what the expenses should be; what the scheduled rents could be; and what the management costs can be. It’s magic!!!
Good post.
Javipa, Thanks for clarifying the GRM. I’m only looking at single family homes for a cash flow and long term hold.
Thanks everyone for your input!
If you are asking about the capitalization rate percentage, it is NOI divided by purchase price. In my spreadsheet, the formula is in cell F38. Cap Rate is really meaningless for a single family (1-4 unit) property as value is determined by comps not by cap rate. The Cap Rate calculation is presented for information only and should not factor into an acquisition decision.
Javipa – So if the deal I’m considering purchase price is 38K and the annual rent is 12K…that would be in the “cash cow” category? A 3.17 GRM
There are 3 furnaces and water heaters in good shape and the building is old but in good shape.
Ha!
A 3.17 GRM certainly indicates cash cowness to me. So, this is a triplex? Even more cash flow amortization. Love it!
I have to side with Javipa on this one. A GRM of 3.17 would be sweet. I would jump on this deal if in fact all of the numbers are accurate. I do not know why the price is so cheap, but I wouldn’t let it pass by.
Brian,
You don’t have enough information to make a purchase decision. You need to know the cash flow the property will generate before making a decision. What if, in the course of your due diligence, you discover the annual expenses are $13K? Does this deal still interest you? GRM is not really that useful here because it ignores the overhead cost.
Yeah, Dave’s right. The GRM is really only for bulk sifting of deals.
However, if we only have GRMs to use as an evaluator tool, then we’ll look at say, eight deals, to see where the GRM falls, on average.
If they’re falling somewhere above 6, and we find one at 3.17, this suggests a bargain.
However, in my experience these outlier deals usually have some hiccup(s) going on that makes the GRM, NOI, GSI, or whatever we’re sifting for, stick out.
Hiccups are good. We make money curing hiccups. The worse they are, the more opportunity to make money.
For me the real way to analyze a given project is to have analyzed a ‘bunch’ of similar projects, using several measures including the net operating income, the gross scheduled income, the gross scheduled expenses, and even the gross rent multiplier.
However, without knowing market rents (vacancy rates) and market expenses first, it’s impossible to recognize the spreads these represent.
Without this perspective, any old deal might look good, or bad.
For example if we didn’t know what the market rents could be, and hadn’t analyzed several properties to gain some perspective, we might believe that a GRM of 3.17 was “great” (like I thought), except that when we found out that the GRM for this area was averaging “2”! Or worse, we found out that the rents were already at market rates, so not only is there no upside, we’re buying at over retail at a 3.17 GRM.
Whoopsie doodle.
In that case, this 3.17 GRM would look as ugly as homemade sin. Just saying.
I’m sure I could have written this more simply, but whatever… 
Dave T – Here’s what I know…
Good rental market. Building is currently rented. It has 2 - two bedroom apartments and a beauty shop.
The two apartments rent for $375/month and the beauty shop rents for $250 (should be getting a lot more in rent)
Purchase price is 38K
Landlord pays the garbage and water.
Here’s a breakdown of income and expenses:
Income is 1K/month (beauty shop rent is very low)
Expenses:
Down Payment - I know the appraiser and played golf with my banker this weekend. The appraiser thought it would easily appraise for 50K. My banker said he’d loan up to 80% of the appraised value. I should be coming out of pocket with minimal costs on this deal with a purchase price of 38K.
Taxes - $112/month
Insurance - $65/month according to seller
Garbage and Water - $100/month
Mortgage (15 years @ 6% using $38,000 as my loan balance) - $321
Total fixed expenses = approx $598
Leaves $402 for vacancy, maintenance, profit.
Please let me know your thoughts on this deal.
Thanks!
Brian
First lets look at your cash flow. Based on your figures that you provided, I would subtract 10% of the gross income for vacancy, 10% for repairs and maintenance and 5% for capital repairs. This will leave you with a net operating income (before taking out the mortgage) of $5,676 or 57% of the gross income. This means that you only have $473 remaining to pay the mortgage and have a profit.
As to the mortgage. I see two problems. #1 Lenders cannot lend based on the appraised value if it is more than the purchase price. Their loans are based on the lower of the two. This means you will need a down payment. (That is unless they are keeping the loan in house.)
Problem #2, if they are going to sell the mortgage to the secondary market, then you would need to meet the minimum of $50k. Here in lies your problem.
Conclusion: Either your rent is too low (verify against market figures) or the expenses are too high. There is not enough income to pay the mortgage and leave the owner the typical profit of $100 per unit/per month.
It’s a small local bank and they keep their mortages in house. Banker emailed me today and thought I’d need to put down 3-4k if property appraises for 50k.
