In our recent Mastermind Group
training session, our key topic of discussion was how to invest
by the numbers. The longer that I spend investing in real estate
and also evaluating projects around the county, the more and
more I am astounded at the lack of knowledge from "so called"
professionals. For most individual real estate investments, the
level of analysis is not terribly difficult…. You find yourself
doing the same thing over and over again. In this article, I
will try and share this simplistic view and how you can know
more than 95% of the "professionals" in this market.
What You Need To Know? For any
investment, there really is 4 things you need to know and guess
what, NOBODY gives them to you in a normal sales presentation.
Let's break down each one and how it is obtained:
1)Purchase Equity – This is one
of the simplest to obtain but is easily abused by sales people.
What you want to know is what is your purchase price, relative
to the actual STREET PRICE; i.e., the price a real individual in
the area would pay to own your property. How do you get it?
Appraisals, talking with agents in the area, running test ads in
newspapers, etc.
2)Annual Appreciation (%) – Now
the witch craft begins….. This requires a CRYSTAL BALL to look
into the future. Because of this, appreciation is an OPINION
that you should form on your own…. An "Experts" OPINION is still
an opinion and you should treat it as such. To make an opinion,
you had to consider things like job growth, lack of similar
product, future demand, etc. Bottom line is that you would like
to come up with a % number and this takes a little practice but
after looking at a few areas, you can pretty easily form an
opinion. PLEASE NOTE: If we "project" appreciation rates in an
area, we are violating securities laws so we don't do this. We
share all the information about an area and why we like it and
then have to leave it up to the individual to form their own
opinion. However, when we have decided to introduce a property,
we have formed our own OPINION and we like what we see.
3)Annual Cashflow – Over time,
you will either be making or losing money on this investment. It
may turn out that small amounts of negative cashflow make sense
if the annual appreciation and purchase equity are strong. The
components that you have to gather for annual cashflow are
•Gross Annual Income; •Management
Expenses; •Taxes, Insurance, HOA; •Interest Expenses; and •Maintenance
Estimates
Fortunately, most of the expenses
can be estimated pretty closely. For gross annual income,
realize that again, NOBODY can predict the future. So, you can
gather market rents data that you believe are comparable, apply
any safety factor that you like, and then use that for ESTIMATES.
4)Special Tax Situations – This
is typically an unusual situation for individual investors but
applies in areas such as the Go Zone where bonus depreciation
can be used.
How Do You Use This Information
Suppose you could see EXACTLY what was going to happen into the
future….. Of course, we know this is unrealistic however it
still does not hurt to try based on our assumptions.
Suppose you looked into the
future and you saw that in 5 years, your net gain on a property
was going to be a little over $87,000 with a $21,000 dollar
total investment and a little bit of your time. If you KNEW that
was GOING to happen, what would you do? Would you purchase the
property? Would you pass on the property? Why?
Realize, that for a $21,000
investment, this equates to making 33.9% on your money, year
after year after year. That is not too shabby. Let's apply the "rule
of 72" here which states that you can calculate how long (approximately)
it will take to double your money with a certain return %. You
take 72% / 33.9% = 2.1 Years to double your money. Is this
something that is good?
The answer of course depends on a
few factors but let's put it into perspective. Suppose you
invested $100,000 at a steady 33.9% rate of return. In 15 years,
then you have now turned that $100,000 into $7.9 Million. Got
your attention yet if you KNEW this was going to happen? Of
course, if we have to take on all kinds of risks to get that
return, then that may, or may not be such a good idea. If,
however, it is low risk, now you have the makings of a good
investment.
My argument now is that IF YOU
COULD SEE INTO THE FUTURE, and you saw this kind of performance,
you would be excited. Right? Well, why not pretend we can look
into the future and CALCULATE what the future looks like using
our 4 KEY parameters above. If we like the "future" answers, and
we believe our assumptions, and we believe the risk to be low,
isn't that a prudent approach?
For many non-investors, they
believe that real estate investors take on tons of risk and are
gun slingers…… Quite contraire, monsieur, that is exactly what
we DON'T do. Good investors simply look at all the FACTS, make
some estimates of key parameters, estimate future performance,
and then play "what if" games to what happens if things don't
work out exactly as thought.
