Real estate investment wins or loses by the numbers, specifically by key ratios. Metrics like monthly rent as a percentage of purchase price, cash flow per rental unit, and debt coverage ratio give investors a road map to REI success and, sometimes, a red flag signalling potentially disastrous deals.
The problem for investors is the sheer volume of data they need to analyze to make prudent investment decisions, especially when they're evaluating dozens of potential deals to find the one or two most likely to pan out. What investors need are scalable assessment methodologies, which enable a quick and effective analysis and promote smart investment decisions.
The Author, the Investor, and the Spreadsheet
Real estate investor and entrepreneur, Tom Sylvester, attributes much of his success to one book: What Every Real Estate Investor Needs to Know about Cash Flow... And 36 Other Key Financial Measures. In it, author Frank Gallinelli explains the numbers and formulas, which investors need to know to be successful. It’s a great read.
Unfortunately, many real estate investors don’t have the time to digest all of its particulars. That’s where Sylvester comes in. He’s created a bottom-line spreadsheet, which includes all the necessary metrics, as well as the related calculations, to make investment decisions quickly and without fuss in 5 simple steps:
1. About the Property: the first step is pretty basic, but necessary to keep you organized. It includes details about each property, such as a basic description, address, square footage, and the date when you prepared the document.
2. Value, Price and Funding: in this section, you list:
- data on the value of the property (including market value and assessed value),
- the purchase price (as well as the purchase price as a percentage of market value), and
- all relevant funding costs (including down payment, annual and monthly mortgage, closing costs, renovation costs, and out-of-pocket costs).
3. Rent: this includes the number of rental units, how much rent each unit is likely to produce (based on comps in the area), the likely vacancy rate, and total expected rent (gross scheduled income) monthly and annually. It also calculates 2% of the purchase price including renovations—this figure becomes important later.
4. Operating Expenses: Sylvester estimates operating expenses at 50% of gross scheduled income as simple shorthand to enable faster decision-making. This section also includes debt service, cash flow, cash flow per rental unit (for which Sylvester sets the threshold at $100), estimated return on investment (based on both down payment and out-of-pocket costs) and debt coverage ratio.
5. The Purchase Decision Trifecta: based on the data you’ve entered and the calculations you’ve made, Sylvester recommends purchasing a property if the answer to the following questions is “yes”:
- Is gross scheduled income at least 2% of the renovated purchase price (calculated in step 3 above)?
- Is cash flow per rental unit at least $100 per month?
- Is debt coverage ratio greater than 1.2?
Every real estate deal is different and no system is perfect. Your best bet is to work with experienced real estate professionals who can walk you the process and give you the help you need.
For more information, contact us today.