When it comes to buying great deals, the property analysis is an essential part that investors need to approach with caution. If not, they can end up making the wrong decisions that could cost them tremendously. While 100 percent financed understands that everyone classifies a deal differently, we emphasize that buy-and-hold investors should watch very specific metrics before they make their decision.
Here are the top three metrics you should evaluate to determine whether or not the deal at hand presents an excellent opportunity.
Cash Flow The primary purpose of venturing into real estate investment is to make money. In other words, we can say that investors buy properties to attract positive cash flow. Basically, cash flow is the net operating income generated by a property after deducting its expenses such as mortgage payments and reserves among others. When the cash leaving the property is greater than the money being generated, the investor has a negative cash flowing property. If recurring expenses and the generated income cancel out, the property has no cash flow, and if the revenue from the investment exceeds the expenses, it has a positive cash flow.
Positive cash flow is by far the most important metric when determining whether or not you’ve got a good deal.. The best part about cash-flow is that it’s absolutely predictable! So how do you calculate cash flow?
The Cash Flow Formula: Cash Flow = Total Revenue – (Expenses + Reserves + Debt Service)
In a nutshell, if a real estate investment has a positive cash flow, it means that it is generating profits, and you’ll be getting passive income from Day 1. NEVER, and we mean never, buy a property that is not cash flowing. There are only a few exceptions to the rule. The first exception is for "fix-and-flippers" who plan on flipping the property to benefit on the appreciation. They don’t play the cashflow game so this rule doesn’t apply. The second exception is for experienced buy-and-hold investors who understand how to force appreciation. If you’re just getting started at buying rental properties, make sure that you run the numbers and your asset is positively cash-flowing before you pull the trigger.
Cash-on-Cash Return Also known as the equity dividend rate, cash-on-cash return is a real estate metric that evaluates returns to the amount of cash you put down on investment. It’s arrived at by dividing the cash flow (net annual cash flow before tax) by the initial amount invested. While the cash-on-cash return is not a common term in other fields, we highly recommend this metric in real estate investment property analysis since it helps investors to measure the performance of their cash investment.
The Cash-on-Cash Formula: Cash-on-Cash Return = Pre-tax Cash Flow/ Total Cash Invested
For example, a 15% cash-on-cash return means that money will come back in about 6 and a half years, i.e. 100/15 = 6.6 years.
Built in Equity Equity is the difference between the value of the property, and what you owe. While it is tough to find properties with built-in equity, that equity can speed up the process of you being able to perform a cash-out refinance on your property for additional investment capital. A cash-out refinance is one of the best strategies buy-and-hold investors can use to benefit from the equity in their property. It gives you access to tax-free capital that you can use to re-invest and scale your portfolio to the next level. 100 Percent Financed recommends that investors purchase a property with 10% equity built into the property.
Final Verdict There you have it, folks, if you want to get the most out of your real estate deals, it is crucial to evaluate those three metrics. Never fall in love with the property, fall in love with the numbers, and if these metrics are on your side, there’s a good chance that you got a great deal.