Many real estate investors use ARV (After Repaired Value) as their determination to purchase a property. The logic is that the purchase price plus repairs should not exceed 65-70% of the After Repaired Value. This leaves room for profit (and some errors) when purchasing property.
This guideline works great if you plan to flip the property to a retail buyer.
But what if you face the following:
- You wish to buy and hold the property – your purchase should be based the income that the property generates
- You can’t quickly flip the property – you would need the option to place a renter and still get a reasonable cash flow.
Bonnie Laslo of Hobby Millionaire outlines two benchmarks for purchasing properties:
- The property must have a $200+ monthly net profit per $100,000 in purchase price
- The property should offer a 10% CAP rate (click here for definition of CAP rate). CAP rate equals Return on Investment (ROI) when you pay cash for the property.
Benchmark 1 – $200+ Monthly Net Profit
Here are the guidelines for a quick assessment of properties:
$100,000 – $1000/month rent to break even + $200 profit = $1,200 is what it should rent for
$50,000 – $500/month rent to break even + $ 200 profit = $700 is what it should rent for
For more expensive properties:
$200,000 – $2000/month rent to break even + $400 profit = $2,400 is what it should rent for
Note – multi-family properties can consider a lower per-unit profit. A duplex should still provide $200/unit/month profit. For an 8-plex – you could consider $150/unit/month. But don’t lower these numbers just to make a poor deal work for you. [Multi-family should consider actuals not proforma or projections]
Benchmark 2 – Minimum 10% Cap Rate
CAP Rate = Annual Net Operating Income / Purchase Price
Gross Monthly Rent $1000
Taxes per month ($200)
Insurance per month ( $ 50)
Maintenance per month ($100) (you should use $100/month/unit as a guideline)
Utilities per month ($ 0) (many older multifamily properties have one water or electric meter)
Total Expenses ($350)
Monthly Net Operating Income $650
Monthly x 10 months $6,500 Annual Net Operating Income (Annual NOI)
The extra 2 months you are not considering (12 in a year) are for ‘oops’ items.
Add a zero to the $6,500 Annual NOI tells you that this property is worth $65,000 max to you. Your acquisition price plus repairs shouldn’t exceed this amount.
CAP Rate – $6,500 Annual NOI/ $65,000 purchase price = 10% CAP rate
Note – in some areas of the US, such as the West Coast, many investors find that a 10% CAP rate is challenging. In this case your options are to either accept a lower rate, or invest in another part of the US. These benchmarks should be considered if you are buying & holding or flipping. Your purchase price should include the cost of all rehab efforts.
Here is an easy calculator to calculate these benchmarks.
[jazzy form = Benchmarks]
You should select the lesser of these two benchmarks as guidelines for purchasing investment property.
Wholesalers – you should ensure that the price you offer is reduced to incorporate your fee while maintaining a 10% CAP rate. Make sure that your calculation considers realistic pricing for rehab costs. Then consider that if you only wholesale – this is a job. Take your profits and invest in low down owner finance deals with monthly cash flow (with a $200 minimum monthly profit and at least 20% annual return on your invested cash.
NOTE: These benchmarks only address purchase price and do not consider financing costs. I will address financing costs in a future post.
Go to this link for an expanded discussion & calculators that discuss ARV and Cash-on-Cash return –
Notice – Entrepreneurs Report nor its authors are financial advisers. Any guidance provided should be verified by your accountant or CPA.