Does this Property Purchase Make Financial Sense?

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:

  1. The property must have a $200+ monthly net profit per $100,000 in purchase price
  2. 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

Example:

Gross Monthly Rent                                $1000

Expenses:

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 –

http://www.entrepreneursreport.com/master_real_estate_financials/

 

Notice – Entrepreneurs Report nor its authors are financial advisers.  Any guidance provided should be verified by your accountant or CPA.

 

 

We have not received any compensation for writing this post. We have no material connection to the brands, products, or services that we have mentioned.

{ 1 comment… add one }
  • Vickie Sunday, 12:27 am

    Thanks Curtis For Making It So Much Easier

    Reply

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