8 Calculations you must learn to do when you invest in real estate

This morning I was thinking about some of the terms and calculations as a real estate investor I needed to learn. You may not use all of these calculations when analyzing a deal, but understanding each of these and when to use them is very important.

They are really not in any particular order, except for the first one.

Net Operating Income (NOI) is the most important calculation to use when it comes to analyzing a multi family apartment building or purchasing a portfolio of single family homes.

Also, Debt Coverage Ration (DCR) is a calculation that banks look at very hard when they are analyzing a multifamily property.

Learn how to make these calculations forwards and backwards.

A. Net Operating Income (NOI)
NOI is a property’s income after being reduced by vacancy and credit loss and all operating expenses. NOI is one of the most important calculations to any real estate investment because it represents the income stream that subsequently determines the property’s market value that is, the price a real estate investor is willing to pay for that income stream.

Gross Operating Income – Operating Expenses = Net Operating Income

B. Gross Scheduled Income (GSI)
GSI is the annual rental income a property would generate if 100% of all space were rented and all rents collected. If vacant units do exist at the time of your real estate analysis then include them at their reasonable market rent.

Rental Income (actual) + Vacant Units (at market rent) = Gross Scheduled Income

C. Gross Operating Income (GOI)
GOI is gross scheduled income less vacancy and credit loss plus income derived from other sources such as coin-operated laundry facilities. Consider GOI as the amount of rental income the real estate investor actually collects to service the rental property.

Gross Scheduled Income – Vacancy and Credit Loss + Other Income = Gross Operating Income

D. Loan to Value (LTV)
LTV measures what percentage of a property’s appraised value or selling price (whichever is less) is attributable to financing. A higher LTV benefits real estate investors with greater leverage, whereas lenders regard a higher LTV as a greater financial risk.

Loan Amount ÷ Lesser of Appraised Value or Selling Price = Loan to Value

E. Debt Coverage Ratio (DCR)
DCR is a ratio that expresses the number of times annual net operating income exceeds debt service (i.e., total loan payment, including both principal and interest).

Net Operating Income ÷ Debt Service = Debt Coverage Ratio

DCR results:

  • Less than 1.0 – not enough NOI to cover the debt
  • Exactly 1.0 – just enough NOI to cover the debt
  • Greater than 1.0 – more than enough NOI to cover the debt

F. Cash on Cash Return (CoC)
CoC is the ratio between a property’s cash flow in a given year and the amount of initial capital investment required to make the acquisition (e.g., mortgage down payment and closing costs). Most investors usually look at cash-on-cash as it relates to cash flow before taxes during the first year of ownership.

Cash Flow Before Taxes ÷ Initial Capital Investment = Cash on Cash Return

G. Cap Rate
This popular return expresses the ratio between a rental property’s value and its net operating income. The cap rate formula commonly serves two useful real estate investing purposes: To calculate a property’s cap rate, or by transposing the formula, to calculate a property’s reasonable estimate of value.

Net Operating Income ÷ Market Value = Cap Rate

Net Operating Income ÷ Cap rate = Market Value

H. Time Value of Money

Time value of money is very important to consider when you invest. What is your money worth today and what will it be worth in the future if you decide to hang on to it. This the calculation you must make when you are thinking about how to spend and invest your money wisely.

Time value of money is the underlying assumption that money, over time, will change value. It’s an important element in real estate investing because it could suggest that the timing of receipts from the investment might be more important than the amount received.

To your success and your future.

Contact me if you are looking to start investing in real estate.

Back of the napkin underwriting, the 50 percent rule.

It goes like this. “Yeah we were having lunch and we were just talking about some ideas and started writing them out on the back of a napkin. And now we have this multi-million dollar company, brand, or product.”

All you need to know is what is the rent roll for a given property. If you can’t get the rent rolls, you can look also look at market rents and do an estimation.

Again, at this point in the process you are just trying to see if this particular property fits the criteria you are investing for. Your criteria and strategy for investing is something we have talked about extensively and you need to determine before looking at any properties.

So if you have the rent rolls, you now know how much income the property will or should generate. Once you know this number. Then you just want to subtract 50% percent of it.

50% is very conservative by most people. But when you add up all of the expenses such as maintenance, utilities, property management, cap-ex, etc. Then the money you have left over must cover your debt on the property and any remaining cash flow, if there is any.

You can do all of this on the back of a napkin. If you determine that this property may be a good fit, then you can take the next steps in the underwriting process and get into the details even more by getting the real data on the income and expenses.

So you would need to see the rent rolls and the T12. The rent rolls are the rents that the building are getting on each of the units. The rent rolls should include the lease date of each unit as well and in most cases the tenants name and information, even though that is irrelevant at this point in the process.

The T12 (trailing twelve): Is the income and expenses a property has had the last twelve months. You could also, get a trailing six as well, which would be the last six months. But you get the point.

Now that you have these two documents you can take the back of the napkin underwriting to actually underwriting to see if this a good deal.

The back of the napkin approach is a way for you to look at more deals and sift through them much quicker.

I hope this was helpful as you are looking at deals. Also, when it comes to single family home investing the metrics are not as simplistic. There rents as many variables and they can vary widely. We will talk more about these later.

To your success and your future.

Why your decision making is keeping you stuck

Several years ago, I read the best book I have ever read on human decision making and the two type of decisions we make.

One of the decision making types really doesn’t do much for you other than it helps you get through your day. The other type of decision is one that actually moves you forward in your life and your goals.

At the end of this article I have the link to the book and the author so you can check it out for yourself. I highly encourage you to do so.

Prevent Pain: One of our motivations and desires when we make decisions is to prevent us from having pain in our lives. It usually isn’t actual pain, like an injury. But it is pain from what happens when we don’t make that decision. These decisions usually are urgent.

Things such as brushing our teeth. This is a prevent pain decision because we don’t want to have bad breath and ultimately our teeth rot out. Taking the garbage out. Again, this is a prevent pain decision because if we don’t take the trash out the house will stink and our spouse might not be happy with us.

Doing the laundry, is another prevent pain decision. If we don’t do it we wont have any clean clothes. Changing the tires on our car. Following up with that email with our boss. Paying the bills.

Prevent pain decisions are simple little decisions we have to make every single day, or it can be infrequent but required when the need arises. Our life doesn’t change much when we make these decisions but they have to be made. If we don’t make them, things will eventually happen that will cause us a lot of problems.

Gain Decisions: Decisions that are driven toward producing more significant positive results in our lives and our business. Gain decisions usually aren’t required for us to make, because there isn’t a consequence for not making that decision like there is with a prevent pain decision. These aren’t urgent decisions.

Gain tasks are focusing on something you want. And like anything we want, we have to actually make time and invest resources in to getting it.

A few examples of this are writing a book, getting further education, spending quality time with our children, closing a big deal, investing in income producing real estate.  

Look at these examples compared to the prevent pain decisions and you will see a big difference. If we don’t accomplish the gain decisions, usually nothing happens, at least not quickly, but if you neglect to do them over time they could have significant consequences.

And this is what causes the problems in our lives and keeps us stuck.

We get caught up making the day to day decisions that are urgent and we never get around to making the bigger and more important decisions that will actually impact our lives significantly and move us closer to our goals we want to accomplish.

How do we start to make better decisions? To get more out of your life and to get out of the day to day decisions that are keeping us where we are, you have to plan.

Everything we do everyday can be broken down into three categories: Habits, To Do items, and calendar events. 

Habits:  Mostly influence parts of our life such as hygiene, health, eating, repeat spending, relaxing chores, emails, and rote tasks.  We don’t have to write them down, because we won’t forget to do them. These are typically prevent pain decisions/tasks.

To do Lists: Maintenance tasks that you don’t want to forget. Updating a file, sending out an email, checking in with a client, going to dry cleaners, grocery shopping, paying a bill. Again these are prevent pain items usually, because if we don’t do them it will cause us immediate pain.

Calendar: For things that are time specific: events, appointments, and anything you have to be on time for, whether it’s business or personal.

Use your calendar for Gain:

  • Anything on your calendar you will defend and protect.  You won’t skip.
  • Use your calendar to give your goals and better decisions the attention they deserve.

So if you want to get out of the constant cycle of making decisions that only affect you in the moment or the day, you have to start planning for it.

For new or veteran real estate investors, if you want to start investing in incoming producing real estate you have to make a decision to do that and put it on your calendar when you will actually make your first purchase, your second, or one-hundredth.

For those who want to spend more time with their children, but can’t find the time. You have to put it on your calendar when you will allocate time to do this.

The key and the point of the book is to get you out of the rat race of everyday small tasks, that won’t actually move you closer to your goals. Making better decisions is thinking about what it is you want to accomplish.

A goal.

And then working backwards to set aside the time to make the goal become a reality.

This is the key to making better decisions.

I wrote a summary of this book you can check out here.

But I highly encourage you to read the actual book you can access it at the link below.

Link to book: http://www.amazon.com/Decide-Smarter-Reduce-Stress-Example/dp/1118554388/

To your success and your future.

The criteria I used to create a million dollar portfolio with single family homes

As a new real estate investor a lot of questions may be running through your head. How do I know which property to invest in? What should I be looking at with each of the properties? And the list can go on and on.

To help you get out of your own head and get you on your way in to investing and accumulating wealth. I compiled a short list of things I thought about and still use in many cases, although my strategies have changed some, when I invest in income producing real estate and more specifically single family homes.

As we have discussed many times before. You first need to determine what is going to be your strategy for investing. Meaning, what are you looking for. Click here and you can learn more about each of these things, but I will quickly outline them for you.

Are you investing for cash flow, cash on cash return, appreciation, tax benefits, etc, or a combination of all of it. By knowing specifically what you are investing for it will help you to look at the right properties and stay away from the ones that don’t fit.

Early on in my investing my criteria was pretty simple:

I had a picture of the type of person or persons that would be renting the place. Typically a two parent household, making about the average household income, and either one or two kids. Or a single mother/father with two kids making less than average household income and could afford one of my places.

I wanted my properties to be in line with what it would cost them to rent a b-c class apartment (to learn more about classes click here), but what they really wanted was a house and would be willing to pay a little more than they would in an apartment to get one.

Specific criteria:

  1. The rent collected had to be double the amount of my mortgage.
  2. Back then and even for the most part now, I want the rent to be at least 1% of the value of the home each month. See here for more information on the 1% rule.
  3. The property had to be in an area that I wouldn’t be afraid of knocking on the door and collecting the rent.
  4. I wanted to be able to get my down payment to be paid back with in two-three years. Ex: If I had to pay $10,000 down, then I wanted to get that amount back before the third year was up.
  5. I preferred houses built on a concrete slab.
  6. No basements.
  7. 3 bedrooms and 1 bath was an absolute. These are way easier to rent.
  8. Not located on a very busy highway.

I had a few other less subjective things as well. Things such as nothing weird about the lot of the house or the layout of the house. I wanted it to be simple. You can be amazed how some of these older houses just have weird configurations or even things built in to the home.

I also preferred no very large trees close to the house. Trees can become very costly to manage and especially costly to get torn down.

Would I compromise on any of the criteria? Not really. Now you have to analyze each deal individually, but the purpose of the criteria is to help you not get paralysis from over analysis. You can’t look at everything. So by coming up with a criteria and a strategy it helps you, your realtor if you are using one, and lastly it helps you make decisions quicker.

As you can see by my criteria, I am really looking at cash on cash return. I want the downpayment back pretty quickly and the only way you can get that is with a great cash on cash return. With cash on cash return, I am investing for cash flow, not extreme cash flow, but I want it to carry my mortgage and all expenses with the property and actually have some cash left over to use.

I used this simple strategy and criteria for close to ten years of investing and I still use it when I am looking at single family income producing real estate.

If you are currently an investor, what is your strategy or criteria?

If you are new and haven’t bought your first property yet, what are you thinking?

Please share in comments.

To your success and your future.

Lessons learned from being a landlord…Going cheap cost you more

One of the goofiest lessons I learned and I say goofiest, because it never crossed my mind in a million years that this would happen.

I had this tenant named Donna. Donna was a tenant for about three years. She was on section eight (government assistance).

She had already gotten another apartment approved for her to rent before she calls me and tells me she is moving out. I hated to see her go. But it happens. It was smart on her part to get the other one approved before she let me know.

Donna, was a little bit of a hoarder so needless to say she had a lot of junk in her place. What was weird though is she had a bunch of baby stuff. Like brand new stuff that had never been used. And she didn’t have kids.

Donna, calls me a couple of weeks later and tells me that she had taken everything she wanted from her apartment.

I said, “Ok. But did you leave anything in there?” She said she left a few things.

I trusted Donna, so I didn’t think much about it. We said a few words and that was that.

I go over to the apartment and quickly found out that she left a bunch of crap. I called her, but she didn’t answer and didn’t care any longer, because she already had her new place approved through section eight, so I was left with cleaning this place up.

By this time in my evolution as a landlord I thought I was a little more advanced. I didn’t do things I knew I could pay someone to do for me. But I was still cheap though.

I call up a reputable company to come out and give me a quote. Three guys come out. One guy you could tell was the boss and then he had two other guys with him.

I don’t mean to be disparaging here, but all three looked like convicts. I think the main guy picked the other two guys up at the Labor Ready office that morning. Because it didn’t seem like they all knew each other that well.

The boss guy does a look around. The mess is evenly scattered throughout the apartment. This apartment is 1200 sq feet with 3 bedrooms and 1.5 baths.

After he does his assessment he calls, who I am assuming the big boss, and starts explaining to that person what it looked like.

While he is on the phone, I am in another room with the two other guys. One of the guys whispers to me that they would be willing to do the job themselves for $500 dollars.

When they whispered this to me, I had not gotten the quote from the boss guy. He was still in the other room on the phone.

I replied back to the guys when they gave me the price. And I pointed to them and said,

“Just you two, and not him?” One of the guys said yes. That they have a truck and would come back after their shift and do it. I said give me your phone number.

I also said, “Will $500 be cheaper than what he is about to say to me? He said “Yes, I guarantee it.”

The boss guy comes and find us. He says to me.

“This job is going to be several thousand dollars and we won’t do it unless you put all of the loose item in to boxes.”

I said, “why would I put it in boxes if you are just going to haul it out and throw it away?”

He said “We can’t move it without all of the small stuff being boxed up.”

I said, “Can’t you all box it up and haul it out?”

He said, “We can, but it is going to cost you more.”

It was obvious to me by this time that this was a job that was not what they normally do and it sounded like they really didn’t want to do it.

So I said to the boss guy, I will let you know what I want to do. But I had already made up my mind that I was going to call the other guys immediately.

They leave, and about an hour later. One of the guys calls me. Out of the two guys, one of them was the leader so to speak.

I met them over at the apartment around five to let them in. They were in a pick up truck and not in one of the big van trucks like they were in earlier and like most moving company’s have.

We confirmed the price again, and I asked them how long it would take. They said a couple of hours.

I said “sounds good” and I left.

Don’t ask me why I was so trusting other than being an idiot, but I knew they wanted the money and I wasn’t going to pay them unless the job was done and done well.

About an hour or so later, the leader guy calls me.

He said “Do you care if we keep any of this stuff?” I said “Heck no”.

He said “Even some of this newer stuff, it is probably worth money?”

I said “I just want it all gone, I could care less.”

We hang up.

About another half hour goes by and he calls me again.

He says “Do you have someone that is going to do the actual cleaning of the place?”

I said “I do, but would you do it and for how much.”

As a landlord you just want to get things done as quickly as possible.

He said “Their wives would do it for an extra $200 dollars.”

I told him what I expected to be done and he said ok.

About three hours go by and he calls me and says they are done.

I go over with the cash in hand. I look at the apartment and they had done a great job. The two guys were there and so were their wives.

I was quite satisfied with their work. I paid them and they left.

About three weeks later, my tenant downstairs calls me and says that there are two citations on her front door from the city. I said what do they say? She couldn’t really tell me, so I go over there later on and pick them up.

I couldn’t understand the citations. So I call the number on the document.

A lady answers the phone and looks the citations up in their system.

She then says “Are you a landlord?”

I said “Yes!”

She said “Did you recently have someone move out of one of your apartments at this address?”

I said “Yes!”

She said “We found a couple of places around the city where mail, furniture, and lots of other items (junk) had been thrown out in alleys, city dumpsters, and in the streets. Did you have someone remove the stuff for you?”

I said “Yes!”

She said “Do you have a receipt from that company, if so, we can reach out to them and let them know they are responsible for these citations!”

My heart sunk and I said “No” I don’t have any receipts.

She said “You are responsible for these citations then.”

I said “How do you even know it is from that apartment?”

She said “In each of the junk piles there was pieces of mail with that address on it.”

I am sure I could have pushed back a little more, but at time I don’t think I would have won. And if I didn’t pay them, they would have filed a lien on my place. So I just moved on and paid them.

I think each citation was $500 dollars or so. I paid them and once again learned a few lessons.

1. Get a receipt
2. Don’t hire people to do work when they openly try to steal business from their current employer while on the job for their current employer. They may not be the best characters.

To your success and your future.

Is the 1% rule still applicable in this market?

At 26, when I bought my first income producing rental property I wished I had known a few basic principles to investing in real estate. The only thing I knew was that everyone I had known growing up that owned real estate, which wasn’t anyone in my family, was rich to me.

This was the whole reason for me to like real estate and want to invest in it. Nowadays, knowledge on investing and real estate in general is everywhere, but 17 years ago, this just wasn’t the case.

Years later, I learned something called the 1% rule. The 1% rule in real estate investing means this. You should be able to rent a property that you purchase for at least 1% of the value of that property.

Example: Property purchased for $100,000 x 1% (.01) = $1,000. This property should be able to generate at least $1,000 a month in rent.

It’s pretty simple. If you put 20% down on $100,000 house. Your mortgage will be $80,000. Let’s say you have 5% interest rate on it. Your mortgage payment is roughly $450. Add in taxes and insurance, which might be another $150 a month. You are now at a payment of $600 or so.

Again, there are a lot of variables here. But you get the point.

I wish I would have known this when I bough my first property I mentioned earlier.

I am sure the critics out there are now saying is the 1% even feasible anymore in today’s market?

I say yes. With some caveats. Years ago I could buy properties in B- neighborhoods and easily get the 1%. However, in the last few years, I have had to downgrade some in to C- neighborhoods to get the 1%. These purchases were in areas I wouldn’t have considered before, but if you are committed to the 1% as a strategy then you have no choice.

However, my point here is clear. You have to come up with your own investment strategy. I have been telling people this for years.

I wrote an earlier post on all the ways income producing real estate makes you money. You can access that article here. Decide what your strategy is and then go look for properties that fit that strategy. Nicer places in better neighborhoods may not fit the 1% rule, but overtime they may appreciate more. And you may have less turnover in the unit and less maintenance.

So the question is can you still find properties that fit the 1% rule? I would answer, yes. However, they may not fit other criteria you may have. Like location and tenant base. Or they may be in other states than you are currently considering.

When it comes to multifamily properties does the 1% rule still apply? For me it does. Now, when I do a full underwriting of a multifamily property I will look deeper into the financials. But when I do a quick back of the napkin underwriting of a deal on whether or not I want to look at it deeper. I will look at what are they asking per door. And what is the rent they are getting per door.

If it is close. Then I will dig deeper into the deal.

One of my mentors says it like this. He says if you can find a property that gets .005% or a half a percent, he said buy all you can. Because it is worth it over time.

And if you take nothing a way from this post, I would say this.

Don’t wait to buy real estate, buy real estate and wait. Because it is the one investment that has proven itself over and over that it goes up over time.

What are your thoughts?

To your success and your future.

It isn’t procrastination and it can be deadly unless you fix it now.

We have all had that moment in life when we get really excited about something, maybe it is dieting, getting out of debt, planning our day more effectively, redoing the kitchen, painting the bedroom, investing, etc.  You name it.  

At that moment we get excited about doing the “thing”, but we don’t take any action to get the ball rolling on actually doing it. For every second, minute, hour, day, week, month that goes by, we lose that passion and excitement about accomplishing what we were so excited about accomplishing.

This is called the “law of diminishing intent”.

I can remember learning this lesson years ago.  It was around November or so, and I was telling a friend of mine that I was planning on starting to workout after the New Year.  Sound familiar?  He replied back “Why wait, why not start now, what is the difference between now and then?”  

The only thing that could have happened over the next 45 days was I would lose interest in actually pursuing the goal and I may have never even started. Instead I started that day.

Starting is obviously very important, but more importantly by starting today you actually start the process of developing the disciplines and habits that will help you continue down the path until you accomplish the goal.

My mentor Jim Rohn says it like this:  “The pain of discipline weighs ounces and the pain of regret weighs tons.”

The key is to set up the discipline while the emotion is at its highest.  

Buy the paint, clean the refrigerator out of all of the snacks, cut up your credit cards, go outside and run a mile or walk, find a realtor to start sending you possible income producing properties.

When it comes to your health it really could be a life or death situation. Maybe you get short of breath, or you see something that looks odd on your body. The key is to call the doctor now and set up an appointment. Because as time goes by, you will start to tell yourself that it is not not that bad and justify not taking action and it could ultimately kill you.

Is there something in your life right now that you are excited about?  What are you doing to set the disciplines and activities in motion to ensure you keep the energy and actions moving forward? Please share with me, I would love to hear them.

To your success and your future.