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SHOW NOTES FOR EPISODE #016 – WHAT IS A GREAT DEAL?
Two weeks ago we had the topic WHERE TO FIND GREAT DEALS. Well, this week we are going to define exactly what a GREAT DEAL is.
Now first, before I get started, I have to say — what a great deal is or isn’t is SUBJECTIVE it could look differently to different people. What may be a great deal for one investor may not be a great deal for another investor with different goals and different criteria.
That’s why SETTING YOUR GOALs and KNOWING WHAT YOU WANT TO ACHIEVE FIRST is key before you can start looking for deals!!! Check out episode #010 for more specific information on setting goals
For example, some will only buy a property if it is a “under market or below market” price. Others are OK paying market price OR EVEN MORE if there are other factors in place (like cash flow or where the property is in the market cycle or a great location, or if it is a Class A or B property vs. a C or D.
OTHERS DEFINE A GREAT DEAL IN MORE “GENERAL TERMS” SUCH AS… “A GREAT DEAL FOR ME IS ONE WHERE I…
- Put as little cash in the deal as possible
- Get what I invested in the deal back as soon as possible
- Achieve the highest appreciation in the shortest period of time
When making an investment in real estate, you should look at it the same way you would look at a financial investment in a bond, stock, annuity, CD or any other investment. You should analyze how much cash equity is being invested — just like you would if you bought a financial asset – and how much cash flow it produces. This is commonly called cash-on-cash return. A bond might pay a 5.0% interest coupon cash-on-cash return or a corporate stock might pay a 2.5% dividend in cash. You also need to compare those returns to what you could earn on an investment in real estate.
Of course, real estate has the added potential benefit of long-term appreciation in value, similar to a stock investment. So going forward, let’s stick with cash-on-cash and cash flow return estimates and while we hope appreciation in value will come, it’s wise to expect and plan for that as best you can. If it does materialize, it will be the icing on the cake on an already smart cash-on-cash positive return investment.
A GREAT DEAL FOR ME IS ONE WHERE…
#1 – Cash Flow is Strong, Solid & Consistent
Cash flow is my top priority! It’s the “net profit” one receives after expenses and after your mortgage payment. If I am not netting $100 per door/unit, then I am not interested. I prefer $300 per door but $100 is my minimum.
#2 – It Must Pay a Fair Cash-on-Cash Return
When you buy property you are taking money out of your liquid financial assets – stocks, bonds, CDs – and investing it into a very illiquid asset – real estate.
Your returns are part cash flow and part appreciation in value.
For example, if your property rental unit income, minus expenses and mortgage, produced $200 per month positive cash flow ($2,400 per year); and your invested cash equity was say $20,000, that’s a cash on cash return of 12.00% ($2,400/$20,000). And that is a pretty darn good deal in real estate.
To add to that, let’s say you project net appreciation in value contributing an extra 1.0% or 2.0% return per year (after subtracting your projected estimated costs of capital repairs and improvements). Summing the cash flows and net appreciation could equal about a 13% to 15%+ projected return per year on a long term basis; and if you achieve those numbers….. that is a great real estate investment!
To do this, you need to buy cash flow-positive properties that earn you decent returns – where you will get your initial investment back as soon as possible .
#3 – Isn’t Too Risky an Investment
All real estate has its elements of risk. Development of real estate, land, Tenant-In-Common (TIC) investments, private real estate funds, fixer uppers, etc., all have much higher risk profiles than just simply a Buy ‘n Hold – nice established cash flow investment property. In many of those investments, you will never see a dime of your money again because there are just so many things that can go wrong! So if you want to own real estate, consider simply taking fee simple title in your own name – or an entity you wholly own – to the properties you purchase. In addition, you must do the proper due diligence, property inspections, analyze, test, review reports, etc., to lower the risk factors.
#4 – It Doesn’t Require a Lot of Time or Managing Effort
Some properties just require way too much time and management to make them smart investments. Examples include vacation rentals, low quality properties in bad areas, some college rentals, etc. Nice boring properties rented for as long as possible to decent credit profile tenants seem to take the least amount of time to manage. In addition, treating your tenants fairly and with respect goes a long way towards keeping good relations with them; and reducing your hassles when there is an issue you need to address. And believe me — there will be issues!
SO, IF I WERE TO APPLY THIS CRITERIA DOWN TO SPECIFICS IN A PROPERTY SEARCH, FOR EXAMPLE , A GREAT PROPERTY FOR ME PERSONALLY WOULD BE…
- A Multifamily/Apartment in a safe neighborhood
- Approximately $1-5 million sales price
- That has a Motivated Seller
- That I can buy under-market
- Where the rents are under market
- And property management is weak or ineffective
- The CAP Rate is a minimum of 8%
- Cash-on-Cash is 12%
- Cash Flow is a minimum of $100 per unit
- Debt Ratio Min – 1.6
- Strong appreciation Prospects
- Good rental market & rental demand
- Good potential tenant base
You see, you can map out your ideal property and clearly convey it to those who are helping you to find this property – namely your brokers and people in your network.
It’s the nice, boring, wholly owned, in good shape, cash flow-positive properties that are the best investments. They are out there for your picking, but it’s not as simple as finding a property on the MLS and just buying it.
You need to do some hard work, research, read up, and make smart, educated decisions to acquire the best real estate investments!
Well that’s our Fun Fact Friday for today!
Just remember, real estate investing is not that difficult to master. Once you get the key concepts in place you’re on your way.
Until our next podcast, keep moving forward and God bless!
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