CASH FLOW INCOME
Long-term ownership is the key to real estate wealth. If you buy decent properties and hold them forever, that’s going to provide the highest likelihood that your real estate will have significant equity down the road.
Also, if it sounds too good to be true, it always is — especially in real estate. Drop the idea that there is fast and easy money to be made in real estate. It’s just not true. Sometimes people get lucky, but you don’t have to worry because that “lucky” person will never end up being you.
A significant portion of investors buy properties that are cash-flow negative or have very low investment returns. That means the buyer puts in their equity cash capital when they purchased the property, and they are still investing additional funds each month, which could go on for decades depending on how bad of a deal they purchased.
The better way to invest is to buy properties where the rents minus all the expenses, including the mortgage payment, provide positive cash flow that you can deposit in the bank. So if you collect $1,500 in monthly rent, then subtract expenses of ($500) and a mortgage of ($600) you will have $400 per month left over. Nice job!
The aim of the one percent rule is to have the rent be greater or equal to the mortgage payment, so the investor breaks even on the property at worst. The rule is used for quick estimation, as there are other costs associated with a piece of property that are not taken into account, such as upkeep, insurance and taxes.
A simple way to do a quick analysis is to take the conservatively estimated monthly rental income and divide it by the purchase price of the house. You still need to pencil out your deal with rents and actual conservatively estimated expenses, but this back-of-the-napkin test is a quick and easy test to see if it makes sense.
Example of a good deal:
If you can collect $1,600 per month in rent and you paid $200,000 for the property, you are collecting rent that is 0.8 percent of the purchase price (0.8 percent = 80 basis points in financial terms). And that’s probably a really fair deal.
Example of a bad deal:
If you can collect $1,600 per month in rent and you paid $400,000 for the property, you are collecting rent that is 0.4 percent of the purchase price, or 40 basis points. And that’s not a really good deal.
Smarter investors work hard up front to find the good areas where the rents provide a nice positive cash flow and investment returns, low crime rates, better schools, and decent amenities nearby like parks or retail. Coupled with good tenants who have excellent credit, you also create low vacancy rates.
Smart investors also buy properties that are in decent shape, although every property needs paint, carpeting and some plumbing and electrical work from time to time. Do that hard work upfront and spend the money to put your properties in very good shape, you’ll get a little more rent and probably have a bigger pool of interested tenants from whom you can then choose.
Lastly, do your homework, talk to other investors, read guides and books, shop properties, pencil out deals and have a long term ownership plan. Hopefully it will translate into a nice cash flow retirement picture.
© 2016 Sunshine International Realty Florida LLC. All Rights Reserved.