Top Three Cocktail Napkin Formulas for Analyzing deals...

Posted on Thursday, November 15, 2012

 Deal Analysis for  individuals whose investment strategy is to " Hold"

If you are an investor whose investment strategy is to hold investment properties long-term, here are a couple of formulas that will help you assess the legitimacy of a deal fast. These quick formulas are not meant to take the place of the due diligence needed to fully assess a deal but it will allow you to filter your search before you waste a lot of time analyzing a bad deal.  The top three formulas that I use for doing an quick analysis: Capitalization Rate, Rent-to-Value Ratio,  Cash-on-Cash Return

Capitalization Rate

The Capitalization Rate, also known as “Cap Rate”, is a quick calculation that allows you to place a value on a property based on the income that the property can generate. This is also a good ratio to use to compare properties with different valuations. The formula for calculating the"cap rate":  Net operation income / sales price

Example:

You purchased a home for $100,000

The rental income that your property has the potential to produce after expenses (N.O.I) is $15,000

$15,000 / $100,000 = .15  or  15%

Rent-to-Value Ratio

The rent-to value is an invaluable guide for an investor to use to evaluate an investment opportunity before they invest a lot of  time performing the due diligence needed to fully analyze a deal.

The formula for the rent-to-value ratio is: 12 months of rent/home price which is called “rental yield.”

Unlike the cap rate, the rent-to-value formula does not take into the account the  operating expenses that you will incur during the year.

Cash-on- Cash Return

Cash on Cash Return is probably the most important ratio you need to focus on when evaluating the long-term performance of a property investment. One down fall of this formula is that it does not take into account the appreciation that the property will experience because appreciation is a non-cash flow item. Appreciation will only be accounted for in the year that the property is sold . Cash on Cash Return is: annual net cash flow/ net investment

Example:

If the net cash flow from a property is $15,000, and the cash invested in the property is $100,000, then the Cash on Cash return is calculated to be 15% ($15,000/$100,000).

Net investment is:  the cost of the property- the amount that you borrowed

Hope these formulas help you assess deals fast.

Auben Realty- Improving Augusta One Home At A Time

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