Assessing What Makes a Deal Work: One Investor’s Perspective

How many times have you seen an investor post a deal in the BiggerPockets Forums with the same question…

“What do you think?”

“Does this work?”

“What would you do?”

I wish I had a nickel for every time that someone replied, “It depends…”

Guilty! I’m often that person who says that. But whether a deal works or not is all relative to the outcomes you want from real estate—your investing goals, your time involvement, your deal metrics, and your desired exit strategy.

Start With Your Goals

First, you need to determine your personal goals for real estate (more on that here). Next, determine your basic investing goals. For example, are you looking to capture appreciation, cash flow, or a balance of both?

Once you have your personal goals set, and your investing goals defined, if you are on the buy-and-hold path, determine your investment strategy goals: How much cashflow per door do you want? Do you want to leave equity in the deal or not?

Assessing the Deals

Now that you have laid some groundwork to actually measure if a deal is right for you, you can use this primer to determine if a deal works for you.

For the purposes of this article, I’ll walk you through examples of deals straight from my deal funnel and/or portfolio for buy and hold strategies, so you can see what this process might look like. I’ll show you my metrics, analysis, and decision-making process along the way.

Also, I will make some assumptions for ease of math:

5% interest rate for permanent debt financing
15% set aside for CapEx and maintenance
8% set aside for property management
20% down for straight purchase scenarios (turnkey and MLS)
25% down for refinancing scenarios (BRRRR)

I’ll also keep things high-level and not get into the weeds about holding and closing costs (both of which are pertinent to your deal).

Turnkey/MLS Deals

For these types of purchases, you will be putting in your own equity to make the down payment. So for this type of purchase, you are really only concerned with appreciation, cash flow, or both, since you are already leaving money in the deal with your down payment.

A Deal That Doesn’t Work for Cash Flow

Deal Specs
- Purchase – $335,000
- Appraised value – $340,000
- Downpayment – $67,000
- Rent – $2,100
Analysis
- Rent to value – .63%
- COC – 1.46% (I’m was cheating by doing my own property management and setting aside only $100 for CapEx and maintenance.)
- DSCR – 1.14 (If I do too many more of these deals, I may not be able to secure lending.)

This was my first rental property. The rent to value on this property was only .63%. While my expenses were covered (barely!) I was making around 1.46% cash on cash on a poorly underwritten property where I wasn’t setting anything for property management or vacancy, and only $100/month for CapEx and maintenance.

I needed cash flow. It was after the toilet broke the first month, that I realized how big of a mistake I had made. We had purchased an appreciation property. Whoops!

I didn’t lose my shirt on this deal, as the property did increase in value in the year that I owned it, and I made a 30.7% return on my down payment in 11 months, but that was a huge risk to take. The point is, I was nowhere close to my goals of replacing cash flow. I had actually invested for appreciation. I’m glad I did this deal because it did get me in the game. Would I do it again? Only if I were investing to be in the appreciation game.

A Deal That Might Work for Cash Flow

Deal Specs
- Purchase – $135,000
- Appraised value – $125,000
- Down payment – $27,000
- Rent – $1,050
My analysis
- Rent to value – .78%
- COC – 3.86% with properly underwritten reserves (or 9.86% with reserves included)
- DSCR – 1.07 (If I do too many more of these deals, I may not be able to secure lending.)

This is a pretty standard turnkey pro forma I see nowadays with this toppy real estate market. The rent to value on this property is .78%, so not horrible.

What bothers me about this is that I see investors give up both cash flow and equity right off the bat to buy a property. In this deal, the investor is giving up $10,000 of future equity right off the bat as “premium” to have a completely rehabbed property, which I don’t feel is necessary.

But this deal could go upside down in a hurry if taxes, insurance, or the cost of management rises quicker than rents do. You can make this deal better by negotiating with the seller to get the purchase price down (the worst thing a turnkey provider can say is no).

A Deal That Works for Cash Flow

Deal Specs
- Purchase – $120,000
- Appraised value – $120,000
- Downpayment – $24,000
- Rent – $1,200
Analysis
- Rent to value – 1%
- COC – 12%
- DSCR – 1.55

This type of turnkey/MLS purchase will work well with the 1% rent to value ratio in a market with low taxes and insurance costs. While you are still putting down a hefty down payment, you are not overpaying for the property and giving up future equity. And you have some wiggle room should your expenses increase or if you need to bring your rents down to remain competitive in the market.

BRRRR Deals

BRRRR is a great strategy to force equity in a deal and use that equity to provide the down payment for a property during the refinance phase. This strategy allows you to recycle your capital over and over. However, I see investors getting themselves in a pickle on a consistent basis with either overpaying for a BRRRR or sacrificing cash flow to get the infinite return, even if it means they only bring home $50 in rent.

A Deal That Doesn’t Work for Equity

Deal Specs
- Purchase – $80,000
- Rehab – $35,000
- ARV – $110,000
- Rent – $900
Analysis
- Rent to value – 1%
- COC – 2.16% (monthly cash flow of $41!)
- DSCR – 1.09 (If I do too many more of these deals, I may not be able to secure lending.)

This deal is challenging, as the home is in need of repair and the combined purchase and rehab already put you over the ARV of the property. Additionally, the point of the BRRRR is to be able to recycle capital. You aren’t able to do that with this deal on the refinance, as you have to leave almost $37,000 in the property.

Also, the rents are below 1% rent to value and make it challenging to cover the expenses properly on this property. To make this a deal, you will need to negotiate down the purchase price significantly or identify some way to significantly increase the value, such as adding a bedroom and bathroom (both of which will increase your construction budget).

Overall, unless you have extra cash that you “need” to park and years on your side, I’d look for higher and better use of your money (and time).

A Deal That Works for Equity but Not Cash Flow

Deal Specs
- Purchase – $80,000
- Rehab – $45,000
- ARV – $175,000
- Rent – $1,200
Analysis
- Rent to value – .70%
- COC – Infinite (However, your cashflow after setting aside reserves is $0.)
- DSCR – 1.0 (If I do too many more of these deals, I may not be able to secure lending.)

You have a quick win in this deal as you can pull almost all of your equity out of the deal, but you are stuck on the cash flow. To move the cash flow numbers, you could look to negotiate your purchase price and lower your construction budget, but you are already behind on being able to raise rents to keep up with the value of the property.

I know many BRRRR investors who will side against me and say this is a home run because of the infinite returns they will eventually get. But again, I’m conservative and want my deal to work now and stress-test well now. With so much equity on the table, this home may make a better flip now, or lease option for a buyer who can qualify (like I did for this deal in my portfolio). Then take those funds and invest in better cash flow deals.

A Deal That Works for Equity and Cash Flow

Deal Specs
- Purchase – $52,000
- Rehab – $28,000
- ARV – $110,000
- Rents – $1,100
Analysis
- Rent to value – 1.0%
- COC – 13.6% (~$200 cash flow in the door after reserves)
- DSCR – 1.41

This deal is a classic slam-dunk for BRRRR. Why? First, you are able to pull all of your capital out of the deal upon refinance (yeah, velocity of money). Second, the rent to value is 1% and you will have plenty to cover the debt service and operational expenses. More importantly, you have plenty of cash flow to adjust to market forces, putting you in a strong financial position, especially in a down market.

Conclusion

As you can see, a deal really does depend on several factors to make it work, most of which are very personal. Some levers you can easily pull to turn the numbers in your favor, and others you can’t.

The most important thing is to understand how your personal goals, investing goals, and exit strategy serve as the foundation for your decision-making.

What do the numbers look like on some of your best deals?

Share your analysis strategies in the comments.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.