What are you essential analysis equations?

10 Replies

Hey BP! - This is a question for the buy-and-hold multi/single family home members!

I'm a new investor with a career in CPG (consumer packaged goods) sales and distribution. I have a set of essential equations to evaluate deals before entertaining further analysis. 

I wanted to know what equations/metrics are a MUST HAVE when looking at a possible deal - I'm having a hard time trying to pin down which hold the most weight and make the largest impact in the rental world!

Thanks! - Jake

Welcome to BP! The market is crazy most places and hitting the basic numbers can be a challenge; but if it were easy everyone would be doing it. I invest in multi family including duplexes and I have one 12 unit apartment, strictly buy and hold. The first thing I look for is the 1% rule: Does a month's total rent equal 1% of the purchase price. Second is a 7-8% CAP rate. Cap rate is deducting ALL expenses from the month's total rent and dividing the result by the purchase price. Along the way I check for cash flow, here I deduct all expenses and projections including cost of capital, vacancy, maintenance, PM, capital expenses, from the total income; the remainder is the free cash generated by the investment. Never assume the numbers in a listing or Pro Forma are accurate-they very rarely are. Most often taxes are based on an old selling price, insurance is out of date, etc. get your own numbers. That will get you started. All the best!

Bjorn! Thank you for that. You focusing on the 1% rule and CAP rate is just what I was looking for, adding to the essentials list now!

Also when you are checking cash flow how positive do you like to be to consider further evaluation? Do you have a cushion of safety in your experience? 

@Bjorn Ahlblad - Hey Bjorn, 7-8% cap rate depends on the market right? 

A lot of YT investors talk about a minimum of 10% cap rate.

Since I don't come from the "real world" experience, and all I know is what I've heard from somebody else, is this "minimum of 10% cap rate" rarely applicable?

@Jacob Holth - Before looking at a deal, for how long do you follow jobs, migration and development of your city or state? What is the time frame you usually take to see the trend? 5 years, 10 years?

CAP rates are generally local yes. However lower caps like 5% don't cash flow, so they are out for me. The 1% rule generally works out to a 7-8 CAP. Don't go by what you find in the listings many/most realtors (who are not BP members) don't know the formula for CAP rate; or they fail to include all the expenses, or the amounts are not current. I get current numbers or come up with my own estimates which are quite accurate-most of the time. ;<)

@Bruno Orsanic  I chose to invest in my hometown and immediate area. I grew up there and visit often. This has been invaluable in seeing  trends in real time and real life.

I do live in a unique place in Indiana where most residents commute to Chicago bringing city money to smaller towns. win win

As far as formulas, at the end of the day, all you should care about is Cap rate or NOI. How hard is your money working for you? If it's super low like 4-5%, go plant it in a good mutual fund and get the same return without the hassle of being a landlord. The 1% rule and 50% expense rule are good rules thumb but don't mean jack if the ROI is low. In NW Indiana, you'll find most MFs (anythings say 3 units and up) trading at a 6 cap on the MLS. You can find better stuff if you put in the time, energy, and money to find the deals off market. I can usually find nice MFs in good areas (Merrillville, Portage, etc) at 12-15 caps, but i spend good money to find the deals. SFhs should be in the 12-15% range or more depending on city and if you self manage. Bottom line is the ROI gives you a thermometer on how hard your money is working for you. Higher ROIs are typically in tougher areas (say Gary). Great cash flow but no appreciation and tough to manage at times. Nicer areas have lower ROIs but you'll get better tenants and have appreciation. Figure out what you want, stick to it, and ACT.

@Jacob Holth I use metrics that I rank against my own performance. I like properties that need rehab, that way I can refinance and pull all my money out. If you can work the numbers to where your cash flow is positive, with the built in conservative numbers, you are on the fast track to financial freedom. Know your numbers, make smart calculations by removing guesses, and leverage.