My First Investment Property, Part 1: Understand the Numbers
Hello BP! As I’ve gotten more involved in the forums lately, I’ve noticed that most members here are like me: part-time (or aspiring) investors looking for a way to boost their incomes or set themselves up for nicer retirements than their 401k’s or pensions (because those will still be there when we Gen. Y’ers are ready to retire) will allow. With that in mind, I decided that a step by step explanation of my first multi-family purchase could be helpful for a lot of members. There are three more segments to come: Identify the Property, Get to Closing, and Actually Make Money.
I hope you can all learn something from my experience!
So you’ve saved some money, joined Bigger Pockets, read a lot, asked some questions in the forums, and you think you want to get started as a part-time investor with a buy-and-hold strategy on a small multifamily. What now?
First, you must understand the numbers.
The most important thing you need to know about investing in small multi-families is that the math is simple. You can crunch a deal into one of the calculators here, but if you still feel the need to post “should I buy this?” in the forums, you don’t really understand the purchase you are considering. Before I found Bigger Pockets, I created my own template in Google Drive to analyze properties, and I still use it to this day. All it does is automatically do the math described below for a given purchase price. To decide if a property is worth looking into, there are really only four basic things you need to know.
A. What is your acquisition cost?
If you are going to leverage your property at 75% LTV (usually the requirement), then divide the purchase price by 4, that is your down payment. Add about 10% for closing costs, and that’s your acquisition cost. If you know there will be renovations involved, you can choose to add those to your acquisition cost (I do). If you can rent the units without renovating them, and use the profit to renovate later, then do not add them to your acquisition cost.
B. What will you get for rent?
When you are just browsing for properties, there are a few good tools to estimate the expected rent. Check rentometer.com for your area, and see what’s listed on Craigslist, Postlets, Zillow, and Trulia. Markets vary so much that any figure I give you here would be meaningless to you, but it’s not hard to find the estimations. Plan to get slightly lower than the market average in your area, just to be safe. You might miss out on some decent opportunities, but nothing we’re getting on the MLS is going to be a steal, so you can pass up the okay deal for the better deal.
C. What are your regular expenses?
Mortgage: You can easily find out how much the mortgage payment will be by searching on google for a calculator. I like mortgagecalculator.org for no reason except it was the first to work on my phone when I googled "mortgage calculator," but there are a bunch that will work. Your borrowed amount will be 75% of the purchase price using conventional financing.
Taxes and insurance: In the beginning stages, you can estimate those. Since markets vary so much, you’ll have to do some research of yours to get decent estimates.
Services: Do you have to pay for landscaping, snow removal, sewer use, water, or a garbage collection outside of taxes? Is there a septic tank that will have to be serviced regularly, or lights in common areas that you will be paying the electric bill for? At least some of that will apply in almost any market. Make sure to include those expenses in your analysis.
D. What should you budget for “unexpected” expenses?
Of course, you should expect to have to replace the roof every 20-30 years, the water heaters every 10, the furnace. . . etc. You should expect vacancy, renovation of units, and new appliances once in a while. Most experts will tell you that all-tolled, you should put away about 2.5% of the purchase price per year. For the sake of simplicity, let’s just stop there.
Now that you understand where the numbers come from, the analysis is easy. It comes down to 8th grade algebra, but you already know all the variables (the mathematical variables, anyway). The one number I care most about when I’m looking at acquiring a new investment property is the cash-on-cash return on investment. To get there, I divide the monthly cash flow by the acquisition cost.
Monthly cash-flow = Rent - Regular Expenses - Savings for future expenses (B - C - D/12).
Cash on Cash ROI = (Monthly cash flow x 12) / Acquisition Cost
Principal paydown, market appreciation, and tax depreciation can also factor into your real ROI, but since they will (theoretically) affect every multifamily investment in the same way, we can ignore them when doing an initial analysis.
If that was all new to you, it was a lot to process for one day! Leave questions and comments below.
I’ll be back soon with the next step: Identify the Property.