Is it a Wise Buy?

The  real estate market has been depressed for a few years now, and the prediction for 2010 is no different.   Foreclosures are still on the rise.  This situation offers tremendous opportunity for the smart investor.

Before you begin, you must decide between single or multi-family housing.  There are pros and cons to each, but for me, income production was the top priority so I chose the multi-family option.  You can buy either type for about the same price, regardless of where you live in the U.S.  But you’ll make  more money in rent from the duplex than a single family home.   The downside is that you’ll have two tenants to manage, and two separate apartments to fix up and maintain.  The trade-off  is more money in your pocket at the end of the day.

When I find a property that interests me, I thoroughly check it out and estimate what it will cost to get it “up and running.”  Before putting in an offer, I need to know it will provide a good return on the investment.  Years ago, I started using the following formula to help me in my decision. 

Diamond or Dud

All figures should be annual amounts

1)  Rental income                                                                                                             

      Subtract 5% for vacancies and uncollected rent                                          

2)  This total (rents minus 5%) is your net rent                                                   

3)  Deductible expenses:

       Repairs  (10% of rental income, #1)                                                                 

       Property taxes                                                                                                        

       Insurance                                                                                                                     

       Management fees                                                                                                      

       Utilities paid by you                                                                                                

Total                                                                                                                                      

4)  Net operating income before mortgage expense:

       Subtract #3 from #2                                                                                                

5)  Mortgage payment                                                                                                    

6)  Pre-tax cash flow:  subtract #5 from #4                                                           

7)  Property depreciation:

       What you paid for the building divided by 27.5 years                              

8)  Tax loss or gain:  subtract #7 from #6                                                              

9)  Tax loss or tax owed:  #8 multiplied by your tax bracket                            

10)  After-tax cash flow:  #6 plus or minus #9                                                      

11)  Cash-on-cash return:  #10 divided by cash invested (cost of

         building plus fixup)                                                                                                 

Before you invest in a property, fill out this worksheet to figure out if it’s worth buying.  Number 11 will give you the annual return you can expect on the cash you invest, once the property is in rentable condition.  If that number is above 10%, go for it.

A final word to the wise…..If you fall in love with a property and the numbers don’t work, walk on by!  You can’t make emotional decisions as an investor, and in this real estate climate, another opportunity is literally around the corner.

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