I've owned between 30 and 40 rental properties. Sadly, I lost a good bit of money on the first few properties. I made the mistake that most investors make: buying the property, rehab it and then trying to rent it to cover my costs. This rarely works. If you acquire a property at the wrong price or terms, its unlikely to get better over time. So, the most important step in successful real estate investment getting the right property at the right price and the right terms. I will only cover the price in this article.
I learned from my mistake and started using some basic analytics and always always made money from that point forward. What was my method? I worked backwards and computed the "break even" price; the absolute maximum price I could offer and not loose money if everything went as planned. Since everything never goes as planned, use this number as a sanity check if nothing else.
If you get the property for the break even price are you guaranteed to make money? No! But if you pay more than the break even price, you will almost certainly lose money pretax (post tax you may still be OK as you will see later). So the break even price is as much a sanity check as anything else. Note that depending on the property and other factors, you might choose to buy a property that loses money. The key word is in the last sentence was "choose". As long as you know what you are doing and it fits your financial goals, that’s fine. Below is an illustration showing the balance that must exist between income and expenses if you are to make money.
How do you do this when there are so many unknowns? Actually, there are only two unknowns (rent and rehab costs) and they can be relatively accurately estimated. Of the two, rehab cost is not as critical because it is a one time cost and can be accurately estimated during the due diligence period (when you can back out of the deal without losing your earnest money) so the key element is the rent. Below is an image illustrating the steps.
Once you have a good estimate for the rent, you can calculate the management fee which is typically about 10% of the collected rent. (Note: My clients receive a special rate of 7% with my preferred property management company.) In Las Vegas, I use 1% of the purchase price as an estimate of the property taxes. What you want to do is calculate all the other cost elements based on the estimated rent. Manually, it is a bit of trial and error but it's not too hard. Let's run the numbers based on: estimated rent of $1,000/mo. (or $12,000/yr), interest rate of 5%, 20% down, insurance 450/yr, 3.5% closing costs, association fees of $35/mo (or $420/yr).
On the fourth try we got close enough. So, only considering pre tax cash flow, you should not pay more than $210,000 for the property. What should you do if you can't buy the property for $170,000 or less? You walk! This is where investors get into trouble, they don't listen to what the numbers are telling them. If you can't find a good deal, take your money some where else.
Calculating the break even price manually is a bit time consuming so I wrote a program which does the work for you and put it on a separate page so it will even work on most smart phones. Also, I added a profit percentage element; if you going for a 5% profit, just enter 5 and press calculate. It can take a second to calculate since the calculation is performed on the server so be a little patient. Click the calculator at left to go to the page.
Contact me if you are considering buying or selling Las Vegas real estate. You will be glad you did.
...Eric
Eric Fernwood
RE/MAX CENTRAL
8400 W. Sahara Ave
Las Vegas NV 89117
Email: EricFernwood@gmail.com
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