Selecting the Best Property

An old adage says that money is made from real estate when it is purchased. I believe this is a truth on many levels. In my upcoming new book, “Collect Rent, Don’t Pay It: A Beginner’s Guide to Rental Property Investing,” I take a look at how we selected our investment properties.

I’ve blogged previously about the absolute importance of location, location, location. I know it is clichéd, but it is absolutely true! Location of the property is the one variable an investor really can’t change. Pick a bad one and the investment may not produce the desired return!

Beyond location, the math has to work for a property to be a profitable investment. Pay too much for a property with hidden issues and the math may never work! For the math to work, there are many different variables that must be considered before making an offer and closing on that first investment property.

In “Collect Rent, Don’t Pay It” I provide a detailed overview of how I figure capitalization rate. Capitalization rate or cap rate is simply the expected net income (rent after subtracting all expenses) divided by the value of the asset and expressed as a percentage

For instance, if annual net rental income for a property is $10000 after all expenses are deducted and the property is valued at $100000 then the cap rate is 10%. This is the “math” used when considering if an investment property may be a good fit.

Generally speaking, investors are shooting for an 8-10% cap rate range to make a good deal. Of course, one can go lower, it’s all how much risk the investor is willing to take!

There are many ways to determine cap rate, each investor may do it a little differently. What are the expenses? Everything! Insurance, property tax, repairs, maintenance, HOA fees, anything related to operating the property as a rental each month. Some investors may even include mortgage principal and interest as expenses when figuring cap rate.

The seller may be willing to share their historical expenses in order for the buyer to determine the cap rate of the property more accurately. As always, trust but verify everything. A detailed property inspection is definitely required to ensure those repair and maintenance figures are accurate!

Before performing a detailed cap rate analysis of a property, I do what I like to call the “field expedient” method to determine at a glance if a seller’s ask is in the ballpark and the property is worth a further look. The following excerpt from my book is what I like to call the “10% rule”.

Before diving into a more formal method for calculating cap rate, I’ll share what I call the “field expedient” method for determining if a property is even close to a good asking price. Field expedient is an old Army term for throwing together a solution on the fly! I like to call it the 10% rule.

Let’s say you are relaxing at home and surfing your favorite online real estate site looking for the next great multi-family investment opportunity. There is a good-looking duplex for sale and the seller is asking $400000. Take 10% of the ask ($40000) and divide by 12. This equals $3333 per month estimated gross for the property or almost $1700 per unit.

If you’ve done an initial market research for the area and know that there is no possible way that class of property at that location will bring over $1200 per unit given the current rental market conditions, then the sellers ask is probably too high. May be best to keep on scrolling or be prepared to do some negotiating!

Using the reverse of the 10% rule, one can figure out a good price range to start a search for an investment. If $1200 per month per unit is the average rent for a good duplex in the area, then take $2400 and multiply by 12. This equals $28800. Multiply by 10 and you get $288000.

This would be a good starting point for a search. If you scroll down from the $400000 property and see one listed for $300000 it’s probably worth pausing and looking at the ad closer.

I can’t stress enough the “10% rule” is just an initial screening tool to determine if a seller’s ask is in the ballpark. There is no real science behind it. Once an initial interest in a property is developed, go take a look! Then perform a detailed capitalization rate analysis before even thinking about making an offer!

There are definitely other screening methods. A rental investor just has to do the homework and figure which works best for them! If you liked that small excerpt, then you’ll love the whole book! Look for Collect Rent, Don’t Pay It: A Beginner’s Guide to Rental Property Investing on Amazon in May!

Want to learn more about the financial truths that have helped our average American family achieve success? Check out my book, Millionaire on a Worker’s Budget: Five Financial Truths to Build Wealth on sale now at Amazon!

The commentary provided in this blog is for informational purposes only and is not intended to be a source of financial or investing advice.

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