So, you’ve at last discovered a motivated property seller. You went to check out the house. The property owner is prepared to sell you the home for $30,000 less than what you think it will appraise for. Is that not a good deal?
Maybe, maybe not. There’s a lot more to real property investing and deal analysis than just comparing what you can purchase a home for and what you think it could appraise for. If you wish to disagree with me, I have practically lots of homes that I could sell you for $30,000 or more below current appraisal value that I wouldn’t touch.
Now, do not get me wrong… I have bought houses with lots of equity; and just because of the equity before. But, I will not obtain properties with plenty of equity with particular exit strategies.
For example, I will not acquire homes merely because they have a great deal of equity if I’m going to rent it long term UNLESS (and it’s a HUGE unless) it is generating good cash flow. Makes logical sense, doesn’t it? Who would want to fee a house $100, $200, $300 or more each month? Even if the home has $30,000 in equity, feeding negative cash flow properties will eat you alive.
This is why I propose studying deals based more than simply on equity. I strongly advise my customers and other property investors to make use of Net Operating Income. Net Operating Income, in my belief, is the only real means to find out what you could truly afford to pay for a property as someone who invests in real estate.
Never heard of Net Operating Income? Well, snatch your favourite drink and settle in. It’s among the best tools for dissecting deals and it is easy to figure out.
Here is a quick break down of how you can calculate Net Operating Income for a property:
1. Discover how much the market rent is.
2. Take off an allowance for vacancies.
What remains is what is referred to Net Rent.
3. Total all the expenditures including taxes, insurance, management, a reasonable approximate of upkeep, HOA, utilities, etcetera WITH THE EXCEPTION OF your mortgage payment.
4. Take off all the expenditures from Net Rent.
The figure that remains when you deduct all the expenses excluding your debt or mortgage payment is what we call Net Operating Income.
The Net Operating Income will tell us just how much debt the house can actually afford. If you are aware what interest rate we can obtain on a loan and the duration of the loan, then you can plug in the Net Operating Income as the payment and a good fiscal calculator can indicate to you the most you can afford to pay for the property with the Net Operating Income as the payment.
Then, when you make your offer to a home seller, you can sit them down, present to them what the real expenditures are for the house and what you are anticipating to get in rent and let them know why you can pay what you are offering them.
Forget about making offers at 70% of the property’s appraised value without being able to justify a silly price… when you make an offer based on Net Operating Income, you will be able to very distinctly show any home seller why it is that you could pay just your price.