Latest / Cash Flow for Life / Chapter 12: Love the Numbers, Not the House

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Chapter 12: Love the Numbers, Not the House · Cash Flow for Life

• 00;00;00;01 - 00;00;27;09 Chapter 12. Love the numbers, not the house. We've been throwing around that. Love the numbers, not the house. Quote quite often in this book. Now it's time to get an education about these numbers and learn how they will ensure you profitable investing with very low risk. All you must do is understand the ways in which to numerically evaluate a property for long term rental cash flow, and your investments will pay off. 00;00;27;16 - 00;00;48;03 We just worked with you on determining the costs involved in purchasing, holding, and managing property. Plug those numbers into the equations that will be taking you through in this next chapter. Some you'll use. Some you won't. You may not need to know some of the math and number crunching we'll talk about in this chapter right now. And heck, maybe you never will. 00;00;48;07 - 00;01;15;02 However, if your future investing moves beyond single family homes, some of the calculations here will be invaluable in determining the feasibility of larger multifamily investment. Knowing the math and finding useful formulas when you need them are essential. So get acquainted with the various calculations and investment measurements here and apply them when necessary to your business. The value of a simple spreadsheet. 00;01;15;05 - 00;01;39;01 Whether you sit down and do it the old fashioned way, such as drawing out rows and columns for your data, or you use spreadsheet software, you need to have your property data formatted correctly. It will be so much faster and easier if you use a computer spreadsheet program. Then you can build in your calculations and automatically recalculate the results when you change data or inputs. 00;01;39;03 - 00;02;04;20 You can run scenarios and you can see how different scenarios will impact your ultimate ROI. Many new computers come with some type of spreadsheet software. Microsoft computers usually come with the Microsoft Suite, and Apple computers usually come with the Apple Suite, both of which have spreadsheet applications. However, if you don't want software right in your computer, there are lots of different online and cloud based resources. 00;02;04;20 - 00;02;36;28 For example, WW Smart Sheet is a good one. Also, Google has free resources in docs.google.com. Using these you can work at a library or coffee shop computer. You can rebuild and save spreadsheets for your investing. You can even share them securely with others and you can access them anywhere that there is internet. Hey Michael, I can't make our meeting today, but log on to our Google Docs sheet account and get the latest numbers for these homes that we're checking out. 00;02;37;01 - 00;03;00;26 Yes, Scott, I just got an update on a couple new sold properties. Sole. Add them to our shared sheet and you could see the results when you're ready. Doing a better CMA than many real estate agents. Even if you use a real estate agent to do a comparative market analysis or CMA for you, you will want to know what makes up a thorough and reliable CMA. 00;03;00;28 - 00;03;25;04 Once you begin to gather your own data on property sales, you can choose to do your own CMAs with what you will learn here. Yours will be better than some of those done by many real estate agents. What do we mean by better? Well, there's only one measurement of how good a CMA is. Is it accurate in determining the true market value of a home at the time it's calculated? 00;03;25;06 - 00;03;52;24 True market value that isn't biased in favor of a buyer or seller is the primary consideration. If there are underlying reasons why a home that didn't seem identical to another should sell for less or more, you need to know this to form the CMA. When considering a property for purchase, you need a comma that tells you the market value as compared to recently sold properties in the area. 00;03;52;27 - 00;04;21;09 What you need to prepare an accurate and useful CMA. You will need recent sales statistics for properties in the area. These comparables or comps as they're called, should be as close as possible in proximity to the property you are considering. The more time that is passed since the property sale, the less valuable the comparable. So you'll want to get the latest sales information as well. 00;04;21;11 - 00;04;56;15 We told you how to work with real estate agents to get solid information, and it's also a matter of public record. In some areas, you try to find recently sold properties that are very similar or comparable to the property you're evaluating. There will be differences and we'll talk about those adjustments here. Other ways to find sold values are with online searches, and many online websites and programs are popping up every day to allow us to pull and assimilate this data, making it easier for you as an investor to do your CMA. 00;04;56;17 - 00;05;21;10 Unlike many real estate agents, we are also going to teach you how to do a CMA based on the current competition. Homes currently listed that would be considered competition because of location and features similar to the home you are evaluating. While you'll be following the same process, you'll be doing one set of numbers for sold properties and another for active listings. 00;05;21;12 - 00;05;48;21 We'll show you how this is important for determining final valuation. You'll also need the current listing information for homes similar to your subject property. Let's get started choosing the comparable properties. We've already said that the comparable properties should be as similar as possible to your subject property, and that they should be in the same neighborhood or as close as possible. 00;05;48;24 - 00;06;16;14 You'll also want to use the latest comps. A comma is most accurate on the day it's run. Homes come on the market and sell daily, so a lapse in time in making a purchase decision could mean having to run another CMA with up to the minute data for both sold and listed homes. It isn't necessary to choose properties with exactly the same features, such as the same number of bedrooms or bathrooms. 00;06;16;21 - 00;06;45;00 Nor does the square footage need to be exactly the same. However, the more similar the properties, the better because we'll have to make some adjustments for any differences between the comp home and your subject properties. The less differences, the better. How many comps you use is up to you. Usually the more comparables, the better your results, and getting about six will give you a good data set. 00;06;45;02 - 00;07;13;07 However, when markets are slow, it can be impossible to get six or more properties that are nearby and have similar features simply because there hasn't been any sales in the recent past. Do the best you can. Stretch the area a bit or move a little farther away if needed, or just as you can for varying features. Aim for at least three properties as your minimum goal, with six or more as your ideal example. 00;07;13;07 - 00;07;37;12 Subject property. For our calculations, let's assume that we're trying to determine the current market value for a home listed for sale in a popular neighborhood. We know that we can get tenants for this home, and we believe the rents will be stable in the area. So we've located a home in this large and popular subdivision with these characteristics. 00;07;37;15 - 00;08;13;22 Three bedrooms, two bathrooms, 1600ft². Standard quarter acre subdivision lot in the middle of the block. Formal living room with dining room off of the kitchen. Single car garage. Reasonable but not very special landscaping. Normal home in good condition, not overly fancy, with no major problems or damage. Listed for sale at $192,800. Has been on the market for 110 days. 00;08;13;22 - 00;08;17;12 When we do our CMA. 00;08;17;14 - 00;08;41;08 This is what we have for information about the home we're considering purchasing. While the real estate agent probably did a CMA to come up with the listing price, we don't know which comparables the agent chose or how thorough they were. We could also probably be certain that they haven't done a follow up. CMA in the last 110 days of the property has been listed. 00;08;41;10 - 00;09;12;11 Our comparables. It's been a little slow in this market, but this is a popular subdivision, so we were able to find three homes in the immediate area that have sold within the last few months and are similar to our subject property. Comparable a three bedrooms, two baths, 1800ft², two car garage, standard quarter acre subdivision lot in the middle of the block. 00;09;12;14 - 00;09;58;11 Normal home in good condition. Sold for 189 after 92 days on the market. Comparable be two bedrooms, one and a half baths, 1400ft², half acre cul de sac lot. Single car garage, extremely well maintained with upgraded appliances and finishes. Sold for $187,500 after 78 days on the market. Comparable see three bedrooms, three bathrooms, 1600ft² standard quarter acre subdivision lot in the middle of the block. 00;09;58;13 - 00;10;38;10 Two car garage. Condition issues requiring repairs, painting and other work. Sold for $167,500 after 130 days on the market. Now that we have the properties for our comparison, it's time to make adjustments so we can equalize them with our subject property and come up with our CMA adjustments. Professional appraisers use this exact same technique, but with a lot more detail than we'll go into using information they maintain on construction costs and the value of certain improvements. 00;10;38;12 - 00;11;05;25 It isn't necessary for you to become an expert on how construction and how much a bedroom is worth. In order to run useful, CMAs will need some idea of what the difference between properties are worth in dollars, however, so we can adjust accordingly. One way to get some of these adjustment numbers is to have a real estate agent do some comps for you, and then show you the calculations. 00;11;05;28 - 00;11;28;09 You can see the numbers that agent is using for the value of an extra bedroom or a garage space, let's say. Even better, if your appraiser team member will give you some numbers to use, you'll be in great shape. Also, you can go to publications online and get ballpark figures. You can find building sites in real estate sites to help you work out approximate numbers. 00;11;28;11 - 00;12;00;07 Remember, these are approximations, so don't get stressed out over it. Even getting close to the adjustment figures will give you a much better idea of the real market value of a home. We're going to use these numbers plus or minus in our adjustments. One an additional bedroom is worth $15,000. Two A full bathroom is worth $5,000. Three A single garage space is worth $3,000. 00;12;00;09 - 00;12;22;27 There are many more subjective things to look at as well. Also, it's easier to compare properties when the lot sizes are all the same as they are here. With the exception of our call de sac lot, that one will require an adjustment for the larger size and more desirable lot. Let's get right into it with adjustments using the following practices. 00;12;23;00 - 00;12;48;21 If the comparable house has more bedrooms, then we would subtract the value of the bedrooms to make the price more comparable to our subject property. The same would apply to more bathrooms or garage spaces. If there are fewer of these features, then we would add the value to the price, as our subject property would carry extra value because it has these spaces or extra rooms comparable. 00;12;48;22 - 00;13;25;20 A the only major difference is the two car garage, so we'll subtract $3,000 from the sold price to more closely compare it to our subject property that has a one car garage, $189,000, -$3,000 equals $186,000 price comparable be. We had $15,000 to bring it to a three bedroom. Comparable. We had $2,500 to do the same for the half bath. 00;13;25;23 - 00;13;36;26 Based on land prices found through research, we subtract $11,000 for the extra quarter acre and the more desirable cul de sac location. 00;13;36;28 - 00;14;21;03 We somewhat subjectively subtract $10,000 for the much nicer finishes and appliances. Now, this will never be perfect, but we've got to pick the best number to do our calculation. The calculation looks like this $187,500 plus $15,000 plus $2,500. -$11,000, -$10,000 equals $184,000. Comparable price comparable. See subtract $5,000 for the extra bath. Subtract $3,000 for the extra garage space. 00;14;21;05 - 00;14;59;17 Add $10,000 for the condition issues. Math looks like this $167,500 -$5,000, -$3,000 plus $10,000 equals $169,500 comparable price. Some real estate people would not do this last repair adjustment. And there are arguments both ways to do it or not to do it. However, if the home had been in better condition, it most likely would have commanded a better price. 00;14;59;23 - 00;15;33;01 Seems reasonable. Now we have three sold prices that are adjusted to reflect the same features as our subject property. The most common way to go forward is to take these comparable prices, divide them by the square footage, and use an average of that number to value our property. So for example, comp A is $186,000 divided by 1800ft² equals $103 per square foot. 00;15;33;04 - 00;16;11;12 Comp B is $184,000 divided by 1400ft² equals $131 per square foot. Comp C equals $169,500 divided by 1600ft² equals $106 per square foot. We can see that can't be the one with the upgraded finishes. And the appliances definitely garnered a higher price because of its condition. This is good information if we want to do some improvements on the property later. 00;16;11;14 - 00;16;47;20 However, right now we just want to get a value on the table. We average the three square foot prices to come up with $113 per square foot. We multiply this $113 per square foot times 1600ft². This is the size of our subject property to come up with a value of $180,800. Immediately we can see that this home appears to be listed about $12,000 over its true value, and sometimes it's listed under its true value. 00;16;47;21 - 00;17;17;07 That's very exciting. This helps us determine what we're willing to pay for if the other numbers work, and we want to purchase it for our rental property. This might seem complicated at first, but after doing a few of these, you'll rapidly gain confidence in your ability to quickly decide if it's worth doing more investigation and research, or if it's unlikely this home can be purchased right now for the true value, or less than your time will be better spent finding another home. 00;17;17;09 - 00;17;44;01 You don't have to do your own Seimas, but understanding how they work will help you be able to examine one provided by a real estate agent. You'll know if a home is in the ballpark or not in terms of market value. Now we've outlined all of these numbers in our audiobook resources on the Audiobook resource page at WW dot dot com slash cashflow for life audiobook. 00;17;44;04 - 00;18;09;01 The other side of the CMA, generally a real estate agent puts together a thorough CMA before listing a property. Some of them drop the ball by stopping. At this point, we, the buyer, have an accurate picture of the value of our subject property in relation to sold properties, but those sales are in the past. The market is evolving daily. 00;18;09;04 - 00;18;39;19 New properties are coming on the market, while others are they're selling or they're being withdrawn from the market. Economic situations are changing. This means that we need to do one more CMA, but this time we'll use currently listed properties to compare our subject property. Go to the Realtor.com site in the US and the realtor.ca in Canada to search current listings and get the active listings in the neighborhood. 00;18;39;21 - 00;19;07;03 Select the best comparables. If there is a lot of comparable inventory, which means high supply, it can mean that the price you are considering as an offer should be reduced. The seller is in a competitive market and supply is high, giving you more choices. If there isn't much inventory, and especially if there are very few properties compared to your subject property, then you may have to pay more for the home. 00;19;07;05 - 00;19;30;14 If the only comparables are higher in price than the offer you are considering, your purchase price may have to rise. If they're lower, you can start with a lower offer. You have now done more to determine the value of a rental property in the market than most real estate agents do. If you want an agent to do these CMAs for you, at least now you know what you want to see. 00;19;30;17 - 00;19;52;11 It's the beginning of loving the numbers, because you'll want to feel confident that you've come up with the appropriate value before looking at the other numbers to see if it's a deal that you want to pursue. You can also get a virtual assistant online to help you crunch these numbers. If you don't want to do it yourself, that might be a little bit later in your investing career, but the option is always there. 00;19;52;14 - 00;20;29;02 Remember. Focus on what you love to do, what you are good at, and delegate the rest. Now we'll look at a number of interesting calculations used by real estate investors at all levels of the business. Gross rent multiplier GRM the gross rent multiplier GRM is one calculation that shouldn't be relied upon to make decisions about purchasing. It's more of a useful tool to weed out multiple opportunities at a high level, and focus your attention on those that should be the most profitable and provide the highest ROI. 00;20;29;04 - 00;21;10;08 First, you're going to need to know the gross rental income of the properties. If a home is generating $8,400 per year in gross rent or $700 per month, then we can use that number to find the GRM. GRM equals market value divided by gross anticipated rent $110,000. Selling price divided by $8,400 equals 13.1 GRM. In this case, the price or value of the property is over 13 times the rent. 00;21;10;11 - 00;21;29;15 Now, if we're evaluating properties for purchase and we have plenty to check out, this could be a way to get the best to rise to the top of our consideration list for us to do further due diligence. While many will not be rented at the current market value, you'll need to estimate the rent that it could be charged. 00;21;29;17 - 00;21;44;25 We'll talk about estimate income potential later in this chapter. Let's take four properties listed for sale and the anticipated rent income or the actual, if they're currently rented to get their GRM. 00;21;44;28 - 00;22;24;18 $125,000 property, generating $10,200 in rent, the group equals 12.3 $100,000 home, generating $8,900 in rent. The GRM equals 11.2 $112,000 home generating $9,800 in rent. The GRM equals 11.4. This gives us an example so we can study the numbers. In reality, you could see in some areas running as low as five and only as high as 10 or 11. 00;22;24;20 - 00;22;53;00 It is different everywhere. However, let's use these examples and these numbers to see how GRM works. If you haven't noticed yet, we want lower Rems, not higher ones. Seem confusing. Well, let's take a look at how those examples worked. If the home costs more but the rent stays the same, the GRM number goes up. We have more invested for the same rent, so it's a less desirable situation. 00;22;53;03 - 00;23;17;25 If the home cost is less and the rent stays the same, the GRM goes down. We pay less for the home to get the same rent, which is a good thing if the price stays even and the rent goes up, the GRM goes down. We're paying the same for a house as compared to another, but we're getting a higher rent, which is good if we have the same price. 00;23;17;29 - 00;23;41;22 With lower rent, the GRM goes up. So you get the picture. So we're looking for lower. It's obvious now that the second two examples are better candidates for immediate research than the first one. However, we may have three homes that shouldn't be considered at all. The only way to know is to have an idea of the average GRM in the area. 00;23;41;25 - 00;24;10;07 Helps us understand if the rent is enough for what we're paying for the home. These numbers can be derived by studying advertisements that include rents and looking at the value of homes, or from actual sold properties that go into rentals and advertise the rent. Here's where your ongoing record keeping comes into play. If the current Ms. for the area are around nine, then none of these is where we want to pull off a lot of effort right now. 00;24;10;09 - 00;24;36;27 If, however, the average GRM in the area is 13, then all of these look like reasonable purchase candidates in the 11 GRM range. GRM, at best is just a quick way to see if a property looks good in the overall rental property availability pool. It's used more by multi-family investors than single family home rental buyers, but you can use it in single family as well. 00;24;37;00 - 00;25;08;20 Remember, GRM is a quick high level assessment. You still have to do all of your due diligence if something looks good with GRM. Cash flow. We've been talking about this in every chapter, and it's the goal of lifetime cashflow that brings you to this book and to our courses and our mentorship and even our coaching programs. Remember our ratty couch and the moment when we realized that our landlord was taking in $500 more each month than he was paying out for the house we were renting. 00;25;08;22 - 00;25;37;02 We were after the cash flow. So let's be certain everybody is on the same page with what that is, and it's really not too complicated. Cash flow is the net result of subtracting all the cash outflow from all the cash coming in. This has nothing to do with taxes or deductibility. It's straight cash. Subtracting every dollar out of pocket from every dollar coming in on the property will give you your cash flow number. 00;25;37;05 - 00;25;59;28 Rent receipts actually received and deposited are normally the only inflow of cash. However, if there is some other amount received, such as extra payment for cable or satellite, or maybe for laundering or additional parking, they would all be part of the inflow. All expenses that are paid, whether they're deductible for tax purposes or not, are part of the flow. 00;25;59;29 - 00;26;30;28 This is cash moving out. So property taxes, insurance premiums, mortgage payments, repairs and remodeling or rehab expenses not the portion finance, but yes, the payments on the improvement loan and any other payments for improvements are all cash outflows. Basically, it's cash in minus cash out. While you will have cash flow goals in dollars. You will balance your cash flow goals with ROI or return on investment. 00;26;31;00 - 00;27;04;19 In other words, you could buy a home for, say, $100,000 with $20,000 down payment or $120,000 home with a $24,000 down payment. You need to consider ROI as well as the cash flow. Taking these two homes as an example, if both would provide the same $500 per month in cash flow due to the rents minus the expenses, then you'd want to buy the one that costs less in order to get the better return on investment, you have less invested for the same return. 00;27;04;22 - 00;27;39;11 Calculate your income to cover vacancy and credit loss we talked about earlier. We'll take the total monthly rent and deduct 5%. For example, if our monthly rent is $1,200, we will subtract $60, which is 5% of the $1,200, and we end up with $1,140. So our income equals our projected monthly rent times 12 or $1140 times 12. Calculate your annual expenses. 00;27;39;14 - 00;28;16;23 These expenses include mortgage payments. Insurance. Property taxes, utilities, maintenance, repairs, homeowner or condo fees, HOA fees, and management costs. Every dollar going out should be included here. Subtract expenses from income subtracting the expense total from your rental income total, as calculated in the first step, will give you your cash flow or profit. Income minus expenses equals profit. Calculate monthly profit. 00;28;16;25 - 00;28;44;09 Dividing your annual profit by 12 will give you your monthly profit. Annual profit divided by 12 equals monthly profit. Never by negative cash flow. Would you put your money into a bank savings account that required you to pay every month to hold it? Buying zero or negative cash flow? Hoping to cash in on appreciation is not a smart move in our opinion. 00;28;44;11 - 00;29;13;29 Appreciation is probable. It's a maybe, but it can't be predicted. By using the calculations and techniques we're teaching, you'll be able to peg your cash flow going into the deal, and you want it to be positive. Two brothers, two approaches. Two brothers are rental property investors. Both of these brothers are profitable investors, but they have different approaches due to other things going on in their lives. 00;29;14;02 - 00;29;39;24 Andrew has a job and family and prefers to have others do repairs, maintenance and management tasks for his rentals. He is willing to realize a lower cash flow due to these extra expenses. Carl has more time to devote to his rentals, and prefers to do as much as the maintenance and management as possible himself, saving the costs and realizing higher cash flows. 00;29;39;26 - 00;30;07;29 As time moves on, both of these brothers can change their approach, putting more or less time into their investments. This is one of the best things about rental property ownership. You can tailor your involvement to your needs and your lifestyle, and by using the appropriate numbers to ensure positive cash flow is based on your approach. The trading off of your time and labor for cash flow is a factor in your calculations and expenses. 00;30;08;01 - 00;30;31;00 Know going in, what you're willing to do and what you're going to have to pay others to do. If you're not sure, ara on the side of caution by adding an anticipated cost for these items, then if you decide to do some or all, your cash will be better, you can pay yourself. But these items, these work packages, these tasks are still part of your budget. 00;30;31;03 - 00;31;12;20 Return on investment or ROI. Let's take a look at a couple of ways to measure our. Each has its own important and use cash on cash return. Many investors do not consider the cash on cash return calculation as a very powerful measurement tool, because it doesn't take into account taxes or other factors. However, it's a great way to look at the first year of a property ownership and see how this investment would compare to placing the money into something completely different, such as the stock market or bonds, or a certificate of deposit or anything else. 00;31;12;23 - 00;31;41;20 Cash on cash return equals your annual cash flow, divided by your cash invested. Remember, this is the cash invested, not the full and entire cost of the property that's being mortgaged. So, for example, if we purchased a $100,000 home with cash invested for the down payment and closing costs totaling $25,000, and we were renting it out with a net cash flow of $400 a month. 00;31;41;24 - 00;32;15;12 Here's how the calculation looks. $400 a month in cash flow equals $4,800. Cash flow for the year, $4,800 cash flow for the year divided by $25,000 invested equals 0.192 or 19.2% cash on cash return. Now go find a bank savings account or a stock market account or anything. Any other investment that will do anything like this for you. 00;32;15;14 - 00;32;47;04 This is how you can really compare investing in real estate or a particular property to the other opportunities you have to invest your cash return on equity or ROE. Return on equity can be calculated in two ways. One is very much like the cash on cash calculation that we just did. The difference here is that you're taking the cash flow after taxes or Kf8, and dividing it by the cash invested. 00;32;47;06 - 00;33;09;09 So you take out the annual cash flow, the income taxes you'll pay on that money. While this is a number that people want to know, it's highly variable because it's based on your individual tax situation, so it really isn't a helpful way to compare properties. It's more of a personal comparison or a comparison based on your personal financial situation. 00;33;09;16 - 00;33;42;28 It's not a metric that's used often, but we want it to let you know about it in case it comes up. However, there's another way to calculate ROE, and this one could influence your investment decisions down the road. Let's say that you purchase a rental home for $200,000. With a $50,000 down payment. You are renting it out for $1,400 per month with a net cash flow of $400 per month, or multiplied by 12 months, a net cash flow of $4,800 per year. 00;33;43;01 - 00;34;25;11 In the first year, your equity is close to the $50,000 you put on the property. You put $50,000 cash and the property hasn't increased in value. So here is your return on equity calculation. Return on equity equals cash flow divided by equity. ROE equals $4,800 in cash flow divided by $50,000 in equity equals 9.6%. You'll find this calculation useful in later years of ownership, as you're paying down your mortgage, and as the home is appreciating in value each year, you'll find that your equity will be growing. 00;34;25;13 - 00;34;49;16 You'll less on the property, but it'll be worth more. Rent will change as well. That will probably grow, though not likely at the same rate as your equity. So let's take a look at this property in five years now, due to appreciation and decreasing loan amount, your equity in the property is about $68,000, increased from the $50,000 you started with. 00;34;49;19 - 00;35;18;23 You have been increasing rents so your cash flow is at $500 per month. Here's the new calculation $500 a month cash flow equals $6,000 a year. Cash flow $6,000 a year. Cash flow divided by $68,000 of equity equals 8.8% return on equity. Now we're just using example made up numbers here in the equity might not have increased that much, or it might have increased ten times that much. 00;35;18;26 - 00;35;40;06 You put in the numbers that work for you. We just want to illustrate an important use for this calculation. Notice that as you pay down your loan, the amount going towards the principal increases at a faster rate. If appreciation is also going well, it's unlikely that your rent increases will keep pace. So each year your ROE will be lower. 00;35;40;08 - 00;36;02;07 The more equity you have, the lower the return on that equity. So when you begin to see other opportunities that will yield a higher ROE, then it may be time to borrow against this property, something that we call flipping to yourself a very exciting strategy. Or this is where you might want to sell, because that equity can be used somewhere else to get you a higher return. 00;36;02;10 - 00;36;27;14 Or both of these more than one. It might be different in different parts of your investing journey. Rental yield. Rental yield is simply defined as the return from rental income as a percentage of the money you have invested. It's an easy calculation, and depending on the method, it can help you make comparisons to other investments quickly. Rental yield property value. 00;36;27;16 - 00;36;57;13 Here we're calculating the yield based on the cost of the property. If you own a home that costs $200,000, regardless of whether you have a mortgage, you would use that number, the cost of the property and divide it into your net rental income after expense. So if you're taking in $9,000 in cash flow after expenses, you would have $9,000 divided by $200,000 equals 4.5% rental yield. 00;36;57;15 - 00;37;31;11 Rental yield, cash on cash. This is the same as the cash on cash ROI calculation we showed you earlier. You take your net rental income after expenses and divide it by the cash you have invested in the home. Using the example here, we paid $50,000 down on the $200,000 home. Now we're dividing that number to get cash on cash rental yield $9,000 cash flow divided by $50,000 equals 18% rental yields. 00;37;31;11 - 00;37;58;15 Cash on cash. Why do the same calculation as the ROI? Cash on cash we discussed earlier and call it a rental yield. It's just because you'll bump into these two uses out there. So we want you to know what's going on. We want you to know the language. You'll also see rental yield numbers quoted often. And you'll need to know if they're based on the full price of the home or the cash invested. 00;37;58;18 - 00;38;24;11 See future potential. But by as is, we're doing a whole lot of analysis and number crunching here, and it's all about ending with positive cash flow. However, there's another aspect of purchasing property that you should always have in mind future potential. While it needs to be profitable immediately, a property can have future added value based on its characteristics or the area. 00;38;24;13 - 00;39;00;02 For example, you may be able to subdivide a large house into 2 or 3 units for an increase in rental income. It could be as simple as adding a separate entrance, which isn't a high cost renovation. Adding bathrooms or another kitchen could be more expensive, but splitting one unit into two can increase cash flow significantly. There are a number of things you can do to a home to make it more desirable to renters, or to increase the rental income, or both, because we're buying with an as is approach that generates cash flow immediately. 00;39;00;07 - 00;39;30;11 These projects can be done whenever we want or never. You are fully in control on how to run your business. However, let's use a checklist to identify the potential in properties. Is the house bigger than most area rental units? Does it have more than one entrance? How much parking is available on site? Is there on street parking? Will the city zoning even allow another unit to be built on site? 00;39;30;13 - 00;39;58;29 How difficult or time consuming is the permit and building process? Can a bathroom be economically added? Can a kitchen be economically added? Is there space for outdoor amenities such as a playground or picnic area? Could an unfinished basement with a separate entrance be finished for a second rental unit? Our infrastructure improvements planned in the area. Can a room be converted to a bedroom in order to raise rents? 00;39;59;01 - 00;40;24;28 Can a loft or attic be converted for a more rental space? Could an addition be built to increase the number of bedrooms? Can a large part of the lot be divided and partially sold off? Are there adjacent lots that could be purchased for future for larger development projects? An amalgamation fall in love with the numbers, not the house. 00;40;25;01 - 00;40;45;29 You want to have this checklist handy and keep the potential in mind, but always buy based on the numbers that will provide a positive cash flow as the property exists. Now, you'll want to have this checklist handy and keep the potential in mind. But always, always buy based on the numbers that will provide a positive cash flow today as the property exists. 00;40;46;00 - 00;41;16;17 Now. Get your copy of the checklist at our Audiobook resource page at Key Aspire Cash Flow for life audiobook, down payment or cash flow. We're back to discussing leverage. How much down payment should you put into a property? The more you invest, the lower the mortgage payment and the higher the cash flow. However, tying up cash in one property that could be used for two properties or more is a consideration as well. 00;41;16;19 - 00;41;43;21 How do we make these decisions? It's part of the numbers. So we're looking at leverage again. Now that you have a firm foundation in the calculations to determine an investments cash flow potential, you can make better decisions about leverage. With mortgages available from almost zero down or with down payments of 5%, 10%, or 20%. You have choices as to how much cash to invest in a property. 00;41;43;23 - 00;42;09;03 In our earlier leverage examples, you saw how buying all cash isn't the best approach because leverage is one of the greatest advantages of real estate. Our two sisters example. Here's a great example to illustrate the power of leverage. Note that you can't always purchase real estate with a 5% down payment or a 10% down payment. The rules change all the time, and each lender has different rules as well. 00;42;09;05 - 00;42;31;15 But we're going to use 5% down payment for the example here to really show you how leverage works. We're simply using in this example to highlight the difference between putting more money and less money down, and what that means for your ROI. I want you to meet Maggie and Sharon. Their uncle Michael gave them each $20,000 when they graduated from college. 00;42;31;19 - 00;43;00;04 His only condition was that they invested in, you guessed it, real estate. Maggie and Sherrod had differing views on how to best invest their money, because this example is all about the cost of financing and leverage, we're going to leave out closing costs and monthly expenses. We're going to focus solely on the cost of financing. Sharon's approach. Sharon wanted a lower monthly payment to increase her cash flow. 00;43;00;07 - 00;43;30;27 She put her entire $20,000 down on one $100,000 house. She believes that she should pay down the house as quickly as possible, and have as much in the house as possible, and have the lowest mortgage as possible. Her monthly mortgage payment was $515, and she rented it out for $800 a month. She generated a monthly positive cash flow of $285, or $3,420 per year. 00;43;31;00 - 00;43;56;29 That gets her a 17% return on her investment. Not bad at all. Maggie's approach Maggie believed in leverage and putting as little down as possible into the house, let in the bank, pay for the rest. Maggie put a small 5% down payment on a $100,000 home, which was a $5,000 investment, and put the rest into a bank account. 00;43;57;01 - 00;44;40;15 Her monthly payment was $612, with $800 a month collected in rent. Her cash flow was $188 a month, though she was almost $100 less than Sharon's cash flow. Maggie did point out to Sharon that her return on investment was much higher. The return on her $5,000 cash invested was 45%, a nice 28% increase over Sharon's. Leveraging the difference in approaches, Maggie quickly saw an opportunity and went right out and put her 15,000 remaining cash to work, buying three more homes, each with 5% down or $5,000 down each. 00;44;40;18 - 00;45;18;16 Now, her cash flow across the four properties is $752 per month, a nice $567 per month extra cash deposited to her account each month. To help illustrate this, here are a couple of charts. The first compares Maggie's and Sharon's investments to the resulting cash flow. Money required Maggie's 5% down $5,000. Sharon's 20% down $20,000 mortgage payment. Maggie's 5% down $612.09. 00;45;18;19 - 00;46;47;29 Sharon's 20%, down $515.44. Cash flow. Maggie's 5%, down $187.91. Sharon's 20%, down $284.56. The marginal increase per $5,000. Maggie's 5%, down $187.91, plus $187.91, plus $187.91. Sharon's 20%, down $187.91, plus $32.22 plus $32.22 cash flow per $20,000. Maggie's 5% down approach $751.64. Sharon's 20% down approach $284.56. Other than this massive increase in cash flow, the other nice thing for Maggie is that she now controls $400,000 in real estate, while Sharon only as the single $100,000 property Maggie will enjoy four times the appreciation potential of the properties for the same $20,000 down in the next chart, we see a decrease in return on each dollar invested as the down payment increases. 00;46;48;01 - 00;47;32;22 Money required 5%, down $5,000, 10% down $10,000 15%. Down $15,000 20%. Down $20,000. Mortgage payment 5%. Down $612 10%. Down $580 15%. Down $548 20%. Down $515. Cash flow at 5% down. It's $188 at 10% down goes up to $220. At 15% down, it goes up to $252. And at 20% down, the cash flow goes up to $285. 00;47;32;25 - 00;48;06;05 The marginal cash flow increase per every $5,000 invested at 5% down, it's $188. At 10% down, it's $32.22, and at both 15 and 20% down, it increases by $32.22. Now, don't forget you have access to these charts at the audiobook resource page at keys for Life audiobook. So if it's a little confusing just listening to them, download the free resource as part of this book and you can follow along. 00;48;06;08 - 00;48;34;03 These charts clearly illustrate the value of leverage. Maggie is definitely in a much better financial position than Sharon because of her prudent use of leverage. There is a positive cash flow in each one of her homes, and Maggie will participate in property appreciation on $400,000 instead of Sharon's $100,000. This means big difference is 5 to 10 years down the line is this compounds rental evaluations. 00;48;34;06 - 00;48;57;18 Everything so far has been about evaluating property for purchase. In many of the examples we've used rental income numbers. Now it's time to determine how we know what rents we'll be able to charge over. Estimating rents will damage your cash flow. Underestimating them could cause you to pass on a good purchase because the cash flow calculations don't pass your tests. 00;48;57;20 - 00;49;26;07 It's very important for you to have valid rental income estimates based on your market and to keep them updated. We discuss this in the chapter about research and learning your market. Let's look at it a little closer now in regard to the rent number, the pivotal cash flow component. The good news is that much of the information you need to estimate how much rent you'll be able to charge is out there trying to get your attention already. 00;49;26;10 - 00;49;57;25 Start keeping records of apartment projects and single family home rental ads. They'll normally tell you a lot about the property, bedrooms, bathrooms, etc. they'll usually tell you the rental amount for those features. You'll have the components of what you might call a rental CMA. Get the data on comparable properties, incomparable or nearby areas. Build a file. Build a spreadsheet to keep tabs and track of average rents for certain sizes and homes. 00;49;57;28 - 00;50;20;07 When you're evaluating a home for purchase, pull out your rental records and look at comparable properties to get a pretty close estimate of what you can get for rent. For the subject property. There are, of course, some subjective items in your comparison. Proximity to parks or green areas, and to other major employers can result in higher rental income. 00;50;20;09 - 00;50;52;13 You looked at these types of variables when you were doing a purchase CMA. Now you're using these same factors to adjust your anticipated rents, advertising to get rental demand, running an inexpensive or free online ad, for example, something on Craigslist or or Facebook Marketplace can provide valuable rental estimate information. You don't have to own the home yet. If you run an ad for rentals in a certain area, when you get the call on it, ask the potential tenant some questions. 00;50;52;15 - 00;51;15;08 You can tell them that you don't have anything at the moment, but you will look for something for them. With this information, find out what they're looking for and more importantly, what they're willing to pay for it. Now you have both sides of the equation. You know what properties landlords are advertising for rent and for how much. You also have feedback from actual renters as to what they're willing to pay. 00;51;15;11 - 00;51;38;20 When you're running the numbers. To evaluate a property for purchase, use this data to build a solid expectation of the rent you charge for the homes you're considering for purchase. And if you want to learn more how to build this amazing tenants list, and if your tenants tell you exactly what they want you to buy for them. Be sure to get the book quick start to Cash Flow where we go through this in detail. 00;51;38;22 - 00;52;08;11 Love the numbers, not the property. What you've learned in this chapter will be the basis for your evaluation of properties to produce lifetime cash flow. Never shortcut the numbers and never cheat the numbers. You're only cheating yourself. Action steps one. For each of the investment calculations in this chapter, run your own examples. Choose the numbers from actual homes for sale or just make them up. 00;52;08;14 - 00;52;37;13 Practice, practice, practice. The more you can practice these numbers, the better you will get at this and the better your investing business will be. Two begin to build your rental database. Include the price properties are renting for as well as their characteristics and features three. Do a sample property potential checklist. What's next? We're going to work on expanding your investment team. 00;52;37;13 - 00;52;43;23 In the next chapter, you'll begin to add team members to help in building your investment business into the future.