Jason Hartman, creator of the Complete Solution for Real Estate Investors™, is no stranger to income property investing. As a real estate
investor for over 20 years, Jason’s investments include properties in 17 cities across 11 states—which makes him uniquely qualified to offer these seven tips for analyzing property before purchasing for investment property:
1.Rent-to-Value Ratio (RV Ratio): This is the most important and
simplest initial metric. The monthly rental income should ideally be 1% to 1.4%
of the purchase price or better in the current market. Many investors make the
mistake of looking at cash flow, which can be very deceiving as it does not
properly account for financing.
2. Leverage: Unless a property investor has an amazing
relationship with their lender, there’s a good chance a larger down payment
will be needed than even five years ago. That’s just the state of the current
banking industry thanks to a tsunami of reckless borrowers, lenders, Wall
Street financiers and government initiatives like the Community Reinvestment Act (CRA) over the last decade and
earlier. These days, it’s fair to say that one will probably have to put down minimum
20 percent of the total purchase price in cash in order to obtain financing. “And
that’s the way it is” as Walter Cronkite used to say.
3. Initial Cash Investment: The initial cash investment is the sum of the
purchase price and any closing costs associated with buying the property. Be
careful that the seller or seller’s agent doesn’t sneak any unexpected items into
the closing. In fact, investors who are prepared to drive a hard bargain might
be able to craft a property deal without paying any closing costs—if the seller
is duly motivated.
4. Operating Income: Before seriously considering a property
investment, take a close look at the income projections. After all, this is
about making money, right? Without income projections, an investor won’t know
if it’s a good deal or a bad one. Property Tracker is the software that Jason Hartman recommends. Enter the
numbers and it presents a nice, neat encapsulation of the important details
related to the deal. Operating income is the annualized gross income expected from
rent. Multiply the monthly rent by twelve, subtract vacancies/bad debt and what’s
left is operating income. Without actual numbers, use eight to 10 percent for
vacancies, depending on how conservative one wants to be in projecting return
on investment (ROI).
5. Operating Expenses: Next up are operating expenses. Any costs
associated with owning, maintaining, managing and renting income property fall
into this category. Examples would be property taxes, insurance, management
fees, advertising fees and maintenance. Right away, if the operating expenses
are more than the operating income, that’s a clear indication of a problem. The
deal already has no hope of positive cash flow. This fact might not be an
automatic deal killer but it should give serious pause for consideration.
6. Net Operating Income: After expenses are subtracted from income,
what’s left is net operating income. This is all profit, right? Not quite. Property
investors still have to pay the mortgage or debt service every month. This doesn’t
fall into the operating expense category but still needs to be taken into
account. Go ahead and subtract mortgage expenses from net operating income to
find out if the property will provide a positive or negative cash flow.
7.Cash Flow: Any positive number here has the makings of a
great property investment. Think about it like this. Income from the property will cover all
expenses, including mortgage payments, which essentially means getting the
investment property for free. This doesn’t mean that a property has to provide
positive cash flow to make financial sense but it is a strong indicator.
Bonus Tip – Tax Benefits: It should be noted that income property is
the most tax-favored asset class in America. If one qualifies for all the tax
benefits offered by income property, the depreciation /passive losses can
provide enormous savings and increase ROI dramatically. Consult a tax
professional to qualify for real estate professional status. The other huge tax benefit offered
by income property is the ability to trade it and defer the capital gains tax on profits.
“There are a handful of cities around the country that offer some exceptional opportunities
for prudent investors,” said Jason Hartman, founder of Empowered Investor
Investor Network, Inc. and host of The Creating Wealth Radio Show. “We see a lot of people making mistakes that
could have been avoided with a little guidance. Do your homework, ask questions and have a trustworthy investment
counselor. There are incredible opportunities in today’s marketplace where
investors can buy far below the cost of construction or replacement.”