I have been hearing the prices are falling quite a bit across US. I am a real estate investor and have been waiting for the prices to fall to buy more investment homes. But, have the prices fallen enough to invest now considering the high interest rates? In this post, I want to share with you how I instantly analyze if a single family home is worth investing. It can be applied to small multifamily investments too that fall under conventional loans.
Photo by Binyamin Mellish: https://www.pexels.com/photo/house-lights-turned-on-106399/
How to instantly analyze using 50% rule
Have you heard of this rule? This is a very simple rule used by most real estate investors to analyze if the investment is worth considering. Let us take an example.
Today, I was looking at a single family home in Denison, TX priced at 214k and rent estimate is at 1600. Let us assume that we are making 25% down payment. Our initial investment would be 53.5k and the closing costs would be around 5k (2.5% of the price). Our total initial investment would be 58k approximately and our total income for the year would be 19200.
First let us look at rent to price ratio
(1600/214000)*100 = .74.
This is not great but looks decent. I would prefer it to be in around .90 area to make sure we have positive cashflow on this investment( 1% is very hard nowadays). We do not want this ratio to be below .5
Now let us look at 50% rule. As per this rule, it tells us to take away 50% of the income for all the expenses and see if you can manage to pay the mortgage that includes principal, interest, insurance and property taxes.
Below is the snapshot of a free mortgage calculator with 6.7% interest rate ( it was automatically filled). I would be taking a loan for around 160.5k when I pay 25% for 214k home
1033 number excludes property payment and insurance.As per this 50% rule, let us keep aside 800 (1/2 of 1600 rent) for expenses. we are left with 800 which is way less than 1033 and we would be on negative cashflow if we had purchased this home.
Some might say that my horizon is 10 years from now and I am not worried if there is no cash flow for now. But, folks, remember, cashflow is a defense metric. No one knows what will happen to the price of the location considered 10 years from now. As we all know, real estate is all about location, location, location. And one important metric to determine the desirability of location is population influx. 10 years is a long horizon and macro economic conditions might change to reduce the desirability of a location. For example, Detroit used to be one of the desired submarket in Detroit because of the auto industry some years back. Now the population is decreasing year over year and the prices are stagnating. check out worldpopulationreview to know the most desired cities/submarkets in US.
If we honor the rules mentioned above, we can have cashflow from day one and if the price appreciates, it is an additional bonus.
TakeAways
As a real estate investor, it is very important to shut down the noise and have minimal acceptance criteria for an investment. I love investing technically using numbers and I would consider an investment only if it satisfies my rent to price ratio and 50% rules. Once, these rules are satisfied, I would further do a detailed analysis to determine my cash on cash return. Usually, if the property inspection is looking good and does not have any major issues, I would invest only if I make at least 100$ per unit ( $200 per duplex, $300 per triplex).
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In my next post, I would share with you how I do my detailed analysis of an investment.
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Disclaimer: All information is for educational purposes only and are not intended to constitute legal, tax, accounting, financial or investment advice. I am not a professional financial advisor, attorney or account, nor am I holding myself out to be. There is no guarantee that you will earn any money using the techniques and ideas mentioned in this video. All financial opinions expressed are from personal research and experience. There may be affiliate links, meaning that I’ll receive a small commission when you click on my link. The information, opinions and views contained herein have not been tailored to the investment objectives of any one individual, are current only as of the date hereof and may be subject to change at any time without prior notice. I do not take ownership of the information described here. Your level of success in attaining the results claimed will require hard-work, experience, and knowledge.
Disclaimer: All information is for educational purposes only and are not intended to constitute legal, tax, accounting, financial or investment advice. I am not a professional financial advisor, attorney or account, nor am I holding myself out to be. There is no guarantee that you will earn any money using the techniques and ideas mentioned in this video. All financial opinions expressed are from personal research and experience. There may be affiliate links, meaning that I’ll receive a small commission when you click on my link. The information, opinions and views contained herein have not been tailored to the investment objectives of any one individual, are current only as of the date hereof and may be subject to change at any time without prior notice. I do not take ownership of the information described here. Your level of success in attaining the results claimed will require hard-work, experience, and knowledge.
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