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I just received a question from one of the listeners to our daily training calls that also purchased How To Analyze Deals Volume #1 and they asked a great question that I have explained before but that I don’t think I ever wrote a short blog post about.
The way that I recommend analyzing a potential property for purchase includes doing a full Net Operating Income calculation where you determine how much income the property produces, subtract out for expected vacancies, subtract out for property management, subtract out for taxes, insurance, HOA, maintenance and any other expenses that you can think of. In fact, I cover how to do this in How To Analyze Deals Volume #2 which is included in the free download bundle for real estate entrepreneurs.
Once you figure out the income and remove all the expenses from it you are left with a number that tells you how much money is left over (either per month or per year depending on whether you were working with annual numbers or monthly numbers). This money that is left over is called Net Operating Income. If you were using yearly numbers, go ahead and divide by 12 to get the monthly Net Operating Income.
If you think about it, the amount of money left over monthly after all the expenses for the property have been removed like vacancy, property management, taxes, insurance, HOA and a maintenance reserve is really how much money the property could support in debt (because debt was the only thing we did not list as an expense of the property when we were calculating it). As a monthly number that is the most the house can afford to pay in monthly payments and it is a critical number to know.
The question that the listener asked me about was: how do you take that number and use it to determine the most that you can afford to pay for the property?
Well, there are four variables in the calculation for loans (five if you have a balloon): the payment amount (usually monthly), the number of payments made until it is paid in full, the interest rate and the amount of money borrowed.
If you know 3 of the 4, you can use a financial calculator to determine the fourth.
One of the calculations that I like to do is to figure out how much total debt the property can afford. If I take the amount of monthly payment and set it equal to monthly Net Operating Income and enter that in a financial calculator that you can buy at just about any store like Best Buy, Staples, Office Max, Office Depot, WalMart or KMart. On my calculator that is the PMT key (presumably an abbreviation for payment) but it may vary depending on which you use.
Enter the interest rate that you can get on the loan with how you will be structuring your financing. If you are getting a bank loan, then enter in what your bank or loan broker has told you as your interest rate. Maybe it is 6.5%. Enter that as interest rate. On my calculator that is the I/Y key (presumably for interest rate per year).
Next, enter in the number of payments you will be making. If it is a bank loan and I am doing a 15 year loan, I would use 180 since I would be making 180 monthly payments. If it was a 30 year loan, I would use 360 since I would be making 360 monthly payments. I’ll use 360 months in the example below. On my calculator this is labeled the N key (presumably for number of payments).
Lastly, I would then calculate how much money I could borrow at 6.5% making monthly payments of the Net Operating Income for 360 months by pressing the CPT (presumably for compute) and then the PV key (presumably for present value of the loan amount). The calculator will “whirl” for a moment and then spit out the amount of loan that makes sense with payments of Net Operating Income at 6.5% for 360 months such that you have it paid off at the end of 360 months.
That number tells you the most you can afford to pay for a house with 100% financing and have break-even cash flow with 360 payments at 6.5% interest. I will definitely be talking a lot more about this on the daily training calls for Inner Circle Members. Join today and download dozens of past episodes (I think there are about 60 right now).
Until my next post,
James
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This episode of The James Orr Show contains the following:
- First, James reminds listeners that you can get the episodes of the show at the Learn To Be Rich website, or on iTunes available as a podcast.
- James also talks a bit about some of the changes that may be coming to The James Orr Show.
- James also recommends some audio courses and books that James thinks are very helpful and informative. He also talks about what some of the courses teach.
- Next, James starts to answer listener questions.
- First, there is a question about whether or not a deal is “good”, and James goes over the deal on the show.
- After the question, James reveals the new Affirmation for the Day and discusses why it is important.
- After the affirmation, James has several announcements. First, James reminds listeners that there will be no Friday episode because James is taking his kids to a water park. The other announcement is that, starting on Monday, The James Orr Show will be from 8-9 AM.
- After the announcements the show returns to audio courses and James discusses a course he listened to the previous day.
- James also explains “pro forma” numbers which are often false.
- Next, James reminds listeners to join the Private Money Mastermind Group for the penultimate time.
- To wrap up the show James talks a bit about 0 percent loans.
This show is now available as a digital download: The James Orr Show – Episode 2010-07-28 or get access to all future live episodes, consulting during the calls and many of the previously recorded episodes as an Inner Circle Member.
Inner Circle Membership - Daily, Live Training for Bird Dogs, Wholesalers, Real Estate Investors and Real Estate Entrepreneurs with Q&A and consulting and more.
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On this episode of The James Orr Show you will find:
- To start of the show, James gives an update on the status of the Thursday and Friday episodes of The James Orr Show. He also reminds listeners that you can find the previous fifty episodes of The James Orr Show on iTunes available as a podcast.
- Next, James points newer listeners to the new real estate entrepreneurs resources, which include many articles, videos, and free downloads.
- After the updates and reminders, James reveals the new Affirmation for the Day, and explains why it is so important.
- After the affirmation, James begins to answer listener questions.
- The first question James answers is about deal analysis, and James talks about factors that make deals better or worse. He also discusses vacancy rate, which affects certain aspects of the deal. After discussing the factors that affect deals, he goes over how to price rent, and what to worry about as far as maintenance costs.
- Next, James discusses bird dogging and wholesaling. He talks about meeting with sellers through an agent and doesn’t recommend it.
- James also talks a little bit about the hierarchy of work. Bird Dogging makes less money and needs less work. Wholesaling is more work for more money. And selling houses is the most work for the most money.
- Near the end of the show, James talks about his new folder system with Dropbox, talks about how useful it is, and suggests listeners to use it in their business.
- To end the show James reminds everyone that he will be “starting over” after the 50th episode of The James Orr Show.
This show is now available as a digital download: The James Orr Show – Episode 2010-07-26 or get access to all future live episodes, consulting during the calls and many of the previously recorded episodes as an Inner Circle Member.
Inner Circle Membership - Daily, Live Training for Bird Dogs, Wholesalers, Real Estate Investors and Real Estate Entrepreneurs with Q&A and consulting and more.
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The following is a video from Zillow talking about how accurate Zillow’s automatic valuation model is in your market.
I have discussed this concept before and talk about possible ways it can be wrong in each of my deal analysis posts, but this video gives some additional information straight from Zillow.
Enjoy the video.
Until my next post,
James
Inner Circle Membership - Daily, Live Training for Bird Dogs, Wholesalers, Real Estate Investors and Real Estate Entrepreneurs with Q&A and consulting and more.
