You have looked at 6 (maybe 12 deals) and you are finding it near impossible to make them cash flow based on collecting a reasonable rent and getting 30 year fixed rate financing.
Take a deep breath. This is one of the most common problems for real estate investors and what I believe to be one of the things that discourage many people away from starting a lucrative real estate investing business. There is hope though.
First, unless you happen to be lucky enough to live in or near a city that has a low income area where you can still buy “rental houses” where the values are about 100 times the monthly rent, you need to realize that finding these deals is like the Easter Egg hunts you had as a kid. You have to look at a lot of deals to find that special one that will work.
How many will you need to look at? It can vary, but I don’t think that looking at 100 is out of the range of possibility.
What?! So, I need to look at 100 houses to find one that will work? Yes, you might need to look at 100 houses, making better distinctions about what might work and what will not work to find a good deal.
You may also find that putting out marketing to find motivated sellers makes finding these types of houses easier rather than just looking at houses that are for sale by owner or listed with a real estate agent.
Buying houses at a discount and/or with good terms can significantly improve your ability to make a house cash flow, especially if the interest rate on the terms you can get from a seller is much better than the current rate you could get from a bank or lender.
What if you have some houses that are very close, but none that will have positive cash flow? First, keep looking. Second, there are some ways to ethically increase the amount a tenant pays you in rent which could make a negative cash flow house a positive cash flow house.
For example, if instead of just renting the house, you sell the house on a rent-to-own, you can get payments that are on par with what your actual mortgage, taxes and insurance expenses are because they need to be able to pay your actual mortgage, taxes and insurance payments to afford that house.
When you interview your potential buyer, you explain that market rent is $1,000 (or whatever it is), but that if they have $10,000 to put down toward purchasing the house their mortgage payment with taxes and insurance would be $1,400 (or whatever it is).
You tell them they need to pay the $1,400 but that you will credit the $400 above market rent toward the purchase of the house when they do go out and get their own loan and buy the house from you. In the meantime, they rent with a payment that resembles your mortgage payment.
So, keep looking for those really good cash flow deals that will work, but also keep in mind some alternative strategies to offset negative cash flow situations.
Until my next post,
James
P.S. For our Real Estate Investor Bronze Members we teach strategies to achieve positive cash flow even on properties you might not think could have positive cash flow. Download our training materials now to learn how.
In this article, I will be taking some time to go over what many real estate investors look for in deals. You should realize that while I am covering what MOST real estate investors look for, there are real estate investors who have very focused interests and may fall outside these parameters. It doesn’t hurt to establish a conversation with individuals from your buyers list to get a feel for what each person is looking for. That way, you will have more confidence when finding deals to wholesale because you know which investors would be most interested in that deal. In fact, a quick call to the investor or investors that you think would be interested in the deal BEFORE you put it under contract may prove to be a time saver in the end since you may, on occasion, find out that it’s not quite the deal you thought it was.
So, let’s get to what real estate investors look for in deals. They tend to look for one or more of the following:
Below Market Price
In the simplest form, investors want to buy a house for less than what it is currently worth. They want to get a discount. The bigger the discount the better, but in many markets the formula for buying houses at a discount is that the most an investor can pay for a house is:
70% of the After Repair Value (ARV) minus what the house needs in repairs. This is often called the Ugly House Maximum Allowable Offer (MAO) Formula or the Ugly MAO in investor jargon.
To explain that formula with an example, if you had a house that was worth $100,000 if it were in great shape (that’s the After Repair Value, abbreviated ARV), and it needed $15,000 in repairs to make it worth the ARV, then the most an investor should pay for that house is $55,000. Here’s how I calculated that:
- 70% of the ARV – Cost of Repairs = MAO
- 70% of $100,000 – $15,000 = MAO
- $70,000 – $15,000 = MAO
- $55,000 = MAO
Notice the phrase above “most an investor should pay.” Many investors want even better deals than being at the edge of that formula–especially in soft real estate markets.
It is also important to note that if an investor wants to buy at that price and you need to make a wholesale fee, you need to put the house under contract for LESS than that amount. How much less? Enough below the price the investor will buy it from you for to pay your marketing expenses and your wholesale fee. So, the answer to how much less is how much money you want to make in your wholesaling business.
Investors that buy based on getting it below current market value, are often fixer upper investors or investors that will be quick turning the property.
Positive Cash Flow
Investors that intend to buy the property and keep it as a rental are often more concerned about buying properties where the income from the property makes sense based on the price they are paying and the financing they can get.
While I don’t believe it to be a sound formula myself, a formula they often use is if the rent from the property covers the entire mortgage payment, taxes and insurance, then the investor has positive cash flow. You should consider reading additional articles on Net Operating Income for a much better analysis of what I believe to be positive cash flow.
So, if you use that formula and a financial calculator that you can pick up for about $25, you can calculate the most that an investor can pay for a house.
Let’s take a look at an over-simplified example, so you can understand the basics on how to do this calculation.
For this example, the house has property taxes of $75 per month and an insurance payment of $50 per month.
If you knew the rent for this property was $1,000 per month and that, by calling a local mortgage broker, the current interest rate that an investor could get for a loan on this property would be at 7%, then you can calculate the maximum payment that you could afford with a financial calculator. Using this figure, you can determine the most you can pay for the house with that payment. Here’s how to calculate the maximum payment:
- Rent – Taxes – Insurance = Maximum Loan Payment
- $1,000 – $75 – $50 = Maximum Loan Payment
- $875 = Maximum Loan Payment
Enter into your financial calculator the following and solve for PV (the amount of the loan in our case):
- N = 360 (that’s for a 30 year loan)
- PMT = – $875 (the Maximum Loan Payment)
- I/Y = 7% (the quote we got from the Lender)
Maximum Loan Amount = approximately $131,423 (you need a financial calculator to solve for this number).
So, with this example, the most your investor could pay to have BREAK-EVEN cash flow (and many investors want to make $100, $200 or more per month in cash flow), would be about $131,000. To wholesale the property and make a wholesale fee, you’d need to get it under contract for less than that.
I want to stress that the example above is an over-simplification and that there is a lot more to buying cash flow properties that you will want to learn.
Owner Financing
Some investors are seeking out investment opportunities where they do not need to borrow money from a hard money lender or a bank to purchase the property. They want to buy properties where some, or preferably all, of the money to buy the house comes from the equity the owner already has in the property. Another way of looking at this is that the owner is willing to accept payments instead of only a lump sum to purchase their property.
You may be seeking properties where the seller can finance all, or part of the down payment or where the seller can finance the entire purchase. There are many variations in what owner financing can look like, but here’s an example:
You agree to purchase a house for $100,000. The seller agrees to accept $80,000 in cash (that would be you getting a new loan from a bank for $80,000 and the seller receives that amount in cash from the bank) and will then accept payments on the remaining $20,000. Of course, you will need to negotiate the interest rate (if any), monthly payment amount and the term (number of payments) of how the $20,000 will be paid to the seller.
Another relatively common, but hotly debated, method of owner financing is buying houses “subject to” the existing financing, where the buyer agrees to make payments on the seller’s original mortgage–often without the lender’s permission. A discussion of “Subject To” is beyond the scope of this article.
Other real estate investors often offer owner financing to attract buyers that do not or cannot go to a bank to get a loan. Rarely do private sellers that are not experienced real estate investors offer owner financing out-right. To get owner financing from private sellers, you almost always need to ask for it and negotiate it. In other words, if someone is advertising owner financing, they’re probably investors and your chance of wholesaling the deal is low. To get owner financing deals you will need to show, through your salesmanship and negotiation what the benefits would be to the seller for selling their house and accepting payments instead of just getting one lump sum.
The More The Better
Finally, it is important to remember that investors look for one or more of the above criteria. If you can get positive cash flow, below market price and owner financing, that’s even better and the deal is likely to be more desirable for real estate investors.
While, investors tend to focus on finding deals that meet the above three criteria, the motivation of the seller is often what dictates your ability to get below market price, positive cash flow and/or owner financing. That is often why you hear real estate investors talking about finding motivated sellers. It is the seller’s challenge that is causing their motivation and your offer to purchase the house must solve their challenge to make it worthwhile for them to sell their property at a discount, with positive cash flow and/or with owner financing.
Until my next post,
James
P.S. Access our deal analysis audio programs with your Real Estate Investor Bronze Membership now.
Some real estate investors buy properties to fix up and immediately resell. Some real estate investors buy properties to rent out and ultimately make a monthly income from their rents.
When you are wholesaling properties, you may come across both types of investors and in this article I will be discussing how to analyze deals from the perspective of a buy, rent and hold investor. By understanding how they look at their deals, you can buy your deals better and also make your best presentation when trying to sell your deals to these types of investors.
Net Operating Income
When you take the rent you are receiving from a property and subtract out all the expenses except the mortgage payment, the remaining value is the Net Operating Income.
Investors use Net Operating Income (or NOI) to determine how much debt a property can afford to support and as a gauge of what they can afford to pay to purchase a new rental property.
While I have done literally thousands of examples of this type of analysis on various websites over the years, here is a quick run down of an over-simplified deal.
Example
If you have a property that brings in $1,000 per month in rent and you assume that for 1 month out of every 20 the property will be vacant, we can subtract off a vacancy allowance of 5% (1 out of 20 months = 5%).
So, $1,000 per month is actually really only $950 per month when you figure that for one month out of every twenty you will have no income from the property. That’s what the vacancy allowance takes into account.
Now, from the $950 per month left over, we can subtract the rest of the expenses including management, maintenance, taxes, insurance, utilities (if the landlord needs to pay them) and any HOA fee.
In this example, here are our expenses:
- Management: 10%
- Maintenance: $50 per month
- Taxes: $105 per month
- Insurance: $50 per month
- Utilities: None – Tenant pays
- HOA: No HOA
So, from the $950 we subtract $95 for management (that’s 10%), $50 for maintenance, $105 for taxes and $50 for insurance. This leaves us with $650 per month in Net Operating Income (NOI).
So, $650 per month is the amount of debt, in the form of a monthly payment, that the house can afford to support.
If we plug into a financial calculator a payment of $650 per month, an interest rate (whatever the current rate is…we’ll use 7% here), and a 360 month term (30 year loan), then we can solve for what amount of money could be borrowed.
As it turns out, when you plug these numbers into a financial calculator, you get $97,604.12.
This number is for break-even cash flow. What if the investors you have on your wholesale list want to see $100 per month in cash flow?
Well, we take the $650 per month NOI and subtract out $100 so they can actually collect $100 per month as income. If we redo the calculations with our financial calculator with $550 per month, then the most you can afford to pay for the house is $82,573.37.
If you wanted to collect a $10,000 wholesale fee for finding that deal, then the most you can put that house under contract for is $72,573.37 ($10,000 less than what your investor buyer would need to buy it for to get their $100 per month cash flow).
I strongly encourage you to run your own examples on dozens of properties so that you can see how this calculation works. If you run into trouble, I have many examples for you to review as well.
Until my next post,
James
P.S. Need help with deal analysis from someone that has analyzed thousands of real estate deals for investors? Sign up for our Real Estate Investor Bronze Membership and get the support and training you need.
Real estate is an amazing way to amass a huge fortune if you buy houses to rent out and let the property rise in value and the tenants pay off your mortgage.
It can also be used to generate immediate income and on-going cash flow.
In this audio program (one of many in the Top Secret Courses series) we’ll teach you about both…
This audio program includes the following:
- Cash Flow versus Equity
- Short Term versus Long Term
- Creative ways to improve your cash flow when:
- Renting property
- Negotiating to buy
- Negotiating to sell
- Carrying back financing
- Finding deals and motivated sellers
- Selling faster and smarter
- Refinancing to lower interest rates
- Doing repairs or maintaining property
- Calculating when a value will double: the rule of 72
- Number of houses to become a millionaire in X years
- Paying off mortgages early as rents go up
- Which loans to pay off first? Interest rate or lowest balance?
- Over time which income and expenses go up, which stay the same?
- Buying twice as many houses as you need so you can sell half to pay off the remaining half
- Taxes and real estate
Details:
- Featuring Jassen Bowman with Steffanie
- Running time: Approximately 64 minutes
- Includes access to members only password protected website with outline and supplemental information
- Product ID: TSC0008
Use the link below to order this audio program and at the end of the checkout process you will be given a download link to instantly download the entire program:
Or, get this download for free! Here’s how: just become a Real Estate Investor Bronze Member and get instant access to this and over 100 other real estate investing course downloads plus much, much more including on-going consulting for your real estate investing business.
When I discuss in other articles some of the benefits of investing in real estate – like appreciation, depreciation, leverage and equity build-up – I often assume that you will have break-even cash flow. But is that realistic?
Well, yes and no.
First, let’s define what determines cash flow for a property. Cash flow is the difference between income from the property – usually rent – and expenses on the property. Expenses usually include taxes, insurance, management, maintenance and any debt payments. While taxes, insurance, management and maintenance can vary a little, what is largely within your direct control is the amount of the debt payments. How so?
Well, you control how much cash you put towards the purchase and how much of the purchase price you finance. If you put more down, your payments will be less. If you finance a larger amount, your payments will be more and you are more likely to have negative cash flow. If you look at negative cash flow as a function of down payment, you could think of negative cash flow as a deferred down payment that you are making over time.
So, can you assume that you will have break-even cash flow? Most people would argue that unless you are putting a large amount down, you are likely to have negative cash flow on a property when you first buy it. I would tend to agree, but what happens over time as rents go up? Well, you have some expenses that rise too – like taxes, insurance, management and maintenance… but usually the largest of your expenses on your property is still your mortgage payment. If you have a fixed mortgage payment, you should see an increase in cash flow over time.
So, while you may have negative cash flow when you first purchase a property, you should see significant positive cash flow as rents tend to rise over time. That is why I feel very comfortable making an assumption that your property can have break-even cash flow over a 30 year period when looking at the other benefits of real estate investing. It is a way to simplify the discussion to see how one benefit looks.
Of course, if you want to see how all the variables interact, I strongly encourage you to try the investment simulator game. You can try various real estate investing strategies in a fun interactive game format to see exactly how income and expenses can change over time and how they affect your investments and net worth.
Until my next post,
James
P.S. There are some great strategies for overcoming negative cash flow through creative deal structuring that we teach to our Real Estate Investor Bronze Members in our training materials and consulting sessions. Sign up today to learn those strategies and have us analyze your deals with you to create positive cash flow for you in your real estate investing business.
So, you finally found a motivated seller. You went to see the house. They are willing to sell you the house for $30,000 less than what you think it will appraise for. Isn’t that a good deal?
Maybe, maybe not. There’s a lot more to real estate investing and deal analysis than just comparing what you can buy a house for and what you think it could appraise for. If you want to disagree with me, I have literally dozens of houses that I can sell you for $30,000 or more below current appraisal value that I wouldn’t touch.
Now, don’t get me wrong… I’ve bought houses with tons of equity; and just because of the equity before. But, I won’t buy houses with tons of equity with certain exit strategies.
For example, I won’t buy houses just because it has tons of equity if I am going to rent it long term UNLESS (and it is a BIG unless) it has positive cash flow. Makes sense right? Who wants to feed a house $100, $200, $300 or more each month? Even if it has $30,000 in equity, feeding negative cash flow houses will eat you alive.
That’s why I suggest analyzing deals based more than just on equity. I strongly advise my clients and other investors to use Net Operating Income. Net Operating Income, in my opinion, is the only true way to determine what you can really afford to pay for a house as a real estate investor.
Never heard of Net Operating Income? Well, grab your favorite beverage and settle in. It is one of the best tools for analyzing deals and it is easy to calculate.
Here’s a quick break down of how to calculate Net Operating Income for a property:
1. Determine what the market rent is.
2. Subtract out an allowance for vacancies.
What remains is what we call Net Rent.
3. Add up all the expenses including taxes, insurance, management, a reasonable estimate of maintenance, HOA, utilities and so on EXCEPT your mortgage payment.
4. Subtract all the expenses from Net Rent.
What remains when you subtract all your expenses except 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 really afford. If we know what interest rate we can get on a loan and the duration of the loan, then we can plug in the Net Operating Income as the payment and any good financial calculator can tell you the most you can afford to pay for the house with the Net Operating Income as the payment.
Then, when you make your offer to a seller, you can sit them down, show them what the real expenses are for the property and what you expect to get in rent and explain to them why you can pay what you can.
Forget about making offers at 70% of value without being able to justify a ridiculous price… when you make an offer based on Net Operating Income, you can very clearly show any seller why it is that you can pay only your price.
If you would like an example of how I analyze an actual deal using Net Operating Income, I’d be happy to provide you with a real live example of one I analyzed recently. We even do live deal analysis with Real Estate Investor Bronze Members during our consulting sessions on deals they are considering buying.
Until my next post,
James
