How To Correctly Value And Analyze Investment Property

SF Property BackyardUnlike stocks, there’s no easy way to ascertain the exact value of your current property or the property you plan to purchase. As a multi-property owner I’m glad there aren’t any ticker symbols jumping around every weekday because they are just a distraction. It’s all about buying, maintaining, and holding for as long as possible to build wealth when it comes to real estate.

Real estate currently makes up around 35-40% of my net worth where it will stay for the foreseeable future as I focus on entrepreneurial endeavors. The earnings that came from focusing on my career instead of chasing unicorns in the stock market was largely reinvested in real estate for diversification purposes.

In this article I’ll approach valuing property from an investor’s stand point. We’ll go through some big picture concepts as well as use a real life example to see whether we are making a good or bad investment. I think you’ll love this particular property I’ve picked. If you are already a homeowner, you’ll get to approach valuing your own property with as realistic an eye as possible.

VALUING PROPERTY – BIG PICTURE FUNDAMENTALS

* It’s all about income. As a real estate investor you must ascertain what is the realistic income the target property can generate on a sustainable basis year in and year out. The current and historical income figures are what matters most. Once you have a income range then you can calculate a property’s gross rental yield and price to earnings valuation to compare with other properties in the neighborhood.

* Price appreciation is secondary. One of the big reasons why there was a housing bubble and then a collapse was because investors moved away from the income component of the property and just focused on potential property appreciation. Investors didn’t care that they were hugely cashflow negative if they could ride the wave and flip for profits within a year or two. Once the party stopped, speculators got crushed which caused a domino affect, hurting those neighbors who planned to buy and hold. If you are primarily focused on property appreciation and not income, you are a speculator. There is no real value for real estate if it does not generate income or save a person on rent.

* Property prices historically rise closely with inflation. Property price appreciation generally tracks inflation by +/- 2%. In other words, if the latest inflation figure is 3%, you can expect a 1-5% increase in national property prices. Over the years property price changes can fluctuate wildly of course. But if you look at property prices over a 10 year period you’ll see a relatively smooth correlation. When you start having expectations for consistent 10% annual price gains you’re becoming delusional. Remember that you should think about property price appreciation as a secondary attribute. If it happens, great. If not, you are focused on your cash flow.

* Property is always local. Be careful not to extrapolate property statistics. Just because one report says San Francisco property prices are up 19.6% in May year over year doesn’t mean I’ll get to sell my home for 19.6% more. My home price is up maybe 10% given it is higher than the median. You can throw national statistics out the window as well. The best price to find out what your home is worth is if your neighbor sells. Property price statistics tell you the general direction of prices and the relative areas of strength.

SPECIFIC STEPS TO VALUE YOUR PROPERTY CORRECTLY

1) Calculate your annual gross rental yield. Take the realistic monthly market rent based on comparables you find online and multiply by 12 to get your annual rent. Now take the gross annual rent and divide by the market price of the property. For example: $2,000/month = $24,000/year. $24,000/$500,000 = 4.8% gross rental yield. The annual gross rental yield is to get a quick apples to apples snapshot of what the blue sky potential is for a property if one were to pay 100% cash and have no ongoing expenses.

2) Compare your gross rental yield to the risk free rate. The risk free rate is the 10-year bond yield. Investors say “risk free” because there is practically 0 chance the US government will default on their debt obligations. All investments need a risk premium over the risk free rate, otherwise, why bother risking your money investing. If the annual gross rental yield of the property is less than the risk free rate, either bargain harder or move on.

3) Calculate your annual net rental yield (my version of cap rate). The net rental yield is basically your net operating income divided by the market value of the property. The way I like to calculate net operating income is by taking your annual gross rent minus mortgage interest, insurance, property taxes, HOA dues, marketing, and maintenance costs. In other words, we are calculating what is the actual bottom line annual profit. We can add by depreciation, which is a non cash expense, but I’m focused on cash flow. For example: $24,000/year in rent – $3,000/year HOA dues – $4,800/year property taxes – $500/year insurance – $1,000/year maintenance – $10,000 in mortgage interest after tax adjustments = $4,700 NOP. $4,700/$500,000 = 1% net rental yield. Not so good, but at least cash flow positive from the get go. Net rental yield can differ by each investor given some put more money down than others, while others are better at streamlining operating costs and charging top dollar for rent.

4) Compare the net rental yield to the risk free rate. Ideally, the net rental yield should be equivalent or higher than the risk free rate. You will pay the principal down over time thereby increasing the net rental yield and spread over the risk free rate. If all goes well, rents will also go up and your property will appreciate. There are plenty of properties in Nevada, Florida, California, and Arizona with net rental yields several percentage points higher than the current risk free rate after the collapse. The reason why more people weren’t snatching them up in 2010-2012 was because buyers often had to pay cash because banks weren’t lending. As a result, large real estate investment companies bought houses in droves instead of individual investors.

5) Calculate the price to earnings ratio of your property. The P/E ratio is simply the market value of your property minus the current net operating profit. In the example above $500,000 / $4,700 = 106. Woah! It will take an owner 106 years of net operating profits to make back his or her investment! This obviously assumes the owner never pays down his mortgage and does not see an increase in rents which is highly unlikely. A nicer way to calculate things is to get the gross rental income divided by the market value of the property = $500,000 / $24,000 = 20.8 for a blue sky scenario. Obviously, the lower the the P/E for the buyer the better and vice versa for the seller.

6) Forecast property price and rental expectations. The P/E ratio and the rental yields are only snapshots in time. The real opportunity is properly forecasting expectations. As a real estate investor you want to take advantage of fear and unfortunate situations such as a divorce, a company relocation, a layoff, a bankrupt city, or a natural disaster. As a real estate seller you want to sell the dream of forever rising prices. The best way to forecast the future is to compare what has happened in the past via online charts provided by DataQuick, Trulia, and Zillow and have realistic expectations about local employment growth. Are employers moving into the city or leaving? Is the city permitting tons more land to develop or do they have restrictions such as building heights? Is the city in financial trouble and looking to gouge owners with more property taxes?

7) Run various scenarios. The final step is to obtain your realistic property price and rental forecasts and run various scenarios. If rents decrease for five years at a pace of 5% a year, will you be OK? If mortgage rates for 30-year fixed loans increase from 3.5% to 5% in five years, what will that do to demand? If the principal value declines another 20%, am I going to jump off a bridge? Hopefully not if you live in one of the non-recourse states where you can hand back the keys and protect your other assets. Always run a bearish case, realistic case, and bullish case scenario as your bare minimum.

8) Be mindful of taxes and depreciation. Almost all expenses related to owning a rental property is tax deductible including mortgage interest and property taxes. The confusion lies in the phaseouts of deductions based on your income (Another article: Maximum Mortgage Deduction Depends On Income). What is also interesting to understand is depreciation, which is a non cash item that reduces your Net Operating Income (depreciation is a non cash cost), to lower your returns but also your tax bill. Be aware but focus on the actual bottom line cash in the end. $250,000 of profits for individuals and $500,000 of profits for married couples is tax free if you live in the property for two out of the last five years. There is also the 1031 exchange which allows investors to rollover proceeds to another property without realizing any gains and therefore taxes. The tax code is confusing but at the margin favors property owners.

9) Always check comparable sales. The easiest best way to check comparable sales over the past six to twelve months is to punch in the property address in Zillow.com. There you will see the tax records, sales history, and comparables on the lower bottom right side. You need to compare your target property’s asking price with previous sales and measure it against what has changed since to make sure you are getting a good deal.

PROPERTY EXAMPLE: BAY VIEW LUXURY CONDO

Description from MLS: Breathtaking views of the Golden Gate Bridge, Palace of Fine Arts, Angel Island and the bay from this 3BR 2.5BA Cow Hollow condo. There is a huge walk-out deck on the top floor where the living room, dining area and kitchen are located to enjoy the view. The kitchen has a center island,granite, eating area and balcony. A half bath complete this floor. The spacious master bedroom suite with jacuzzi tub, walk in closet and a balcony occupy the entire second floor. The first floor has 2BRs in the rear with French doors in each to access the private garden. A bath & laundry room complete this floor.In addition to the beautiful north bay views, the neighboring manicured gardens are enjoyed from all 3 levels.Extra wide parking & storage.

San Francisco Condo

$1,699,000 (LP)Price/SqFt:  852.91 2533  Greenwich St,  San Francisco, CA  94123 *      Active 
Beds: 3 Baths: 2.50 Sq Ft: 1992* Lot Sz:
District: 7 – Cow Hollow Yr: 1990*

My initial take: Great location with a multi-million dollar view. I love the outdoor indoor combination. A property that a family of three or four can enjoy. A great property for a swinging bachelor or a couple as well given the proximity to all the shops and restaurants in the north end of San Francisco.

At $852.91 a square foot, the property is inexpensive based on a list of comparables I see on Zillow for $900-$1,100/sqft. Your realtor should also provide you a long list of comparables as well. Interesting to see that the property last sold on 10/07/1997 for $988,000 for a 72% increase if they get asking.

Annual Gross Rental Yield: Monthly rent is anywhere from $6,000 – $8,000 a month based off comparables online. Let’s take the midpoint of $7,000 and multiply by 12 to get $84,000. $84,000 divided by $1,700,000 = 4.9%. Not bad compared to the risk free rate of 2.15%.

Annual Net Rental Yield (Cap Rate): $84,000 – $18,000 in adjusted property taxes – $3,000 in estimated HOAs – $40,000 mortgage interest adjusted for taxes – $5,000 maintenance = $18,000 net rental income. $18,000 / $1,700,000 = 1.05%. To be cash flow positive in San Francisco from the beginning is very rare given San Francisco has historically a huge P/E compared to the rest of the country.

Price To Earnings Ratio: $1,700,000 / $84,000 = 20.23 gross P/E. $1,700,000 / $18,000 = 94.5. Now compare the average P/E in San Francisco of 35-40X and you’re in the ballpark. 35-40X is expensive compared to areas like Detroit at 15-18X. But again, real estate is local. Nobody goes on vacation to Detroit, but tons of people come to San Francisco.

Price Forecast: Pricing trends are strong with employment growth surging due to Twitter, Facebook, Google, Pinterest, AirBnb, and a host of other internet companies. Over half of the 20 rental applicants I received for my rental property open house in 2013 came from these companies. Real estate consultants are expecting San Francisco property prices to rise by another 5-8% a year for the next several years. Rents are expected to slowdown to a 5% per annum increase.

Conclusion: The property’s views are amazing, but the inside needs some updating. The entrance is oddly shared by its neighbor through an easement and there are some structural issues that need to be addressed. If you are spending $1.7 million on a piece of property, I should hope that one has their own private entrance. The other downside of the property is that it takes one flight of stairs to get up to the first floor and the condo is three stories high. The number of steps won’t be ideal for older folks.

Despite the downsides, there are other great features including balconies in the back along with a small yard. The views are priceless. I would buy the property for $1.7 million if I planned on living there for the next 10 years. From a price appreciation perspective, there’s potential to hit the $1,000/sqft mark or basically $2 million dollars with a little bit of remodeling. Going from $1.7 million to $2 million is a 17% appreciation which can be achieved in four years at a rate of 4% a year give or take. Not bad, but not something to count on at all.

From a rental perspective, this property isn’t a great deal. This is usually the case with higher priced properties due to more of the property’s value being associated with luxuries that aren’t fully appreciated e.g. fixtures, flooring, location, views. In other words, look for lower priced properties that are bare bones with only the basic necessities to maximize rental yields.

The real question is: How much do you think the property will sell for? I don’t think there’s a snowball’s chance in hell I’ll be able to snag the property for its $1.7 million asking. Given how hot the market is in San Francisco, I’m guesstimating $1.85 million will be the final price. A cap rate of ~1% is crazy expensive, but that’s what it costs to live in the most beautiful city in North America. I’ll find out the final pricing this summer and report back.

VALUING PROPERTY IS PART SCIENCE PART GUESS WORK

The more open houses and transactions you follow from start to close, the more comfortable you will get with the exercise of assessing property values. It almost becomes a sixth sense where you instantly know whether the property is a good deal or not. Everybody looking to buy property should definitely hit the weekly open houses for a couple months to get a feel for your local market.

I cannot emphasize enough how property must be viewed as a long term investment largely due to high selling costs of 5-6% commission levels. It’s my sincere hope the public rises up against such egregious pricing practices by the real estate industry. It is absolutely baffling to me why realtors are unwilling to cut their commissions to boost volume given volume is down 40-50% in tight markets such as San Francisco. It’s worth doing your own research and checking out Zillow.com out for the latest comparables.

Property is a tangible asset unlike stocks which can lose value in a nanosecond for countless reasons. What other asset class allows you to live potentially for free, positively affect the value, and make a profit without having to stress too much if you can afford the mortgage payments? I encourage everyone to diversify their net worth into tangible assets such as property or anything that allows you to be a price setter.

Recommendations For Real Estate Investors

* Get the best home insurance possible. In order for your property to grow in value you must protect your property from damage. Fires, floods, leaks, theft, and other accidents happen all the time. If you have cut-rate insurance, you could very well pay way more than you should. I highly recommend checking with USInsurance.com online to find the best home insurance rates. They have a huge network of providers that will compete against each other to provide the most tailored home insurance coverage possible that is affordable. Mobile home insurance, renters insurance, condo insurance, and homeowners insurance are just a few of the options based on the type of home in which you reside. Leverage the internet to save money and protect your largest asset.

* Make sure you shop around for the lowest mortgage rates. Rates have begun ticking up as the Fed hints at easing off its bond buying program. Quicken Loans is the largest online mortgage retailer with some of the lowest rates. They also seem more streamlined in the refinancing process than traditional bricks and mortar banks as well. Interest rates are at all time lows and won’t stay this low forever. My latest refinance was for a 5/1 jumbo ARM at 2.625% from 3.125%. Might as well check because it’s free and there’s no obligation.

Photo: Back of 2533 Greenwich St., 2013, FS.

Regards,

Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

You can sign up to receive his articles via email or by RSS. Sam also sends out a private quarterly newsletter with information on where he's investing his money and more sensitive information.

Subscribe To Private Newsletter

Comments

  1. Martin says

    Great article, Ive really enjoyed reading your blog. In regards to your Cap rate analysis can you expand on the mortgage interest adjusted for taxes? I’ve always seen cap rate calculated to exclude mortgage payments. From my understanding it is a way to evaluate properties as if you were to pay all cash since there are just to many variables that can effect payments.

    • says

      Property gets tricky when we start calculating taxes, income and depreciation. My version of cap rate is to look at what goes in my bank account after all is said and done. I adjust the mortgage interest based off my own personal marginal tax rate. Each person’a is different. Depreciation is a non cash expense that helps lower NOI and therefore taxes. You can also depreciate in different ways.

      • Dividend Growth Investor says

        I compared your investing thesis about div stocks and investment property, and I find a very stark contrast. You are essentially treating stocks like lottery tickets, but building your wealth by sticking to fundamentals with RE. I wonder what causes this disconnect.

        • says

          The disconnect is you think I’m against dividend stock investing and buying and holding for the long term when I’m not. I’m for dividend investing in a diversified stock portfolio for older investors or retirees who want less volatility and more income. My article simply states that dividend investing is a suboptimal wealth building strategy for younger investors who want to achieve financial freedom sooner rather than later. Dividend stock investing while one already has a real estate and bond portfolio is not proper diversification.

          I know you’re all about dividend stocks, but I encourage you to think in more dimensions. Be more flexible in your thoughts as different people have different goals. All we’ve got to do is look at our existing portfolios, returns, and age and see whether they suffice.

        • Dividend Growth Investor says

          I am fine either way whether you like dividend stocks or not. You are not hurting my feelings ;-) I approach dividend investing very similarly to how you approach real estate investments ( minus the leverage part). So I thought that was funny, given you article yesterday.

          I disagree it’s suboptimal for younger investors, but then I am fine that you disagree with me. My first goal is making money, and i have seen that DGI works perfectly, based on all the data I have reviewed.

          Actually, I have come to dividend investing after reviewing a host of other strategies – technical fundamental etc etc. I understand that everyone has different objectives, but I have identified that people who actively trade chinese internet stocks are mostly gambling their money away. With the growth stocks you discussed, I am always amazed how someone always looks for the next GOOG, AAPL, TSLA… and lose a ton of money in the process..

          • says

            I’d rather be lucky than good. :) Even though you don’t share with us the amounts of your gains, I’m sure you’ve done fine. Your performance looks good, and i have to admit my growth portfolio has significantly outperformed yours since 2008 using a growth strategy. I probably got lucky again, but I’ll take it. There’s no need to defend dividend stocks. It’s a great strategy for many individuals and I’m a fan. It’s just not my strategy at this stage in my life.

  2. says

    Nice overview. Real estate isn’t an area we’ve ventured into yet but it’s definitely something to consider for the future. I couldn’t agree more that you’re investing for income, not price appreciation. Too many people get in trouble expecting huge returns in value. Definitely bookmarking this article to come back to if I get more serious about real estate.

  3. says

    Thanks for the analysis and case study of valuing property. I think people see all those flip shows and the quick cash can be tempting. Focusing on cash flow isn’t nearly as sexy, but it makes the most financial sense long-term.

  4. nbsdmp says

    Another great article, the volume and consistency with which you put these topics out and the thoughtfulness of your analysis is impressive! So as a fellow land lord I have a couple questions for you. 1) Do you use your free cash flow to pay down the note quicker? 2) Is your strategy to pay off all the properties or to recap them at some point then use that equity to buy more properties? Getting into real estate was definitely a great decision for me, a game changer actually & I would encourage everybody to do the same in a responsible manner.

    • says

      Thanks mate. I figure if I’m going to write, why not try harder and be as thorough as possible to help others.

      To answer your questions:

      1) It all depends on liquidity needs, desired ROIC, and other opportunities. The back stop is a mortgage free place before death or no more alternative income streams. Now that I don’t have w2 income, I’m encouraged to pay down the mortgage since my tax rates are lower now. That said, it’s a bull market in equities and I’m hunting for better returns now that risk appetite is back.

      2) I don’t want more than 40% of my net worth in real estate, hence I’m happy with the property I own. In focused on my X Factor, which if it grows large enough will lower my RE exposure for me.

  5. says

    Nice work. I always think rental income first… which is why the NY market feels so ridiculous. Some of the real estate I see on the market would still be too high relative to rent if they were *half* their sales prices.

    • says

      Are you talking about good ol NY City? I remember wanting to buy a 2/2 near Madison Square Park for around $795,000 or so. It’s now worth around $1.6 million! Prices have always been high, and will stay high in NYC imo. Well maybe not in the 80s, but who had money then?

      • says

        I sure am, but am sticking to outerborough stuff. Was looking at modest three-bedroom condos to use as a shared apartment in Brooklyn. Going rates for rent in the nicer neighborhoods would be around $1500 per person, so $4500 total. I struggled to find anything listed under $1 million!

  6. says

    I did the analysis when I purchased our 4 plex, but badly underestimated the repair cost. That’s the problem with older properties. Hopefully, the repair and maintenance cost will slow down a bit soon.
    $1.7 mil is pretty expensive… Are you planning to get a loan? Pay cash?

    • Matt says

      Agreed, I ran into this with my first two-family investment. Even the most experienced investor can come across a money pit from time to time. Best advice is to look at the major systems: plumbing, electrical, roof, foundation. It’s worth it to pass on the token home inspection and spend $500 on a licensed electrician, plumber, and structural engineer for an hour of their time.

      A fridge or stove that goes isn’t a big deal.

    • says

      These type of properties at this range are very well maintained actually. Otherwise, people would balk during the inspection. I will pay cash from my Financial Samurai account. Just kidding. This property is an example as I’m limiting my net worth exposure to no more than 40% in RE.

  7. says

    Really solid post. There are so many things to consider when buying property and making decisions based on emotions alone isn’t good. Looking at comps in your neighborhood, checking industry trends, looking at price per square foot, and all of the ratios and yield calculations you mentioned are great ways to analyze whether to buy and at what price when making such a large investment decision as property. I like the real example you provided as well. Luxury properties with new amenities are selling like hot cakes in SF but I wouldn’t pay above asking for that place, although I bet many people will bid above given the frenzy that’s going on these last few months.

    • says

      There are some properties that so rarely come up. When it’s a panoramic bay view, I think people go crazy. It’s weird the place doesn’t have it’s own main entrance. What were the architects thinking?! Let’s see if that’s a stumbling block.

  8. says

    Great timing with this article. I’m just getting in the market for a rental property and have been looking for good posts like this.

    As for what it sells for: I think the exposure it gets from this post creates a bidding war and it finally sells for 1.895mm!

  9. says

    You mention how your earnings/savings from your career job went to real estate rather than chasing unicorns in the stock market? Isn’t the unicorn scenario akin to investing in pure growth stocks? You also mention how the reason for the real estate bubble was due to “investors” not focusing on the cash flow and true valuation of the properties but instead just assumed they could eventually sell it for more in a year or two. Also, you like how real estate doesn’t have a market that is constantly throwing prices at you. Shouldn’t that be the approach to investing in the stock markets/companies? If the markets closed tomorrow for 5 years I’d feel comfortable knowing that when they opened 5 years later I would have more money than when I started by investing with dividend growth stocks. Some pure growth companies I’m not so sure about. Will TSLA be around in 5 years? Will they be making consistent and growing profits? Sorry just had to bring back your previous article since some of your comments here support investing in dividend growth stocks.

    Great article! I’ve been trying to learn more about valuing real estate and expected cash flows and this was right up my alley. I still won’t be acquiring any rentals at this time unless the opportunity is just that good. I’d have to have a property manager look at the rental because my wife wants nothing to do with that.

    • says

      Indeed. I regret not being more aggressive and risk taking in my youth as I wrote in my article, which is why I encourage younger investors to be more aggressive. Although property has done well for me over the past 10 years, I think I would have better optimized my wealth if I had continued searching for unicorns with a portion of my wealth.

      It’s very hard to close your eyes, and wake up 5 years from now with stocks because they are always in your face and prices can be volatile. It’s why active managers and retail investors like myself will underperform for the most part. With real estate, thanks to ridiculously high transaction costs, selling is more difficult. It is MUCH easier to enjoy your home, not think about the money, or let your tenants pay your mortgage and wake up 5 years from now. At least for me it is. That said, I’m diversified as I keep mentioning and telling everyone.

      I truly believe that most people will get in a heap of trouble if they have predominantly all their net worth in one place. Real estate acts as my dividend portfolio, which is why investing in more dividend stocks is suboptimal.

      • says

        I agree on your last point about not having all your net worth in one place. I need/want to get some exposure to real estate although I’m not completely sure if I want to be a landlord or not. As of now I think I’d like it, but there’s really only one way to find out. Of course there’s always the property manager route as long as the cash flow still makes sense.

  10. Max says

    For #3, I think an interesting variable of your scenario to consider using as well is net profit per year divided by your total current equity in and cost of the property. In your scenario, considering 18,000 / (down payment + closing costs). Let’s say you put 20% down (339,800) and an estimate for closing costs were 5%, or 84,950. Net yield initially would be 4.24% (18,000/424,750). This considers the leverage you are using instead of just using the total property value for a more accurate representation of your current yield off the money you are putting to work in the property.

  11. Terry says

    You’ve previously suggested that renters should pay a renters tax, wouldn’t that reduce your rental income since it would impair the ability of renters to pay rent?

    • says

      Not if there is a commensurate reduction in property taxes.

      With a Renters Tax, less renters would vote on more wasteful government spending. Less spending means less crowding out of the private sector through muni bond fund raising. As a result, demand for apartments would increase further as more jobs are created.

      Private sector > public sector

  12. says

    Your analysis is great! Using a 20-25% down payment, I would rather invest my money in an apartment building. You spread your risk and can increase income easier. I could buy a 12-15 unit building in a good area of Los Angeles for approximately the same price. I don’t have a particular property in mind so I cannot do the same analysis. Unlike a home or condo, the property will appreciate based on the income generated.

    • says

      This $1.7 million condo is for illustrative purposes, although it currently is live and in contract. Multi-unit buildings will definitely provide more income and yield that’s for sure. I’d only buy this condo to live, not so much to rent.

  13. moshennik says

    Good post, but I think you are forgetting a few things
    1) You can’t estimate 100% occupancy, even in a hot market you will not likely achieve it
    2) Your maintenance costs are very low for a high-end property like this. Especially when you are talking 7k/month rent, every time you have your tenant moves out you will spend 2x that much to clean and paint.
    I would say, based on what I am seeing this property is will lose you money for at least 5 years.

    • says

      This is why in my conclusion I write that I’m a buyer to live in the place at $1.7 million and that this place isn’t great for a rental return.

      Good you mention occupancy and you’re right for probably most of the country. I just did some analysis for my rental of 8 years and actually there has never been a day of vacancy with four tenant moves. Each leaves before the month is over and I’m able to get one starting the first of the month.

      Maybe this is a testament to proper management, or maybe the rental maaket is that hot.

  14. Matt says

    Great post Sam. One investor’s tip I learned a long time ago was to take the gross monthly rent and multiply by 100. If that figure is close to or greater than the purchase price, you should investigate further. Very close to the GRM, but a simpler calculation to make on the fly.

    This has served me well and I think is particularly useful for volume investors who might be looking at multiple properties on a weekly basis.

    • says

      Hi Matt, you must not live in a very expensive place with lots of good value!

      If I took $7,000 X 100 for this condo example, I’d only have $700,000 vs. an asking price of $1.7 million!

      I’d buy at 100X monthly rent any day for sure!

      • Matt says

        I almost added that caveat! My experience is in NH and the Boston suburbs. Buying in Boston proper leads to multiples closer to San Fran and New York.

        I actually prefer these mid-market areas. In 2009, I bought a 2 unit in Salem, MA for $265k, right next to a college and stable renting population. Gross rents are $2,700/month and if I wanted to be more aggressive I could probably get an additional $200-300 monthly.

        Works for me and allows me to buy more properties down the road!

  15. says

    Hello Matt, I’m really thank you for sharing this. I’m planning to try real estate investing when I have my own job and have saved enough money. I know that it’s early for me to plan things like this one but this article will help me a lot in the future. Kudos!

  16. says

    Good stuff, Sam. Good stuff. If this doesn’t go viral, I don’t know what will. This is a burning question in just about every wannabe real estate investor’s mind. I hope other big name bloggers give you love in their round-ups.

    • says

      Highly doubt this post will go viral as it’s too useful focused to be popular. Gotta have some fluff and humor cause who wants to go so much into detail about investing in one of the most important asset classes to build wealth? Miley Cyrus and Lindsay Lohan coming up next!

  17. says

    I am pretty far from owning rental property but huge fan of the post (I was a lot closer before I used most of my cash to buy our new place a few months back lol). Question, and I think this comes to maybe what you and DGI were talking about…

    With a cap rate (i.e. income flow) of 1%ish…why go through the hassle of owning property? I know I am missing something but I can’t put my finger on it. Is it the capital growth portion but you get that with stocks also? Is it the fact you are only putting X% down so you are using other people’s money? what is it?

    • says

      Yep, capital appreciation with leverage would be the main reason. The rental income for my main property was simply used to pay for the holding cost. If I was cashflow positive, then great, but the income is insignificant in the beginning. Fast forward 10 years later, the income is significant now, which is great in this low interest rate environment. What I’m more pleased with is the value.

      It all depends on where you are in your life. As a retiree, I now appreciate more the cashflow. As a young gun looking to build my financial nut, I was way more interested in capital appreciation since I had a job.

      The key while young is to take some risks and build the nut. There are two investment classes for properties: Landlords or Investors.

  18. Ryan says

    Should we use market rate or price we paid when calculating? It’s hard to say what the true market rate is. I know Zillow was way off and undervalued my house by 40k.

  19. john says

    Sam, If you run the numbers using only the down payment would it not be a totally different rate of return? Not sure why you calculated as if you are using 100% down payment.

    Or maybe I am missing something?

  20. Chris says

    I see this all the time. Management and vacancy need to be considered as well or your life will be filled with regret. Both vary with the investment, but figure 5%-10% of gross rents on both. The approach shown here is too optimistic in my opinion. To anyone reading this and thinking real estate is a good way to go, I recommend you start with the “50% rule” and a long time reading biggerpockets.com before jumping in!

    $1,000 / year maintenance on a 1.7 million dollar condo? You’ll spend more than that on bathroom remodels alone over time!

    • says

      Too optimistic? I would be willing to pay $1.85 million and the place sold for $2.3 million.

      Can you tell us about your real estate portfolio and your real estate experience so we get a better understanding of where you are coming from?

Leave a Reply

Your email address will not be published. Required fields are marked *