How to Analyze Real Estate Deals to Find Cash-Flowing Properties
There are many reasons why real estate properties are valuable assets to add to your investment portfolio. Along with appreciation, diversification, and a hedge against inflation, real estate investments can generate monthly cash flow. Which is what many savvy investors are after.
Building a portfolio of cash-flowing properties takes time and due diligence. Seasoned investors know that generating real estate cash flow requires accurately analyzing deals. While it’s not an exact science, there are common things to look for so that you can feel confident in the investments you make.
Investors who choose to continue building real estate investment cash flow eventually settle into a process of analyzing potential investment properties that they can use repeatedly with minor tweaks depending on the type of property.
Knowing The Types of Cash-Flowing Properties
When you first get started investing in real estate, your mind may jump to single-family homes, but there are many types of cash-generating properties to choose from.
Multi-family properties: duplexes, triplexes, fourplexes
Apartment complexes
Townhomes and condos
Short-term rentals in vacation destinations
Mobile home parks
Turnkey properties
The more experienced you become, the more creative you will get with the kinds of deals you’re interested in. The sky’s the limit for real estate investors who can analyze a deal quickly and understand creative ways to finance real estate purchases.
Most investors start small and that may be where you’re at. The learning curve for accurately analyzing real estate investments can be steep in the beginning. Most people start with a single-family home or a small multi-family property like a duplex.
The way that you analyze these deals will vary. The value of a single-family home is typically based mainly on the price of comparable properties that have sold recently in the same area. While the value of multi-family properties is determined by how much income they generate.
Comparing Markets for Real Estate Cash Flow Potential
Before you start buying investment properties to generate real estate cash flow you will want to familiarize yourself with the market. In the past, it was difficult to invest in real estate outside of the market you live in. This is no longer the case. With virtual accessibility, it’s not uncommon for investors to own cash-flowing properties that they’ve never physically seen, in states they’ve never set foot in.
To invest outside of your immediate area, developing relationships with a few key professionals in the location you’re interested in will be important. Say you’re located in Seattle but want to invest in Des Moines. Finding an investor-friendly real estate agent and property manager would be a good place to start building a network of reliable individuals in that area.
Before you start putting in offers, you’ll want to analyze the Des Moines market and know some key information. The economic health of the area is an important factor. Are there jobs available in the area? If there isn’t work for people, they’re less likely to live there. Is there good infrastructure in place? Is there relative political stability in the area?
Knowing the median home price and the average rental rates in your market will help you make sound decisions. Regardless of the local market, ensure you are charging enough in rent to cover your costs. Many people forget to factor in all the expenses when they hear the rental rate. If you’re not making money after the expenses are paid then you don’t have a cash-flowing property.
Formulas For Analyzing Real Estate Investment Cash Flow
There are different ways to analyze potential investment properties. As I mentioned above, you will most likely find a specific analysis tool or formula that works best for you as you become a more seasoned investor. But when you’re just starting, it’s helpful to understand a couple of the popular formulas to compare and analyze properties.
The 1% Rule
To analyze the real estate investment cash flow of a rental property, the 1% rule is an easy rule of thumb. To know if a property you have your eye on meets the criteria you simply need to know the purchase price and the potential rental rate.
The formula is simple. Let’s assume you’re looking at a property that is on the market for $250,000. The formula looks like this:
$250,000 x .01 = $2,500
For you to purchase a $250,000 property and make it cash flow, according to the 1% formula, you would have to be able to rent it for $2,500 per month. With real estate costs soaring, it’s getting harder to find properties that meet this criterion but it’s not a bad starting point to keep in mind.
Cash On Cash Return
Cash on cash return is a more advanced metric than the 1% rule. But it is a great way to determine the potential profitability of a real estate property. It’s used to compare properties and find out how much of your initial investment you will be able to earn back each year. The formula looks like this:
(Annual Pre-Tax Cash Flow / Total Initial Investment) x 100% = Cash on Cash Return
If you’re buying a property that is already operating as a rental then you’ll know what the monthly rental rate is and can easily plug it into the formula. If you’re buying an owner-occupied, single-family home then you’ll need to make your best guess based on current market rates.
You’ll also need to know the expenses associated with the property so you can subtract them from the estimated rent to determine your annual pre-tax cash flow. Once you’ve entered all of the variables into the equation you’ll end up with a percentage for your annual return.
Cash on cash return is a good way to compare one property to another. Maybe there are a few different properties that you’re interested in purchasing as a cash-flowing property. Upon analysis, one property that appeared similar to the others may end up with a significantly higher rate of return. This is why running your numbers is such an important part of successful real estate investing.
Generate Real Estate Cash Flow With Chicago Trust Administration Services
If you’re ready to add real estate investment cash flow to your portfolio, you might want to consider using a self-directed IRA to invest. Using this type of account gives you the flexibility of managing your own investments while enjoying the tax benefits of a traditional IRA.
At Chicago Trust Administration Services, we understand that many people are afraid of the complexities and tax implications of taking advantage of this strategy. Our goal is to demystify the process for our clients so that you can make informed decisions that you feel confident with.
To see how we can help, we invite you to schedule a complimentary meeting with us by calling 312-869-9394 or emailing steve@ctasira.com.