Why is a focus on identifying solid cash on cash return is so vitally important?
In real estate, it is commonly accepted that you make your money when you buy a house. Choosing the right property takes a combination of patience and the ability to react quickly. Reacting quickly requires decisive actions and therefore we try to simplify the variables that we evaluate when looking at a rental property.
Evaluating the Neighborhood
The first that we do when considering purchasing a property is to evaluate the neighborhood. This can be done via a multitude of sources. You can check Niche, crime statistics, and even look at Zillow, Redfin, and Realtor.com to learn more about the neighborhood.
You want to find the neighborhoods that have high desirability ratings – and the goal is to find the worst house in the neighborhood.
Personally, we like to go to the neighborhood and use a subjective test. We ask ourselves if we would feel comfortable to let our girlfriend/wife/mom live in this rental property alone. If the answer is yes, then usually we feel comfortable moving forward with the investment analysis – if not; then we save the time and usually stop analyzing at this point.
Other options to evaluate a neighborhood when buying a home include speaking to the law enforcement officers in the area, as well as speaking to the neighborhood watch.
You can also call up local landlords (find them by looking for homes for rent) and asking them about their experiences being a landlord in the area. Don’t be shy because most people in real estate love speaking about real estate.
After this stage, we will run a quick analysis and look at some of the costs associated with buying a rental.
Let's start by talking about the easy part when analyzing a rental property.
First thing’s first, let’s figure out how much we are going to make every month in rent since that is the whole reason that we are looking at investing, right?
There are a few common ways to determine expected rent, and they should all be employed in some form before purchasing a property to make sure you have the most realistic expectations possible.
Ways to Estimate Rent
- Check Comparables: You can do this by going to Zillow, Redfin, Craigslist, etc.
- Call Landlords: Again, you can get a great idea of what to expect by calling local landlords and asking them about their experiences. If they don’t seem too receptive about sharing this information than you can pretend to be interested in renting their property.
- Call property management companies: Ask them what rent will be in the area that you are looking to buy.
Don’t forget that there can be great variability between rental properties and the rent that they command even within neighborhoods. For this reason, we like to talk to local property managers (PM’s) because nobody is going to be better informed on the situation than the local PM’s.
The purchase price is the agreed amount of the property. The mortgage amount will be the purchase price minus the closing costs and minus any seller concessions (a negotiation technique that allows for sellers to receive more money for their home in asking price, but then concede some of that revenue back to the homeowner usually in the form of closing cost assistance.)
Depending on your contract, the purchase price is usually only reflective of the home (and not any personal belongings), and the land that the home is situated on.
In real estate, there are a few rules of thumb utilized to estimate what a purchase price should be but the most essential one to remember is:
MAO = (ARV X 70%) – Repair Costs
Closing costs simply refer to the costs that are associated with purchasing the property. You can learn everything you’ll want to know about closing costs and what they are via our closing costs guide.
Overall, expect these costs to range from 5-10% of the purchase price of the home. Just know that you will need to pay this money out of pocket at closing – unless you are able to finance the closing costs, which you can speak to your mortgage broker about.
You may have additional financing costs depending on the loan and broker that you utilize.
Estimating rehab costs historically has been one of the most truly rough “estimates” real estate investors utilize when analyzing real estate investments.
Since estimating rehab costs tends to be insanely difficult, it makes sense why even seasoned real estate investors would utilize a Rule of Thumb to estimate rehab costs.
Similar to this chart, people have utilized formulas and blanket $/Sq. Ft estimates in order to get a number to plug into the formula to analyze real estate.
If you would rather a more effective way to estimate rehab costs, you can sign up for free for Nailed-It. Nailed-It contains more than 100 common rehab projects and has location-specific pricing to help you get the best hassle-free estimate for rehab costs.
How to Get an Accurate Rehab Estimate?
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Operational costs are the expenses that landlords incur managing rentals. These are unavoidable costs whether a rental property is vacant or not. The typical monthly operational costs are included in the picture of typical land lording costs in NJ.
Operational costs include:
- Property taxes,
- Property insurance,
- Operating expenses,
- This includes upkeep and maintenance to keep the property functional.
- Utilities required in common areas.
Operational costs do not typically include:
- Capital reserve savings,
- Property management costs as these costs are not necessary to the functionality of the rental property.
If you are budgeting for a period of time that you will not be collecting rent, make sure to budget for operational costs that will still accrue during this time.
We included a screenshot from our simple to use Nailed-It Rental Analysis that can be downloaded to utilize in conjunction with Nailed It.
To analyze the rental, you’ll have to figure out the following information:
Like I mentioned, estimating rehab costs is now hassle-free and easy at Nailed-It.
Go to the County Tax Assessor Website and dig around, you’ll find tax records on there. Be warned, these websites are generally outdated, slow and confusing. Enjoy.
Easy enough, call a few brokers and tell them about the home you’re thinking about purchasing and see what that will cost. Make sure to mention if there is a time period when the home is vacant for repairs as this will affect property insurance.
Property management fees usually run approximately 10% of Rent after vacancy is accounted for. Also, property managers will also charge 1 month’s rent for turnover between renters, which can really eat away at profitability. While you’re asking them about the estimated rent for your property you can also ask them about costs to manage that property.
This number will depend on the area. Again, you can ask local property managers or landlords and get a good estimate for vacancy costs in your area. 5-10% is a reasonable estimate for vacancy costs.
This is the cost to repair big ticket items such as the roof, the boiler, the AC, etc. When these items break it is a costly expense, and guess what, you know they are going to break eventually – so budget for them monthly and try not to touch this money because it will be extremely helpful on that rainy day when the AC breaks in the middle of the summer.
Real Estate Rental Analysis Results
So using the above rental property analysis costs guide, estimating accurate rehab costs using Nailed-It and filling in the required information in the rental property calculator, we are able to quickly make a decision on a rental property.
If the property passed your specific goal requirements, then time to make an offer and see if this property is a realistic opportunity. When making the initial decision to pursue property, there is no necessity to complicate the analysis – K.I.S.S.
When we are making the initial decision, we like to look at the Stabilized Cash On Cash Return. This number allows us to evaluate the property while keeping in perspective the amount of money that we have invested in the deal.
A Cash on Cash return in real estate is useful to us because it's a way to evaluate our returns with regards to the risk - the amount that we have invested is a literal risk that we have incurred.
A Stabilized Cash on Cash Return is the return on a rental property after the property has been renovated and rented. It's often utilized to analyze the rental income for a property that was once in distress and has recently been renovated. This is most often seen in the BRRR method.
The cash on cash return is calculated as follows:
- All Equity Invested: This usually consists of the Down Payment, Rehab Costs if out of pocket, Loan Costs, Closing Costs, Due Diligence Costs.
- Annual Stabilized Income: This is the amount of profit that the property will generate when completed.
Stabilized Cash on Cash Return Real Estate
Annual Stabilized Income / All Equity Invested
In the above data points, we know that our costs estimates are historically accurate and we are able to accurately estimate rehab costs.
By combining the use of the Nailed-It rental sheet combined with Nailed-It Rehab Estimator it is amazingly simple to analyze a rental property even on the go. Therefore, we are able to confidently analyze the property quickly and determine our Maximum Allowable Offer Utilizing Nailed It and the super simple Nailed-It Rental Analysis sheet.