One of the most important questions you’ll ever have to answer as a real estate investor is this:
It's a very important question, because your offer price has everything to do with your ability (or inability) to make money on a real estate deal. Offer too much, and you won't have a large enough profit margin. Offer too little, and the seller won't do the deal. Considering how important the offer price is, I'd like to provide a bit of explanation on the basic math I use to come up with this number for any given property. // The Importance Of PriceNo matter how you slice it, your offer price is going to play a major role in the overall scope of any transaction. With the right number, you'll have a grand slam deal on your hands. With the wrong number, you can lose yourself a lot of money in an instant. There are a couple of sayings that a lot of real estate investors like to throw around:
Well, guess what, both are true. If you make the right assumptions about a property's market value and have an accurate idea of what your closing costs, holding costs and improvement costs (if any) will be along the way, you can essentially write yourself an enormous paycheck, simply by choosing an offer price that allows enough room for your profit margin… however big or small you'd like it to be. How Most Investors ThinkMost of the people who flip houses and buy investment properties use something called the 70% Rule – perhaps you've heard of it. It's a simple mathematical equation where you take the anticipated value of a property (ARV or After Repair Value), multiply it by seventy percent (0.70), and subtract ALL costs along the way, which will give you your “maximum offer price” that you should consider for your subject property. As an example, if you think a property will eventually sell for $100,000, and you estimate that you'll have to pay $10,000 in various costs along the way, your equation would look like this:
Since you'll be paying $60,000 for the property and another $10,000 for various closing and improvement costs, your total investment will be approximately $70,000. However, since you're planning to sell it for $100,000 in the end, this means you'll have a net profit of $30,000. Want to run the numbers yourself? Give it a shot with this calculator. Of course, if you make any errors in your assumptions along the way, your net profit is also your margin of error. Fore example, if you end up selling the property at a lower price than planned, or if you fail to account for some huge costs along the way, those errors will eat into your profit margin, and could even cause you to lose money if your assumptions are wrong enough. The equation makes sense on paper. It's not a bad framework for making offers IF the market is trending upwards, IF your assumptions are perfect, and IF you really are able to sell the property immediately, it could work… but personally, I don't think it offers nearly enough certainty. How I'm DifferentWhen I was living through the great recession from 2008 – 2013, when real estate values in the United States were absolutely sabotaged, I saw too many people lose their shirts using this “tried and true” 70% rule. There is always an element of uncertainty with any real estate deal, and with all the wild cards that can come up in a real estate deal, 30% just isn't a big enough profit margin to make me comfortable. I need more. You see… a lot of the properties I buy are vacant lots, raw land and housing in C-class neighborhoods. When a real estate recession hits, these types of properties don't tend to sell quite as quickly when they're listed at “full retail value” (which by the way, is an incredibly subjective number to begin with). Unless I'm offering some kind of crazy incentive in the form of:
…I just don't think it's wise to rely on the 70% rule, because there's not enough profit and protection built in. To put it another way… I don't want to leave ANY possibility of getting hurt, regardless of whether the market changes or I've made some kind of judgment error on the property's fair market value. In my mind, the only way to get around this is to make offers that are way, WAY below market value. I'm talking 30%, 20%, even 10% of market value. You might think this kind of offer is crazy, but it's not a pipe dream – trust me. I make offers like this all the time and when you're reaching out to the right demographic of property owners, many people are happy to accept them. RELATED: Understanding the Motivated Seller It's just a matter of knowing how to find motivated sellers (which is a topic for another blog post). If you want to see my take on how I run these numbers, this video explains my approach. As you can see, it follows a different logic than the 70% Rule. Rather than giving me a wide range of percentages to base my offer on, it forces me to stay FAR below 70% (and frankly, I think 40% is too high for most of the vacant land properties I purchase – I generally keep my offers within the 10% – 20% range, depending on the market value). It's important to note that the market value you determine for this property is a very, very important number. If you get this number wrong (particularly, if you set it too high), it will completely screw up your results. As with any calculator, the quality of your outputs are only as good as the quality of your inputs, so make sure you have a reasonably accurate ballpark idea (at the very least) of what the property is worth. This is NOT the time to simply “wing it” and guess on the numbers without doing some research. RELATED: The Real Estate Investor's Guide to Valuing Vacant Land The beauty of it is, if I know my goal is to make an ROI of at least 100%, or if I have a specific number I need to hit as my Net Profit, it's very easy to adjust the numbers (whichever ones have the most flexibility) until those numbers fall where they're supposed to… and if I can't get the numbers to work, I walk from the deal. It's that simple. Base Your Offers On Math, Not EmotionWhat I love about this calculator is that it tells me in very plain terms what the consequences of my numbers will be – for better or worse. If I'm going to stick to my business model and keep my emotions out of the equation, I need to make sure my Net Profit and ROI fall in line, and this all starts with finding a reasonably accurate market value for the property, and keeping the offer price in the acceptable range. This approach help keep my emotions in check, so I can make my decision based on what the data says. Am I going to miss out on some opportunities because my offer prices are too low? Absolutely. Am I willing to compromise my business model just because I'm worried a seller might not accept my offer? Absolutely not. Am I going to break my own rules and bump up my offer price just because I “fell in love” with a particular property? Um… are you kidding me? YES – I have to play the numbers game and send out a lot of offers. Do I hear the word “No” a lot more than I hear “Yes”? Of course! But what do I get in return? I get peace of mind. When someone does accept my offer – I get to be 1,000% SURE I'm holding the deal of a lifetime in my hands. And it's worth the effort! When we stick to our guns and make data-driven decisions, we can reap some huge benefits. If there's anything I've learned about real estate investing, it's that data-driven decisions beat emotion-driven decisions every time. The post How Much Should You Offer For That Property? appeared first on REtipster. from https://retipster.com/offerprice/
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Two years ago, I put together a blog post and video explaining how Fundrise works. Quick Recap: Fundrise is a real estate crowdfunding platform that allows people to invest smaller amounts of money (as little as $500) into eREITs. Essentially, it's like buying into a “pool of real estate”, rather than tying up all of your investment dollars in one single property. Back in 2017, I decided to invest $1,000 of my own money into the site while also recording the process and showing people how it worked. You can see the original video here. After posting that video, some of the more common questions I heard from people were,
I thought these were all valid questions, so I put together a one-year follow up video to show people how the results turned out. You can see that blog post and video here. Of course, the performance of my investment doesn't necessarily dictate what YOUR returns may look like (because every eREIT performs differently) – but it does offer some insights on how Fundrise performs as a company – specifically in comparison with other investment options like the stock market, mutual funds, or some of the other real estate crowdfunding websites out there. RELATED: Today's Top Real Estate Crowdfunding Websites So – for what it's worth, I just put together ANOTHER follow-up video to show what my returns have been, now that Fundrise has been working with my money for 24 months. IYou can see it here… Disclaimer: The information contained herein neither constitutes an offer for nor a solicitation of interest in any securities offering; however, if an indication of interest is provided, it may be withdrawn or revoked, without obligation or commitment of any kind prior to being accepted following the qualification or effectiveness of the applicable offering document, and any offer, solicitation or sale of any securities will be made only by means of an offering circular, private placement memorandum, or prospectus. No money or other consideration is hereby being solicited, and will not be accepted without such potential investor having been provided the applicable offering document. Joining the Fundrise Platform neither constitutes an indication of interest in any offering nor involves any obligation or commitment of any kind. The publicly filed offering circulars of the issuers sponsored by Rise Companies Corp., not all of which may be currently qualified by the Securities and Exchange Commission, may be found at www.fundrise.com/oc. We’re into real estate investing. We're also into keeping it real.Some of the links in this article help to financially support this website, but the real-world guidance is all REtipster. As you can see – my original $1,000 investment (with all dividends automatically reinvested) have earned a pretty steady 11.4% over the past year, and it has average the same amount since I first invested the money. This screen shot above was taken on April 11, 2019 – just a day after receiving my Q1 dividend for the year. Here's a quick snapshot of EVERY dividend I've received since I got started 2 years ago:
When I first set this up 2 years ago, I told Fundrise to automatically reinvest all of my dividends (rather than sending them to my bank account), which is why the portfolio value has grown like it has (rather than just staying at $1,000). After looking at my portfolio positions, I did find it interesting that even though I originally chose to invest in the East Coast eREIT, my dividends had been invested in other eREITS. Fundrise presumably reinvested these dividends into other eREITs because the East Coast eREIT met its fundraising goals and wasn't taking any more contributions. In any event, it doesn't seem to have hurt the performance at all. Now, I know what you're thinking – 11.4% isn't a staggeringly high return. One could certainly do better by going through the work of finding, analyzing, buying, improving and selling a property on their own… but on the same coin, doing everything yourself takes a lot more time, energy and effort. It's definitely NOT passive to do it all one your own. The returns I've earned with Fundrise have required virtually nothing from me, aside from the 5 minutes I spent deciding which eREIT to invest in, and the inherent risk that the returns might not pan out according to plan. Another important point worth noting is that my $1,000 principal investment with Fundrise is basically tied up for 5 years (give or take), so the earliest I'll be able to get my money back is about 3 years from now. I also don't have any control over which properties are included in the eREIT funds I'm invested in, how those properties are managed when they're sold off, etc. I'm putting a lot of trust in the folks at Fundrise to manage my money with prudence. So far, it looks like they're doing a good job – but only time will tell if it remains this way over the next 5+ years. Have you invested your money with any real estate crowdfunding companies? How have your investment dollars performed? Let us know in the comments below!The post My Fundrise Investment – Two Years Later (2019 Update) appeared first on REtipster. from https://retipster.com/fundrise2019/ 039: How to Quit Your Job and Make $20000/mo in the Land Business Interview w/ Willie Goldberg4/15/2019 Willie Goldberg has been on my radar for a while now. In less than two years, this guy has built his land flipping business up to 95 notes through seller-financing, he's averaging over $20,000 in monthly revenue and he actively buys and sells 15 – 20 properties per month. I don’t know many people in the land business who are doing this well, especially when you consider that he’s only been at it for two years. Willie dishes out a ton of details on how he's been able to reach this level in such a short amount of time. You might be surprised to find that even though it takes a lot of work an investment, this kind of success is more achievable than most people think. Links and Resources
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Thanks again for joining me this week. Until next time! Right-click here and “Save As” to download this episode to your computer. The post 039: How to Quit Your Job and Make $20,000/mo in the Land Business – Interview w/ Willie Goldberg appeared first on REtipster. from https://retipster.com/039-willie-goldberg/ There's a major problem almost every real estate investor has to deal with in their business. It's the problem of getting financing for your deals. Having access to funding is a huge issue that affects just about everyone in the real estate industry. If you've been active as real estate investor for any length of time, you've probably dealt with it too. A few months ago, I discovered a new way to get “interest free” short-term financing through a company called Fund and Grow. In episode 35 of the REtipster Podcast, Seth and I interviewed Mike Banks, COO of the company, and we learned a lot about how they're able to help all kinds of people (including real estate investors) get access to working capital. In this interview, we talked about how this kind of short-term financing works, and everything this company does to make it happen. Now, what I'm about to share with you in this blog post isn't just hearsay. I actually applied with Fund & Grow recently and got approved for a lot of money. It really worked! So, let's get into the specifics. How Fund & Grow WorksBefore we dive into my personal experience with them, I'll give you a quick overview of what Fund & Grow actually “does”. To put it simply, Fund & Grow is a company that applies to several different 0% interest credit cards on your behalf, and they do this through a power of attorney, signed by you. Once you're approved for one or more of these credit cards, they coach you on how to use the money available and put it to work. They do this through a company called Plastiq. Fund & Grow has a team of trained staff that negotiates with various banks to increase the credit limits as much as possible and they conduct a total of four rounds of applications on your behalf per year. To enlist their services, you pay them an annual fee of $3,997 (note: if you go through our affiliate link, you'll get a $500 discount that brings it down to $3,497). This annual fee will include all four rounds of applications, so if you continue working with them repeatedly, you’ll have to pay them again for each additional year you work with them. Fund & Grow will typically apply for business credit cards (not personal credit cards). This means the balances shouldn't show up on or affect your personal credit report – which can be a significant benefit (there is a slight caveat to this, but I’ll dive into that under the “What They Don’t Tell You” section). In my case, their goal was to get me and my wife $100,000 each in 0% interest credit limits within the first year (again, I know this sounds too good to be true, but that’s why I tested the waters first before posting about them here). With a few caveats, we can essentially use this money for whatever we want. As a real estate investor, my intent was to use this money to buy real estate – but many of their customers (e.g. – doctors, lawyers, small business owners) use it for things like purchasing inventory, paying for initial marketing costs, and a lot more. Unlike a mortgage or auto loan… the lender isn't standing over your shoulder and dictating what you can and can't spend it on. There is a TON of flexibility with this type of financing. Is This Really Legit?If you're anything like I me, the whole idea of interest-free financing might sound a little “scammy” and too good to be true. I’m not going to lie, I was very skeptical of Fund and Grow at first. At the same time, I first heard about them from Seth, and he is VERY strict about who he stands behind. I remember during the interview, I thought to myself,
I wanted to get to the bottom of it, so I took it upon myself to scope them out and go through the entire process from start to finish to see if they could really deliver on what they promised. A few months later – I’m happy to report that they not only delivered, but they went above and beyond. This blog post is my official report of my experience of working with the company. REtipster provides real estate guidance — not tax or investment advice.This article should not be interpreted as financial advice. Always seek the help of a licensed financial professional before taking action. My Experience with Fund & Grow in 6 StepsLet’s talk about what my experience was like working with them. 1. The Sign UpAs I mentioned earlier, we have an affiliate link with Fund and Grow that saves you $500 off of their $3,997 fee: When I signed up, I filled out the prompts at the link above and then worked directly with the staff to set up a consultation meeting from there. 2. Consultation MeetingPrior to the meeting, a Fund & Grow representative had pulled my credit and said it looked like something fishy had come up, related to a paid medical bill that was showing on my credit report as “Unpaid”. They suggested I bring my wife along to apply with me (I’ll speak on this more later, but they actually helped me identify some major issues on my credit report that shouldn’t be there – which I thought was very cool). I also had my wife fill out the prompts from that pre-qualifying link and for the rest of the process, they primarily used her information for the applications. During the consultation, we determined it was best for our situation to use a “mixed” application approach, which means we applied for both business and personal credit cards. My wife doesn’t have a business in her name, so they set her up with a sole-proprietorship for free so that they could apply for business credit cards on her behalf. 3. Complete Application, Sign Power of Attorney and Upload Requested DocumentationAfter the consultation, they sent us a few emails requesting certain items to be uploaded and an application to be filled out via their online portal. The application asked some basic financial questions and then their system prompted us to upload the signed copy of the Power of Attorney so they could function as “us” legally, both with the applications and with the negotiations. Fund and Grow functioning as “You” is 100% ethical, just as long as you agree to give them power of attorney. They take handling the communication with the banks so seriously that they discouraged us from answering ANY calls or responding to ANY emails that came in from the banks. In one of the emails they sent me after the consultation, they attached several items that covered an overview of their plan for my wife and I and options on how to use our credit lines after the first round of applications was completed (more on that later). Included in these documents was a questionnaire that asked a lot of personal information, so that when the banks would try to verify “our” identity, Fund & Grow would know how to answer their security questions on our behalf. The list of items they requested of my wife and I were as follows:
4. We Let Them “Do Their Thing”After all of that, the largest part of this process was to sit and wait while Fund and Grow applied for credit cards and negotiated the credit limits. From start to finish, it took a total of 55 days from when we first applied to when our first round of applications were complete (From 01/12/2019 to 03/07/2019). Any mail, email or voicemail that came from the banks while Fund & Grow “did their thing” was either scanned and emailed or sent to our Fund & Grow representative via text message. 5. 0% Interest Credit Cards Came in the Mail!During the wait, 0% promotional credit cards started to trickle in the mail and each time they did, I was instructed to update our Fund & Grow representative about the arrival of the welcome letter and which bank issued the card. I was told not to use the cards until the first round of applications was completed. In total, we were granted five cards:
The total balance available was $34,900. So in summary, with the help of Fund & Grow, I turned $3,497 into $34,900 at 0% interest in 55 days. And this is just round one! We still have three more this year… it’s pretty incredible! 6. I Used a Portion of the Credit Line to Purchase Real EstateMy trial run of Fund & Grow wouldn't be complete without actually buying real estate with this funding. So I purchased a total of four land deals on two credit cards, and I did it through Plastiq.com. Before I dive into Plastiq and why I ultimately chose them as my method of liquidation, I want to be very clear that they are not the only way to convert your credit cards into usable cash. Fund & Grow even provides a “Cash Acquisition Strategy Handbook” that gives 9 different examples of how you can do it. After an in-depth conversation with a friend who introduced me to the world of credit-card arbitrage, I found there are even more ways to liquidate your credit cards than what Fund & Grow suggests. For the sake of simplicity, I’ll provide my suggested top three here: 1. Manufactured SpendingThis is where you buy several maxed out visa (or equivalent) gift cards and then cash them out. There are several retailers that will cash out visa gift cards (Simon Malls is one of the major ones). There is a “transaction fee” of sorts, because you have to pay out-of-pocket for the gift cards and then there are processing fees charged by the retailers who cash them out. The biggest problem with this approach is that it's tedious and time-consuming. Visa gift cards have a $500 limit, so you have to buy several of them at once (at least for real estate purchases) and then you have to physically go to a retailer to cash them out. A lot of retailers will also have a cap on how much cash they’re willing to give you each day (Simon Malls has the largest cap that I’m aware of at $25,000 per day). 2. Credit Card “Convenience Checks”Many of the banks that issue these 0% promotional credit cards will also allow “convenience checks” to be issued against the credit limits of accounts in good standing, for a minimal processing fee (usually around 3% – 4%). These are great if you can get them because you can simply cash the checks in and put the funds in your account. They generally coincide with the 0% APR promotion of the card as well. The problem is that not all banks or credit cards will issue these with the same promotional benefits (if they issue them at all), so you need to call your bank to find out if they will provide these or not for your specific card. Additionally, 3% – 4% when buying real estate is pretty good, but there is one option that’s better. 3. PlastiqPlastiq.com is an online service that allows you to add a payee and pay them for almost anything (including real estate purchases). The major restriction is that you can’t pay yourself using Plastiq. However, as long as you can prove you’re paying someone else for services rendered… they’ll allow you to use your credit card for almost anything – including mortgage or rent payments, utility bills, business payroll and more. You have three options on how you send out money:
The best part? They only charge a 2.5% transaction fee. Ultimately, because of the convenience and affordability, it was a no brainer for me to go with Plastiq. I gave all three payout options to my sellers, and they all unanimously chose to have their money come in through a wire transfer. Now I will tell you, Plastiq is a little annoying to work with. They require significant proof that you’re not paying yourself or doing anything unethical. Because a lot of the credit cards I got from Fund & Grow are in my wife’s name, the underwriting department at Plastiq literally made me take a picture of her, holding her driver’s license next to her face, in order to prove her identity. For real estate transactions, they asked me to send them a copy of the purchase agreements and the deeds before they would release the funds. I don’t know if this was because I’m a new account or if it’s simply their standard practice, but when you have sellers expecting funds, having to wait for underwriting’s approval was a little nerve-racking! Ultimately, all four of the properties I purchased had the wire arrive within 24 hours or less, even with all the underwriting requirements. I plan on using Plastiq a lot in the future – but if you decide to use them, just expect that they will ask you for thorough documentation before releasing funds. As long as you are prepared for that and can prepare your seller for a real estate transaction, you should be good to go! What They Don’t Tell YouBefore we end this post, I wanted to take a moment to share with you some insights I found interesting that Fund and Grow didn't make “abundantly clear” to me on the front end. 1. Any type of financing arrangement involves risk, and it's not right for everyoneNo matter how you slice it, debt is debt. Using credit cards to purchase anything, let alone REAL ESTATE, is a big risk. Both Seth and I want to make it crystal clear that if you struggle with financial responsibility when it comes to credit cards, you should not use Fund & Grow. The fastest way to financial ruin is to mismanage credit card debt. So please. PLEASE. Proceed with caution. If you don’t pay off the balances of these credit cards within their allotted promotional period (usually around 12 months), the APRs can jump to 24% overnight! Think of Fund and Grow as a short-term solution where you will need to either re-sell the property or refinance the loan quickly after you purchase. You should also be aware that, even though these cards are at 0% interest, they still require minimum monthly payments (usually around 1% of the outstanding balance), so you need to be financially prepared to cover those payments. That said, if you can be responsible and understand the risks you face, then using Fund & Grow is great for most transactional real estate investing: Flipping Houses, Wholesaling, Buying and Selling Land etc. It could even work with a rental property if you can get an equity line of credit large enough to pay off the credit card balance within 6 – 12 months of buying the property (but there is never a guarantee with this – so, again, please be cautious!). Just be careful and fully understand the risks you face if you decide to sign up with Fund & Grow. 2. Credit Inquiries DO Show Up On Your Personal Credit ReportA lot of the advertising Fund & Grow puts out says they can get you these 0% interest credit cards, and they won't affect your personal credit report. While this is mostly true, it's important to note that the credit inquiries that are run during the application process do show up on your personal credit report. Now, a credit inquiry is NOT the same as the credit card balance. An inquiry simply shows evidence that a lender pulled your credit report (which implies that you've been trying to get financing elsewhere). What’s nice though, is that Fund & Grow has an in-house service that can help you remove these for an extra fee if they become a problem. If you don’t want to pay them for it, then they’ll happy coach you on how to do it yourself – in fact, it’s a necessary step they'll need to conduct during the next round of applications. For me, they even took it a step further and outlined all the major issues I needed to settle with the credit bureaus conveniently in an email. They also provided me with templates to use when communicating with them and if I didn't want to handle this on my own, they also have connections with a credit repair company that they’ve vetted and partnered with, who I could hire to do everything for me. 3. There's a $50 “Newsletter” Subscription They Automatically Add You to When You Sign UpThey do disclose this in the consultation meeting, but it’s pretty easy to forget. The Newsletter subscription does come with some perks. With the 12-month membership, you get a 7 day/6 night accommodation anywhere within the U.S. and other countries abroad each year, no strings attached. BUT for me, I know I would never use this, so I had to make sure I didn’t forget to cancel it, and if this isn’t appealing to you, you’ll probably want to do the same. 4. You Can Do What Fund and Grow Does And Cut Out the Middle ManWhat Fund and Grow does is a huge convenience, but it's not something you couldn’t do yourself. It would be quite time-consuming and would require a lot of organization, but you can simply search online for “0% promotional credit cards” and then do a round of applications yourself, learn how to clean up your credit and then rinse and repeat. In fact, there is a whole world of travel enthusiast who do something very similar (and blog about it), but instead of focusing on 0% promotional cards, they focus on travel reward cards instead. For me, the biggest appeal of Fund & Grow is that it's convenient. I don’t have time for a new hobby to figure this out on my own, so I plan on using them for years to come. My ConclusionI really like Fund & Grow as a company. Their services is a great solution for a lot of real estate investors who are short on working capital and need access to short-term financing WITHOUT being forced into partnerships that cost them most of their profits or conventional loans with much more harder requirements and take significantly longer to get approved. In an effort to vet out Fund & Grow, I went through the process from start to finish, and the proof is in the pudding: I now own four properties I bought at 0% interest through their system. Based on my experience, Fund & Grow has my endorsement and I hope other real estate investors and entrepreneurs find this review helpful. Again: this are not the right fit for everyone. So proceed with caution. However, for the right person who knows how to manage this kind of financing, they’re an AWESOME solution. Get Prequalified With Fund & Grow Have you had any experience with Fund & Grow? What was your experience like? Let us know in the comments below!The post My Experience with Fund & Grow: 0% Interest Loans for Real Estate Investing and Beyond appeared first on REtipster. from https://retipster.com/fundandgrowreview/ Selling a home can be an exciting but complicated process, whether you’re the seller or the agent. When you get an offer, it’s easy to get carried away and think, “This is it!” Unfortunately, not everyone who puts an offer on the table is truly serious about buying. Some may just be testing the waters, while others may get cold feet as closing draws near. There are also those who are “perennial shoppers” – they like looking around for options but know deep down they’re not really ready to make the big move. How do you know if you have a serious buyer? Here are the signs to watch for:
If you want more home buying or selling tips, check our blog for similar resources, or get in touch with us at 1.800.979.5799. The post Spotting a Serious Buyer: What to Watch Out For appeared first on Best Real Estate Websites for Agents and Brokers. from https://www.agentimage.com/blog/spotting-a-serious-buyer-what-to-watch-out-for/ // initIframe('5c89620ba453045023fb9c2f'); // REtipster provides real estate guidance — not tax or investment advice.This article should not be interpreted as financial advice. Always seek the help of a licensed financial professional before taking action. Capitalization Rate – or “Cap Rate” for short – is one of those terms that needlessly intimidates new real estate investors. Don’t be daunted! It’s actually a very simple concept, and you can master it in under five minutes. Here’s what new investors need to know about cap rates, how to calculate them, and even a couple of handy calculators to run the numbers for you (you can see an ultra-simplified version above, and a more advanced version of this calculator below). What Is Capitalization Rate?A cap rate is simply a ratio of a property's income over its cost or value. It’s one way of measuring the rate of return for an income-producing property such as a rental property, apartment building, office building, or other commercial structure. The cap rate is the answer to a fundamental question:
Another way to think about cap rates is annual yield, similar to the dividend yields for stocks. How Are Cap Rates Calculated?The math behind cap rates is simple enough:
Again, it’s just a ratio of income over cost. But both components in the equation need some further explanation. Net Operating Income (NOI)Net operating income (NOI) is the total annual income a property produces after vacancy and expenses. In other words, gross rent minus expenses. Annual Gross RentTo do this, we start by considering what the subject property could generate in a perfect world, if it was 100% occupied all the time. Then we would subtract the anticipated vacancy rate. For example, if a property could generate a maximum of $10,000 per year, but we expect it to have a vacancy rate of 10%, then the most it can actually generate each year is $9,000. $10,000 rent – 10% vacancy rate ($1,000) = $9,000 annual gross rent Another way to run the same calculation would be: $10,000 – (10,000 x 0.10) = $9,000 or $10,000 x 0.90 = $9,000 You get the idea. Annual ExpensesThe next step is to subtract the annual expenses. This includes all the anticipated things that will drain your bank account each year. For example:
One expense that’s NOT included when calculating the cap rate is financing costs, such as mortgage principal and interest payments. Cap rates do not include loans or leverage. They analyze the raw income over the raw cost of a property. Market Value or CostA property's cap rate can be calculated based on either the current market value of a property or the cost you can acquired it for – and these two things aren't always the same number. A property may be worth $600,000, but if you know you can acquire it, cover all closing costs and pay for any immediate repairs for $500,000, then THAT becomes the more relevant number to use. Ultimately, the most useful way to calculate cap rates is by starting with:
ExampleSuppose you're able to buy a small apartment building all-in for $500,000. You then set about calculating the net operating income for a year: Annual Gross Rent: $80,000 – 5% vacancy rate (or $4,000) = $76,000 Annual Expenses:
Net Operating Income: $49,600 Therefore, the cap rate would be: $49,600 / $500,000 = 9.92% Try running it through this calculator to see if you get the same thing! // initIframe('5c89620ba453045023fb9c2f'); //
Why Do Cap Rates Matter?Cap rates are useful as a quick way to estimate returns on any particular property. Oftentimes, real estate investors and real estate brokers will quickly reference this particular number (rather than the cash on cash return, the return on investment, the internet rate or return or any other number of ratios). Why do they focus on the Cap Rate? Because this number is not affected by the financing terms of the property. Whether an investor buys the property for cash, whether they put 10% down, or whether they put 25% down – the Cap Rate will stay the same. Cap rates are also a great tool to help you compare two different properties using an objective measure. Imagine you have a choice between buying two identical properties, across the street from each other. If one offers a cap rate of 7%, and the other 9%, then all else being equal, it would make more sense to buy the property offering the higher cap rate. Of course, all else is never equal in the real world. One property may be occupied with less reliable tenants, most of whom will need to be replaced with better quality renters or the other property may need significant repairs soon, or may feature a more desirable location, or may come with more land. While a cap rate by itself never tells the whole story, you can think of this number as a quick way to compare property returns. While a cap rate by itself never tells the whole story, you can think of this number as a quick way to compare property returns.Click To TweetJust remember that cap rates are the beginning of your due diligence, not the end. Shortcomings of Cap RatesThe simplicity of a cap rates proves both an advantage and a limitation. By removing interest and financing-related costs from the equation, investors can use cap rates to compare the “raw” income returns between two properties, but don't assume that cap rates tell the whole story. One piece of the puzzle that cap rates ignore is the difficulty that may arise in property management and rent collection. Two properties might have the exact same cap rate, yet one could be in an upscale neighborhood, populated by reliable residents with high credit scores, and the other could be in a slum, where late rents and defaults are the norm rather than the exception. Along with higher default rates, low-end rental properties also tend to suffer from greater wear and tear. Crime could prove a problem as well – another reality of some rental properties that cap rates fail to capture. Then there are the financing terms. Interest and closing costs do matter, as does the amount of the down payment. Which is why many investors use cash-on-cash return in addition to cap rates. Cash-on-Cash ReturnUnlike cap rates, the cash-on-cash return is a ratio of the actual net profit received over the actual acquisition costs – taking the full financing picture into account. When a property is acquired with financing (as most are), the annual net income will also account for all loan payments. Furthermore, the cash-on-cash return will reflect the buyer's personal out-of-pocket expenses. This includes the buyer's down payment, closing costs and any other costs the investor incurred while getting the property in rent-ready condition. Cash-on-cash returns reflect your personal return on investment only from your own cash, rather than the property's theoretical return. Example: How Financing Costs Impact Cash-on-Cash ReturnsLet's say you find two properties available at an identical price of $500,000 and the same cap rate of 9.92%. Yet, when you discuss the two properties with your lender, they offer to lend 75% of the purchase price of Property A, and 80% of the price of Property B (both with a term of 30 years and an interest rate of 7%). That means your up-front cash investment is $125,000 for Property A, and $100,000 for Property B.
After you subtract out the ongoing mortgage payments for each property…
Here’s how the two cash-on-cash returns compare:
Both properties have a cap rate of 9.92% Yes, the mortgage payment is higher for Property B, but because you wouldn't have to inject as much cash upfront, but your cash-on-cash return would be higher. If we look at cash-on-cash return as a measure of how hard your cash is working for you – your money would be working harder with Property B. If you want to take a more in-depth look at an investment scenario – in a way that will accounts for financing terms, and will also show you the cap rate AND the cash-on-cash return for an investment property, this advanced version of the Cap Rate calculator will allow you to input a lot more details, and will also should you much more detailed results. // initIframe('5c9924c471b41809d4512129'); //
How to Improve Cap RatesAre cap rates written in stone? Is there anything you can do as an investor to improve a property’s cap rate? First, and most obviously, paying less for a property will improve its cap rate. RELATED: 10 Real Estate Negotiation Tactics to Score the Best Price on Properties But paying less for a property isn’t the only way to improve its cap rate. Another option is to raise the property's annual net income. This can be done in many ways. An obvious approach is to raise rents (if current rents are below market rates). Another way is to make improvements to the property, so it can justify a higher rent price. But keep in mind – investors can also raise their net income by reducing expenses. For example, an investor could use preventative maintenance to reduce repair costs. They could find ways to make their units more energy-efficient and/or reduce their utility costs if they include utilities with the rent. Example: How to Improve Cap RatesTo continue the example above, say you have your heart set on a cap rate of 12% and the property’s numbers are coming in at 9.92%. You could reach 12% by negotiating the seller down to a purchase price of $413,333 ($49,600 / $413,333 = 12%). Suppose the seller will go as low as $450,000, but not all the way to $413,333. In that case, you could turn to raising the gross rent as well. To reach a 12% cap rate, you need an NOI of $54,000, rather than the $49,600 the property earns currently ($54,000 / $450,000 = 12%). This means you need to find another $4,400 in income each year. You could approach your property manager with an offer:
They agree to drop their total fees to equal 8% of revenues – an annual savings of $1,600. With a thorough market analysis, you discover that there’s room to raise rents and add another $2,800 a year in net revenue. Congratulations! You now have your 12% cap rate. What’s a “Normal” Cap Rate?A “normal” cap rate can vary widely, depending on the property type, the real estate market, the investor's negotiating power, and a lot of other factors. Most real estate investors would consider a 12% cap rate to be on the higher side of normal. Generally speaking, the better the neighborhood, the lower the cap rate, because the headaches and hidden costs of property management are also lower. In lower-end neighborhoods, you can often find high cap rates on paper, but be prepared to work harder for every cent of rent you collect. As a sweeping generalization, a normal cap rate could be as low as 4% in the best areas, and up to 10% or higher in lower-end districts of town. Here's how cap rates have looked in the US over the last five years: Final WordCap rates are a useful shorthand calculation. You can do them on the back of a napkin in 30 seconds, assuming you have accurate numbers at your disposal. The simplicity of the cap rate makes it an easy metric to use, especially as a yardstick to quickly compare returns between two properties. However, it's simplicity also means its usefulness is limited and doesn’t tell the full story about a property’s returns. Don’t confuse cap rates for actual returns. The two are related, but not identical. Use cap rates as one metric among several to get a sense for a property’s returns, and always run cash-on-cash returns in addition to cap rates before making an investment decision. The post Cap Rate Calculator: What it is, why it matters, and the formula to find yours. appeared first on REtipster. from https://retipster.com/cap-rate-calculator-what-it-is-why-it-matters-and-the-formula-to-find-yours/ Have you ever heard a profoundly inspirational quote that just blew your mind? I'm always amazed when I hear people who can deliver an incredibly impactful message in just a few words. I love these kinds of quotes… so much that I've made a little hobby out of collecting them over the years. Whenever I encounter these little tidbits of wisdom, I like to put together a little graphic image with Canva (if you're connected with me on Facebook, Twitter or Instagram, you've probably seen me post some of these in the past). Since I've been stockpiling these little gems for so long, I wanted to share some of them with you here on the blog. Take a few minutes and read through these things and you'll see what I mean, they're pretty brilliant! With any luck, they might just help you look at your business, life and career in a new light, just like they did for me.
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