Articles that suggest ways to succeed at real estate investing commonly have something to sell. But this article has nothing to do with the get-rich-quick methods normally touted in real estate investing seminars.
Rather, in this article, we want to help you better understand some of the nuances associated with real estate investing by suggesting four things you should do if you want to succeed at real estate investing freely.
- Develop an Investment Plan
- Develop Meaningful Goals
- Understand Financial Analysis Models
- Tool Up to Run the Numbers
1. Develop an Investment Plan
Having a plan with stated goals is one of the most important foundations of successful investing. You must develop a general plan with stated goals and a method on how to get there.
2. Develop Meaningful Goals
Goals are essential to successful real estate investing. To work for you, however, the goals must be attainable, measurable, tied to a timetable, and clearly defined.
First, figure out how much cash do you have available to invest comfortably. What length of time do you plan to stay invested? How much of your own effort do you plan to contribute to your real estate investment projects?
Next, define a general plan. Decide on whether you plan to develop or own only the highest quality properties in prestige locations, for example, or to maximize your tax benefits on purchases and use tax-deferred exchanges and installment sales when available.
Finally, define a detailed plan by asking yourself questions like, “How much cash do I want to collect each year beginning in the 10th year?” “What net worth do I want to attain by investing in rental properties after the 15th year?” “Do I want to withdraw $5,000 in two years for a trip to Europe, want to generate $30,000 in five years to buy a second house, or maybe withdraw $20,000 over the next several years for my daughters college tuition?”
The idea is to create a target and then monitor your progress continually against that target to insure that you’re on the right course. A written plan with stated goals that projects where you’re headed and then reviewed regularly is critical to successful investing.
3. Understand Financial Analysis Models
At the very least, understand these three popular investment value measures regularly used by real estate investors and real estate analysts.
- Cash on Cash Return Cash on cash measures the initial profitability of a rental property. The higher the better, and typically a first-year cash on cash return ranges from about 4% to 10%. Formula: Cash on Cash = Before Tax Cash Flow / Cash Equity (Initial Investment)
- Gross Rent Multiplier Gross rent multiplier measures the ratio between annual gross rental income and sale price. Think of it as an indication of the number of years it takes the annual rental income to equal the price, so the lower the better. It is good for simple comparisons to other rental property opportunities but insufficient as a stand-alone number. Formula: Gross Rent Multiplier = Purchase Price / Gross Rent
- Capitalization Rate Cap Rate (it’s popular name)) is essentially a return on asset indicator of how much debt an income property can carry. The higher the return rate, the more debt a property can support, and hence the better the investment opportunity for the real estate investor. Sellers of income property, of course, prefer to sell at lower cap rates. Local markets dictate capitalization rate (there is no one-size-fits-all) but they typically run from about 5% to 12% Formula: Capitalization Rate = Net Operating Income / Purchase Price or Value
4. Tool Up to Run the Numbers
Being able to determine a property’s cash flow, rate of return and profitability correctly is crucial to making a smart real estate investment decision. How could you possibly know whether an investment opportunity is a good choice unless you can adequately run the numbers on it? Perhaps you’re trying to make a buying decision between several properties. How could you know which offers the best long-term cash flow and return on investment unless you created a proforma income statement and made all the vital computations?
If you want to succeed at real estate investing, you must be able to run the numbers. In this case, either use Excel and create your own spreadsheet, or invest in a good real estate investment software program. Making real estate investment decisions based on the bottom line, not emotion, is really the only proven way to succeed at real estate investing.
