Formula for figuring out if property is "good deal" - Posted by Brenda K

Posted by JohnBoy on June 06, 2000 at 19:05:06:

As a general rule, you add up the total rents coming in, take 40% of that amount for expenses, and the 60% left over is your NOI (net operating income). From the NOI, you deduct your mortgage payment including taxes and insurance. What’s left will be your monthly profit. If the numbers don’t work to where their is nothing left as enough profit to justify your risk doing the deal, then you don’t have a deal to work with.

The general rule of thumb is only that, a general rule of thumb. It doesn’t guarantee a profit using this formula. The expenses could be more or less in any given deal. But if using the 40% expense factor is in the ballpark, then the deal is worth looking into more and doing all the due diligence involved.

Formula for figuring out if property is “good deal” - Posted by Brenda K

Posted by Brenda K on June 06, 2000 at 24:59:51:

I have noticed that some of you on this site seem to have a formula for figuring out if a property is a good deal or not. I am very new to this and can’t quite seem to figure out how you calculate this. Could you explain this for me

Re: Formula for figuring out if property is “good deal” - Posted by Ed Garcia

Posted by Ed Garcia on June 06, 2000 at 08:46:57:

Brenda:

I’m sorry to say that, I’ve answered this question so many times. I now save my
answer to reprint it when the question comes up again.

Here is what I tell a Newbie who is starting out.

First, is to evaluate how much time you are going to be able to commit to
Real-estate? If your approach is hit and miss, so will be your result.

Second: Go to the street. It is the best teacher. Rather than talk about doing
deals, reading in the library, getting courses, JUST DO IT.

You’ll find in the long run, the street is the best teacher. Not only that by getting
out an doing it, you’ll learn your MARKET, meet people to build a NETWORK, learn
the demographics as well as the geographics of your area, and of course you
would have over come the biggest obstacle in getting started, PROCRASTINATION.

We need to do what we call, penciling out a deal. When doing that, we ask ourselves a
battery of questions necessary in structuring a deal.

I’m going to give you 5 steps to get you started.

(1) How much do we want to make?

So many times I hear someone act as if they are afraid of loosing a deal because of the
profit they put into it. Forget about it. I’d rather be sorry about the deal I did not make,
rather than the one I did. The profit is what protects you in a deal. Don’t be afraid to make it.

When doing a deal I want to make at least 30% and believe me when I tell you, when I structure
a deal with 30% in it, I never get it. Some how the profit always dissipates, even after I thought
I figured it to the penny.

Would I do a deal with less profit? Yes but I would do it as a flip, lease option, or as a leveraged
deal with positive cash flow.

(2) Determine the Value of the Property.

The next thing I must do is determine what the property is worth. The obvious thing to do, is comp
it. Don’t let the seller or real-estate broker tell you what it is worth. Get it comped yourself.

(3) Deferred maintenance.

Usually I figure my profit after taking off the deferred maintenance, otherwise it distorts my
profit. So it must be figured in the beginning to determine your profit.

(4) Game plan.

What do I want to do with the property? Do I want to fix it and sell it? Do I want to keep it
long term or short term? When I buy a property, I have a plan for it. And usually I buy it with that
plan in mind. This part is so important, I’m going to go into more detail by giving you an example.

Remember, you make your money on the buy.

GAME PLAN.

Each deal speaks for it’s self. For example, if I bought a house for lets
say $50,000 and had to put $10,000 into it for fix up. I’m in this deal
$60,000. Now what would that house have to be worth in order for me
to feel comfortable to buy it, and debt service it on my line of credit.

$70,000 ? No I don’t think so. I have no room in this deal for error.
What if after a month or two I don’t sell it ?
Now remember, we can play the what if game all day. I can create a fast
Sale for the purpose of this posting to make myself look good, but that’s
Not the answer. So remember we have to always be careful with
hypothetical questions and answers. The profit structure on this deal is not
good enough for me to do the deal.

$80,000 ? Were getting better, but No. I have to keep in mind that things
can go wrong with my deal. What if I sell it after 2 months, and then the
sale falls through after being under contract for 45 days because of financing.

Now I have had the property for 31/2 months, and have to put it back on
the market again. Also what if the market changes or slows down ?
Even though I show on paper that I have a $20,000 profit, that’s not so.

For the fun of it, lets take this so call $20,000 profit and structure a
Game Plan around it.

(1.) I plug in 6 month worth of debt service on my deal. I’m in the
deal $60,000. Interest, depending on the interest of your credit line,
Let say for the benefit of our example is 9.5%. Our payments would
Then be $475 per month. 475X 6 = $2850.

(2.) What ever the market value you come up with, always cut it 5%.
Because realistically, the potential buyer is going to want you to
Discount your price. Now if you don’t have to, great. But lets face
It. If you were trying to sell it for $80,000 and someone offered
You $ 76,000, you know you wouldn’t want to wait for another
Buyer. You would still be debt servicing the deal. With you luck,
You wait another month or two and the next buyer would make
The same offer. Terry Vaughan will tell you, that the first 10% of
a deal is water. I agree with Terry, but for the purpose of this
deal we’ll just keep it at 5%. So lets take off another $4000.

(3.) I always plug in a realtor. Now I know that there are a lot of
Geniuses out there that don’t need them. They are so great that
they can sell the property themselves. Great, you plug in a
Realtor. 76,000 X .06 = $4,560.

Lets recap. A sale of $80,000, gives us on paper a $20,000 profit.

$20,000
-$ 2,850 Debt service
-$4,000 5% Discount
-$4,560 6% Sales commission.

Potential Profit $8,590.

As you can see the profit dissipates quickly. And personally I don’t think
It’s enough to take the risk your taking with your line.

How about $90,000 ? Now all of a sudden the deal can make sense.
We have between a $17,500 and $18,000 profit.

Lets look at our LTV (loan to value). 60,000 divided by 90,000 =
67% LTV.

So you see the deal speaks for it’s self, but the structuring of a deal with a Game Plan is what will
let you know if you should do the deal.

(5) Financing.

How am I going to take my deal down? An I going to create a seller carry back, and use a lender
to give some money to the seller? Will the seller carry back the whole deal? Will I have to buy it with
a combination of down payment and financing? Or will I pay cash and then refinance it later, getting
all of my money back.

These are just a few basic fundamentals of doing a deal. I hope this is some help to you.

Ed Garcia

Thank you!!! I Saw another formula for figuring out Rental Properties I think - Posted by Brenda K

Posted by Brenda K on June 06, 2000 at 17:59:39:

Thanks for the info— I have printed it out and am sure it will be very useful. I have also seen another formula on here where you multiply the FMV by something (40% maybe) and then you add a percentage of what you figure the renters will pay. Anyway I’m not sure exactly how it goes but when you’re done you will know if you have a positive cash flow property or not.

Anybody know how this works??