Real estate investing is famous for its potential to create and build wealth.
But if it was easy, everyone would do it.
Real estate also famously eats money for breakfast, lunch and dinner.
So… if you’re researching real estate investment properties, you need a simple formula to make your life easier.
The following is a simple formula you can use to quickly evaluate real estate deals – then move forward on the ones that make sense – and pass on the ones that don’t.
The Simple Formula For Buying Real Estate
The following formula is a simple rule of thumb using only two variables:
1) Target revenue
2) Target return
Here you go. You can do this calculation on the back of a napkin or in your head:
- Target Revenue: An investment property should produce at least 1% of the purchase price per month in gross rent (revenue).
- Target Return: After calculating your revenue and expenses, aim for at least a 10% return per year.
The “target return” number should include any operating expenses, vacancy, capital improvements you would make to the property, after you buy.
Let’s say you are looking at a $300,000 single family investment property to buy.
Your purchase price is $275,000, including fees, etc… plus you expect that you will have to invest $25,000 into it after you close.
All in, the your investment would be $300,000.
On a $300,000 investment, your target revenue should be $3,000 (or 1% of the purchase price of $300,000) per month in gross rents.
This is a simple calculation that you can do immediately. You can use it as a parameter for determining a “go” or “no go” situation.
Talk to local brokers and do some market research. Find comparable real estate properties (aka “comps”) in your area and find out how much rent they’re receiving.
For your target profit, when penciling out your simple “back of the napkin” profit and loss statement, don’t forget to factor in the following costs which come with almost any real estate investment:
- Purchase Price
- Mortgage (Principle and Interest)1
- Property Taxes
- Maintenance Costs
Add up these costs on a monthly and yearly basis.
When subtracted from your goal of 1% per month in revenue, you should have a profit.2
Aim for a return on investment of at least 10% annually.
Of course, every property, mortgage loan and real estate market is different… But the aforementioned formula is a good rule of thumb.
And remember, the deals you don’t do will be as valuable as the deals you do.
Walk away from deals that don’t make sense.
Buy good investments… Not good properties.
Never make an investment in anything unless you’re confident you will make money.
- Your mortgage amount and interest rate will vary. However, commercial property mortgage lenders typically like to see a 30-35% equity commitment by the buyer/owner of the property. Interest rates can vary by your credit history and whether you intend to pay principle and interest, or just have an interest only loan. Mortgage interest rates are at historic lows now, even with the recent run up of interest rates.
- This simple calculation does not factor in any of the depreciation benefits or other tax advantages of real estate investment. It also obviously doesn’t factor in other tax incentives, such as those from adding solar to your property.