How to Speak “Investor Speak” with Your Clients

Have you ever been approached by an investor who can speak “investor speak” to the point your head is spinning?

Or do you have 1st-time investors that are just beginning the process? Both can be great sources of commission checks, but only if you can differentiate the “posers” from the serious clients.

Note: Few investors call me (they already have lines of credit set up before they find the property) or have more than four properties (Fannie Mae’s limit), so I’m just dispensing free information.

FYI: I “stay in my lane” Fannie/Freddie, FHA, and VA loans only.

I have one contact for reverse mortgages, and that’s Paul Scheper of Longevity Mortgage, a friend and trusted colleague who specializes only in reverse mortgages and who you can call directly.

Occasionally, when investors do call, I get confused by all the “investor speak,” which is its own language.

Below is an article written by the same person who composed the Rental Property Calculator, which is easy to use (just input the numbers into the fields). Presto, you will have all the information needed to evaluate an investment property.

Enjoy the post!

Rental Property Investments

Rental property investment refers to real estate investment that involves purchasing real estate and holding, leasing, and selling it.

Depending on the type of rental property, investors need a certain level of expertise and knowledge to profit from their ventures.

Real property can include most leasable properties, such as a single unit, a duplex, a single-family home, an entire apartment complex, a commercial retail plaza, or an office space.

Occasionally, industrial properties can also be used as rental property investments.

Due to various factors resulting from the larger scale, more commercial rental properties, such as apartment complexes or office buildings, are more complicated and difficult to analyze.

For older properties, it’s typical to have higher maintenance/repair costs.

Rental property investments are generally capital-intensive and cash flow dependent with low levels of liquidity.

However, compared with equity markets, rental property investments usually are more stable, have tax benefits, and are more likely to hedge against inflation.

Given proper financial analysis, they can turn out to be profitable and worthwhile investments.

The Rental Property Calculator that can help run the numbers.

Income

There are several ways in which rental property investments earn income.

First, investors earn regular cash flow, usually monthly, from tenant rental payments.

In addition, as with the ownership of any equity, rental properties allow the investor to earn profit from the appreciation or increase in value over time of the property.

Unlike rental income, a sale provides one significant, single return.

Responsibilities

Rental property investing is not passive income. It requires time and work.

The investor or owner must assume the role of landlord and all the job responsibilities associated with it.

General responsibilities of owning a rental property include:

· Tenant Management—finding tenants, performing background screenings for potential tenants, creating legal lease contracts, collecting rent, and evicting tenants if necessary.

· Property Maintenance—repairs, upkeep, renovations, etc.

· Administrative—filing paperwork, setting rent, handling taxes, paying employees, budgeting, etc.

It is common for rental property owners to hire property management companies at a fixed or percentage fee to handle all the responsibilities.

Investors with limited time, who don’t live near their rental property, aren’t interested in hands-on management, or can afford the cost can benefit from hiring a property management company.

This is roughly estimated to cost about 10% of rental property income.

General Guidelines

Real estate investing can be complex, but some general principles are helpful and quick starting points when analyzing investments.

However, every market is different, and it is possible that these guidelines will not work for specific situations.

They must be treated as such, not as replacements for complex financial analysis or advice from real estate professionals.

50% Rule—A rental property’s sum of operating expenses hovers around 50% of income.

Operating expenses do not include mortgage principal or interest.

The other 50% can be used to pay the monthly mortgage payment. This can be used to quickly estimate the cash flow and profit of investment.

1% Rule—The gross monthly rental income should be 1% or more of the property purchase price after repairs.

It is common to hear of people who use the 2% or even 3% Rule – the higher, the better.

A lesser-known rule is the 70% Rule.

This is a rule for purchasing and flipping distressed real estate for a profit. It states that the purchase price should be less than 70% of the after-repair value (ARV) minus repair costs (rehab).

Internal Rate of Return

The internal rate of return (IRR) or annualized total return is the annual rate earned on each dollar invested for the period it is funded.

It is generally used by most, if not all, investors to compare different investments.

The higher the IRR, the more desirable the investment. IRR is one of the most critical measures of a rental property’s profitability; capitalization rate is too primary, and Cash Flow Return on Investment (CFROI) does not account for the time value of money.

Capitalization Rate

The capitalization rate, often called the cap rate, is the net operating income (NOI) ratio to the investment asset or current market value.

Cap rate = Net Operating Income – divided by property price. 

Cap rate is the best indicator for quick investment property comparisons.

It can also be helpful to evaluate a property’s past cap rates to gain some insight into its past performance, which may allow the investor to extrapolate how the property may perform in the future.

If measuring net operating income for a given rental property is particularly complex, discounted cash flow analysis can be a more accurate alternative.

Cash Flow Return on Investment

Cash flows need to be scrutinized when purchasing rental properties with loans. Unsustainable, negative cash flows can cause rental property investment failures.

Cash Flow Return on Investment (CFROI) is a metric for this.

Sometimes called Cash-on-Cash Return, CFROI helps investors identify the losses/gains associated with ongoing cash flows.

Sustainable rental properties should generally have increasing annual CFROI percentages due to fixed mortgage payments and rent incomes that appreciate over time.

Things to Keep in Mind

Generally, the higher an investment’s IRR, CFROI, and cap rate, the better.

In the real world, it is unlikely that an investment in a rental property will go precisely as planned or as calculated by this Rental Property Calculator.

Making so many financial assumptions extended over long periods (usually several decades) may result in undesirable/unexpected surprises.

Whether a short recession significantly depreciates a property’s value or the construction of a thriving shopping complex inflates values, both can have drastic influences on cap rate, IRR, and CFROI.

Even mid-level changes, such as hikes in maintenance costs or vacancy rates, can affect the numbers.

The monthly rent may also fluctuate drastically from year to year, so taking the estimated rent from a specific time and extrapolating it several decades into the future based on an appreciation rate might not be realistic.

Furthermore, while the appreciation of values is accounted for, inflation might not drastically distort such prominent figures.

In Conclusion!

So, there you have it—a basic primer on how to begin understanding the investor game.