How to Speak “Investor Speak” with Your ClientsDaniel Dobbs2023-05-25T13:24:09-07:00
Have you ever been approached by an investor that 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 a great source of commission checks, but only IF you can differentiate the “posers” vs. serious clients.
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YouTube – Straight Talk Lending – Daniel Dobbs
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 that you can call directly.
Occasionally, and investors do call, I often get confused by all the “investor speak,” which in and by itself is its own language.
Below is an article written by the same person that composed the Rental Property Calculator,” which is easy to use (just input the numbers into the fields), and 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 involving real estate and its purchase, followed by the holding, leasing, and selling of 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 be most properties that are leasable, such as a single unit, a duplex, a single-family home, an entire apartment complex, a commercial retail plaza, or an office space.
In some cases, industrial properties can also be used as rental property investments.
More commercial rental properties, such as apartment complexes or office buildings, are more complicated and difficult to analyze due to various factors that result from the larger scale.
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.
Income
There are several ways in which rental property investments earn income.
The first is that investors earn regular cash flow, usually on a monthly basis, in the form of rental payments from tenants.
In addition, as with the ownership of any equity, rental properties give the investor the possibility of earning 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 has to take on the role of the 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 who have limited time, who don’t live near their rental property, who aren’t interested in hands-on management, or who 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.
It is essential that they be treated as such, not as replacements for complex financial analysis nor advice from real estate professionals.
50% Rule—A rental property’s sum of operating expenses hover 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 estimate the cash flow and profit of investment quickly.
1% Rule—The gross monthly rental income should be 1% or more of the property purchase price after repairs.
It is not uncommon 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, which states that the purchase price should be less than 70% of after-repair value (ARV) minus repair costs (rehab).
Internal Rate of Return
Internal rate of return (IRR) or annualized total return is an annual rate earned on each dollar invested, for the period it is invested.
It is generally used by most, if not all, investors as a way to compare different investments.
The higher the IRR, the more desirable the investment. IRR is one of the most critical measures of the profitability of a rental property; 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 ratio of net operating income (NOI) to the investment asset value 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 the past cap rates of a property to gain some insight into how the property has performed in the past, which may allow the investor to extrapolate how the property may perform in the future.
If it is particularly complex to measure net operating income for a given rental property, discounted cash flow analysis can be a more accurate alternative.
Cash Flow Return on Investment
When purchasing rental properties with loans, cash flows need to be scrutinized. Rental property investment failures can be caused by unsustainable, negative cash flows.
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, usually due to fixed mortgage payments along with 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 improbable that an investment in a rental property goes 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 depreciates the value of a property significantly 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 in a nut a nutshell, a basic primer on how to begin to understand the investor game.
