You’re probably familiar with the 80/20 rule also known as the “Pareto’s Principle.” The 80/20 rule is a general rule that basically means there is not an equal relationship between your efforts and your results.
The principle states that 20% of your effort is responsible for 80% of your results. That’s not particularly a good thing because the opposite is that 80% of your effort only produces 20% of your results. If you want more time in your life, you want t techniques that produce more results from your work.
Numbers vary but another rule of
thumb is that about 80% of the investment properties that you consider won’t
work out financially. A useful technique is one that quickly discards deals
that will not meet your financial goals. That leaves you with a lot more time
to do detailed analysis on the deals promising superior financial performance
or however else you like to spend your time.
Step Basic Analysis
You can use the following
preliminary analysis for rentals or with slight changes it can be applied to
rehab and flip deals. Each step builds on the previous step. When one step
doesn’t meet your criteria, you can stop without putting in any more effort. Often
this can be done without visiting the property or as a decision guide to
whether you do want to inspect the property closer.
Only consider the types of houses that you are knowledgeable about and are in your financial investing range. You should already know the neighborhood. You should be familiar with the school district, shops, average home prices, crime rate, etc. If the house interests you but you don’t know the neighborhood, stop using this technique and instead spend your time learning the neighborhood before digging into a specific house.
Consider basic rehab costs. This shouldn’t be much more than fresh paint and carpet. Since you know the neighborhood, you should have a hip pocket idea about the needed quality and cost - perhaps a $4,000 average on the low end. With experience, you should also have hip pocket estimates for medium and major rehab costs. Maybe $15,000 and $25,000 respectively. Along with labor and materials be sure to include vacancy and demolition costs.
Add the purchase cost and rehab costs together. Include typical closing costs and related fees. This total is your investment cost. If the purchase cost is $70,000 and you have $7,000 in basic rehab plus $10,000 in closing costs, your investment cost adds up to $87,000.
Calculate your monthly loan payment. Some experienced investors think knocking off two zeros from your investment cost is close enough but it’s worth the minute it takes to run the numbers through a mortgage calculator. In the $87,000 example with $5,000 down and at 4% interest the monthly payment is about $400 (before taxes and insurance) rather than the $870 you get by knocking off the two zeros ($87,0ØØ).
Based on the neighborhood and your experience, add a little more to the monthly cost to account for future vacancies and maintenance. Maybe $150, which brings your average monthly cost up to $550.
Roughly calculate your cash flow and equity. Subtract your monthly costs from the low end of the rent that you expect to collect for a rough estimate of your cash flow. Your equity is the difference between the after rehab value and your total purchase plus investment cost. Obviously, a good investment is one with both positive cash flow and positive equity.
It should take no more than a few minutes
to walk through this basic investment analysis. Stop at any time the numbers
make it clear the opportunity doesn’t meet your financial criteria. If it
passes all six steps, you want to move on to a thorough analysis and due
diligence that includes a visit to the property for a detailed inspection and
spreadsheet that captures all of your costs.
Ways to Save Time and Improve Efficiency
Look for other ways to reduce the tasks
that take up 80% of your time but only produce 20% of the results. A few ideas are:
Evaluate where most of your motivated seller leads are coming from. If you use a combination of wholesalers, bandit signs, and craigslist ads but 80% of your leads come from wholesalers that is where most of your effort should be.
Do the same thing regarding finding renters or buyers (for flips). Put most of your effort into the method that produces the most results.
Evaluate your rehab and remolding costs. How much more rent are you able to generate by upgrading the kitchen instead of just sprucing up the paint and carpet? How long does it take you to recover the kitchen investment?
Which of your properties are generating the most profit? On a regular basis, you should be considering the cost of “opportunity lost”. In other words, is it time to sell a lower performing property and replace it with a higher performing property?
What time saving and efficiency techniques
can you share with others? Please leave a comment.
Also, our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions, inquiries, or article ideas to [email protected].
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