What's worse than having no prospective investment properties to consider purchasing? Having too many properties and spending too much time analyzing one only to find that it doesn't even come close to your goals.
To this end, I have created the 60 Second Screening Tool. The purpose of the tool isn't to give you a purchase price or to convince you to purchase a property; instead, the goal is to quickly screen properties to determine if it might meet your investment criteria.
Let's begin by looking at a property. In this example, I went to Coldwell Bankers and pulled up a random property - 801 Pennsylvania Ave.
Property Type: Duplex
Asking Price: $59,900.00
Income: Not listed
When I did a search on Coldwell - a single website - I had somewhere in the range of 600 properties for sale in the area. Using the Advanced Search and selecting only multi-family properties, it was closer to 50 properties. While this is much more manageable, I still don't have time to fully analyze each property.
How does an investor decide which properties to look at? Do you choose a purchase price range? Do you throw darts? Do you judge a book by its cover, and go for looks? After trying all of these methods myself (except for the darts - my wife won't allow them in the house due to a 1 year old son), I decided to develop a tool with which I could quickly check a property to see if it was close to what I look for in a property.
Please note: This tool is not my only method of analyzing a property, nor do I use it to determine a purchase price or my personal returns.
The purpose of this tool is to quickly evaluate if a property is close to my target metrics as an investment property. I use this tool when initially looking at a list of properties, and weed out the ones that are nowhere close to what I want in an investment.
The first inputs are the Property Details.
- Loan Amount: This is the purchase price of the property. The property in my example is listed at $55,900, so that's what I'll use.
- Estimated Repairs: How much deferred maintenance is there? What updates do you plan to do? For my calculations, I assume that these will be paid out of pocket rather than included in the loan. In this case, the property looks to be in decent shape; however, I like to play it safe, and put in 10% of the asking price.
- Estimated Expenses: The "rule of thumb" is the 50% rule, and that is what this value defaults to. The idea is that X% of your monthly income will go toward expenses that are not financing-related. Capital Expenses, maintenance, property management, taxes, and insurance are all examples of these expenses. In this case, I put expenses at 60% due to the high amount of taxes in York City.
- Desired Cap Rate: This is used for valuation of the property. The user puts in what cap rate they want, and the calculator will give an estimated purchase price based on the Estimated Expenses, purchase price, and cap rate. I used 8% because that is my own goal for an investment property.
- Percentage Rule to Follow: the 1% rule is nothing new to investors - basically, it states that your monthly gross income should be 1% of the purchase price. A higher percentage is better for an investor. The two options are 1% and 2%, and can be toggled based on the user's preference.
The next set of inputs is for the financing details.
- Down Payment: this is the percentage down payment that you plan to make. For a conventional loan, I used 20% as my example.
- Length of Loan: Amortization period of the loan. I put in 25 years for this example in case I were to use a portfolio lender - the local bank that I use has a 25 year portfolio loan, which helps build equity a little quicker.
- Yearly Interest Rate: this is the interest rate of the loan. I have been getting closer to 4.125% lately, but used 5% as a worst-case scenario for my example.
- Closing Costs: I assume this to be out of pocket, but will add an option to wrap these into the loan. For this property, I think that I can get the inspection and appraisal fairly cheap, and keep my closing costs around $4,000.
The final three inputs are all income related.
- Number of Units: how many units are in the investment property. This is a duplex, so I used 2
- Avg Monthly Rent per Unit: I know the market fairly well, and the duplex units are 2- and 3-bedroom, which go for $600 and $700 respectively. If you are unsure of what to put in here, I suggest using RentJungle or RentoMeter and find comparable rentals in your area to base your estimation off of. If you can get actual rent numbers, that would be better - either ask the landlord, or even consider asking the tenants.
- Other Monthly Income: Laundry Services, garage rentals, or storage spaces are all examples of other income. This property doesn't have any of these options, so I put in a nice easy Zero.
Now comes the fun part: the results. On the right-hand side of the final inputs are the "Property Valuation" outputs. These are estimated using the Expense Percentage that the user puts in, the desired cap rate, the 1% or 2% rule, and the income details.
- "Based on X% Cap Rate": this is the estimated value of a property based on the Desired Cap Rate that the user put in earlier. This value will change if you change the desired cap rate, the percentage of income that goes to expenses, or the income details. As expenses go up, the value of the property will go down, while a lower desired cap rate will result in an increased property value. In this example, the property would be worth $68,400.00 to meet an 8% cap rate.
- "Based on 2% Rule": this is the estimated value of a property based on monthly income and the 2% (or 1%) rule, which states that monthly income should roughly be 2% (or 1%) of the purchase price. Since I used the 1% rule, and monthly income is $650 x 2 = $1300, the value of the property is $130,000.00
- "Based on Average": this is the average of the previous two estimated values, in order to show the middle ground between two separate methods of evaluating a property.
The final section is the "Outputs"
- "Annual NOI": This is your Net Operating Income, which includes all expenses except for financing (mortgage). This is based on your rental income and the percentage that you estimated for expenses.
- "Monthly Mortgage": This one is fairly self-explanatory, and accounts for the rest of your expenses.
- "Monthly Cash Flow": This is the estimated monthly cash flow based on the above details. This is only an estimate, but is a good first look at how a property might perform.
- "Cap Rate": A ratio of NOI divided by value of the property. In this case, I use total investment as the value of the property. Your target Cap rate will be dependent on your market and preferences.
- "Annual GRM": Gross Rent Multiplier, which is how many year's worth of Gross Rent is needed to recoup your initial investment. Again, a "good" GRM is based on your current market.
- "DSCR": Debt Service Coverage Ratio - calculated by taking the NOI and dividing by the annual mortgage payments. Depending on the lender, a commercial loan should usually be above 1.25 in order to be considered for financing.
- LTV: Total loan amount as a percentage of the purchased value of the property. Depending on the lender, this value should usually be below 80% in order to be considered for financing.
While the above walk through was a lot of words, I can usually plug in numbers for a property and can have a basic evaluation within sixty seconds.
This tool isn't used to determine a purchase price - it is used to quickly and efficiently evaluate a potential property to see if it is close to your goals for an investment. If the valuation estimates at the bottom are close to the asking price, start a deeper dive into the property to determine what you are willing to pay for the investment.
Every investment property should have a value that you are willing to pay in order to make it worth your time and money. This tool is the first step toward narrowing down properties.
Next week, I will do a full analysis example of a property to show a deeper dive into a potential investment.