How to See A Property Through An Investor's Eyes

A successful San Fransisco real estate investor creates a website in 2006 and begins dispensing real estate advice through his blog. His story is both encouraging and his advice is well-meaning.

His advice is also dead wrong.

I hate to be a critic, but a recent post on the Real Estate Weblog website drew my attention. The premise of the post, " How to See A Property Through an Investor's Eye" was good, but as I kept reading something didn't hit me quite right.

The post stated that the investor purchased a 4-plex in Albuquerque, New Mexico for $170K. According to the investor, once he spends $15K for rehab costs, the 4-plex would be worth $200K and he would net $500 per month cash flow. At a glance the investor has just made $15K in equity plus $6K in annual cash flow. Not too shabby right?

Wrong.

When you are working with real estate investors, you must advice your client that he or she needs to consider all holding and selling costs in order to truly calculate his cash-on-cash return.

In the example above we will make the following assumptions:

• Rehab cost at 15K, though final rehab expenses are always higher.
• Assume that the investor flips the property after rehab and he gets his asking price. Right now the Albuquerque market is appreciating at 7.7% , so we will give him the benefit of the doubt and will put his projected sales price at 215K.
• Assume he has a no-money down interest-only loan at 7% interest.
• All units are rented during rehab.

Now let's do the math.

• Projected sales price x 6% commission equals $12.9K
• Projected sales price x transaction costs @ 2% equals $4.3K.
• Projected rehab costs equal $15K
• Interim mortgage costs @ 5 months ( 2months rehab plus 3 months on market) equal $4.9K
• Interim propert taxes @ 5 months equal $885.
• Loan pre-payment penalty @ 6months equal $5.1K.
• Contribution to buyer's costs in seller market @1% equal $2.1K
• Loan pay-off equals $170K

The grand total of his debits will be approimately $215,100 and if you take that away from his sales price he owes escrow $100. Since the investor received $2500 dollars in cash-flow while he was rehabbing the property, his profit is a whopping $2400.

That's unacceptable to most investors.

I've often told you that real estate investing is all about the numbers. So an offer just under listing price is for the most part not the most prudent thing to do for an investor. Advice your investor clients to use an net sheet when calculating profit and always advice them to be conservative and not speculative. Once you guide him through a profitable endeavor, you can be sure he will do business with you again and again.


Happy selling.