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Summary:
This is likely the best real estate book that I have come across. Many of the other books talk about the soft-skills or general tips to keep in mind, but this book provided me with the confidence to start actively analyzing deals by providing me with the calculations (and their uses, strengths, and weaknesses) for acquiring deals. Some key, consolidated themes include:
- Information is a valuable commodity, so you shouldn't expect that it'll simply fall into your lap without some effort on your part.
- Always keep in mind the time value of money by calculating the PV (by discounting) and FV (by calculating added interest).
- Since you'll eventually need to sell, it pays to run tomorrow's numbers today.
- IRR is one of the more useful measures because of its sensitivity to both the timing and the magnitude of cash flows. Since it provides annual breakdowns, it can say: “Don’t be fooled by the fact that you show cash flow increases every year. You made your biggest impact in the first three years. That’s when you should consider cashing out and doing this all over again somewhere else.”
- There is no silver bullet formula; it helps to have a toolkit.
- Do your reps by practicing your analysis on case studies in order to avoid making mistakes on the battleground.
- Apart from verifying the information you've been given is correct, be sure to look for the information that is missing in the first place.
- Look out for your lender too and be aware of his/her preferred DCR .
- You may properly envision the conjoining of risk and reward as a law of nature. If this investment presents a lower risk than other property types, then you should expect that it will also offer a lower return.
Main Highlights:
- You understand that every income property has the potential to provide you with as many as four different returns: cash flow, appreciation, loan amortization, and tax shelter. Cash flow is the money you have left after paying all your bills; appreciation is the growth in equity caused by an increase in the property’s value; amortization represents the growth in equity caused by the gradual paydown of your mortgage; and tax shelter signifies the property’s ability to shield from taxation some of its own income and perhaps even income from other investments.
- In general, however, revenue—particularly net revenue (after operating expenses)—drives the value of income property. We’re returning to one of our basic principles here, that real estate investors really buy the property’s income stream.
- Information is a valuable commodity; you shouldn’t start off with any illusions that good information will fall into your lap without some effort on your part.
- For the type of financial forecasting you’ll learn to perform, it’s very valuable to know what the typical capitalization rate is for a particular kind of property in a particular geographic area.
- The time value of money plays a critical role when you consider just how valuable your property’s cash flows really are. Timing is everything.
- Cash you receive sooner is more valuable than cash you receive later because the sooner you have it, the sooner you can put it to work earning more cash.
- Rule of Thumb: Recite this mantra whenever you consider purchasing an income property: If it’s not worth selling, then it’s not worth buying.
- The world may not be perfect, but at least it’s flat—as in “level playing field.” You can reasonably assume that if you would scrutinize a property’s income, operating expenses, financing, and various measures of return before you purchase, then tomorrow some equally astute investor will apply a similarly jaundiced eye to your numbers when you choose to sell. It pays, therefore, to run tomorrow’s numbers today and to see just what this investment will look like to a future buyer.
- IRR packs more analytical power than most other measures of investment quality you have seen so far, primarily because of its sensitivity to both the timing and the magnitude of cash flows. Now is when you can really start having some fun with the numbers and using their power to guide you to good investment decisions.
- Rule of Thumb: When you make your forecasts for a property, don’t just run the numbers for a single holding period (for example, five years, as in our case study). Run as many different holding periods as you can, and then look to see if there is one year where the IRR peaks. If so, this is the year you should consider selling to maximize your return. If there is no definitive peak, but rather a period of years where the IRR is more or less the same, that means there is no optimum sale year, and you can sell whenever it suits you.
- the IRR is capable of delivering a very powerful and perhaps surprising message: “Don’t be fooled by the fact that you show cash flow increases every year. You made your biggest impact in the first three years. That’s when you should consider cashing out and doing this all over again somewhere else.”
- Now that you’ve mastered cash flow and resale and IRR, you don’t have to look just for an optimum holding period. What happens to your IRR if you take a bigger mortgage and use less cash? What happens if you do the opposite? What if you spend money for improvements that allow you to raise rents—will that boost your return or reduce it?
- Perhaps you’re evaluating a single property. Clearly, a capital accumulation comparison isn’t necessary. Maybe you expect that property to enjoy robust positive cash flows. In that case, internal rate of return should do nicely. Or possibly the property will have some negative cash flows, and you would be best served by MIRR. The smart investor will understand all these techniques, consider them all, and use the one (or several) that seems best suited to the actual investment decision at hand. After all, you wouldn’t keep just one kind of screwdriver or one size wrench in your basement toolbox. Do no less with your investments.
- Real-life experience always makes the best teacher, but you can also get a head start on the learning process with some guided practice using what we might call “unreal estate”—made-up case studies that allow you to work through common investment scenarios as if you were a participant in an actual transaction.
- Let’s start by looking at that skeleton you called an APOD. You’ve made what is one of the most common mistakes committed by beginning (and sometimes even by more experienced) investors: You’ve focused on verifying and analyzing the information you’ve been provided, but you haven’t thought about the information that might be missing. All the data you have in hand is indeed factually correct, but the story doesn’t end there. You’ve made the erroneous and potentially damaging assumption that the seller or the seller’s representative has told you everything you really need to know. As you will see in a moment, that can be an expensive mistake.
- The debt coverage ratio (DCR) often doesn’t get the amount of attention from investors that it deserves, but here again you’re looking at positive news. Remember that the lender was requiring at least a 1.20 DCR in order to underwrite the mortgage.
- Likelihood of lower return. You may properly envision the conjoining of risk and reward as a law of nature. If this investment presents a lower risk than other property types, then you should expect that it will also offer a lower return.
Highlights (excluding the Metrics highlights at the end):
- You can download any of the Excel files shown at http://www.realdata.com/book
- The key concepts underlying most real estate calculations are explained in depth in Part I, but Part II is designed as a reference guide and frequently repeats capsule summaries of the ideas elaborated in detail in Part I.
- In real estate investing, the profits and gains that are lost by the envelope scratchers accrue to those who take the time to do the math.
- four basic returns: 1. Cash flow 2. Appreciation 3. Loan amortization 4. Tax shelter
- Not all properties generate a meaningful cash flow, however, and for those that don’t, the next most important of the four basic returns is appreciation.
- In general, however, revenue—particularly net revenue (after operating expenses)—drives the value of income property. We’re returning to one of our basic principles here, that real estate investors really buy the property’s income stream.
- Amortization is the liquidation of this debt by the application of installment payments over time (for the Latin scholars, think of “ad” [toward] and “mort-” [death]—killing off the loan).
- Debt Service (i.e., total mortgage payment) less Interest Paid = Amortization
- Tax Shelters: (1) The first of these deductions is for mortgage interest. (2) The second source of tax shelter is through the depreciation deduction, which is now called cost recovery in the tax code as of this writing, but is still usually called depreciation by real flesh-and-blood investors.
- You understand that every income property has the potential to provide you with as many as four different returns: cash flow, appreciation, loan amortization, and tax shelter. Cash flow is the money you have left after paying all your bills; appreciation is the growth in equity caused by an increase in the property’s value; amortization represents the growth in equity caused by the gradual paydown of your mortgage; and tax shelter signifies the property’s ability to shield from taxation some of its own income and perhaps even income from other investments.
- Information is a valuable commodity; you shouldn’t start off with any illusions that good information will fall into your lap without some effort on your part.
- As we will emphasize throughout this book, you are not really buying a physical property so much as you are buying its income stream.
- Recite the Representations About the Leases and the Schedule of Rent Income in the Offer to Purchase: "but put into the offer to purchase something along the lines of “The Seller warrants and represents that as of the date of this agreement, the leases are for [such and such amounts] and the expiration dates and renewal options are [whatever].” Then ask the lawyer about adding, “and that these warranties will survive the delivery of the deed.” The first part means the seller swears to tell nothing but the truth, and the second part means that he or she is not off the hook if you discover the lie after you complete the purchase."
- Data seldom tell you enough by themselves, however, to lead you to a decision about buying or selling.
- For the type of financial forecasting you’ll learn to perform, it’s very valuable to know what the typical capitalization rate is for a particular kind of property in a particular geographic area.
- In the absence of usable market data, many investors like to use a vacancy allowance in the range of 3 to 6%.
- Conventional wisdom also has it that a property whose actual vacancy history is close to zero has probably been rented at less than market rates. In other words, if you don’t experience some vacancy, you’re just not charging enough.
- The APOD is not just a source of answers about an investment property, but rather the source of the most important questions.
- Also, you should always verify heating and other utility costs by contacting the utility suppliers directly.
- The time value of money plays a critical role when you consider just how valuable your property’s cash flows really are. Timing is everything.
- Cash you receive sooner is more valuable than cash you receive later because the sooner you have it, the sooner you can put it to work earning more cash.
- “What is this property really worth?” It may be argued that value, like beauty, is in the eye of the beholder. This argument tends to ring true in regard to single-family homes, where conventional wisdom has always held that a house is worth what someone is willing to pay for it. Income-producing property, however, is different. Value is determined by the numbers.
- To be considered a real estate operating expense, an item must be necessary to maintain a piece of a property and to ensure its ability to continue to produce income. Loan payments, depreciation, and capital expenditures are not considered operating expenses.
- For example, utilities, supplies, snow removal, and property management are all operating expenses. Repairs and maintenance are operating expenses, but improvements and additions are not—they are capital expenditures.
- there are two elements to a property’s value equation: the NOI and the cap rate (universal shorthand for capitalization rate). The NOI represents a return on the purchase price of the property, and the cap rate is the rate of that return. Hence, a property with a $1,000,000 purchase price and a $100,000 NOI has a 10% capitalization rate. However, the investor will purchase that property for $1,000,000 only if he or she judges 10% to be a satisfactory rate of return.
- In short, the NOI expresses an objective measure of a property’s income stream, while the required capitalization rate is the investor’s subjective estimate of how well his or her capital must perform.
- NOI is the starting point of our discussion here. Once you know the property’s NOI, you branch off in one direction to figure its taxable income and in another to figure its cash flow.
- A positive cash flow is important to all investors and essential to some. Is CFAT, then, the end of your continuing saga of investment analysis? Not at all. Next, you’ll look at the ultimate resale of your property and at how value impacts the overall quality of your investment.
- One topic that sometimes gets less attention than it deserves from beginning real estate investors, however, is resale. That’s fine; may all your plans go without a hitch. But what if you need to sell this property next year? What if a better opportunity comes along in five years, and you want to cash out?
- Rule of Thumb: Recite this mantra whenever you consider purchasing an income property: If it’s not worth selling, then it’s not worth buying.
- The world may not be perfect, but at least it’s flat—as in “level playing field.” You can reasonably assume that if you would scrutinize a property’s income, operating expenses, financing, and various measures of return before you purchase, then tomorrow some equally astute investor will apply a similarly jaundiced eye to your numbers when you choose to sell. It pays, therefore, to run tomorrow’s numbers today and to see just what this investment will look like to a future buyer.
- Rule of Thumb: If you’re the buyer, you generally prefer to capitalize the current year’s NOI when you estimate what a property is worth. If you’re the seller, you typically prefer to capitalize your estimate of the coming year’s NOI.
- When you use a cap rate to forecast a property’s value at some point in the future, the first judgment you must make is
This is likely the best real estate book that I have come across. Many of the other books talk about the soft-skills or general tips to keep in mind, but this book provided me with the confidence to start actively analyzing deals by providing me with the calculations (and their uses, strengths, and weaknesses) for acquiring deals. Some key, consolidated themes include:
- Information is a valuable commodity, so you shouldn't expect that it'll simply fall into your lap without some effort on your part.
- Always keep in mind the time value of money by calculating the PV (by discounting) and FV (by calculating added interest).
- Since you'll eventually need to sell, it pays to run tomorrow's numbers today.
- IRR is one of the more useful measures because of its sensitivity to both the timing and the magnitude of cash flows. Since it provides annual breakdowns, it can say: “Don’t be fooled by the fact that you show cash flow increases every year. You made your biggest impact in the first three years. That’s when you should consider cashing out and doing this all over again somewhere else.”
- There is no silver bullet formula; it helps to have a toolkit.
- Do your reps by practicing your analysis on case studies in order to avoid making mistakes on the battleground.
- Apart from verifying the information you've been given is correct, be sure to look for the information that is missing in the first place.
- Look out for your lender too and be aware of his/her preferred DCR .
- You may properly envision the conjoining of risk and reward as a law of nature. If this investment presents a lower risk than other property types, then you should expect that it will also offer a lower return.
Main Highlights:
- You understand that every income property has the potential to provide you with as many as four different returns: cash flow, appreciation, loan amortization, and tax shelter. Cash flow is the money you have left after paying all your bills; appreciation is the growth in equity caused by an increase in the property’s value; amortization represents the growth in equity caused by the gradual paydown of your mortgage; and tax shelter signifies the property’s ability to shield from taxation some of its own income and perhaps even income from other investments.
- In general, however, revenue—particularly net revenue (after operating expenses)—drives the value of income property. We’re returning to one of our basic principles here, that real estate investors really buy the property’s income stream.
- Information is a valuable commodity; you shouldn’t start off with any illusions that good information will fall into your lap without some effort on your part.
- For the type of financial forecasting you’ll learn to perform, it’s very valuable to know what the typical capitalization rate is for a particular kind of property in a particular geographic area.
- The time value of money plays a critical role when you consider just how valuable your property’s cash flows really are. Timing is everything.
- Cash you receive sooner is more valuable than cash you receive later because the sooner you have it, the sooner you can put it to work earning more cash.
- Rule of Thumb: Recite this mantra whenever you consider purchasing an income property: If it’s not worth selling, then it’s not worth buying.
- The world may not be perfect, but at least it’s flat—as in “level playing field.” You can reasonably assume that if you would scrutinize a property’s income, operating expenses, financing, and various measures of return before you purchase, then tomorrow some equally astute investor will apply a similarly jaundiced eye to your numbers when you choose to sell. It pays, therefore, to run tomorrow’s numbers today and to see just what this investment will look like to a future buyer.
- IRR packs more analytical power than most other measures of investment quality you have seen so far, primarily because of its sensitivity to both the timing and the magnitude of cash flows. Now is when you can really start having some fun with the numbers and using their power to guide you to good investment decisions.
- Rule of Thumb: When you make your forecasts for a property, don’t just run the numbers for a single holding period (for example, five years, as in our case study). Run as many different holding periods as you can, and then look to see if there is one year where the IRR peaks. If so, this is the year you should consider selling to maximize your return. If there is no definitive peak, but rather a period of years where the IRR is more or less the same, that means there is no optimum sale year, and you can sell whenever it suits you.
- the IRR is capable of delivering a very powerful and perhaps surprising message: “Don’t be fooled by the fact that you show cash flow increases every year. You made your biggest impact in the first three years. That’s when you should consider cashing out and doing this all over again somewhere else.”
- Now that you’ve mastered cash flow and resale and IRR, you don’t have to look just for an optimum holding period. What happens to your IRR if you take a bigger mortgage and use less cash? What happens if you do the opposite? What if you spend money for improvements that allow you to raise rents—will that boost your return or reduce it?
- Perhaps you’re evaluating a single property. Clearly, a capital accumulation comparison isn’t necessary. Maybe you expect that property to enjoy robust positive cash flows. In that case, internal rate of return should do nicely. Or possibly the property will have some negative cash flows, and you would be best served by MIRR. The smart investor will understand all these techniques, consider them all, and use the one (or several) that seems best suited to the actual investment decision at hand. After all, you wouldn’t keep just one kind of screwdriver or one size wrench in your basement toolbox. Do no less with your investments.
- Real-life experience always makes the best teacher, but you can also get a head start on the learning process with some guided practice using what we might call “unreal estate”—made-up case studies that allow you to work through common investment scenarios as if you were a participant in an actual transaction.
- Let’s start by looking at that skeleton you called an APOD. You’ve made what is one of the most common mistakes committed by beginning (and sometimes even by more experienced) investors: You’ve focused on verifying and analyzing the information you’ve been provided, but you haven’t thought about the information that might be missing. All the data you have in hand is indeed factually correct, but the story doesn’t end there. You’ve made the erroneous and potentially damaging assumption that the seller or the seller’s representative has told you everything you really need to know. As you will see in a moment, that can be an expensive mistake.
- The debt coverage ratio (DCR) often doesn’t get the amount of attention from investors that it deserves, but here again you’re looking at positive news. Remember that the lender was requiring at least a 1.20 DCR in order to underwrite the mortgage.
- Likelihood of lower return. You may properly envision the conjoining of risk and reward as a law of nature. If this investment presents a lower risk than other property types, then you should expect that it will also offer a lower return.
Highlights (excluding the Metrics highlights at the end):
- You can download any of the Excel files shown at http://www.realdata.com/book
- The key concepts underlying most real estate calculations are explained in depth in Part I, but Part II is designed as a reference guide and frequently repeats capsule summaries of the ideas elaborated in detail in Part I.
- In real estate investing, the profits and gains that are lost by the envelope scratchers accrue to those who take the time to do the math.
- four basic returns: 1. Cash flow 2. Appreciation 3. Loan amortization 4. Tax shelter
- Not all properties generate a meaningful cash flow, however, and for those that don’t, the next most important of the four basic returns is appreciation.
- In general, however, revenue—particularly net revenue (after operating expenses)—drives the value of income property. We’re returning to one of our basic principles here, that real estate investors really buy the property’s income stream.
- Amortization is the liquidation of this debt by the application of installment payments over time (for the Latin scholars, think of “ad” [toward] and “mort-” [death]—killing off the loan).
- Debt Service (i.e., total mortgage payment) less Interest Paid = Amortization
- Tax Shelters: (1) The first of these deductions is for mortgage interest. (2) The second source of tax shelter is through the depreciation deduction, which is now called cost recovery in the tax code as of this writing, but is still usually called depreciation by real flesh-and-blood investors.
- You understand that every income property has the potential to provide you with as many as four different returns: cash flow, appreciation, loan amortization, and tax shelter. Cash flow is the money you have left after paying all your bills; appreciation is the growth in equity caused by an increase in the property’s value; amortization represents the growth in equity caused by the gradual paydown of your mortgage; and tax shelter signifies the property’s ability to shield from taxation some of its own income and perhaps even income from other investments.
- Information is a valuable commodity; you shouldn’t start off with any illusions that good information will fall into your lap without some effort on your part.
- As we will emphasize throughout this book, you are not really buying a physical property so much as you are buying its income stream.
- Recite the Representations About the Leases and the Schedule of Rent Income in the Offer to Purchase: "but put into the offer to purchase something along the lines of “The Seller warrants and represents that as of the date of this agreement, the leases are for [such and such amounts] and the expiration dates and renewal options are [whatever].” Then ask the lawyer about adding, “and that these warranties will survive the delivery of the deed.” The first part means the seller swears to tell nothing but the truth, and the second part means that he or she is not off the hook if you discover the lie after you complete the purchase."
- Data seldom tell you enough by themselves, however, to lead you to a decision about buying or selling.
- For the type of financial forecasting you’ll learn to perform, it’s very valuable to know what the typical capitalization rate is for a particular kind of property in a particular geographic area.
- In the absence of usable market data, many investors like to use a vacancy allowance in the range of 3 to 6%.
- Conventional wisdom also has it that a property whose actual vacancy history is close to zero has probably been rented at less than market rates. In other words, if you don’t experience some vacancy, you’re just not charging enough.
- The APOD is not just a source of answers about an investment property, but rather the source of the most important questions.
- Also, you should always verify heating and other utility costs by contacting the utility suppliers directly.
- The time value of money plays a critical role when you consider just how valuable your property’s cash flows really are. Timing is everything.
- Cash you receive sooner is more valuable than cash you receive later because the sooner you have it, the sooner you can put it to work earning more cash.
- “What is this property really worth?” It may be argued that value, like beauty, is in the eye of the beholder. This argument tends to ring true in regard to single-family homes, where conventional wisdom has always held that a house is worth what someone is willing to pay for it. Income-producing property, however, is different. Value is determined by the numbers.
- To be considered a real estate operating expense, an item must be necessary to maintain a piece of a property and to ensure its ability to continue to produce income. Loan payments, depreciation, and capital expenditures are not considered operating expenses.
- For example, utilities, supplies, snow removal, and property management are all operating expenses. Repairs and maintenance are operating expenses, but improvements and additions are not—they are capital expenditures.
- there are two elements to a property’s value equation: the NOI and the cap rate (universal shorthand for capitalization rate). The NOI represents a return on the purchase price of the property, and the cap rate is the rate of that return. Hence, a property with a $1,000,000 purchase price and a $100,000 NOI has a 10% capitalization rate. However, the investor will purchase that property for $1,000,000 only if he or she judges 10% to be a satisfactory rate of return.
- In short, the NOI expresses an objective measure of a property’s income stream, while the required capitalization rate is the investor’s subjective estimate of how well his or her capital must perform.
- NOI is the starting point of our discussion here. Once you know the property’s NOI, you branch off in one direction to figure its taxable income and in another to figure its cash flow.
- A positive cash flow is important to all investors and essential to some. Is CFAT, then, the end of your continuing saga of investment analysis? Not at all. Next, you’ll look at the ultimate resale of your property and at how value impacts the overall quality of your investment.
- One topic that sometimes gets less attention than it deserves from beginning real estate investors, however, is resale. That’s fine; may all your plans go without a hitch. But what if you need to sell this property next year? What if a better opportunity comes along in five years, and you want to cash out?
- Rule of Thumb: Recite this mantra whenever you consider purchasing an income property: If it’s not worth selling, then it’s not worth buying.
- The world may not be perfect, but at least it’s flat—as in “level playing field.” You can reasonably assume that if you would scrutinize a property’s income, operating expenses, financing, and various measures of return before you purchase, then tomorrow some equally astute investor will apply a similarly jaundiced eye to your numbers when you choose to sell. It pays, therefore, to run tomorrow’s numbers today and to see just what this investment will look like to a future buyer.
- Rule of Thumb: If you’re the buyer, you generally prefer to capitalize the current year’s NOI when you estimate what a property is worth. If you’re the seller, you typically prefer to capitalize your estimate of the coming year’s NOI.
- When you use a cap rate to forecast a property’s value at some point in the future, the first judgment you must make is
