Hey everyone, this is Steve Rozenberg with Empire Industries Property Management Company located in Houston, Texas.
I get a lot of investors that always come and ask me, you know, they have a deal and they’re asking me, “is this a good deal?” And I don’t really know if it’s a good deal or not because I don’t know what their goals are. So, if you’re trying to get a deal and you wanna know if it’s a deal for you, I would suggest first thing you do is you figure out what your goals are. When I say goals, I mean your 20-30 year goals, and think about where you’re going with this, and how does it look as a finished product.
Now I’m gonna attempt to show you what you do when you’re analyzing a deal and how do I identify if something is or is not a good deal based on your goals. I’m gonna take a basic property. We’re gonna walk through it and I’m gonna give you my thought test on why something could or could not be a good deal.
So, let’s say for example, somebody comes to me and they have a house that is worth $150,000, and let’s say they’re gonna buy that house for $120,000. The cash flow on that property is gonna be roughly, let’s just say, for the sake of argument, $200 per month. So my first question is, when someone asks me is that a good deal, I have to ask them what are their goals. Where are you going with this, meaning do you need money to survive off of, because if you need money to survive off of, $200 a month may not be enough. If you have other goals, long term goals, which we’re gonna talk about, then maybe they are.
So the first thing you gotta think about is a lot of people hang their hat on cash flow, and they always tell themselves I want a property that makes a lot of money as cash flow. And the reality is I was one of the people that used to think that, and it was really just for my ego because I had a career; I had a job. I didn’t need the cash flow. I just wanted to be able to say that I had a cash flow in property.
So first of all, let’s say that you have a property, it’s worth $150, but maybe the motivated seller has something going on in their life that they need to sell it for $120. But the market value is $150 on the property. So right there when you buy the property, you’re gonna get equity capture.; and you’re gonna capture basically $30,000 in what’s called unrealized capital gain, meaning it doesn’t go into your pocket; it doesn’t go into your bank, but it is there because the property’s worth $150, you bought it for $120. So right here is you’re gonna get what is called equity capture. After you get the equity capture of that, let’s say you’re gonna put 20% down on the property, which is going to be $24,000. Okay so you’re gonna put $24,000 down and you are gonna finance $96,000. Now the thing to think about is you know the house is worth $150,000. Statistically if you are living on the West Coast or East Coast of the United States, property appreciates or doubles in value every seven to nine years. In the Midwest, it’s every twelve to fifteen years. Now the caveat to that is land appreciates but you depreciate the structure. So it’s not a straight line doubling of value. But let’s say that you’re a long-term investor, and you’re gonna hold this property for thirty years, okay. Let’s say that this property that you’re holding for thirty years, let’s say if you doubled it, it would be $300 and here in Houston, and then you held it for another fifteen years, it would be worth $600 in a perfect world. But we all know life is not perfect. Let’s say for the sake of argument that thirty years from now, this house is now worth $450,000. And I think we can all agree that that is a realistic number, $450,000.
So, when you bought the property for $120, it is now you put 20% down so you put $24,000 down. So the question is when you now have an asset worth $450,000, did you put 20% down? You didn’t. You really put about 4% down, because it’s 4% of the $450,000. That’s the first thing. Now you have an asset that is producing income every month. Now, once you pay back the rest of your $24,000, your return on your asset is infinite. You’re getting an infinite return because all the money you had invested, the $24,000, is back to you and now you have an infinite return.
Now let’s talk about this mortgage. The bank says, Mister Buyer, you give me an interest rate of 5% or whatever the interest rate is, and I will give you $96,000 that you’re gonna pay me over the course of thirty years. And over the course of thirty years, I don’t care if it goes up in value, goes down in value, you get to depreciate it, none of that matters to me. The only thing that matters to me is that over the course of thirty years, you pay me back $96,000 plus an interest rate of 5% and we’re square. Pretty good deal. Now something to think about: who pays down this $96,000? It’s not you, the tenant pays down the $96,000. So what happens is you get what’s called debt pay down, where someone else is paying down the debt for you. That someone else is going to be the tenant. Now you may have months and times where you’re going to have to put capital improvements in the property when you have vacancies, but that’s okay. You’re still gonna have someone paying down the debt. Now, you’re also gonna get appreciation, like I said, because every twelve to fifteen years, this is gonna double in value. That’s just the historical number. If you broke it down, you could see years in times like we had in 2007-2010, where it’s gonna dip, but historically it will double.
So now, something to think about: you have depreciation. Depending on if you are a W-wage earner or what your financial situation is, depreciation can be something that could be a big benefit for you. So, something to about: you now have cash flow, you have equity capture, you have appreciation, you have debt pay down, you have depreciation. This is all from a property that you bought for $150, no it was worth $150, you bought it for $120, you make $200 a month. Now here’s the thing: when this house is worth $450,000, do you think it’s still going to be giving you a $200 a month positive cash flow? No, because you have a fixed expense of $96,000 mortgage and you have taxes and you have insurance, now these may go up a little bit but they’re not gonna go up much. Is it safe to say that when this house is going through maybe $200 or $250,000 that this property rent is gonna go up as well? They call it the 1% rule, roughly 1%, it depends. It changes in different parts of the country. But they like to use the 1% rule. So if you use the 1% rule and you were even a little conservative, let’s just say you had the mortgage paid off, and now let’s just say the rent is $4,000 a month. Your rent is $4,000 a month, you have no mortgage, you just have taxes and insurance. So the return that you’re getting is much more than $200 a month. My point is that appreciation will always outpace cash flow. Always. But I would tell you, I would look at these 5 things: cash flow, equity capture, appreciation, debt pay down and depreciation, and for your own financial situation, you need to define what is the most important. So what I’d like to think of is I’d like to think of a three-legged stool. I would pick the three things that are the most important to me when it comes to buying property. If I had a good job and I do not care about $300 a month, except for my ego to tell people I’m making a lot of money, I would rather get a property that I’m gonna capture some equity. I’ve got a job so I would like to get the depreciation, and I would like it to have a tenant pay that down. To me, if you can find a deal that fits three of your main criteria, that may be a deal worth looking at. So what you’re doing is you’re basically identifying what you want to buy based on your goals. I don’t need to have $300 a month if I’m looking to retire down the road. I’m looking for depreciation. I’m looking for debt pay down and I want appreciation.
So again, it’s just something to think about that when you are purchasing a property that you really look at all the things that are the factors when you’re coming to buy a property. Don’t get caught up in the $200 a month, because that doesn’t mean anything when it comes to the long play, and the long play is you buy property for $120. It was okay, it was maybe a base hit, it wasn’t great. It’s worth $150 but you have to look downstream of what it would be, and what it would be would be a lot of cash flow, you have an asset that’s still producing income, and it fits your criteria. So hopefully this helps you when you’re looking to buy a property or trying to analyze a deal. This is something that I recommend you do. Put your numbers down. Make it a math computation. Buying an investment property is just math. Make sure you can analyze it based on numbers not based on emotion. This is Steve Rozenberg with Empire Industries Property Management. If you’d like to know more, you can give us a call at 888-866-6727 or go to our website at www.empireindustriesllc.com and we have a lot of video blogs and other educational topics that we can help you with. Thank you very much.