There is a lot of discussion today about, “What is a deal?” A deal is not the same for everybody. Some people are looking for cash flow properties and some people are looking for appreciation. There are two ways that you can make money on a deal: cash flow and/or appreciation. I would like to have a discussion about these two ways to make money.
How do I determine if this is a deal? In order to answer this, you need to factor in four things. How much is needed for the initial investment? What amount is needed to cover the down payment, the closing costs, the carrying costs and the repairs? For example, if you have invested $50,000 for those four things, what would make this a deal? It depends! It depends on how much that property can make for you in the next 12 months from the two categories that I mentioned before, appreciation and or cash flow.
Cash flow is the money made from all the income generated by the property minus the expenses. Typically cash flow is determined on an annual basis. So if the cash flow on the property is $5,000 and you invested $50,000, then you are getting a 10% return on investment. You determine the cash on cash return by taking the annual cash flow in this case $5,000 and dividing it by the initial cash investment of $50,000. $5,000/$50,000 is a 10% cash on cash return.
The next number we need to know is appreciation. Appreciation is determined by the surrounding properties and the economic trends. If the economy is strong then the supposition is that the area will continue to appreciate. If the property increased in value by $5,000 based on properties in the area and strong economic conditions, then you can assume that the property will continue to increase in value by $5,000 a year. Market appreciation is a result of supply and demand.
There are two types of growth: market appreciation, as discussed above and forced appreciation. Forced appreciation is where you do something physically to the property to increase its value. You may paint or fix up the property or add square footage or a bedroom or bathroom. Once you have improved the property, then you will be able to sell it for current market value.
Back to determining if this is a deal. Let say that the property has $5,000 in profit from cash flow, and $5000 in appreciation, this means that the property profit is a total of $10,000. To determine the Return on Investment, you take the total profit from appreciation and cash flow and divide that by the initial investment. In this case that is $10,000/$50,000 for a 20% return on investment.
Ultimately, you are the only one that can decide if the property is a good enough deal that you want to move forward on it. Make sure that you consider all the expenses and run the numbers before you purchase a property. It is too late to crunch the numbers after you have purchased the property.
Rich Dad Education Elite Trainer and Mentor