Judging a property

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From: Michael Howser


Hello to all

Some opinions please...

In just about every book I read I find the phrase "do the numbers" (or something similar.)
Even throughout this site I constantly come across the advice that can be simply put as:
Find a property and crunch some numbers...

My questions:

HOW!!!??? Where does a beginner begin with the numbers. I've read lots of books that tell me to "do the numbers" but as of yet haven't found any that tell me HOW to do the numbers. I'm pulling my hair out here, guys.
I understand that there is no one way to compute if an IP is well priced, but I'd greatly appreciate any advice as to where to start.
Can anyone suggest a book/site that might have some pointers. Or offer some information of their own.
I can't express how much this would be appreciated.

Thanks in advance,

TwoThree
 
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Reply: 1
From: Phillip Jacovelli


Michael,

What lit the light bulb for me with regards to whether a property was a good deal for me was playing a game of cashflow - if the numbers stacked up and bought you closer to your goal - then you went for it.

rgs
 
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Reply: 2
From: Michael G


Ok,

Don't this as advice it is purely my own views.

With my first property, "crunching the numbers" was getting a gross rental yield above 7%.

I had my target area (a suburb with good transport and facilities).

My target was new, and my funds determined my price range (I had about $18k)

So having 5% for deposit and 5% for costs. Meant my funds were split 50/50.

This meant a deposit of $9k

Now I got a 95% LVR loan, so...

$9,000 divided by 5 (5%) x 100 = $180,000

This was my maximum purchase price.

The minimum rent I wanted was 7% gross of the purchase price (gross means not factoring in any expenses).

So... $180,000 divided by 100 x 7 = $12,600 in rent per year.

$12,600 divided by 52 (weeks) = $242.31 /week

So this was my number crunching for my 1st deal.

Incidently I managed to by my brand new 3br/2ba 2 story townhouse for $167,000 and rented it out for $230/wk

So cruching the numbers...

$230 x 52 = $11,960

$11,960 / $167,00 = 7.16% gross rental return

Which fit my criteria.

Looking for positive geared properties just means having a NET RETURN criteria and this means finding out ALL the costs and subtracting these from the income (rent) and seeing it your return is either +ve or -ve.

Michael G
 
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Reply: 2.1
From: Steve Navra


Hi Michael,

My most important rule when purchasing a property is to make sure I am getting it at the correct price:

I value the property by doing an assessment of 'Real' value based on rental reality.

So if for example the rental yield in an area is 5% and the property is returning $300 per week,

Then $300 X 52 = $15,600
divided by 5% = $312,000 (Real objective value)

Therefore only purchase the property up to this price.

Note: Other methods of valuation could reflect very differently depending on market sentiment at the time. The asking price could be much higher because the market is running hot, and these high prices might well be achieved - doesn't mean they are valid, probably just means the market is too expensive at this point in the cycle.
Meaning you don't buy!

The corollary of this of course is seeing rental returns drop:

The rents are NOT actually dropping, it is just that the prices have increased at a rate greater than rental reality (affordability) and thus reflect a lower percentage. Once again the actual rental reflects the true value.

Hope this helps,

Regards,

Steve
 
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Reply: 1.1
From: Asy .


Hi Michael.

Sheesh, thanks for bringing to our attention that we are taking things for granted. I understand your frustration.

I guess the big frustration is that everyone "Does the numbers" differently.

As a basis for consideration, if you are purchasing a property for tenanting, take the year's rent, and divide by the purchase price then x 100 to give percentage, you then get a %return per year.

For instance, if the property costs $200,000 and you get $200 per week in rent, then your return is:

rent x 52
----------
purchase price

200 x 52
--------
200,000

10400
------
200,000

=.052 x 100 = 5.2


Which is a return of 5.2% per year.

Now, to complicate things, you can add in variables, depending on your comfort level, such as, allow a vacancy rate of say, 2 - 4 weeks per year (adjust # weeks in equation accordingly), add a maintenance/rates allowance (reduce yearly rental by this amount) or factor in renovation or purchase costs (add to purchase price).

As I mentioned in a previous post, people buy for different results, some buy for cashflow (i.e. a high rate of return, in an area which may not grow as quickly as others) or they may buy for a high possibility of equity growth.

You need to decide what you want out of your portfolio, at the time you are looking. I say that because it pays to have a mixture of growth and cashflow... generally.

Anyway, sorry for rambling, but I hope it was understandable. And I hope it helped.. ;o)

asy

I wonder how much deeper would the ocean be without sponges.
 
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Reply: 2.1.1
From: Glenn Mott


Attached is an excel file that I use to "crunch the numbers". It shows you the before and after tax cashflows required/generated by properties given their purchase price, costs and rent received

Glenn
 
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Reply: 2.1.1.1
From: Owen .


Good spreadsheet Glenn. Another way is to buy PIA Software and you can crunch all the numbers you like. Invaluable for analysing your properties and available from your friendly forum hosts, Jan and Ian.

Well worth it too.

Owen

"Gambling promises the poor what property performs for the rich – something for nothing"
 
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Reply: 3
From: Nigel W


Michael

Maybe I'm a simple kind of guy, but I use the following quick method (albeit checked by some later calculations and research to narrow the field):

1) the price I'll pay is (weekly rent/1.9 * 1000) eg. if the property returns $135 pw, I'll be looking to pay around $71K. If you do the calcs, you'll see paying this price returns 9.88% gross rental yield (or 9.5% exactly based on 50 weeks a year rent to account for some changeover etc).

2) I then look for value add. Ie what reno can I do to the property which will bring it up substantially in capital value. Partly this will depend on the property itself and partly on what the comparative sales for similar properties have been ie there's no point spending 20K to renovate a place when similar properties, renovated, haven't been selling for much more than the result from 1.

3) in my area 9.88% gross yield makes it cashflow postive from day one (a nice little earner!). The beauty though is that when you do the reno you A) get a cap growth boost and B) the rent you can charge is increased so your yield based on your acquisition cost will in fact increase too (although you should include reno cost in your cost base)!

4) stir and repeat until wealth mix thickens...

At the end of the day, all property purchases involve subjective views on value vs price...ie the buyer thinks that the value is greater than the price and vice versa for the seller. The trick is to identify those properties where, for whatever reason, the vendor has wrongly discounted the value of the property based upon the above calculations.

ps after a while you get a feel for the right numbers to quickly sift the potential purchases from the chaff (but always do your numbers before committing to a contract!)
Cheers
N.
 
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Reply: 3.1
From: Michael Howser


Thank you ever so much to all who responded!

The info is great and I finally feel that I'm starting to understand this all now. (Have you ever had one of those moments when somewhere in the back of your head, those little gears engage as if for the first time!!!)

I feel like I'm getting closer to my dreams every day.

Thanks again!

TwoThree
 
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Reply: 3.1.1
From: The Wife


Michael,

As you can see, the answers are as variable as the the answers to the question, "What kind of property should I buy?" Pick a way that suits you best, or take a little from everyone and make it your own. Good Luck with it all, look forward to hearing about your journey!

Cheers, TW
 
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Reply: 3.1.1.1
From: Les .



G'day Michael,

And don't forget, when someone talks of a "5% return" they are talking of the return based on price paid.

When you're investing, you might well be borrowing 95% of the money, so (for example) if you are buying a $200k property, YOUR money in the deal will be something like:-

Deposit $10k
Costs $12k
M'gage $12k / year (near enough)
Rates, etc $5k

TOTAL $39k

Now, the "5% return" was on $200k - your input is nearer $39k - so the returns really are better than "Savings Bank Deposits" ...

And, when you already have "runs on the board", and can use existing Equity in other property, it looks more like THIS:-


Deposit $10k (borrowed against other property - m'gage cost $700 / year)
Costs $12k )borrowed against other property - m'gage cost $800 / year)
M'gage $12k / year (near enough)
Rates, etc $5k

TOTAL ~ $19k


How's the return now??? Nearer 50% ????

Yeah, I know, this doesn't cover everything - but, at least, when you hear "5% return", think past it - it doesn't mean what it sounds like it means !!!!

In fact, some are buying with NONE of their own money in the deal - what's the return then? Yep - it's infinite !!!

Regards,


Les


- "Eschew Obfuscation" - ;^)
 
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Reply: 3.1.1.1.1.1
From: Tibor Berenyi


Michael,

I'd be interested to see what people had to suggest. If you still have a copy of responses, and could post it that would be great. Thanks.
 
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Reply: 3.1.1.1.1.2
From: Les .



G'day Even,

The example was very simplistic, but I'm sure the numbers hold true.

e.g. If you "invested" $2 in a Lotto ticket and won $20, what was your return on investment?

It is :-

Money gained divided by money invested, multiplied by 100 and expressed as a percentage - thus, 20/2 x 100 = 1000%
Agreed?

Now, if someone GAVE you a Lotto ticket, and you won $20, what was your return on investment????

And, in my "infinite return" example, I don't include the cost/value of YOUR TIME. In ANY investment, you must spend some TIME (which has a value), so, bearing that in mind, an infinite return becomes an impossibility, doesn't it?


It's "playing with numbers", of course - but the main thrust of my message (I hope) was to look behind the "5% return" and see what it really means. Most people, on hearing of a 5% return, would probably be thinking "So what?" knowing they can get 4% with no risk in some Bank Investment account.


And thanks for your question, Even.

Regards,

Les


- "Eschew Obfuscation" - ;^)
 
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Reply: 3.1.1.1.1.2.1
From: J J


Glenn,
Thanks for showing us that spreadsheet- you've now given me the motivation to finally learn how to use Excel!
Cheers, Jacque :)
 
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