There is a lot that goes into evaluating a real estate investment. If you are just starting out, it can be easy to get overwhelmed with all of the ratios and formulas involved. While they may seem daunting and at times a little overdone, the reality is that knowing these numbers is critical to success. If you do not know where all of the numbers come from, all you are doing is taking an educated guess on the profitability of a property. This can be a very expensive gamble to take. If you are wrong, it can wipe away all of the good things you have done with your business. The right numbers are important for every real estate transaction – no exceptions.
The most common mistake overzealous investors make is bending the numbers to make the deal work. Instead of using realistic estimates, they will fudge them just enough to make the deal look favorable. You can do this with pretty much all of the numbers involved in a deal to make them look good, but you will be the one that suffers in the end. Even though you may like a property and see value in it, if area rents only yield $800/mo., there is probably no amount of work you can do to get that number up to $1200. Under this scenario, you would have increased your budget to try to get a rental number that was never realistic in the first place. This is money that would have been of more use to you elsewhere.
Unfortunately, inexperienced investors are relying on past data or seller information as fact. This should not be the case. Any numbers you get from the seller, or any other source, should only be used in your preliminary evaluation of the property. Once you get closer to making an offer, you need to do your due diligence and find out the most current and accurate numbers possible. If you are forced to estimate error on the side of caution and always increase those estimates 5-10%. This may not make the property look as great, but it will give you a much more accurate depiction of the profitability of the property.
It is important that you look at the big picture when you run your numbers. Is the purchase price suppressed because of a short sale or foreclosure? Are the rental numbers below market value because the tenant has been in the property for years? Are you including all utilities: snow removal, lawn care and property management? Was this a mild or severe winter that could impact these costs? The more numbers you can plug in, the clearer you will be in evaluating whether or not this is a property you want to get involved in. Once you have run your numbers and are confident in their accuracy it is important to trust them. One of the hardest things for an investor to do is to walk away from a property that they like, but the numbers just aren’t there. There may be other factors to like about a property, but more often than not it all comes back to the numbers.
Real estate investing is a numbers game. Everything from the number of properties you make offers on to the specific numbers in every deal. The best investors are the ones that know how to evaluate these numbers and to walk away if they are not in their favor.