What should your ideal first deal should look like?
How many units should it have?
What should you pay for it?
How much debt should you have?
What should the CAP rate be?
Let me show you an example of what an ideal deal looks like and how that deal can double your investment.
Your ideal first deal should look something like this:
AROUND THIRTY-TWO UNITS
You want a unit number that is large enough to produce cash flow to cover your debt and pay you each month. You want a number that can weather economic cycles to ensure that you will come out ahead when you exit. You’ll also want to pay attention to the number of units so having vacancies doesn’t tip the scales and ruin your investment.
ABOUT FOUR MILLION IN COST
This number will fluctuate of course based on geographic area and other factors. Four million puts each unit at $125,000 which means that it is in a good market, in good condition, etc. This is a guideline that I explain more in my book, “How To Create Wealth, Investing In Real Estate”.
Putting one-million dollars as a down payment so you finance three million.
This is gives you a good debt ratio as well as allows you to aim for an interest only loan. If you can’t invest this much, go in with an investor who is doing larger deals. Small deals will sink you and are always the first to be foreclosed because there is not enough margin to keep it afloat if something changes like vacancy, improvements needed, insurance, etc.
SIX PERCENT CAP RATE
Remember, this number helps evaluate a real estate investment. The CAP rate determines the net operating income (NOI) of the current market value (sales price) of the asset. So if a property is at a CAP rate of six percent it means that it is earning $240,000 per year in net operating income (income from rent). Six percent of four-million dollars is $240,000. The lower the cap rate, the worse the property makes in rent.
Now, let’s look at the magic and power of real estate and controlling an asset that produces cash flow.
On the deal above with paying one-million dollars down on a four-million-dollar property leaves a three-million-dollar debt. Keep in mind, the only out of pocket is the one-million dollars that was put down. So, what you want to double is that amount to two-million dollars.
Paying interest only on three million is $136,500 per year. We’ve already calculated the CAP rate of six percent so we are making $240,000 per year. Minus the interest, we are left with $103,500 in cash flow. That’s ten percent cash flow rate. In five years, you would have made half your one-million-dollar investment back. Now that doesn’t take into account any property management or improvements you make. Doing anything with each of those two areas, would mean you could increase rent thus increasing your cash flow.
So following this simple math, in five years if you sell the property for $4.5 million you’d have doubled your original investment of one million to two million. And this would be a non-taxable event.
Increasing your cash flow is going to increase the value of your property. The most obvious way to do this is by increasing the rent. That’s one of the things to look for in your deal is the ability to raise rent.
There’s a few ways to raise rent. You can just because. This would be a generic cost of living increase. You could raise rents due to exterior improvements to the property like landscaping or paint. Give tenants something in return for increasing the rent like washer/dryers, ceiling fans, better lighting, countertops, etc. Don’t overcomplicate it though. For every dollar you spend, you want a 25% return.
Investing in real estate is investing in a real asset that will inflate in value and will produce positive cash flow and double your investment if you do it right.
GC, Cardone Capital.