Investment Lending Metrics Explained: Discount Rate, NPV and IRR

Loans for real estate concept, a man and a women hand holding a money bag and a model home put together in the public park., Investment Lending, Real Estate Investment

Loans for real estate concept, a man and a women hand holding a money bag and  a model home put together in the public park., Investment Lending, Real Estate InvestmentFollowing up on our “Investment Lending Metrics Explained” series, we will be breaking down three commonly used terms in the real estate investment industry. Let’s get to it!

Discount Rate

While the discount rate can refer to either the interest rate charged to financial institutions for the loans they take from the Federal Reserve Bank or the rate used to discount future cash flows in discounted cash flow (DCF) analysis, our focus will be on the latter. DCF is a method used by real estate investors to help determine the value of an investment based on its future cash flows. The formula can be written as follows:

DCF = (Cash flow for the first year / (1+r)1)+(Cash flow for the second year / (1+r)2)+(Cash flow for N year / (1+r)N)+(Cash flow for final year / (1+r)

The “r” represents the discount rate, which is the rate used to discount the future cash flows from an investment to the present value to determine if an investment will be profitable. As the formula shows, discount rates are applied to future income streams. Many large brokerage companies conduct discount rate surveys for real estate investors.

NPV

Net Present Value is the value of all future cash flows over the entire life of an investment discounted to the present. It is used to calculate today’s value of a future stream of payments. The net present value analysis subtracts the discounted cash flows from your initial investment.

NPV = (Cash flow/1 + r) N – initial investment

IRR

IRR is the annual rate of growth an investment is expected to generate. IRR is calculated using the same concept as NPV, except it sets the NPV equal to zero. In other words, the IRR represents the discount rate that makes the NPV of future cash flows equal to zero.

0 = (Cash flow/1 + IRR) N – initial investment

Suppose, for example, you have $100,000 to invest in a property, and the rental is estimated to pull in $20,000 in cash flow each year for the 10 years you plan to hang on to the property. The IRR will be the interest earned over the full 10-year period, or 15.1%.

Are you ready to take the plunge of investing in real estate? RLG has the tools and resources at its disposal to get you on your way and not waste a moment of your time. Call us today to learn more and experience firsthand the dedicated, personalized customer service and undivided attention that RLG has to offer!

Fix and Flip: Estimating Rehab Costs and Profit

fix-and-flip loan

fix-and-flip loanSavvy investors focused on fix-and-flip properties know that estimating rehab costs is perhaps the most critical and challenging part of the deal. If your estimate to fix-and-flip the property is too high, you will likely lose the deal to another investor. If you underestimate, your potential profit will adversely be affected.

The better you assess rehab costs, the more successful you will be. Let us look at some key aspects to consider as you estimate rehab costs that will help ensure a strong ROI:

  • Know your buyer and neighborhood: Study the comparables – recently sold properties in the neighborhood similar to the property you are interested in – so you have a clear idea for how much you should be able to sell the house. If the property is in an upmarket neighborhood, potential buyers will want higher end rehabs. If it is in a med-low income neighborhood, you will need to spend less on the total project.
  • Spend time in the property and note problems: With an idea of how you want the property to look post flip, have a checklist in hand as you walk through the home. Take notes of all issues or problems with the home that you will want to address. If you need help, take your contractor with you. Taking photos and videos is also a great tip.
  • Begin your estimate: Sort your check list into categories (Exterior, Foundation, Interior, etc) and include other line items such as contractors. Either from experience, with the aid of a contractor, or by searching the web, assign costs to the items in each category so you come up with total costs for each category. Now you know your estimated rehab cost.

It is important to never lose sight of your after-repair value (ARV), the value of the home post fix. Your ARV will not only help you determine your rehab budget, but also how much you are willing to pay initially for the property. Most experts agree that to profit from the project, you should bid no more than 70% of the price for which you believe you can sell the property. But remember to factor in what it will cost you to fix up the property.

There is no doubt there is much money to be made in the fix-and-flip market. And lots of factors will determine whether or not you are successful. Contact the RLG team today to schedule some time to discuss how RLG’s vast experience in the sector can help guide you to success.

Buying A Turnkey Investment Property

house key in door, turnkey investment property

house key in door, turnkey investment propertyIt is called turnkey investment property because all you must do is unlock the door. A turnkey property is one that is fully renovated and ready to rent. There are generally no fixes or repairs to be made. Once your renter signs the contract, they can move in straight away. Let us take a look at some of the pros and cons of investing in turnkey property.

Pros of turnkey properties

  • The property requires no or minimal repairs and is ready to rent.
  • There should not be significant repair costs during the first years as the property has been recently renovated, translating to good cash flow prospect.
  • The turnkey concept provides the opportunity to easily and quickly invest in areas or states far from you.
  • Can help you diversify your real estate properties and weather economic ups and downs by buying properties in different markets.
  • For investors who are incredibly busy, turnkey properties can save you time. There is no months-long rehab. Your property is ready to generate income.

Cons of turnkey properties

  • It can be hard to find good deals that will maximize your cap rate. Someone has already rehabbed the property and seeks to capitalize on their investment.
  • Either you or a management company will have to manage the property.
  • Unlike flipping houses, you need to evaluate the long-term economic health of the local market since you are making a long-term investment.
  • Turnkey properties can come already rented. Check to ensure they have been properly vetted.
  • Many investors work with turnkey companies who handle many of the details. Make sure you trust them. A lot could go wrong.

Turnkey real estate investing is not for everyone. There are inherent risks, including working with a turnkey company. But there is also a lot to gain. If all turns out splendidly, you could be poised to make solid passive income without doing too much work.

If you are interested in turnkey investing, be sure to research thoroughly. And that begins by contacting the experts at RLG. We stand ready to help you grow your investment portfolio.

Purchasing A Home or Investment Property Through Financing vs. All Cash

Cash, Investment Lending, Investment Property

Cash, Investment Lending, Investment PropertyWhen purchasing a home or investment property most homebuyers provide a down payment and rely on financing for the rest. But did you know that some 20% of home purchases in the United States are made with cash? Some finance gurus even urge folks to avoid debt as much as possible. So, it may be logical to think that, if your coffers allow, paying cash for a home or putting down as much as you can is the sound approach. But there is a lot to consider before deciding to finance a home or paying cash. Let us take a look at the pros and cons of buying a home or investment property with cash versus mortgage.

CASH

Pros of buying a house or investment property with cash:

  • No interest – the cost of interest on a 30-year loan can be many thousands of dollars.
  • No closing costs – you will avoid loan origination fees, appraisal fees, and other fees.
  • More attractive to sellers – private sellers may be keener to accept cash offers over financed offers as they do not have to worry about buyers backing out due to financing issues.
  • Faster closing – by skipping the mortgage process, closings are generally much faster.
  • It’s your home – You will own the home outright, which will make it easier to sell.

Cons of buying a house or investment property with cash:

  • Loss of liquidity – Tying up a lot of money in a house can be risky. Cash tied in real estate is not easily accessed in case of financial misfortunes.
  • Loss of leverage – Most people eschew debt or work to pay it off quickly. However, being leveraged in real estate presents an upside to debt. If your mortgage is locked in and you have a low interest rate, you may make money having a mortgage due to the effects of inflation. Paying cash would give up that leverage.
  • Cheap financing – Mortgages are typically the cheapest source of financing.
  • ROI – You may miss out on other investments that could yield high return.

FINANCING

Pros of buying a house or investment property with a mortgage:

  • Affordability – Spreading payments over many years translates to manageable payments.
  • Flexibility – Tying up less of your money in the house purchase, you can put more money into a reserve account or invest it elsewhere.
  • Low rates – Mortgage rates are low compared to other types of loans.
  • Tax Benefits – You can deduct mortgage interest.

Cons of buying a house or investment property with a mortgage:

  • Interest – The total you pay back is much more than the cost of the home.
  • Process – You must qualify for a mortgage and the mortgage process can be lengthy.
  • PMI – If you put less than 20% down, you will have to pay a mortgage insurance premium, which increases your monthly payment.
  • Debt – A mortgage is the highest form of debt most folks will ever have.

This is just a broad overview of the pros and cons between using cash to buy a home or investment property versus working with a lender to secure financing. The best place to start is by running the numbers. Contact the professionals at RLG today who are ready to work with you to see what best fits your needs in home and investment property purchasing.

Credit Requirements for Investment Property Loans

There is no easy answer as to what credit score you need for a residential or commercial investment property loan as credit requirements can differ greatly among lenders and are based on numerous factors. Let us look at credit requirements for a conventional mortgage for an investment property.

You will need a credit score of at least 720 to obtain a conventional investment property loan from a private lender. However, this requirement is flexible depending on other factors, such as your debt-to-income ratio and credit history. Interest rates will run 1-3% higher than those of traditional home loans. You can expect to be required to make a down payment of at least 20% on a conventional mortgage for investment property. The loan-to-value ratio will need to be 80% or less and you may need as many as six months liquid cash reserves.

Call your mortgage professionals at RLG today and we will be happy to discuss in more detail how to set you up with an investment property loan that will fit your growth needs.

What is the 1% Rule for an Investment Property?

The 1% rule is predicated on the idea that for an investment property to generate positive cash flow, the monthly rent earned from it must be greater than or equal to 1% of the total purchase price. The end goal is to ensure that the monthly mortgage payments never exceeds the rent. For instance, assume you purchased an investment property for $250,000. Using the 1% rule, we can determine that your monthly mortgage payments should be less than $2,500 and your rental income equal to or higher than $2,500.

In addition, the 1% rule can be a helpful tool when used in reverse to calculate a maximum purchase price for a rental property. The formula is given as follows:

100 x Monthly Rent = Maximum Purchase Price

Suppose you are an investor looking to buy a condo listed at $200,000. To cover upfront repair costs, you would factor in an estimated $20,000, for a total of $220,000. If you know that comparable properties in the neighborhood rent for $2,000, you can quickly deduce it is not in your best interest to pay more than $180,000 for it. This is particularly useful as you put together an offer on the property or negotiate contingencies to include in your offer.

While this rule serves a baseline for most real estate investors, it is only one step of several in determining whether a property is a good investment or not. A high cap rate is another popular metric to gauge your returns on a rental property. Other points to consider in your decision-making process may include the local market, forecasted price appreciate, and projected rent growth, to name a few.

A property that does not quite meet the 1% rule could still be a lucrative long-term investment based on appreciation if your goal is to build equity over time. An attractive commuting distance, easy access to or ongoing expansion of transportation systems and hubs, as well as steep demographic growth all suggest a desirable area that can be worth investing in.

Do you have more questions about rental homes? Are you ready to invest in real estate and build wealth?  RLG has the tools and resources at its disposal to get you on your way. Call us today to learn more and experience firsthand the dedicated, personalized customer service and undivided attention that RLG has to offer!

What is ARV?

Assorted,Work,Tools,On,Wood, ARV, Investment Lending

Assorted,Work,Tools,On,Wood, ARV, Investment LendingThe ARV, or After Repair Value, is a figure used in the BRRR Method (Buy, Rehab, Rent, Refi) to determine the difference between the as-is price of the home and the value of the property after repairs. It is a critical number for real estate investors as loans are granted based on the loan-to-value derived from the ARV.

The after-repair value formula is:

ARV = Property’s Current Value + Value of Renovations

To calculate the property’s current value, it is important to enlist the help of a professional appraiser as they have the expertise needed to identify any issues and “quirks” that could affect the property’s value.

Once you have the property’s value pinned down, you will need to estimate the costs of renovations. Keep in mind that the costs incurred to flip the house must be less than the value of the renovation so your investment will see positive returns. Here are some factors to consider:

  1. Size of space

Remodeling a guest bathroom will almost certainly be less costly than larger areas such as the master bedroom or the kitchen. Full kitchen remodeling projects are likely to run at least $50,000. To cut back on expenses, you may want to consider a partial renovation and avoid major structural changes such as knocking down walls and rearranging the layout.

  1. Property condition

Older houses will often require more maintenance and have underlying issues. An inspection report is key in ensuring that your fixer-upper does not turn out to be a money pit.

  1. Design and Materials

When it comes to pricing, cabinetry, flooring, and windows run the gamut. Choose finished materials that fit into your budget.

  1. Contractor

Get estimates from at least three contractors to zero in on an offer that combines both quality and fair price. Asking for specifics about the scope of work, such as itemized list of repairs, is a good idea.

When determining the maximum price you should consider paying for a property, many real estate investors abide by the 70% rule. Imagine the ARV for your property is $100,000, and it needs $25,000 in repairs, then the most you should pay for it is $45,000. Lenders often times rely on the ARV to determine how much money you can borrow.

Do you have any questions about a property investment you have been eyeing? RLG has the tools and resources at its disposal to get you on your way and not waste a moment of your time. Call us today to learn more and experience firsthand the dedicated, personalized customer service and undivided attention that RLG has to offer!

Metrics Explained: Debt-to-Income Ratio

Debt to Income Ratio, Investment Lending

Debt to Income Ratio, Investment LendingDebt-to-income ratio, or DTI, is a ratio between all your monthly debt payments and your gross monthly income. In essence, it measures your ability to manage your monthly payments to pay back the money you plan to borrow. When you apply for a mortgage loan, lenders use this metric to help ascertain the risk involved with taking out a loan. If your debt-to-income ration is low, it indicates that you have more room to absorb more expenses and still manage to pay your mortgage.

In fact, a low DTI coupled with strong assets can often compensate for a lower-than-expected credit score when lenders make a determination on whether or not you qualify for a loan. The maximum debt-to-income ratio will vary by mortgage lender, loan program, and investor, but the highest ratio a borrower can have and still get a Qualified Mortgage is 43%.

You can lower your DTI by paying off your loans ahead of time, avoiding large purchases, finding a second job to boost income, and even refinancing your existing loans.

For part one of our metrics explained series on ROI, click here.

Are you enjoying our education program? Follow our YouTube channel to learn more. Ready to invest in real estate? Call us today to learn more and experience firsthand the dedicated, personalized customer service and undivided attention that RLG has to offer!

Metrics Explained: Return on Investment

ROI, Return on investment, Business and financial concept., real estate investment

ROI, Return on investment, Business and financial concept, Real estate investment

In our series “Metrics Explained”, we will dive into two concepts that are commonplace to any seasoned real estate investor. This article about ROI is part-one of a two-part series.

Return on Investment, or ROI, is one of the best-known measurements of how much money or profit is made on a given investment. It is a ratio between net profit and cost of investment that can be stated as follows:

ROI = Gain – Cost / Cost

Though it is a simple concept, there are a number of variables you must account for to render an accurate measurement. For example, when calculating gains, you should be mindful of the time your rental property stays vacant, such as transitions between tenants, as the lack of income during that period will affect the ROI. When it comes to costs, be sure to include repair and preventative maintenance expenses, property taxes and insurance costs on top of down payments and mortgage payments.

Because the ROI is a snapshot in time of profitability, appreciation of (and sometimes depreciation) the real estate value along with tax advantages of rental can have an impact on your returns. Additionally, rents will typically go up with inflation while your mortgage payments stay the same, all of which can increase your ROI.

The 203(k) FHA Loan: Adding on Your Rehab Costs to Your Loan

5 little red houses, The 203(k) FHA Loan: Adding on Your Rehab Costs to Your LoanAn 203(k) FHA Loan, sometimes called a Rehab loan or FHA Construction Loan, allows you to buy or refinance a home that needs work. With this FHA loan, you can include in your mortgage the dollar value needed to repair or upgrade the home. Your loan will then cover the purchase or refinance price and the cost of upgrades, allowing you to pay for the renovations over time as you pay down the mortgage. This is a superb financing tool that may allow you to get into an area where turn-key homes are more expensive. It is important to remember that in order for a lender to approve financing, the home must meet certain safety and livability standards. As 203(k) loans are insured by the Federal Housing Administration, lenders may be able to offer more lenient qualification requirements than other type of renovation loans.

The process for an FHA 203(k) loan is quite similar to that of regular home buying, but with a few extra steps:

  1. Apply with a 203(k) approved lender
  2. Get approval for the loan
  3. Select a contractor for your renovation project
  4. Get estimates for the project
  5. Close the loan
  6. Complete the repairs
  7. Move into your new home

Are you interested in a 203(k) loan or would you like more information? RLG has the tools and resources at its disposal to get you on your way. Call us today to experience firsthand the dedicated, personalized customer service and undivided attention that RLG has to offer!