Analyzing Real Estate Deals - the Truth About Buying Equity

So, you finally found a motivated seller. You went to see the house. They are willing to sell you the house for $30,000 less than what you think it will appraise for. Isn't that a good deal?

Maybe, maybe not. There's a lot more to real estate investing and deal analysis than just comparing what you can buy a house for and what you think it could appraise for. If you want to disagree with me, I have literally dozens of houses that I can sell you for $30,000 or more below current appraisal value that I wouldn't touch.

Now, don't get me wrong... I've bought houses with tons of equity; and just because of the equity before. But, I won't buy houses with tons of equity with certain exit strategies.

For example, I won't buy houses just because it has tons of equity if I am going to rent it long term UNLESS (and it is a BIG unless) it has positive cash flow. Makes sense right? Who wants to feed a house $100, $200, $300 or more each month? Even if it has $30,000 in equity, feeding negative cash flow houses will eat you alive.

That's why I suggest analyzing deals based more than just on equity. I strongly advise my clients and other investors to use Net Operating Income. Net Operating Income, in my opinion, is the only true way to determine what you can really afford to pay for a house as a real estate investor.

Never heard of Net Operating Income? Well, grab your favorite beverage and settle in. It is one of the best tools for analyzing deals and it is easy to calculate.

Here's a quick break down of how to calculate Net Operating Income for a property:

1. Determine what the market rent is.

2. Subtract out an allowance for vacancies.

What remains is what we call Net Rent.

3. Add up all the expenses including taxes, insurance, management, a reasonable estimate of maintenance, HOA, utilities and so on EXCEPT your mortgage payment.

4. Subtract all the expenses from Net Rent.

What remains when you subtract all your expenses except your debt or mortgage payment is what we call Net Operating Income.

The Net Operating Income will tell us just how much debt the house can really afford. If we know what interest rate we can get on a loan and the duration of the loan, then we can plug in the Net Operating Income as the payment and any good financial calculator can tell you the most you can afford to pay for the house with the Net Operating Income as the payment.

Then, when you make your offer to a seller, you can sit them down, show them what the real expenses are for the property and what you expect to get in rent and explain to them why you can pay what you can.

Forget about making offers at 70% of value without being able to justify a ridiculous price... when you make an offer based on Net Operating Income, you can very clearly show any seller why it is that you can pay only your price.

If you would like an example of how I analyze an actual deal using Net Operating Income, I'd be happy to provide you with a real live example of one I analyzed recently. Check out the analyzed deals on this website to see exactly how I do my deal analysis.

Until my next post,

James