Cash Flow Guys Podcast 054 What Does A Good Deal Look Like?
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People always say they are looking for good deals….but when I ask them what a good deal to them is, they are often unable to answer. In this episode we will discuss what a good deal may or may not look like to you.
Regardless of the investment opportunity, there are usually many factors that determine if a deal is good or bad. The problem is that many investors (and their Realtors) don’t spend enough time in the discovery of identifying what a good deal means to them (or their client if they are Realtors.)
How are we paying for it? The terms of the deal (for our team) is the “maker or breaker” of the deal. We don’t believe in paying cash for properties if it can be avoided. Each and every offer we present for investment property includes an offer of terms for the seller to consider. For us to make such an offer we must first understand why a seller is selling and what they plan to use the proceeds for. (more of this to follow on future episodes)
Below are a few of the benefits that a buyer and seller can receive from structuring terms for a real estate purchase (payments for equity over time)
Buyer Benefit:
Greatly diminished closing costs for the buyer
No Appraisal Fees
No Origination Fees
No Points
No Flood Insurance Required
Seller Benefit:
Reduced Capital Gains Tax
Faster Closing
Predictable Stream of Income For The Future
Higher Sales Price
Higher Overall Return From The Sale
Hedge Against Inflation
A HUGE mistake that I see investors make often is paying based on the future performance of an asset versus its current performance. We as investors cannot reward a seller for poor performance of an asset by compensating them based on future performance.
Speaking of performance, when underwriting an investment opportunity, we must identify the reason the property is not performing as it should. If we are unable to identify that we should not be proceeding with the purchase until such time the issue is found and a solution is decided upon.
An example would be poor financial management practices, caused by a weak and ineffective property manager who did not keep good records. A solution would be to request all bank records for the property and management company to audit the situation and discover the amounts of deposits made and identify any shortcomings. Additionally, a new manager must be identified and briefed before closing in order to take over immediately after transfer of the deed. As an extra measure, the trailing 12 months or 24 months reports should be scrutinized along with the last 24 months of tax returns.
When analyzing an opportunity, the investor should consider how much cash they have in the deal, and what their cash on cash return is. Then decide what an acceptable return should be to make it worth your time. One method of determining that is to factor your time spent in the deal and assign an hourly value to that. Once you have determined the hourly rate, multiply it by the number of hours you feel you will spend working on this deal throughout the year.
Cap Rate...I dislike this term! it provides false assurance of a solid investment. Capitalization Rate is carelessly used in the industry as a baseline and sometimes a deciding factor when making a purchase decision. It is best defined as the ratio of the net operating income to the purchase price. This metric does not factor in repairs or debt service, and these two items on their own can make or break a deal.
Debt Coverage Ratio / DCR / DSCR is best defined as the ratio of cash available to service the debt (principal and Interest) of an asset. Acceptable ratios fall between 1.25 and 2.0 or higher depending on who you ask. By nature, I am conservative thus a DCR around 2.0 is my ideal metric.
When working with a real estate professional buying multi family property be sure your agent owns or has owned or controlled such assets. This is a critical qualifier to be assured they fully understand the ownership aspect of this type of investment.
More often than not inexperienced Realtors use “comps” or comparable cales as a means to price or value multi family properties. This usually leads to inaccurate and often over inflated values. The true value of a rental property is derived from the income it produces.