2-Step Process to Evaluate a One to Four-Unit Real Estate Deal
Recently, a Best Ever listener (Neil) asked me the following questions: “I’m a newbie to the real estate business, and I’m thinking about buying a quadplex in my area … It would be nice if you could do a podcast about how you calculate numbers for a property you’re thinking about buying.”
Even though my current business model is to raise money from private investors to buy apartment buildings, I got my start in real estate buying single-family properties.
When I evaluated single-family deals (and the same logic applies to 2 to 4 unit properties), I would ask and answer two questions
- What’s the rent to all-in-price ratio
- Does the property meet my three deal criteria?
The rent to all-in-price ratio, commonly referred to as the 1% rule, is a quick calculation where you divide the monthly rent by the all-in price of the project. For example, for a single-family purchased for $70,000 with $30,000 in renovations and a monthly rent of $1000, the ratio is 1% ($1000 / $100,000).
I considered 1% to be the bare minimum. Every investor has their own opinion on it because the acceptable ratio depends on the area, the business plan, the overall goal, etc. But I personally consider 1% to lowest. I bought all four of the SFRs in my portfolio at a ratio between 1.4% and 1.6%.
If the monthly rent to all-in ratio is equal too or great than 1%, I moved on to the next step: does the property meet my three deal criteria.
Just like the 1% rule, everyone also has his or her own deal criteria (based on similar reasons i.e. market, business plan, goal, etc.). For me, my three criteria were:
- Is the property move-in ready? (Costing a maximum of $1000 to be move-in ready)
- Do I have at least $10,000 in equity based on the valuation of sales comps at closing?
- Does it make me at least $100 per month in rent?
To calculate the answers to these three questions, I created a simple Excel calculator. If you are interested being sent the calculator, email firstname.lastname@example.org and put “SFR calculator” in the subject line.
Knowing what I know now, after interviewing 1,000 people and evolving my business accordingly, I would have purchased deals with more equity in them. I was basically buying turnkey properties in lieu of improving the properties and putting in sweat equity. That’s what I would do now if I were buying single-family homes (but I’m not).
For the investor who wants to follow my path and purchase turnkey properties, you can use the exact same criteria as me. However, I would recommend changing the first criteria to reflect the idea of adding value through sweat equity.
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