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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Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.