Cash Flow For Both Investments And Calculate Their Present Value First Time Real Estate Investors – Their Three Biggest Misconceptions

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First Time Real Estate Investors – Their Three Biggest Misconceptions

In such markets, everyone wants to become a real estate investor. Values ​​are lower, sellers are eager to sell, and everywhere you turn, people are talking about “steals” in the real estate market.

This can mean new clients for those of us in real estate – but it also means new students. It’s our responsibility to educate new people about real estate, and one of the most important ways to do that is to address any misconceptions right from the start.

If you’re considering your first real estate investment purchase, you may be harboring some of these misconceptions yourself. I hope I can help educate you a bit so you can make a more informed real estate investment decision.

The three BIG misconceptions I run into over and over again are:

  • THE PROPERTY THEY WANT TO PURCHASE MUST GENERATE HUGE CASH FLOW TO BE CONSIDERED A GOOD BUSINESS.
  • This is a difficult one to address because it can be true depending on the investor. However, a first-time investor usually thinks this is the law without knowing exactly why they think so.

    The truth is, cash flow is mostly needed. No one likes to buy a property that will cost them money every month. BUT, that doesn’t necessarily mean the cash flow has to be fantastic right from the start.

    If you have any questions or need any advice or guidance in your endeavors, please contact me by email at nick@philadelphiainvestordeals.com or by visiting my website at http://www.philadelphiainvestordeals.com. I will be happy to help you.

    A few years ago I bought an investment property in Philadelphia for $40,000. The tenant paid only $250 a month in rent. My total monthly payment was $375, which meant I was paying $125 a month. Should I back out of this deal? Was I an idiot for buying it? The answer is no, but there is more to the story.

    The property was in need of repairs and the ARV (After Repair Value) was approximately $65,000. And the tenant was a relative of the previous owner and her rent was $400 a month at market rent for the area. So I made the necessary repairs to the property in the three months she stayed there (total repairs cost me about $4,000), and when she moved out, I rented the home for $725 a month. Now was I an idiot for buying it? Ofcourse not! In three months I built $15,000 in equity and generated $350 per month in positive cash flow.

    Taking the case a step further, would it still be a good deal if I stayed with the first tenant for a year? How about two years? Do you see where this is going?

    Another misconception:

  • THEY CAN SIMPLY RAISE THE RENTS IMMEDIATELY TO COMPENSATE THE LOW EXISTING RENTS ON THE PROPERTY THEY ARE BUYING.
  • You’d be surprised how many beginners think this is the case. When I told one of my initial investors about the aforementioned deal, he immediately asked, “Why the hell didn’t you raise the rent as soon as you settled on the property?” When I told him he had three months left on his lease, he said, “It doesn’t matter, you’re the new owner. You can raise the rent.”

    NO, you can’t. The lease follows the property. Unless the existing lease specifically states that the lease terminates immediately upon transfer of ownership (which rarely, if ever, happens), the new landlord is stuck with the lease signed by the previous owner.

    Thus, the length of the remaining lease could greatly affect a buyer’s ability to purchase the property. If the investor cannot afford to have negative cash flow for several months until the rent can be renegotiated, the property needs to be reconsidered or the deal needs to be negotiated in a different way (perhaps through settlement depending on whether the seller gets out current tenant or increases the rent before settlement.)

  • THEY “EXPECT” TO GET THEIR MONEY OUT OF THE BUSINESS ASAP.
  • When a customer asks “how long will it take to get my money back”, I know I have some learning to do. They ask, “Nick, I’m going to spend a $20,000 down payment on this duplex, how long will it take before I make that money back in rental income?”

    At first glance, it seems like a valid question, except they don’t actually spend anything! The $20,000 is really a shift of funds from a liquid asset (cash) to equity in the property they are buying. It’s still an asset on their balance sheet and hasn’t really been “spent” at all. The misconception that they have “wasted” their deposit is common.

    What they spent was their closing cost (if the seller wasn’t asked to pay for it) and I’ll calculate how long it will take them to recoup it… but it’s not as simple as taking the closing cost and dividing it by the monthly cash flow. There is also year-end equity build-up to consider.

    Here is a real life example. Mike bought a 4 unit property from me for $120,000 and put down $12,000. He had $5,000 in closing costs (the rest of his costs were paid by the seller). He lost $17,000 out of pocket. The property generated a monthly net cash flow of $300 per month. The $12,000 is still his. It has just converted cash into capital. We want to analyze $5,000 in closing costs. You could do a quick calculation like this: Closing costs divided by monthly net cash flow = # of months to recoup $5,000 in closing costs divided by $300 per month of net cash flow = 16.6 months. Not bad, it will recoup its closing costs in about 17 months, right? Wrong! What about the equity he collects at the end of the first year?

    (Hold on… here’s the math):

    In this case, the average multi-unit in the area increases at an average rate of 3.5% per year. Thus, at the end of the first year of his ownership, the property will be worth and appraised at $124,200 ($120,000 X 103.5%). So by the end of the year, one Mike has earned rental income of $3,600 ($300 x 12) PLUS accumulated additional capital of $4,200 ($124,200 minus the original cost of $120,000)…that’s $7,800 in profit! This can be converted to $650 per month in the first year ($7,800 divided by 12 months). And that cuts the time to recoup those costs from 16.6 months to 7.7 months ($5,000 closing costs divided by $650)!

    Of course there are more, but I seem to see these three more often than many others. If you are a new investor and thinking about buying your first property, I hope you found this article informative.

    I deal with many beginner real estate investors in Philadelphia and Delaware County, and believe me, as much as they are looking for the best investment properties in Philadelphia, I insist that they first learn to evaluate these properties to some extent. As a new investor, it is imperative that you grasp some basic concepts in order to make the most informed real estate investment decisions possible.

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