Simple Investment Screening

Even in the worst of markets, there are still numerous possible real estate deals that you could do. The question on most investors’ lips is, “Which properties should I look in to?”

If you want to know the answer, you have two choices.

1) You can spend hours running a complete profit and loss analysis on every property that shows up in the paper, on craigslist.com or wherever else you look for new investments, or
2) You can use a rule of thumb, a simple investment screening process that helps you weed out the 95% of possibilities that you shouldn’t waste you time looking into.

There are a few simple investment screening processes that experienced investors use. Some are based on property values (used by folks who concentrate on flipping) and some are based on property operating numbers (used by folks who concentrate on long-term investments).

A person looking to the long-term viability of a property can screen out most of the bad deals by doing a quick cash flow analysis.
Here’s the steps to take to see if a property is worth looking into:

1. Make some kind of loan assumptions (based on the purchase price, how much your down payment, and the current lending market rates)
2. Calculate the loan payments resulting from the assumptions you just made. There are several places online that can help you make the calculation. In fact, members of Middle Class Millionaires have access to a couple such calculators.
3. Approximate the net operating income (NOI) for the property. Depending on what information is given in the ad, you can figure the NOI several ways.
   1. The lister puts the NOI in the ad. That’s the easy way.
   2. The lister puts the gross income and expenses in the ad. The formula is simple: gross income minus expenses equals NOI.
   3. The lister just puts the gross income. Here, you have to estimate the expenses. For apartments, you might start with an estimate of 35% of gross income being expenses.
   4. The lister puts the number of units in the property. If you know what units of that type (1 bedroom, 2 bedroom…) are renting for in your area, you can estimate the gross income. If you don’t already know the market rents, just call around. Once you’ve got a number for the gross income, estimate the expenses & calculate the NOI.
4. Finally, calculate the cash flow. Monthly NOI minus the monthly loan payments equals the monthly cash flow.

Now, You should never expect the number you come up with to be any sort of guarantee that the property will actually kick out (or suck up) that much money per month. All this tells you is:

1. “According to estimated numbers, this property has a good chance of producing cash flow”, or
2. “There is no reasonable way this property is going to make money.”

If a property looks like it might have positive cash flow, circle the ad in the paper or write it down. Then go down your the list and screen the next classified.

Pretty soon, you have a short list of possibilities. In this way, you’ve quickly screened out the majority of the bad investments and now you can start calling owners or agents to get real numbers. You’ll save yourself hours and hours of calling and “running all the numbers” on properties that would only lead you slowly to bankruptcy.

That may seem like a lot of work. If you did it all by hand, it would be. I dislike (very much so) figuring out the cash flow by hand, and most financial calculators aren’t straightforward enough to use (at least for my tastes), so I wrote myself a little program to see whether or not a property should cash flow. Sign up for a free account here at Middle Class Millionaires if you don't already have one, and you can download this program for free.

Check out the program here: Quick Cashflow Calculator