Analyzing real estate investment opportunities involves many different factors. There are
calculations and equations for practically any scenario to help investors gather data. Below are
three very basic tried and true computations that the experts know and utilize often. Relatively
easy to understand, they should help you quickly assess important metrics when evaluating
future scenarios.
The 70% Rule
(ARV * .7) – Rehab = Maximum Offer
This rule allows an investor to calculate a maximum offer when evaluating distressed real estate
by considering two key variables, after repair value (ARV) and repair estimates. It is important
that the two variables being considered are as accurate as possible. If either the ARV or repair
estimate is inaccurate, potential profit can be affected significantly.
The percentage of ARV can also be adjusted depending on disposition or market conditions.
70% is the traditional threshold, but tighter markets may require a more aggressive calculation.
In addition, buying a property with the intention of renting it may warrant buying at a higher
percentage of ARV. Equity spread may not be as important as the cash flow in that scenario.
Cash on Cash Return
Net Profit or Annual Net Cash Flow/Total Cash Invested = COC Return
This formula simply calculates the return on cash invested. This calculation is typically used for
evaluating rental properties, but in can be useful for flips as well. There is no “good” number
for this metric as every deal and scenario is different. Investors will usually have a threshold in
mind when evaluating opportunities to determine whether the investment is a fit for them. An
example is provided below:
An investor buys a rental property using a hard money loan and is required to put $20,000 into
the deal at closing. Net rental income per month is $300. The investor is generating $3,600 in
net cash flow annually against a cash outlay of $20,000. The investor’s cash on cash return is
18%.
Debt Service Coverage Ratio
Monthly Rental Income/PITIA* = DSCR
* Principal, interest, taxes, insurance, and HOA (if applicable)
This metric is typically used when investors or lenders are evaluating an asset’s ability to cash
flow after debt service in a given month. A higher number indicates a better cash flowing
property for an investor and a less risky scenario for the lender. A lower number would
indicate a poorer cash flowing property for an investor and a riskier scenario for the lender. An
example is provided below:
The monthly PITIA on a property is $1200. Month rents are $1500. DSCR in this scenario is
1.25. Let’s assume taxes increase on the property and monthly PITIA is now $1300. That
lowers our DSCR number to 1.15 and reflects a poorer cash flowing investment. Let’s now
assume that taxes are reduced and month PITIA is $1100. That increases our DSCR number to
1.36 and reflect a more positively cash flowing investment.
There are many factors to consider when evaluating single-family assets as investment
opportunities. Whether the disposition strategy is to flip the property or rent it, the metrics
above can be valuable when making a final decision. The more tools and knowledge you have
in your arsenal, the better your chances of making sound decisions.
