The ability to decide whether or not a real estate deal is profitable is crucial to your success as a real estate investor. If your investment breaks even (or worse, loses money) then you’re not moving closer to your goal of financial freedom. There are a few different methods you can use to evaluate whether or not a deal makes sense financially.
One commonly used method is the 1% Rule. The 1% Rule helps investors determine if a rental property will produce cash flow. Basically, when you purchase a piece of real estate, it should cash flow up to 1% of the purchase price every single month.
To use round numbers, let’s say you purchased a real estate investment for $100k. Following the 1% Rule, that property would need to produce $1000 in rental income every month. This is a simple tactic used to ensure that your expenses will be covered.
Personally, my main focus is cash flow, so 1% isn’t as sturdy as I’d like. That’s why I use an incredibly conservative ROI formula. ROI is a formula used to evaluate the performance of an investment. ROI is the way you can measure how much profit a property is accumulating. Typically, ROI is calculated by dividing the net profit of investment by the amount of money invested.
But I like to take it one step further. I always subtract 40% of my annual rental income to account for vacancies, repairs, or expenses that could occur throughout the year. You might think that sounds like too large of a portion, but it gives me peace of mind. I don’t have to worry if something goes wrong at my properties. If a furnace goes out, I want to know that the money is there to replace it. Expenses are inevitable, so I like to prepared.
Regardless of what method you choose to evaluate your real estate deal, make sure your focus remains on the end goal: financial freedom.