Not only should you avoid these mistakes when you run your own numbers on a property, but you should also be on the lookout for anyone else who is making these mistakes when they try to sell you a property that is supposedly a great investment.
For anyone newer out there who doesn’t understand what I mean when I say “the numbers,” I am referring to the numbers used in calculating the projected returns on an investment property.
You’ve probably heard the term “cap rate” and “cash-on-cash return” and likely some other ones. More or less, they are all measures of the return you will get, or are getting, on your investment. “The numbers” are what are used in calculating those returns. For a more detailed breakdown of these numbers and formulas, check out Rental Property Numbers So Easy You Can Calculate Them on a Napkin.
So what are the biggest mistakes people make when running numbers on an investment property? Are you ready?
1.) Using Estimates Instead of Actual Numbers
There are actually three different ways I see people using estimations when trying to project returns on an investment property.
a.) The 50% rule
I hate this rule. I don’t know why, but I just don’t like it. Actually, I do know why. I don’t like it because it can steer new investors (and even some experienced) along a path of believing it should be used for actual evaluation rather than be used as a guideline.
However, I know a lot of people advocate this “rule”, so I’ll leave my opinions about it at that and look at it factual. The 50% rule says that, in theory, 50% of the rent you collect from a property will go towards expenses.
People use that as a guideline for whether they want a particular property or not…does it meet the 50% rule?
Here’s what you need to understand about this rule. The term “rule” is a hugely misleading term. Technically the “rule” should have been labeled “the 50% guideline.” It should absolutely only be used as a guideline when you initially glance at a potential property.
If it meets the 50% rule, great, go ahead and pursue it. But at that point, drop the “rule” from you mind and actually calculate the real expenses and don’t assume they equal 50% of the rents. If you were to pull that on a FL property for example, you could be setting yourself up for a major loss when you find out how much the actual insurance and taxes are down there. So much for that 50% safety net!
Never decide on a property solely because it meets the 50% rule. Use it only as a guideline (or if you’re like me, don’t use it at all) and then drop it.
b.) Calculating expenses
Oh MAN does this one drive me crazy. I hear it more than I could ever imagine; someone is evaluating a property to buy and they share the numbers associated with that property and they say things like “insurance is usually around $300/year”, “the taxes should be about $179/month”, “I should be able to get $1100/month in rent”, “I think it will be about $8,000 for the rehab”…