In order to build wealth, you must first understand how money works. Most people do not. They prefer a good story and chase whatever is popular. Real estate was popular a few years ago. Now that prices have fallen to the point where you can actually make money once again, it is become very unpopular.
Real estate investing, when done the right way, is not such a fun and exciting process. It involves crunching numbers to see if a potential property makes any investment sense. When real estate was more popular, people bought houses and had to ‘feed’ that property each and every month. That makes no financial sense and should have been a red flag that there was something wrong with the market. Today, you can find properties that will give you over 20% positive cash flow on your investment.
In one of my favorite books, The Art of Contrary Thinking, Humphrey Neill says that when everybody thinks the same thing, everybody is likely to be wrong. This has long been a truth that has plagued people with investing. Psychologically, we are hardwired to be copycats and follow the trends. This is how we survived in the days before civilization. In the modern world, we have to be mindful of our heuristics; especially when to avoid using them. Those who don’t think ahead will continue to buy at the top of the market and sell at the bottom.
Now, I will get back to my point that real estate is a numbers game. Where does one start? I have a Cash Flow Analysis calculator that will get you started. You simply enter in the expected income, expenses, and loan terms. The mortgage payments are calculated for you and items that often get overlooked get factored in. One of these includes deducting a percentage of the rent to factor in vacancy time. Obviously, a property is not rented 100% of the time. Therefore, a 5% vacancy rate is included as a default value. If the average rate is higher in your area, you can change it to a higher amount.
Obviously, what you pay for an investment is crucial. If you don’t buy correctly, you will not have a good return on your investment. Using Cash Flow Analysis will determine what the investment potential is. This tool will calculate return on investment for you. If capital appreciation and tax savings are part of your strategy, our tool can factor that in also.
Building wealth involves saving and investing the right way. Warren Buffet has a strategy that involves getting a business for less than its intrinsic value. Using our Cash Flow Analysis calculator, you have one tool to apply to real estate that’s similar to what Buffet uses at Berkshire Hathaway. By entering the numbers, you will know if the property you’re interested in is undervalued or not.
There are value traps, however. You may find that a property seems to look good from a numbers standpoint. When you go physically inspect the property, it may be run down or it’s in a bad neighborhood. Therefore, this tool is by no means perfect. But, it can save you from overpaying and help sort out the financial data associated with a potential investment.