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| Another
Way to Escape - Obtaining Financial Independence: Real Estate Investing |
| Prior to my
departure from the U.S., many of my friends and acquaintances couldn’t
believe what I was doing: leaving a secure job with a good salary and great
retirement to live in the 3rd world with a “lower standard of living,”
while simultaneously investing in real estate. |
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| Had I lost
my mind? Well, I could write an entire article on how, while my cost
of living has dramatically decreased, my standard of living has in fact
increased, but I digress. The purpose of this article is to give
the reader a taste of something a little different. |
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| Obtaining
financial independence isn’t rocket science, nor will it take long, especially
if you’re thinking globally. In this article I will attempt to simplify
some of the “mysteries” surrounding the real estate investing world, more
specifically, property analysis as it relates to cash-flow. |
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| Keep in mind,
however, that I am by no means an expert. I strongly recommend that
you do your homework before investing your hard-earned money into anything;
read some books, surf the web, and analyze lots of potential properties. |
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| Seek
out good, qualified help in the form of real estate agents/brokers (finding
a good one that knows anything about investing will be your most challenging
task), mortgage brokers, property managers, insurance agents, a qualified
attorney, and other investors who have “been there and done that”.
At the end of this article, I will provide you with a few useful websites
and books to help get you started. |
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| Before
we embark on our journey to financial freedom, let’s learn a few basic
terms: |
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| Capital
gain- The increased value of a property over time (the difference between
the purchase and the sale price of the property is the capital gain). |
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| Cash-flow-
Your income after all expenses are paid. |
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| Cash on
Cash return (CCR)- The return on your investment, expressed as a percentage. |
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| Down Payment-
the money you have to take out of your pocket to make the purchase (often
20% of the purchase price + closing costs). |
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| Expenses-
Anything that takes money out of your pocket (mortgage, insurance, maintenance,
vacancies, upgrades, taxes, etc). |
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| Gross operating
income (GOI)- Total income, anything that puts money into your pocket
(typically derived from rent, washing machines, storage units, parking,
etc). |
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| Net operating
income (NOI)- Gross operating income minus total expenses. |
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| PITI-
Principle, interest, taxes & insurance (the biggest expenses). |
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| Proforma-
Proforma analysis, much like a hypothesis, is an educated guess of the
property’s performance. |
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| RE-
Real estate. |
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| Vacancy
rate- The percentage of time the property will be unoccupied. |
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| There are
basically three types of RE investors: |
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| Those looking
for capital gains (a subject for another time). |
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| Those looking
for cash-flow. |
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| Those looking
for a combination of both. For this article we’ll focus on investing
for cash-flow. |
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| The easiest
way to determine a piece of property’s worth is through the use of a few
simple formulas. |
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| Of course,
“worth
or value” are rather subjective and can be determined by a myriad of
variables, including the investor’s comfort level and experience, financial
needs, capital required, availability of loans, etc, but once again, in
this article we’re going to concentrate on cash-flow and nothing else. |
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| For this analysis
we’ll use the following hypothetical 4-plex, being offered at $175,000,
with rents of $500 per month per unit. |
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| Step One.
Determining the Gross Operating Income. |
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| To determine
GOI, add up all the income produced by the property. The major component
here is rent. |
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Example: Using
our prospective 4-plex, rents: $500 X 4 = $2,000/mo or $24,000/yr.
The property
is not generating any other income, which is a possible opportunity for
you.
[Incidentally,
in the U.S., buyers of properties of 5-units and under are supposed to
be protected by certain disclosure laws, meaning if the owner knows about
any problems, he/she should (read: SHOULD, not WILL) tell you about them]. |
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| Step Two.
Determining the Expenses. |
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| This step
is a little more complicated, and a lot more subjective. First, your
agent/broker should be able to provide you with copies of all the expenses
for the past year or so (i.e. gas, electric, water bills (if applicable),
repairs, etc). My experience is that most sellers don’t keep good
records, or don’t want to show them to you. Either way, you will
likely wind up using proforma information (created by you, not the selling
agent). The good news is that you can obtain near-perfect data on
the biggest expenses, PITI (principle, interest, taxes & insurance). |
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| Contact your
mortgage broker to get a quote that includes PITI. Maintenance costs
and vacancy rates can be obtained through one or more of the large firms
that provide free information on the subject (and the RE market in general).
You can get an average from them, you can attempt to obtain the information
from the seller, or you can guesstimate. I tend to use a combination
of all three methods. Property management costs will vary (usually between
5% and 10%) and can be determined by contacting local agencies. |
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| To recap,
our expenses include: |
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PITI, utilities
(when applicable), maintenance, vacancy, and property management.
In our above
hypothetical example, we’ll say:
PITI = $1,100/mo
Water = $100/mo
(tenants pay gas and electric)
Refuse = $50/mo
Maintenance
= 7.5% of GOI or $150/mo
Vacancy =
7.5% of GOI or $150/mo
Property management
= 10% of GOI or $200/mo
Total expenses
= $1750/mo. |
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| Step Three.
Determining the Net Operating Income, your cash-flow. |
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| Subtract the
total expenses from the gross income. GOI – Total expenses = NOI,
or cash-flow. $2,000 - $1,750 = $250/mo or $3,000/yr. |
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| Remember that
these are quick, down-and-dirty numbers. The true numbers won’t be
realized until you’ve owned the property for a year or so. |
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| Step Four.
Determining the Cash on Cash Return. |
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| Divide the
annual NOI by the Down Payment (20% of $175,000 + closing costs).
$3,000/$37,000 = 8.1% CCR, excluding any capital gains. |
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| And now you’ve
got it, easy as ABC, you mastered the basics. Given our hypothetical
scenario then, is 8% or $250 per month an adequate return for you, given
the level of risk and expected capital gain? How many of these investments
will it take to get you legal residence and a second passport? Do
you have the money for the down payment? If not, perhaps you should
be saving, or look for distressed properties or motivated sellers that
will carry back the down payment. This is just the tip of the iceberg...Now
go invest! |
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