Formulas for investment success (Page 1 of 2)

Formulas for investment success

In today's market, real estate investors have to carefully analyze expenses and project revenues to make sure the numbers work in their favor before making a deal. Bankrate spoke to two seasoned investors who shared their formulas for real estate investment success.

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Cash-on-cash return
Boaz Gilad, a New York-based investor and author of the new book "The Real Estate Millionaire: How to Invest in Rental Markets and Make a Fortune," uses a cash-on-cash-return formula to assess the investment potential of a particular property. Here's how it works:

Cash-on-cash return

Shortcut formula: (Cash in - cash out) / down payment = cash-on-cash return.

Explanation: (Cash the property is expected to bring in annually minus annual expenses such as mortgage payments, repairs, insurance, etc.) divided by the total amount invested (i.e., down payment plus closing costs) equals the cash-on-cash return.

Example: For a $250,000 investment, you put down $25,000. You estimate that after you pay the mortgage, taxes, insurance, the lawn guy, the plumber and the water bill, you'll clear $2,000 annually.

$2,000/$25,000 = 8 percent cash-on-cash return

Gilad's advice: Don't buy if the cash-on-cash return is below 3 percent. Strive for a return above 6 percent.

After-repair value
Doug Crowe, president of the Chicago-based Springboard Group, which teaches real estate investing, offers two formulas for prospective investors. For short-term investors who plan to buy, fix up and sell their properties right away, he uses the after-repair-value formula, or ARV.

After-repair-value formula

Formula: The purchase price should be no more than 65 percent of the after-repair value of the property.

Alternate calculation method: 75 percent of your after-repair value - repair expenses = purchase price.

Example: You see an older home on the market that is visibly rundown and in a state of disrepair. Asking price is $160,000 "as is." After you assess the damage, you estimate it will require $25,000 in new materials to get it in good shape. Homes of the same size in the neighborhood have been selling for $220,000 in "move-in, turn-key condition." You would need to buy the home for $140,000 to make it a worthwhile investment. (75 percent of $220,000 = $165,000. $165,000 minus $25,000 = $140,000.)