063: Rules of Thumb – Friday Fundamentals

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Real estate investing is a numbers game. If you’re just getting started investing or are an experienced investor, you understand this.

From analyzing deals, crunching numbers, and estimating expenses to searching for deals, making offers and closing, everything revolves around the numbers.

We’ve talked about the importance of keeping a full pipeline of deals. If you’ve looked at 100 deals, maybe only 50 of those deals appear worth analyzing further. Out of these 50 properties, maybe only 10 are worth making an offer on. Out of the 10 offers, you might only have 1 accepted.

Rent to Value Ratio (RV Ratio) – ratio of the purchase price to the monthly rents. For example, if you purchase a property for $100,000 and the total rents are $1,000 per month, then the RV ratio is 1%

Most real estate investors consider 1% RV ratios to be a good rule of thumb. However, that number is highly dependent on your market and property type. Markets like San Francisco, Chicago, and New York will be harder to find 1% RV ratios, whereas markets that are known for cashflow – typically cities in the South Midwest, like Memphis, St. Louis, Indianapolis, & Mobile, might be much easier to find 1% RV ratios and perhaps even higher.

Gross Rent Multiplier (GRM) – is another metric very similar to the RV ratio. It’s a ratio of the purchase price to the annual gross rents. So let’s say you take the same $100k property, with $1,000/month rents for a total of $12k annual rents. $100k divided by the annual rent of $12K gives us a 8.33 GRM.

This GRM tells us how many years it would take to pay for itself with gross rents received. Keep in mind, this isn’t reality, as you will have expenses and a mortgage to deduct from the gross rents.

2% rule. When analyzing deals, it’s important to be able to estimate the expenses of a property. When estimating expenses, there is a rule of thumb called the 2% rule. This is the income to expense ratio. So let’s take our $1,000 per month rent. The rent to expense ratio of 2% will tell us that our expected expenses will be $500.

Another way of putting this is your expenses will be roughly half of the total rents.

Keep in mind that the expenses calculated in this number do not include your Principal and Interest payment.

By using these numbers, you can quickly assess whether a property is worth further analyzing with more accurate numbers. This will allow you to more efficiently analyze more deals, leading you to more offers and ultimately, more properties!

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