As a real estate investor, your most critical skill is your ability to evaluate investment opportunities as quickly and as effectively as possible so you only get involved with the best deals.
Real estate investors are constantly turning away bad deals because it’s better not to do any deal at all than to do a bad deal.
As a new investor especially, you want to stay far away from bad deals as you are not yet equipped with the skills, experience and resources to turn it around.
In this chapter, you will learn about how to evaluate real estate deals, what you should be looking out for when deals are presented to you, potential red flags and everything in between.
So lets jump right into it!
Building a successful real estate investment business that creates wealth for you and your family is like playing a good game of chess – you must make your next move wisely.
That’s why learning how to evaluate juicy real estate deals is the biggest strength you can gain as an investor.
When deals are presented to you, the first thing you need to check is, what type of real estate is this?
Check part one here to learn more about the different types of real estate.
The next thing you need to check is what your investment will be structured as because this has wildly different implications for your relationship with the project
Debt: You are essentially giving the contractor a loan to handle construction for a pre-agreed return. So for example, you give the contractor $3000 for a 15% return in 18 months. Within 18 months, you will get your money back plus your exactly 15% return no more no less.
Equity: This is a bit more complicated as you are “buying” a portion of the project and are in it for the long haul.
For example, you give the developer $5000 as an equity contribution to the project, the developer has projected a 40% return over the 10-year lifetime of the project.
Typically your return starts to flow back to you after a moratorium period of between 12-18 months, then you start getting a “distribution” periodically throughout the entire lifecycle of the project.
Now here is the tricky part; in financial structures, equity is subordinated to debt which means that the debt MUST be paid out first, making debt contribution less risky, however, your return is also capped while the equity contributors will typically get paid last, but their returns are not capped and usually end up making more money.
You need to evaluate your investment profile to see what might be best for you and what you have an appetite for. Click here to learn more about investment profiles.
The next step is to check who the different players in the deal are, this is the single most important part of your evaluation process, the people and entities who will be executing on the project are critically important to the success of the project. You want to check;
Their track record
Potential red flags
If they have executed a similar project in the past.
After this, you want to check the location and compare it to the details of the project as presented, which is typically called the business plan, ask yourself;
Does this project make sense for this location?
Is the location saturated with similar projects?
Is there an opportunity here that no one else can see?
What are the government’s plans for this neighbourhood?
Once you have all the above information, you can now begin to have a look at the numbers.
How much are you investing
How long is your money going to be locked up in the project?
What is the return on your investment and how does it compare to market averages i.e treasury bills, bank rates etc
We typically don’t encourage investors to compare stock market returns to real estate returns because it’s like comparing apples and oranges, these are 2 different investment vehicles that act very differently.
We’re going to take a quick look at 5 of the top factors you should consider before investing in any real estate deal – commercial, industrial or residential.
Five things that make a good investment. If you find a property with these five things, it’s probably a good deal.
Cash flow is a good reason to consider buying a property. This is a parameter and an indicator that can be pretty reliable. If there’s an N150,000 home that will cash flow a couple of thousand Nairas a month, you might immediately think it’s a good deal. It probably is, but consider the other four parameters as well.
Certainly, you’ve heard the common adage, “You make your money when you buy, not when you sell.”
This means that your purchase price is the main factor that determines your profit later on.
If the house is worth N150,000 in Maryland, and you buy it for N125,000, you are making N25,000 in unrealized capital gain when you sign on the dotted line.
This isn’t money you can take and put in your pocket, but it’s there in your housing value. This is called equity capture. You are capturing that equity by signing a contract. You earn an immediate N25,000.
Look at that house over the course of 30 years. For 30 years, a N150,000 house with simple appreciation could be worth nearly N400,000. So, in the 30 years, you could get N400,000 from N150,000. That’s not a bad investment.
Remember that you will not put N125,000 down when you make this purchase. You will probably put 20 per cent down. So, if the house is N125,000, you probably put N25,000 down, and that’s your out of the pocket expense.
When the investment is worth N400,000, you are highly leveraged and you earn a lot of your appreciation.
Another way to identify whether you have a good deal is to look at depreciation. Property depreciation helps you make money.
There are several other tax advantages for real estate investors, so make sure you talk to a tax attorney or a CPA to help determine whether your deal is a potentially good one.
Always look at the full picture when you’re deciding whether a deal is good or bad. It’s not just about the cash flow or the sales price.
Be sure that you choose properties that look good based on all five of these criteria, not just one or two. These are five great questions you should ask yourself before choosing the deal you want to go with.
They can also serve by letting you know what things need to negotiate with the seller before closing on a deal. Once all five criteria get five-star treatment, you should feel pretty confident that you’ve got a juicy real estate investment deal on the line!
This is part of a series on how to become a real estate investor by Cofundie, click here to read the first part
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And come back next week for the next part of the series.