Investing By The Numbers, Part 1 ~ By Chris Anderson, Ph.D.

November 15, 2006

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In our recent Mastermind Group training session, our key topic of discussion was how to invest by the numbers.  The longer that I spend investing in real estate and also evaluating projects around the county, the more and more I am astounded at the lack of knowledge from "so called" professionals.   For most individual real estate investments, the level of analysis is not terribly difficult.. You find yourself doing the same thing over and over again.  In this article, I will try and share this simplistic view and how you can know more than 95% of the "professionals" in this market.

What You Need To Know?

For any investment, there really is 4 things you need to know and guess what, NOBODY gives them to you in a normal sales presentation.  Let's break down each one and how it is obtained:

1. Purchase Equity - This is one of the simplest to obtain but is easily abused by sales people. What you want to know is what is your purchase price, relative to the actual STREET PRICE; i.e., the price a real individual in the area would pay to own your property. How do you get it? Appraisals, talking with agents in the area, running test ads in newspapers, etc.
2. Annual Appreciation (%) - Now the witch craft begins... This requires a CRYSTAL BALL to look into the future. Because of this, appreciation is an OPINION that you should form on your own.. An "Experts" OPINION is still an opinion and you should treat it as such. To make an opinion, you had to consider things like job growth, lack of similar product, future demand, etc. Bottom line is that you would like to come up with a % number and this takes a little practice but after looking at a few areas, you can pretty easily form an opinion. PLEASE NOTE: If we "project" appreciation rates in an area, we are violating securities laws so we don't do this. We share all the information about an area and why we like it and then have to leave it up to the individual to form their own opinion. However, when we have decided to introduce a property, we have formed our own OPINION and we like what we see.
3. Annual Cashflow - Over time, you will either be making or losing money on this investment. It may turn out that small amounts of negative cashflow make sense if the annual appreciation and purchase equity are strong. The components that you have to gather for annual cashflow are
   
   • Gross Annual Income;
   • Management Expenses;
   • Taxes, Insurance, HOA;
   • Interest Expenses; and
   • Maintenance Estimates
     
Fortunately, most of the expenses can be estimated pretty closely. For gross annual income, realize that again, NOBODY can predict the future. So, you can gather market rents data that you believe are comparable, apply any safety factor that you like, and then use that for ESTIMATES.
4. Special Tax Situations - This is typically an unusual situation for individual investors but applies in areas such as the Go Zone where bonus depreciation can be used.

How Do You Use This Information

Suppose you could see EXACTLY what was going to happen into the future... Of course, we know this is unrealistic however it still does not hurt to try based on our assumptions. 

Suppose you looked into the future and you saw that in 5 years, your net gain on a property was going to be a little over $87,000 with a $21,000 dollar total investment and a little bit of your time.  If you KNEW that was GOING to happen, what would you do?  Would you purchase the property?  Would you pass on the property?  Why?  

Realize, that for a $21,000 investment, this equates to making 33.9% on your money, year after year after year.   That is not too shabby.   Let's apply the "rule of 72" here which states that you can calculate how long (approximately) it will take to double your money with a certain return %.   You take 72% / 33.9% = 2.1 Years to double your money.   Is this something that is good?

The answer of course depends on a few factors but let's put it into perspective.  Suppose you invested $100,000 at a steady 33.9% rate of return.  In 15 years, then you have now turned that $100,000 into $7.9 Million.   Got your attention yet if you KNEW this was going to happen?   Of course, if we have to take on all kinds of risks to get that return, then that may, or may not be such a good idea.  If, however, it is low risk, now you have the makings of a good investment.

My argument now is that IF YOU COULD SEE INTO THE FUTURE, and you saw this kind of performance, you would be excited.  Right?  Well, why not pretend we can look into the future and CALCULATE what the future looks like using our 4 KEY parameters above.   If we like the "future" answers, and we believe our assumptions, and we believe the risk to be low, isn't that a prudent approach?

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