IT’S TRUE … every deal will always be different. But that does not mean you can’t use a series of simple measures, to help you sift the “wheat from the chaff”!
Only then, are those properties entitled to make it through to the next stage of detailed analysis.
How to Quickly Shortlist Your Properties
Basically, there are three simple tests you can apply — to filter out potential properties, not worth spending any further time on.
1. The Net Yield
This is the figure that quickly tells you what the Net Operating Income (NOI) represents as a percentage of the actual Purchase Price you may ultimately pay [where NOI = Gross income – Operating Expenses].
Naturally, the appropriate Net Yield will vary with the type, age and location of the property; as well as, the actual marketplace over time. However, with a little research (or help from your consulting team) you’ll quickly be able to establish what that figure ought be, for potential properties in your area.
2. Cash-on-Cash Return
[sam id=43 codes=’true’]You should also establish what your Annual Cashflow is as a percentage of the Equity you invest [where Annual Cashflow = NOI – interest payments].
However, when calculating your Equity contribution … an LVR of 70% requires you to provide 30% of the purchase price, PLUS acquisition costs (like stamp duty, legals, etc) — for which you should allow a further 7.5% to 8% of the purchase price.
By way of a guide … your Cash-on-Cash return ought calculate to be no less than 10% — in order to make a deal worthy of further consideration.
3. Debt Coverage Ratio
Your next test is a favourite with financiers. And you calculate it by simply dividing your NOI by the interest payment.
Generally, financiers like to see this figure is at least 1.2 times your debt servicing costs. Otherwise, you will need to provide proof of additional income; or pledge further assets as additional collateral.
Remember: You can have a positive cash flow AND still have a negative taxable income … by fully claiming your appreciation entitlements.
Armed with a viable shortlist, you are now in a position to determine which property (or properties) should undergo a more thorough financial analysis.
To further trim this shortlist, clients use my High Speed Filter — to help ensure a quick and consistent selection, going forward.
This also serves to match up your Investment Objectives with your Buying Criteria — and thereby, impartially rate each potential property for you.
Your Takeaway: The secret in all of this is to confirm you are working with real numbers.
Always ensure your NOI calculation is based on what the property actually returns. Instead of relying upon a vendor’s rosy projections of what the property might potentially generate.