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Underwriting an Investment Property (Video)

Posted by Michael J. Allen on February 13, 2023
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Today, we’re going to be talking about one of the most important steps in real estate investing: underwriting an investment property to determine whether or not the deal is good. This process can be a bit intimidating, especially if you’re new to real estate investing, but I’m here to make it simple and straightforward. So, grab a pen and paper and let’s get started!

Step 1: Determine the property’s Gross Rent Multiplier (GRM) The first step in underwriting a property is to determine its Gross Rent Multiplier (GRM). GRM is a quick and easy way to estimate the value of a rental property based on its monthly rental income. To calculate GRM, divide the purchase price of the property by the gross rental income.

For example, if a property costs $200,000 and rents for $18,000.00 per year, the GRM would be 200,000 / 18,000.00 = 11.1.

Step 2: Research comparable properties Once you have determined the GRM, it’s time to research comparable properties in the same area. This will help you determine if the GRM of your potential investment property is in line with the market. Look for properties that are similar in size, age, condition, and location to the property you’re considering. You can find this information on websites like Zillow or Redfin.

Step 3: Calculate the Capitalization Rate (Cap Rate) Next, you’ll need to calculate the Capitalization Rate, or Cap Rate. The Cap Rate is the rate of return you can expect to receive on your investment, based on the income generated by the property. To calculate the Cap Rate, divide the property’s Net Operating Income (NOI) by its purchase price. For example, if a property’s NOI is $18,000 and its purchase price is $200,000, the Cap Rate would be 18,000 / 200,000 = 0.09, or 9%.

Compare the Cap Rate to the market Now that you’ve calculated the Cap Rate, it’s time to compare it to the market. A good rule of thumb is to look for properties with a Cap Rate that is at least equal to or higher than the average Cap Rate for similar properties in the area. This will ensure that you’re getting a good return on your investment.

Please Note: Consider other expenses In addition to the Cap Rate, you’ll also need to consider other expenses, such as property management fees, property taxes, and insurance. These expenses will eat into your profits, so it’s important to factor them into your calculations.

Step 4: Determine your cash flow Finally, it’s time to determine your expected cash flow. To do this, subtract your monthly expenses (including mortgage payments, property management fees, property taxes, and insurance) from your monthly rental income. This will give you an estimate of how much money you can expect to make each month.

And there you have it, folks! These are the steps to underwrite an investment property and determine whether or not the deal is good. Remember, this is just one part of the process and there are many other factors to consider when investing in real estate. But by following these steps, you’ll be able to make informed decisions and potentially find some great investment opportunities.

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