Since 1999, my career has been focused on buying and selling real estate, over 2000 houses to be exact, and I’ve learned a lot of lessons the hard way. Learning to use a capitalization rate calculator was a great tool to help me analyze properties quickly.
I was thinking about return on investment today and wanted to share my experience. Return on investment is one thing when you’re brainstorming with the capitalization rate calculator and projecting numbers on a piece of real estate. Return on investment is a completely different thing when you own a piece of real estate, you may or may not have some financing on it, you’re collecting rent, and you have to pay for things such as real estate taxes insurance and the occasional repairs that come up.
Not only do you have to be careful when projecting profits property, but you need to understand sometimes there are almost no similarities between your projected numbers and your actual numbers. When you first analyze a piece of real estate, it’s easy to get overly excited by thinking you have found a great deal. My real estate investment courses and training taught me to use reserves for replacement, vacancy and collection reserves, and also small reserve for our unexpected expenses. My experience as a real estate investor has taught me that although sometimes it takes the fun out of that initial analyzation, it’s important to include those potential drawbacks because in real life situations, they almost always come up.
I see marketing and receive emails every day talking about potential real estate investments with return on investments of 16% or even 20%, I see the same thing with capitalization rates at or near 20%. It’s important to understand that there are many different tools and formulas for calculating these numbers.
How to use a Capitalization Rate Calculator
I know when I was considering using capitalization rate and return investment on my marketing, I wanted to find what I thought was the most popular formula for a capitalization rate calculator. I wanted to find a formula that my potential clients could use to project numbers on the subject property, and also I wanted to make sure that the projected numbers were in line with the real-life numbers that my investors would experience in the future.
The answer that I came up with is that it’s not so important to find the most popular or the most common capitalization rate formula for return on investment, but what is important is to use a formula that is very conservative. In other words, the formula that includes all the potential downfalls experienced in a property, including reserves for replacement. Consideration for vacancy in collections, consideration for repairs, and if you really want to protect your future investment, a reserve for unexpected major expenses are all also a must.
The drawback to this conservative approach is that it can take the wind out of your sails when you think you found the cheap investment house of a lifetime. I’ve had countless experiences with my acquisition team when they feel they have found a terrific investment and then I sit down with the cap rate formula and include all these conservative items and it turns out to be a bad one. Well, it’s not very fun to realize that your investment went from being a home run to a strikeout, but the result is you buying real estate with accurate expectations. I can tell you that having accurate expectations is so much more important and satisfying than other factors. I have watched a lot of investors choose the wrong investment properties to purchase because they failed to include these items in their expenses and reserves. It’s much better to become a long-term investor with long-term success than to be the investor who jumped in headfirst that’s over their head and ends up losing their portfolio of real estate.