When I started investing, it felt like I had no idea what I was doing. At times, the world of real estate seemed like a completely different language. Can anyone relate?
It’s natural to feel that way. Navigating the world of passive real estate investments can be like charting a course through uncharted waters. But don’t forget, history has shown us that the most significant opportunities arise during economic downturns.
That means this is a time for learning, for investigating potential investments, and for preparing ourselves for the rebound. My first investment was a debt deal that promised a 13% return. That sounded good to me. But more valuable than the return was the education it offered me. I learned about crowdfunding and strategies for investments in real estate at lower minimums. I had new investment tools to apply to other opportunities.
Just as sailors rely on their compass, the stars, and maps, we real estate investors have our own guiding tools. Today, we’re focusing on four essential metrics that act as our investment compass: Cash Flow, Internal Rate of Return (IRR), Equity Multiple, and Cap Rate. These metrics are crucial strategies for real estate investing in challenging economic times. These tools help us make informed decisions while positioning ourselves for success as the market turns around.
Table of Contents
Key Metric 1: Cash Flow
We are in the middle of an economic winter, which means many of us are experiencing a period of tight or even non-existent Cash Flow. This is all the more reason to understand the importance of Cash Flow.
Cash Flow is potential income your property can generate after all expenses. While our Cash Flow might not be net-positive right now, understanding this metric helps us identify future opportunities.
During our recent Passive Real Estate Academy meeting, one of our community members asked this crucial question: “How do I identify properties with potential for positive cash flow when the market recovers? And how do I calculate cash flow for the property?” The best way to do both is to look for properties in areas with a history of resilience and growth. Consider their potential for rent increases and expense management. To calculate potential cash flow, you would simply subtract the expenses from the rental income. Keep in mind, this formula does not include any debt on the property.
This slow-market period is an excellent time to identify such properties, as inventory is staying on the market longer.
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Key Metric 2: Internal Rate of Return
Investors are often driven by a common concern: What is the lifetime potential profitability of an investment? The Internal Rate of Return (IRR) is the metric that answers that question.
IRR gives a comprehensive view of an investment property, detailing its potential performance over time when considering all cash flows and the time-value of money. It’s especially relevant and vital now because our goal is to evaluate long-term investments that can weather economic winters and thrive in the future.
At a meeting last fall, a member of our Passive Real Estate Academy asked, “What makes a good IRR in times like these? What do I look for? And can deals still be found?” Here’s what to look for. A good IRR in these times is one that outperforms other investment options while considering the risk involved. It’s about finding those investments that promise steady growth once the market recovers. When calculating, successful investments will have an IRR over 10%, and the best investments will sit at 18-20%.
Key Metric 3: Equity Multiplier
The Equity Multiplier shows us how much money we can potentially make on our investment in total. As you can see, this is a crucial metric to understand.
It’s calculated by dividing the total distributions received from an investment by the total equity invested. For instance, if you put $100,00 down on a deal and received $200,000 back, you’ve made a nice $100,000 profit, doubling your initial investment. That means your Equity Multiple is 2.0x. The higher the Equity Multiplier, the better the investment opportunity.
How can you evaluate a good Equity Multiple during an economic winter? The answer lies in searching for passive real estate investments with a strong potential for growth and recovery. Properties in emerging markets or those with unique value-add opportunities tend to offer higher Equity Multiples once the economy rebounds.
Key Metric 4: Cap Rate
In some markets, prices seem astronomical. How can you be sure that things are being priced accurately? The Cap Rate is a metric that lets investors determine if a property is priced fairly by comparing the potential return of comparable properties on the market. It allows us to gauge the intrinsic value and return potential of a property separate from the ebbs and flows of the market.
Cap Rate is calculated by taking the net operating income (NOI) of a property and dividing it by the property’s current market value.
When the market is fluctuating, understanding the Cap Rate is more crucial than ever. At a recent gathering, a Passive Real Estate Academy member asked, “How do Cap Rates work in a declining market?” A great question! In a declining market, a property’s Cap Rate might increase. A higher Cap Rate typically indicates a higher potential return, but it may also indicate higher risks.
To account for risk, it’s essential to analyze why the Cap Rate is high. Is it due to market conditions, property location, or something else? Answering questions like these helps us compare properties in different markets and choose those that offer the best potential for stable returns as the economy recovers.
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Navigating Real Estate Investment During an Economic Downturn
We now have our guiding tools—the investor’s version of compasses, maps, and stars. The current economic climate, while challenging, is also a time rich in learning opportunities and potential for future growth. It’s time to build resilience in our real estate portfolios during economic uncertainty.
The world of passive real estate investing is vast and filled with opportunities, but it’s essential to navigate it with the right tools at your disposal. You’ll be equipping yourself with the knowledge to make informed decisions to maximize your returns in passive real estate investments.
As you explore real estate opportunities, continue to add tools to your toolbelt. Join the Passive Real Estate Academy and the many other communities and conferences available through Passive Income MD. There, you’ll join a community of like-minded individuals to network with and learn from. You’ll also receive regular updates on market trends, investment opportunities, and strategies. We look forward to supporting you as we navigate this economic winter together.
We hope to work with you in one of our communities soon. Until then, stay curious, and remember: The best investment you can make is in yourself!
Peter Kim, MD is the founder of Passive Income MD, the creator of Passive Real Estate Academy, and offers weekly education through his Monday podcast, the Passive Income MD Podcast. Join our community at Passive Income Doc Facebook Group. And let us know in the comments below about what you are planning for the new year!