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When I first started investing, I felt like I had no idea what I was doing. At times the world of real estate seemed to be a completely different language. Can anyone understand that?
It's completely natural to feel this way. Navigating the world of passive real estate investing can be like traveling through uncharted waters. But remember: History has shown us that the greatest opportunities come during economic downturns.
This means this is a time to learn, evaluate potential investments and prepare for the recovery. My first investment was a debt deal that promised a 13% return. That sounded good to me. But more valuable than the returns was the education it offered me. I learned about crowdfunding and strategies for investing in real estate at lower minimums. I had new investment tools that I could apply to other opportunities.
Just as sailors rely on their compass, the stars and maps, we real estate investors also have our own guidance. Today we'll focus on four key metrics that serve as our investment compass: cash flow, internal rate of return (IRR), equity multiplier, and capitalization rate. These metrics are crucial strategies for real estate investing in difficult economic times. These tools help us make informed decisions while positioning ourselves for success as the market turns.
Table of contents
Key Metric 1: Cash Flow
We are in the midst of an economic winter, which means many of us are experiencing a period of tight or non-existent cash flow. This is another reason to understand the importance of cash flow.
Cash flow is the potential income your property can generate after deducting all expenses. Although our cash flow may not currently be net positive, understanding this metric will help 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 the cash flow for the property?” The The best way to achieve both is to look for properties in areas with a history of resilience and growth. Consider their potential for rent increases and cost management. To calculate potential cash flow, simply subtract expenses from rental income. Note that this formula does not take into account debts on the property.
This slow market period is an excellent time to identify such properties as inventory will remain on the market for longer.
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Key Metric 2: Internal Rate of Return
Investors are often driven by a common concern: What is the potential lifetime return on an investment? Internal rate of return (IRR) is the metric that answers this question.
The IRR provides a comprehensive overview of an investment property and describes its potential performance over time, taking into account all cash flows and the time value of money. This is particularly relevant and vital now as 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 this?” What am I looking for? And can you still find offers?” Here you can find out what you should pay attention to. A good IRR in these times is one that outperforms other investment options considering the risk involved. It's about finding those investments that promise consistent growth once the market recovers. When calculated, successful investments have an IRR of over 10%, and the best investments are around 18-20%.
Key Metric 3: Equity Multiplier
The equity multiplier shows us how much money we can potentially earn overall with our investment. As you can see, this is a crucial metric to understand.
It is calculated by dividing the total distributions from an investment by the total equity invested. For example, if you deposit $100,000 into a trade and get $200,000 back, you've made a nice $100,000 profit, doubling your original investment. This means your equity multiple is 2.0x. The higher the equity multiplier, the better the investment opportunities.
How can you value a good equity multiple during an economic winter? The answer lies in finding passive real estate investments with strong growth and recovery potential. Properties in emerging markets or those with unique value creation opportunities tend to offer higher equity multiples once the economy recovers.
Key Metric 4: Cap Rate
In some markets prices seem to be astronomical. How can you be sure the prices are correct? Cap rate is a metric that helps investors determine whether a property is fairly priced by comparing the potential return of comparable properties on the market. It allows us to estimate the intrinsic value and return potential of a property regardless of the ups and downs of the market.
The capitalization rate is calculated by dividing a property's net operating income (NOI) by the property's current market value.
When the market fluctuates, understanding the cap rate is more important than ever. At a recent meeting, a Passive Real Estate Academy member asked, “How do cap rates work in a declining market?” Great question! In a declining market, a property's capitalization rate could increase. A higher capitalization rate usually indicates a higher potential return, but can also indicate higher risks.
To consider risk, it is important to analyze why the cap rate is high. Is it due to market conditions, the location of the property or something else? Answering questions like these helps us compare properties in different markets and select those that offer the best potential for stable returns as the economy recovers.
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Navigating Real Estate Investing During an Economic Downturn
We now have our guides – the investor version of compasses, maps and stars. While the current economic climate is challenging, it is also a time full of learning opportunities and potential for future growth. It’s time to make our real estate portfolios more resilient in times of economic uncertainty.
The world of passive real estate investing is vast and full of possibilities, but it's important to navigate it with the right tools. You'll gain the knowledge you need to make informed decisions and maximize your returns on passive real estate investments.
As you explore real estate opportunities, continue to add tools to your tool belt. Join the Passive Real Estate Academy and the many other communities and conferences offered through Passive Income MD. There you will become part of a community of like-minded people with whom you can network and learn from. Additionally, you will 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, creator of the Passive Real Estate Academy, and offers weekly training through his Monday podcast, the Passive Income MD Podcast. Join our community in the Passive Income Doc Facebook group. And let us know what you're planning for the new year in the comments below!
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Create your very own Auto Publish News/Blog Site and Earn Passive Income in Just 4 Easy Steps
